The Texas Supreme Court has refrained from ruling on a constitutional challenge to the imposition of the Revised Texas Franchise Tax (RTFT) based on "want of jurisdiction."1 The case was dismissed because the taxpayers failed to comply with statutory prerequisites to filing suit. Specifically, prior to filing, the taxpayers did not pay their taxes under protest or request a refund from the Comptroller of Public Accounts. Accordingly, the Court found that it lacked jurisdiction to decide the merits of the case.
Background
Three taxpayers with distinctive fact patterns joined together in bringing a lawsuit before the Texas Supreme Court: Nestle USA, Inc., a Delaware corporation, Switchplace, LLC, a Texas limited liability company, and NSBMA, LP, a Texas limited partnership. Nestle is a manufacturer and distributor of food and beverages that only engages in wholesale activities in Texas, but it was nevertheless classified as a manufacturer subject to the higher 1 percent RTFT rate.2 Switchplace, a global temporary housing company, and NSBMA, a company that rents large equipment for use in construction, were not allowed to deduct significant costs in their businesses as cost of goods sold (COGS), though other companies that were considered by the taxpayers to be similarly situated were allowed the deduction.3
The taxpayers' suit claimed that the RTFT violated the Texas and United States Constitutions. The suit was filed under an RTFT provision, "Section 24," that allows a direct challenge of constitutional issues with an expedited review and decision required by the Texas Supreme Court within 120 days.4
Constitutional Arguments
In their lawsuit, the taxpayers alleged that the RTFT violated the Equal and Uniform Clause of the Texas Constitution5 as well as the Equal Protection, Due Process, and Commerce Clauses of the United States Constitution.
With respect to the Texas Constitution, the taxpayers argued that the RTFT, both facially and "as applied," did not treat similarly situated taxpayers in an equal and uniform manner. According to the taxpayers, similarly situated taxpayers (those with the privilege of doing business in Texas), were treated differently based on industry type. For instance, arbitrary rates applied to manufacturers like Nestle even though Nestle only operated as a wholesaler within the state.6
With respect to the U.S. Constitution, the taxpayers took the position that the RTFT violated the Due Process Clause because its varying tax rates for different industries had no correlation to a difference in the amount of protection or benefits a taxpayer received from the state.7 Moreover, the taxpayers asserted that the RTFT violated the Commerce Clause because, among other reasons, it taxed an activity without substantial nexus to Texas and the tax was not fairly apportioned. The taxpayers also attacked the RTFT on the basis that it violated the Equal Protection Clause of the U.S. Constitution by allowing for the disparate treatment of taxpayers without: (i) a rational basis and (ii) a fair and substantial relation to the object of the legislation (the value of the privilege of doing business in Texas).8
While the taxpayers paid the RTFT on their originally filed 2008_2011 returns, the taxpayers did not pay their taxes under protest or request a refund from the Comptroller via the process outlined in Chapter 112 of the Texas Tax Code that are statutory prerequisites to filing taxpayer suits in district court. Rather, the taxpayers were seeking a declaration from the Texas Supreme Court that the RTFT was unconstitutional, an injunction prohibiting the collection of the RTFT, and mandamus relief9 requiring the Comptroller to refund the RTFT paid in 2008-2011. Since the taxpayers bypassed the district court, the initial (and ultimately only) issue considered by the Texas Supreme Court was whether the prerequisites contained in Chapter 112 applied to the taxpayers' Section 24 suit in the Texas Supreme Court context.
Statutory Prerequisites to Filing Taxpayer Suits
Chapter 112 allows a taxpayer to bring suit against the state to recover a franchise tax "if the person has first paid the tax under protest"10 and the "protest must be in writing and must state fully and in detail each reason for recovering the payment."11 A taxpayer must file suit against the tax collector, Comptroller and the Attorney General within 90 days after the protest payment is made.12 Chapter 112 also permits injunctive relief for the taxpayer if the taxpayer first meets certain requirements, including the filing of a statement of grounds with the Attorney General and the payment of taxes or the posting of a bond.13 The taxpayers argued that these statutory prerequisites to filing suits only applied to actions brought in the district court and did not apply to their original suit in the Texas Supreme Court.
Section 24 Suits for Injunctive Relief Are Subject to Prerequisites
Section 24 of the RTFT Act provides that the Texas Supreme Court has "exclusive and original jurisdiction over a challenge to the Constitutionality of [the RTFT]...and may issue injunctive or declaratory relief in connection with the challenge."14
The taxpayers contended that Section 24 jurisdiction creates a right to bring suit independent of the limitations contained within Chapter 112. The Court rejected this contention and reaffirmed its 2011 determination, in Allcat Claims Service, L.P.,15 that Section 24 is only a specific, limited exception to Chapter 112's general rule that district courts of Travis County have exclusive, original jurisdiction over taxpayer suits.16
In reaching its conclusion, the Court noted that the codified restrictions pertaining to taxpayers' suits are part of "the State's entire tax collection scheme" and to allow a Section 24 action free of such restrictions "would severely disrupt that scheme." According to the Court, permitting taxpayers to bring Section 24 actions without first meeting the protest-payment and refund-claim requirements would prevent the Comptroller from being put on notice that the tax was being attacked as illegal, perhaps for years. Under such a scenario, a determination that a tax was illegal would require the payment of substantial refunds to similarly situated taxpayers, imposing a significantly larger monetary burden of loss on the state than would be the case if the Comptroller were immediately notified through the protest-payment and refund-claim requirement mechanism outlined in Chapter 112.
Moreover, the Court considered the history of the Chapter 112 procedural requirements to deduce the legislature's intent. Given the nearly 70 years of caution exercised by the legislature in permitting taxpayer suits, the Court found it both unreasonable and contrary to the intent of the legislature to hold that the procedural requirements did not apply to Section 24 suits.
Retrospective Monetary Claims Against State Require Waiver of Sovereign Immunity
The Texas Supreme Court then addressed the waiver of sovereign immunity that is required in order to permit a suit against the state. Taxpayer rights of action are created by statutory provisions which waive the state's sovereign immunity from suit. Without specific waiver of sovereign immunity, a taxpayer cannot bring a retrospective monetary claim against the state. In addition, the Court mentioned the hurdle to a taxpayer claim contained within the Texas Government Code. Pursuant to the Texas Government Code, the waiver of immunity must be both "clear and unambiguous." The Court held that Section 24's grant of jurisdiction to the Court was not a "clear and unambiguous" waiver. Therefore, the Court was prohibited from granting mandamus relief to the taxpayers. Although Section 24 gave the Court constitutional authority "to grant injunctions or declaratory orders in original proceedings where it is necessary to effectuate mandamus relief," the present taxpayers failed to adhere to the prerequisites of bringing their action. As a result, the Court lacked jurisdiction and dismissed the case.
Commentary
Since its enactment, the RTFT has been challenged by taxpayers as violating both the Texas and U.S. Constitutions. While the Texas Supreme Court now has avoided making a decision on the "as applied" constitutional validity of the RTFT on two occasions,17 there is still a potential opportunity to bring forward an action absent procedural deficiencies. While it is clear that a taxpayer can file suit using the traditional channel of the lower level Texas courts, a question exists as to whether any taxpayer will be able to obtain a declaration that the RTFT is unconstitutional from the Texas Supreme Court, even if all procedural niceties are followed. The "failure to exhaust administrative remedies" procedural issue is one which the courts are seldom reluctant to rely upon.
At the very least, it appears that the taxpayers in this case will have the opportunity to follow the dictates of Chapter 112 and either refile their lawsuit at the Texas Supreme Court, or begin at the district court level, the result could be appealed by the losing party until the case reaches the Texas Supreme Court. Either process could take several years. It would appear that another attempt to bring an expedited constitutional challenge to the RTFT will be difficult to succeed, considering the Court's earlier decision in Allcat. It should be noted that the decision in Allcat restricting the Court's analysis on "as applied" issues only involved an attack on the RTFT rooted in Texas constitutional grounds. Nestle and its co-plaintiffs set forth a much broader attack on the RTFT on a variety of Texas and U.S. constitutional grounds (both on a facial and as-applied basis), and perhaps a future substantive decision by the Texas Supreme Court could differ from Allcat as a result.
Even so, the Nestle challenge may be a precursor to future challenges that may claim violation of the commerce clause of the U.S. Constitution18 as applied to foreign commerce. Many U.S. retailers of electronic products are denied the 0.5% tax rate generally applied to retailers by virtue of the manufacture of the products performed by affiliates in foreign nations.19 Foreign affiliates are precluded from being included in a Texas combined report, yet Texas' recognition of their affiliation results in the higher (1.0%) tax rate imposed on the U.S.-based group.
If the Texas Supreme Court does eventually resolve the constitutional issues surrounding the RTFT and invalidates the tax, then a significant amount of the state's tax revenue would be at risk. The outcome would likely force Texas to immediately reconsider, in a special session of the legislature, how to tax corporations to prevent a budgetary disaster.
Footnotes
1 In re Nestle USA, Inc., Switchplace, LLC, and NSBMA, LP, Relators, Texas Supreme Court, No. 11-0855, Feb. 10, 2012.
2 The RTFT is imposed at either a 1 percent rate (applicable to most taxpayers, including taxpayers engaging predominately in manufacturing operations) or a 0.5 percent rate (applicable to taxpayers engaging predominantly in wholesale or retail operations). TEX. TAX CODE ANN. § 171.002(a), (b).
3 In calculating the RTFT base, taxpayers are allowed an elective deduction, which is made on an annual basis, equal to the greatest of three different components: (i) COGS; (ii) compensation; and (iii) a flat 30 percent deduction from total gross revenue. TEX. TAX CODE ANN. § 171.101(a).
4 H.B. 3, Laws 2006, § 24(a).
5 TEX. CONST. art. VIII, § 1(a) reads, "Taxation shall be equal and uniform."
6 Relators' Brief on the Merits, In Re Nestle, Inc., No. 11-0855, filed Nov. 12, 2011.
7 For example, although Nestle was taxed at a higher rate for manufacturers, it did not receive any benefits from Texas with respect to its manufacturing operations because the operations took place entirely outside the state.
8 Relators' Brief on the Merits, In Re Nestle, Inc., No. 11-0855, filed Nov. 12, 2011.
9 A writ of mandamus is "a writ which issues from a court of superior jurisdiction, and is directed to a private or municipal corporation, or any of its officers, or to an executive, administrative or judicial officer, or to an inferior court, commanding the performance of a particular act therein specified, and belonging to his or their public, official, or ministerial duty, or directing the restoration of the complaint to rights or privileges of which he has been illegally deprived." BLACK'S LAW DICTIONARY, 866 (5th ed. 1979).
10 TEX. TAX CODE ANN. § 112.052(a).
11 TEX. TAX CODE ANN. § 112.051(b).
12 TEX. TAX CODE ANN. § 112.052(b).
13 TEX. TAX CODE ANN. § 112.101(a).
14 H.B. 3, Laws 2006, § 24(a).
15 Texas Supreme Court, No. 11-0589, Nov. 28, 2011.
16 Id.
17 In Allcat, the Court limited its jurisdiction to the taxpayer's facial challenge to the RTFT.
18 U.S. CONST. Art. I, § 8.
19 TEX. TAX CODE ANN. § 171.002(c)(2).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
