On Friday, April 21, 2023, the Texas Supreme Court signaled further interest in two cases addressing whether the proceeds from the sale of certain securities treated as inventory for federal income tax purposes are properly included in the franchise tax apportionment factor on a gross basis, rather than net. Specifically, the Texas Supreme Court reversed its prior denial of review in Citgo Petroleum Corp v. Hegar and requested briefing on the merits in that case, as well as briefing in Conagra Brands, Inc. v. Hegar. Both of these cases were wins for the Texas Comptroller at the intermediate appellate court level. Taxpayers with receipts from the sale of securities should evaluate the potential impact of a reversal by the Texas Supreme Court.
Citgo Reinstated
As discussed in our October 2022 Client Alert, the Texas Third Court of Appeals held in Citgo Petroleum Corp v. Hegar1 that receipts from the sale of non-inventory securities, which the taxpayer elected to be treated as inventory using mark-to-market accounting for federal income tax purposes under Internal Revenue Code ("IRC") Sections 475(e) and 475(f), were properly included in the company's franchise tax apportionment factor at net rather than at gross. The Texas Supreme Court denied Citgo's Petition for Review in September 2022. Citgo then filed a Motion for Rehearing, which asserted that the Court of Appeals' opinion was contrary to recent Texas Supreme Court precedent and overly deferential to the Texas Comptroller. Citgo also implored the high court to hear the case due to the importance and reach of the issue. On this point, Citgo relied heavily upon amici briefs filed by the Council on State Taxation and the Texas Taxpayers and Research Association. In a rare move, the Texas Supreme Court granted Citgo's Motion for Rehearing and withdrew its prior denial of Citgo's Petition for Review. The Court also ordered briefing on the merits. The Court did not, however, grant review of the case. Thus, the Court may ultimately decline to take up the matter following full briefing.
Conagra Avoids Denial of Review
The same day, the Texas Supreme Court also requested briefing on the merits in Conagra Brands, Inc. v. Hegar.2 Conagra also concerns the gross versus net treatment of receipts from the sale securities for franchise tax apportionment purposes, but the facts and arguments vary from those in Citgo. Conagra, one of North America's leading food companies, argues that its commodity hedges (used to protect against inventory price risk) were treated as inventory for federal tax purposes and, therefore, are entitled to inclusion in its Texas franchise tax apportionment factor on a gross basis. Conagra relies on IRC Section 1221 and federal case law treating inventory surrogates, such as commodity hedging contracts for raw food materials, similar to actual inventory.
Relying on its previously issued Citgo opinion, the Texas Third Court of Appeals disagreed, holding that Texas Tax Code Section 171.106(f)'s special grant of gross treatment for receipts from the sale of inventory securities did not apply to receipts from non-inventory securities, regardless of whether the securities were treated in a manner similar to inventory for federal income tax purposes. Conagra subsequently petitioned the Texas Supreme Court for review. Unlike the situation in Citgo, the Court had not previously ruled on Conagra's Petition for Rreview, so it could simply request briefing on the merits.
What's next?
Because many counterparties for securities transactions are located outside of Texas, the inclusion of securities transactions in the franchise tax apportionment factor at gross rather than net often reduces a taxpayer's franchise tax liability. Accordingly, if the Texas Supreme Court ultimately reverses Citgo and Conagra, this would have a positive impact on many taxpayers with receipts from the sale of securities.
Although the Texas Supreme Court's request for briefing on the merits does not mean that the Texas Supreme Court will decide these cases or that it will reverse the decisions of the Court of Appeals, it does signal interest by the Court, which is a positive development for taxpayers. If the Court decides to take the cases, the Court's reversal statistics would suggest a ruling in favor of the taxpayers. The Texas Supreme Court typically reverses the Court of Appeals in 75% of the cases it decides.
It is unlikely that the Texas Supreme Court will decide Citgo and Conagra before the statute of limitations for Texas franchise tax report year 2019 closes in the next few months. Therefore, taxpayers that would benefit from including receipts from securities transactions at gross in their franchise tax apportionment percentage should consider filing refund claims before the limitations period for refund claims closes.
Footnotes
1. Citgo Petroleum Corp. v. Hegar, 636 S.W.3d 281 (Tex. App.—Austin 2021, pet. pending).
2. Conagra Brands, Inc. v. Hegar, No. 03-21-00111-CV, 2022 Tex. App. LEXIS 6229 (Tex. App.—Austin 2021, pet. pending).
Originally published 25 April 2023.
This article is presented for informational purposes only and is not intended to constitute legal advice.
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