The Geo Group, Inc. v. Hegar, No. 07-22-00005-CV (Tex. App.-Amarillo Jan. 23, 2023, no pet. hist.)—The Seventh Court of Appeals held that a company that owns and operates correctional and detention facilities under contracts with the state of Texas and the United States was not entitled to a sales tax refund due to the company’s purchases being exempt, affirming the trial court’s decision to that effect.
The company had argued that the detention and rehabilitation services that it provided are a quintessential governmental function, making the company an “instrumentality” of the state and federal governments and thereby rendering the company’s purchases exempt from sales or use tax under 34 Tex. Admin. Code 3.322(c) (Exempt Organizations).
The court of appeals noted that “instrumentality” isn’t defined in the Texas Administrative Code and the Black’s Law Dictionary defines “instrumentality” as: “1. A thing used to achieve an end or purpose. 2. A means or agency through which a function of another entity is accomplished, such as a branch of a governing body.” Finding the first definition to be too broad to serve any purpose (virtually any independent contractor employed by the government could be an instrumentality under this definition), the court of appeals determined that the second definition of “instrumentality”— relating the term to “a branch of a governing body”—was more in harmony with the exemption in question.
The court of appeals found that while the company housed federal detainees and was required to comply with specific government regulations, the company was a distinct entity engaged in commercial for-profit activities, wasn’t controlled by the federal or state or federal government and didn’t contract exclusively with the federal or state government. For all of these reasons, the court of appeals held that the company wasn’t an instrumentality of the federal or state government that was exempt from sales or use tax.
The United States Virgin Islands (“USVI”) is an unincorporated territory of the United States. But that doesn’t mean that they’re subject to exactly the same laws as in the United States—especially when it comes to taxes.
The Mirror Code
As a territory, the U.S. Congress is empowered to “make all needful Rules and Regulations respecting” the USVI. As far as taxes go, Congress requires that the USVI impose an income tax that “mirrors” the U.S. federal income tax found in United States Code, Title 26 (also known as the “Internal Revenue Code” or “IRC”). Because of this requirement, USVI’s income tax law is commonly called a “mirror code.” One of the basic principles used in the application of the “mirror code” is the substitution principle, according to which “Virgin Islands” generally is substituted for “United States” wherever that phrase appears in the IRC.
Under the IRC, the United States taxes citizens and residents on their worldwide income and nonresident aliens on income from sources within the United States or that is effectively connected with the conduct of a United States trade or business. For these purposes, the United States includes only the States and the District of Columbia.
The USVI applies similar rules to its residents and nonresident aliens under the mirror code.
Non-Bona Fide Residents
A U.S. citizen or resident who isn’t a bona fide resident of the USVI during the entire taxable year and who has income derived from USVI sources or effectively connected with a trade or business within the USVI is required to file income tax returns in the taxable years with both the United States and the USVI. The income taxes that such a person is required to pay to the USVI is determined by multiplying the income taxes imposed under the IRC by the “applicable percentage,” which means the percentage that USVI adjusted gross income bears to adjusted gross income. USVI gross income is adjusted gross income determined by only taking into account income from USVI sources and deductions allocable to that income.
Bona Fide Residents
Welcome back to another for another edition of Texas Tax Roundup! We got some franchise tax apportionment, some sales and use tax in the oil and gas industry, and some mulling over the age-old question: Is a franchise tax an occupation tax? Let’s dive in!
Distinction from Occupation Tax
Swift Transp. Co. of Az., LLC v. Hegar, No. 13-21-00010-CV (Tex. App.—Corpus Christi-Edinburg Nov. 10, 2022)—The Thirteenth Court of Appeals held that the franchise tax wasn’t an occupation tax. Thus, Tex. Transp. Code § 20.001 (Certain Carries Exempt from Gross Receipts Tax), which exempts certain motor carriers from any occupation tax measured by gross receipts, didn’t apply to franchise tax. The court of appeals observed that Texas franchise taxes and occupations tax dated back to at least 1880, that both types of taxes were in existence when Section 20.001 was enacted, and that various statutes implied a distinction between these types of taxes. The court of appeals also distinguished as dicta (and thus nonbinding) insinuations in the case law that the franchise tax was an occupation tax or that that a franchise tax and an occupation was basically the same.
Are you U.S. citizen or resident? Have you ever just wanted to leave the whole U.S. federal tax system behind? Well, you can . . . try at least. But there’s a cost.
U.S. citizens and residents are subject to federal income tax on their worldwide income. They’re subject to federal estate tax based on all assets wherever located upon death. And, they’re subject to gift tax on the transfer of all property, whether it be real or personal, tangible or intangible.
Noncitizens-nonresidents, on the other hand, are subject to federal income tax only on certain U.S. source income and income that’s effectively connected with the conduct of a U.S. trade or business. They’re subject to federal estate tax only with regards to assets situated within the United States upon death. And, they’re generally subject to gift tax only when the gift is real estate or tangible personal property located in the United States at the time of the gift.
Transfer pricing has to do with the allocation of income among parties controlled by the same persons (controlled parties) that engage in transactions with each other (controlled transactions). In the international context where controlled parties may operate in different countries with different tax burdens, the concern is that the controlled parties may shift income from a higher-taxed country from a lower-taxed country. Here’s a simple example:
Here ProdCo and WidgCo are controlled parties because they are both 100% owned by Owner. And they’re engaged in a controlled transaction, because ProdCo is purchasing Widgets from WidgCo, which ProdCo then incorporates into Product which it sells to consumers for $100 a pop. ProdCo is based out of Country A, which has a 20% income tax rate, while WidgCo is based out Country B with a 10% income tax rate.
Sales and Use Tax
Hegar v. Tex. Westmoreland Coal Co., Case 21-1007 (Tex. Sept. 30, 2022)—In this case, the Texas Supreme Court denied the Comptroller’s petition for review, leaving the decision of the Third Court of Appeals in favor of the taxpayer in place. The Court of Appeals had held that equipment used to break apart lignite coal from a coal formation qualified for the manufacturing exemption from sales and use tax. The Court of Appeals disregarded the Comptroller’s argument that the manufacturing exemption didn’t apply because the equipment was used on real property to create tangible personal property, holding that there was no basis in the statute for any requirement that an input to the manufacturing process had to be tangible personal property.
Citgo Petroleum Corporation v. Hegar, 21-0997 (Tex. Sept. 30, 2022)—The Texas Supreme Court denied the taxpayer’s petition for review in this case, so the decision of the Third Court of Appeals in favor of the Comptroller remains the law of the land. The Court of Appeals had held that only the net proceeds of sales of commodity futures contracts and options on commodity futures contracts could be included in the calculation of the taxpayer’s apportionment factor for purpose of calculating Texas franchise tax.
One of the more confusing areas of international tax law is determining when withholding is required. Getting it wrong can have dire consequences.
Currently, U.S. international withholding provisions can be found in Chapters 3 and 4 of the Internal Revenue Code. Chapter 3 contains the withholding provisions that are intended to approximate a foreign person’s U.S. federal income tax liability. Chapter 4, on the other hand, deals with withholding provisions put in place by the Foreign Accounts Tax Compliance Act of 2010 and is primarily aimed at obtaining information regarding account holders of foreign financial institutions and owners of certain foreign entities.
In this post, we’ll focus on Chapter 3 withholding, setting aside Chapter 4 for another time.
But first . . .
Why International Tax Withholding?
Conagra Brands, Inc. v. Hegar, No. 03-21-00111-CV (Tex. App.—Austin Aug 24, 2022, no pet. h.)—The Third Court of Appeals held that a taxpayer could not include gross receipts from certain securities in its apportionment-factor denominator for purposes of calculating its Texas franchise tax.
- The taxpayer in question was in the business of producing food products for sale to grocery stores, convenience stores and food service businesses. In order to mitigate the risks associated with potential fluctuations in the price of necessary components and raw materials, the taxpayer bought and sold commodity futures contracts.
- The taxpayer argued that these securities were inventory for federal tax purposes and that the gross proceeds from the sale of these securities should be included in its apportionment factor denominator. On appeal, however, the taxpayer didn’t dispute the trial court’s finding that the securities weren’t inventory as defined in the Internal Revenue Code. Instead, the taxpayer argued that the securities were in substance inventory under the U.S. Supreme Court’s decision in Corn Products Refining Co. v. Comm’r, 350 U.S. 46 (1955).
Texas Legislature Adds Suits After Redetermination As Option To Challenge State Tax Assessments
In 2021, the Texas Legislature made it easier for taxpayers to challenge tax assessments without first paying the disputed amounts of tax due.
Prior to this change, pay-to-play was the only game in town. Under pay-to-play, a taxpayer first has to pay the total amount of tax, penalties, and interest assessed before challenging that assessment in court.
This obviously created problems for taxpayers who can’t afford to pay, which could violate the Open Courts Provision in the Texas Constitution. The Open Courts Provision provides that “[a]ll courts shall be open, and every person for an injury done him, in his lands, goods, person or reputation, shall have remedy by due course of law.” The Texas Supreme Court has indicated that under certain circumstances a statute that requires prepayment of a tax assessment for judicial review may violate this provision.
Bailey v. Drexel Furniture Co., 259 U.S. 20 (1922) (a/k/a “Child Labor Tax Case”)
Summary: In the Child Tax Labor Case, the U.S. Supreme Court ruled that a purported “tax” was really a “penalty” and therefore an unconstitutional exercise of Congress’s power to tax. While the breadth of the decision has been limited in light of subsequent interpretations of Congress’s power to regulate interstate commerce, it remains relevant when Congress passes a “tax” that’s unsupported by any other enumerated power.
Background: Among the powers that the U.S. Constitution grants to Congress are “Power To lay and collect Taxes, Duties, Imposts and Excises” (the “Taxing Power”) and “to regulate commerce . . . among the several states” (the “Interstate Commerce Clause”). The Tenth Amendment to the Constitution clarifies that “[t]he powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.”