Trial Court Holds Texas Franchise Tax Is Preempted By Federal Statute

Key takeaways

• Travis County District Court concluded that the Texas franchise tax, as applied to American Airlines, Inc. ("American"), was preempted by the federal Anti-Head Tax Act ("AHTA").¹
• The court rejected the Comptroller's arguments that the Texas franchise tax was not a gross receipts tax and that it did not apply to gross receipts from air commerce or air transportation.
• The Texas franchise tax is susceptible to further federal preemption challenges.

Authors: Rich Moore

Background

American is an airline carrier based in Fort Worth, Texas, that operates a fleet of approximately 1,000 aircraft and transports people and baggage to destinations in North America, the Caribbean, Latin America, Europe, and the Asia-Pacific Region. This lawsuit concerned American's Texas franchise tax for report year 2015, which covered fiscal year 2014.

The Texas franchise tax is based on the taxable margin of certain entities that do business in Texas. An entity's taxable margin is equal to either 70% of the entity's total revenue, or the entity's total revenue less a deduction for one of the following: (i) $1 million; (ii) cost of goods sold; or (iii) compensation. The resulting taxable margin is then apportioned to Texas using a gross receipts factor. The franchise tax is then calculated by multiplying the apportioned taxable margin by the applicable franchise tax rate.

In calculating its taxable margin for report year 2015, American did not subtract revenues from passenger ticket sales, baggage fees, and freight transportation, because it opted to calculate its taxable margin by multiplying its total revenue by 70%.

American contended that its revenue from baggage fees, passenger fees, and freight transportation ("transportation revenue") was not subject to the Texas franchise tax because the authority of Texas to tax the transportation revenue was preempted by the AHTA, which bars states from levying any tax on gross receipts from air commerce or air transportation. Transporting people, baggage, and freight by air constitutes air commerce and air transportation under the AHTA.

For report years 2009–2014, the Comptroller agreed with American's position and did not include American's transportation revenue in its franchise tax base. However, the Comptroller later changed course and sought an opinion from the United States Department of Transportation (the "DOT")—the federal agency responsible for administering the AHTA—that the AHTA did not preempt the Texas franchise tax as applied to revenues received from air commerce or transportation. The DOT disagreed with the Comptroller's position and affirmed that the AHTA preempted such a tax.

Before American filed its 2015 franchise tax report, Comptroller staff encouraged American to pay its franchise tax under protest for report year 2015 and file suit to expedite resolution of its franchise tax dispute for that year. In May 2015, American filed its franchise tax return under protest and paid the amount due under protest. American then timely filed suit to challenge the Comptroller's authority to impose franchise tax on American's transportation receipts, as well as to obtain a refund of the amount of franchise tax it overpaid for report year 2015.

The Comptroller later refunded to American $107,577.04 and subsequently issued a jeopardy determination, demanding payment of $107,577.04. On January 12, 2016, American paid under protest the amount indicated on the determination. It timely filed another suit to obtain a final confirmation that the Comptroller was prohibited by the AHTA from imposing franchise tax on American's gross receipts from air commerce or transportation, as well as to obtain a refund of the amount of franchise tax it overpaid for report year 2015.

The Comptroller timely filed a counterclaim in the litigation raising, among other things, computational arguments, as well as claiming that American should pay the franchise tax on its transportation receipts.

Decision

The court issued its findings of fact and conclusions of law, which concluded that American was a transportation company within the meaning of Comptroller Rule 3.591(e)(32) as in effect for report year 2015. The court also concluded that the Texas franchise tax was a gross-receipts tax as applied to American's transportation receipts.

The court agreed with American that the AHTA preempted Texas's franchise tax as applied to American's transportation receipts because it was an impermissible tax on "gross receipts" from "air commerce or air transportation." The court cited several cases from other jurisdictions that reached the same conclusion, including the U.S. Supreme Court's decision in Aloha Airlines, Inc. v. Director of Taxation of Hawaii, 464 U.S. 7 (1983).

The court held that, pursuant to the AHTA, American properly excluded its transportation receipts, from its total revenue when re-calculating its franchise tax liability for report year 2015 and ordered the Comptroller to issue a refund to American. The court also dismissed the Comptroller's counterclaim. It is not yet certain whether the Comptroller will appeal this decision.

Implications

The court's decision is a significant victory for American and other air carriers that do business in Texas. It confirms that the AHTA preempts the Texas franchise tax as applied to revenues derived from air commerce or air transportation, and that the Comptroller cannot change its position on this issue without a valid legal basis. Other businesses operating in Texas should evaluate whether federal statutes other than AHTA could preempt the imposition of the franchise tax on their gross receipts.

Footnote

1. 49 U.S.C. § 40116.