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Click here for the full text of this decision FACTS:Home Interiors of Texas employs approximately 350 employees in Texas. It has no manufacturing, warehousing or administrative facilities in any other state. HIT does, however, use independent contractors to display HIT products. These displayers host promotional parties where they provide HIT samples and demonstrations. Customers order products from the displayers, and the displayers also recruit other salespeople. HIT does not pay a salary to the displayers, provide any kind of benefits or deal directly with the customers. Instead, HIT pays a commission to the displayers based on sales by newly recruited salespeople. Between 1994 and 1999, HIT timely paid its Texas franchise taxes. Until January 1992, the franchise tax was assessed solely on a corporation’s taxable capital. Taxable capital referred to a company’s capital and its surplus. After 1992, the tax was broadened to add an alternative assessment for noncapital-intensive businesses. The new assessment was called the “net taxable earned surplus,” which was comprised of reportable taxable income, plus certain other sums and minus certain others. The net capital earned surplus is calculated by “adding the tax on net taxable capital to the difference between the tax on net taxable earned surplus and the tax on net taxable capital.” The practical effect is that a corporation’s liability is the greater of a 4.5 percent tax on net taxable earned surplus or a .25 percent tax on net taxable capital. Either tax is apportioned to the state by dividing the corporation’s gross receipts generated in Texas by the corporation’s total worldwide gross receipts. Additionally, a corporation’s gross receipts from each sale of tangible personal property shipped from Texas to a buyer in another state is “thrown back” to Texas and added to the gross receipts from business done in Texas. Gross receipts used to apportion net taxable capital are only thrown back if the corporation is not subject to taxation in the buyer’s state. HIT sought a refund of the taxes it paid from 1994 to 1999, contending that the statutory method for apportioning the earned surplus component of the franchise tax is unconstitutional as applied to the company. The comptroller passed on HIT’s refund request, finding that she did not have authority to rule on the statute’s constitutionality. The trial court next heard the case and ruled in the comptroller’s favor, finding the statute constitutionally sound. On appeal, HIT claims that the inclusion of the throw back receipts is significant because, during the relevant time period, approximately 90 percent of its revenues were generated from sales outside of Texas. Accordingly, HIT contends that the application of the earned surplus throwback provision results in an unfairly apportioned franchise tax assessment. Specifically, HIT argues that the application of the earned surplus throwback provision causes the franchise tax to unconstitutionally burden interstate commerce because it results in an assessment that: 1. is unfairly apportioned; 2. discriminates against interstate commerce; and 3. unfairly relates to services provided by Texas. HOLDING:Reversed and rendered. The court explains that the purpose of the earned surplus throwback provision was to capture and tax income generated from the sales in other states that would otherwise go untaxed because of Public Law 86-272. That law, passed in 1959, to create minimum standards for business activity required within a state before that state may impose state income tax on an out-of-state corporation. Specifically, the statute prohibits a state from imposing a net income tax if the foreign taxpayer’s only business activity in the state is the solicitation of orders. The court also confirms that all parties agree that Public Law 86-272 protects HIT from being taxed on income generated from sales of its products to displayers in most states. Consequently, the gross receipts from sales to displayers in those states were thrown back to Texas and added to HIT’s receipts from business done in Texas. The court then begins its analysis by reviewing cases interpreting the commerce clause, concluding that the test from Complete Auto Transit Inc. v. Brady, 430 U.S. 274 (1977), still informs the court’s analysis. The court says there is no dispute over the first part of the Complete Auto test, whether the corporation’s activities have a substantial nexus with the state justifying the application of the franchise tax. As to the second prong, whether the tax result in an unfair apportionment, the court says that in order to determine whether a tax is fairly apportioned, it first has to determine whether the tax is “internally consistent.” If it is internally consistent, then the court has to decide whether it is also externally consistent. Under the internal consistency test, the court says it is required to imagine a hypothetical scenario that assumes that every state imposes a tax identical to the one at issue. The court gleans three principles about internal consistency from the several cases it reviews: “First, a tax may be internally inconsistent even if a corporation doing intrastate business pays more than a corporation doing interstate business. . . . Second, the internal consistency test does not require a showing of either actual discrimination or actual multiple taxation; the test is purely hypothetical. . . . Finally, a tax that is internally inconsistent, and therefore unfairly apportioned, discriminates against interstate commerce.” The court starts by imagining a situation where every state imposes an integrated franchise tax, identical to the Texas tax, in which a corporation’s liability is the greater of a 4.5 percent tax on net taxable earned surplus or a .25 percent tax on net taxable capital. Next, the court imagines two HIT-like corporations: an “intrastate corporation” that resides in Texas and sells all of its products in-state; and an “interstate corporation” that resides in Texas but sells its products both in-state and out-of-state. “Under this hypothetical tax scheme, the intrastate corporation will only pay franchise tax to Texas. Its franchise tax liability will be the greater of a 4.5 percent tax on net taxable earned surplus or a .25 percent tax on net taxable capital. It will never pay a tax on both its taxable capital and its net taxable earned surplus. . . . Essentially, the intrastate corporation’s franchise tax liability will be assessed on 100 percent of either its taxable capital or its net taxable earned surplus. . . . The interstate corporation is potentially liable for franchise tax in each state in which it has a substantial nexus, basically each state in which it sold its products.” The court further finds that even though Public Law 86-272 protects the interstate corporation from a tax based on net income in states other than Texas, the interstate corporation would still be liable for franchise taxes on its net taxable capital in those states that hypothetically apply the integrated Texas franchise tax. The court rejects the comptroller’s contentions that the internal consistency test should be applied to one tax based at a time, that is, net taxable capital or net taxable earned surplus, but the court says previous case law makes clear that the test can be applied to tax schemes that consist of two distinct tax bases. The court also rejects the comptroller’s contention that, but for Public Law 86-272, the Texas law would be internally consistent because it is facially neutral. The court agrees that the law is facially neutral, but the court finds no support for the general proposition that a facially neutral tax scheme would automatically survive commerce clause scrutiny. “In conclusion, we hold that the interplay between Public Law 86-272 and the earned surplus throwback provision causes the franchise tax, as applied to Home Interiors, to be internally inconsistent. Therefore, it fails Complete Auto’s fair apportionment requirement. Because we hold that the tax is unfairly apportioned as to Home Interiors, we need not address the final two prongs of the Complete Auto test.” Though HIT’s interstate commerce is not actually burdened by the earned surplus throwback provisions and the risk of multiple taxation is only hypothetical, the mere risk of multiple taxation is sufficient to invalidate a state tax as unduly burdensome on interstate commerce. The court then notes that the U.S. Supreme Court has recognized that a system of credits can be used to remedy an apportionment problem. The court suggests that “the Texas legislature might explore granting an interstate company a franchise tax credit to offset any taxes assessed on the interstate company’s capital by a state that threw back receipts to Texas.” OPINION:Smith, J.; Law, C.J., Smith and Pemberton, JJ. CONCURRENCE:Pemberton, J. “I join the majority opinion with the exception of its expressed dissatisfaction with the United States Supreme Court’s current internal consistency test.”

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