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Click here for the full text of this decision FACTS:Anderson-Clayton Bros. Funeral Home provides prepaid funeral services. Individuals can prearrange their own, or a beneficiary’s, funeral by purchasing a fixed-price contract. Anderson-Clayton, like other funeral service providers, deposits the money from these contracts into interest-bearing accounts in savings and loans or banks, or in the trust department of a Texas bank. When the money is placed in a trust, the trustee is to prepare an investment plan and place the funds in certain types of investments. Many of these investments will be made out-of-state. When it filed its Texas tax returns for 1993 through 1996, Anderson-Clayton determined that the out-of-state corporations the Texas trusts dealt with, not the trusts themselves, were the relevant payors, and the earnings out-of-state earnings. It came to this conclusion because, under federal tax law, investment earnings from Anderson-Clayton’s prepaid funeral benefits trusts were properly reportable as income of Anderson-Clayton, as opposed to the trust into which the earnings were paid. That is, the trusts were simply disregarded and the investment earnings treated as if they flowed directly from the out-of-state investment vehicles to Anderson-Clayton. In 1997, the Texas comptroller audited Anderson-Clayton for compliance with the state franchise tax: the tax levied by the state on companies for the privilege of doing business in the state. The tax is based on a company’s gross receipts; the higher the gross receipts, the larger the percentage of its taxable earned surplus is subject to the franchise tax. Only earnings in Texas are counted, so to determine the geographic origin of the earnings, Texas courts apply the “location of the payor” rule: “the domicile of the debtor or payor in the case of interest and the declaring corporation in the case of dividends is regarded as the location of the business receipt without regard to the domicile of the payee.” The comptroller determined that the investment earnings from the trust accounts should have been treated as Texas receipts, resulting in underpaid franchise tax for 1993 through 1996. Anderson-Clayton exhausted its state remedies, paid the tax under protest, and then filed suit to recover the more than $515,000 in franchise taxes, interest and penalties. The trial court granted the comptroller’s motion for summary judgment and denied Anderson-Clayton’s. HOLDING:Affirmed. The court addresses the proper interpretation of Tax Code 171.1121(b), part of the gross receipts for taxable earned surplus provision, which states, “Except as otherwise provided by this section, a corporation shall use the same accounting methods to apportion taxable earned surplus as used in computing reportable federal taxable income.” Anderson-Clayton says that the subsection requires it to use the same “accounting method” to “apportion” taxable earned surplus as it uses in computing its federal taxable income. Since it disregards the trusts in computing its federal tax obligation, it should also ignore the trusts’ income in its state return. It should include the investment earnings from the trusts as direct payments from the out-of-state investment vehicles, and not include the funds as earnings in gross receipts from business done in this state. On the other hand, the comptroller argues that subsection (b) is only intended to address the sourcing of receipts under other provisions of the code, but only when gross receipts and related earned surplus income are recognized. That is, the subsection merely requires taxpayers to use the same method of accounting — cash or accrual — to determine when to recognize earned surplus for franchise tax purposes. The source of the funds, the comptroller continues, should be determined by Texas tax and trust laws. The court then discusses the different types of accounting methods: the cash method, where income is realized only upon actual receipt of cash, and the accrual method, whereby income is realized when all of the events that fix the right to receive income have occurred. These methods relate primarily to the timing of revenue and income recognition, not to sourcing, as Anderson-Clayton argues. Nor does the term “apportion” refer to sourcing, the court adds. Though 171.1121(b) does not define the term, the court says it merely requires corporations to apply the same accounting method when calculating both reportable federal taxable income and the “gross receipts” it uses in the apportionment factor of Tax Code 171.106. Under that section, taxable earned surplus is to be “apportioned” to Texas by multiplying it by a fraction, the numerator of which is the corporation’s “gross receipts from business done in this state,” as determined under Tax Code 171.1032 and the denominator of which is the corporation’s “gross receipts from its entire business,” as determined under Tax Code 171.1051. “If a corporation used inconsistent accounting methods to calculate”reportable federal taxable income’ (the foundation of taxable earned surplus) and the”revenues reportable by a corporation on its federal income tax return’ (used in calculating”gross receipts’ for apportionment), it could conceivably recognize revenues and income for the current tax year in calculating one of these figures, yet recognize the same revenue and income in a different tax year when calculating the other figure.” Because 171.1121(b) is silent on the source of receipts, the court holds that it must look to other law to determine whether the income derived from the trusts should be considered a Texas receipt. Under longstanding Texas law, trusts are considered separate entities, even where they may not be subject to federal income tax or the franchise tax. Because it is ultimately these separate and distinct entities that pay income to the funeral homes earned from their investments, the court conclude that the comptroller’s determination that the trusts are the payors is reasonable. The court thus applies the location-of-payor rule, ruling that the investment income derived from the trusts are Texas receipts. “We also observe that sourcing the receipts to the Texas trusts is consistent with the broader policies underlying tax apportionment. By establishing a Texas trust to hold and invest revenues from its sale of prepaid funeral benefit plans, Anderson-Clayton availed itself of the benefits and protections of Texas law. It is not unreasonable for the Comptroller to attempt to apportion franchise taxes commensurate with these privileges and benefits.” OPINION:Pemberton, J.; before Kidd, Puryear and Pemberton, JJ. Puryear, J., dissents.

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