Texas Franchise Tax – Net Losses and Gross Receipts

Summary

In Hallmark Marketing Co. LLC v. Combs, Tex. App. Ct., No 13-14-00093-CV (11/13/14), the Texas Court of Appeals stated that a net loss from investment and capital asset sales could be used to reduce the taxpayer’s total gross receipts calculation, but also have a secondary effect of increasing its Texas apportionment calculation. The Court effectively resolved a conflict between a statute that only allowed a net gain of investment and capital asset sales to be included in the total gross receipts calculation, and an administrative rule that provided that a net loss could be used to net against the taxpayer’s other total gross receipts calculation.

Discussion

Hallmark generated a net loss from the sale of investment and capital assets in its 2008 franchise tax year.  The loss resulted in a negative amount which would produce no reportable net gain.  Hallmark argued that zero receipts should have been reported on its calculation of everywhere receipts. The Comptroller argued its administrative rule requires that “if the net gains and losses results in a net loss, the taxable entity should net the loss against other (gross) receipts.” This had the effect of reducing Hallmark’s sales factor denominator and increasing its Texas apportionment factor.

Under Hallmark’s approach netting lines 8 and 9 on the 2007 consolidated federal income tax return of Hallmark and its subsidiaries resulted in a net loss. However, the company reasoned that it had no net gain from sales of investment and capital assets in 2007. Therefore, it filed its combined Texas franchise tax report for the 2008 report year by applying a zero amount from those sales to the rest of its gross receipts for apportionment purposes.

The Comptroller took the position that Hallmark was required to subtract the full net loss generated on its investment and capital asset sales in 2007 against the combined group’s other gross receipts for that year. This reduced the denominator in the apportionment formula and increased the company’s apportionment factors, which ultimately lead to a higher liability for Hallmark. The Court upheld the Comptroller’s method.

How Does This Affect My Business?

The difference between using Hallmark’s method verses the Comptroller’s method only changed the apportionment percentage by approximately 1 percent. However, this difference resulted in approximately $212,000 in additional franchise tax liability for Hallmark. Taxpayers should pay close attention to this new development because a small difference here can make a major difference in a company’s ultimate Texas franchise tax liability. 

For more information on this case and how it may apply to your business, please contact us.