How to Amend Statutes Without Being Elected to The Legislature in One Easy Lesson: Texas Court of Appeals Rules That Texas’ Statutory Definition of Use Includes "Distribution" Even Though it Doesn’t

In May Department Stores Company v. Strayhorn et al., Cause No. 03-03-00729-CV (Tex. App. - Austin, 2004), the Texas Court of Appeals for the Third Circuit ruled that Texas may assess use tax upon charges for out-of-state printing of advertising materials mailed to prospective customers in Texas by a retail chain.

During the period between April 1, 1996 and March 31, 1999 (the "Audit Period"), the May Department Stores Company ("May") (which includes Foley’s Department Stores) operated department stores in 17 markets, some of which were located in Texas. In order to promote sales at its stores, May advertises through various media, including the mailing of catalogs, circulars and postcards to potential customers. All aspects of the design, development and layout of the advertising materials were performed by May personnel outside Texas.

To facilitate the printing of the advertising materials, May purchased bulk paper from various vendors located outside Texas and had the paper delivered to contract printers located outside the state. The out-of-state printers transformed the paper into mailed advertising materials. After completion, May instructed the out-of-state printers to either: mail the materials to potential customers located in Texas (approximately 17% of the materials); deliver the advertising materials to a mailing company located in Grand Prairie, Texas (approximately 80% of the materials); or deliver the materials directly to Foley’s stores and offices (approximately 3% of the materials).

The Texas Comptroller assessed May Texas use tax on the price paid for the bulk paper and the out-of-state printing services. May paid the assessed taxes and sought a refund of the taxes paid with respect to the bulk paper and the printing services. The Comptroller refunded the taxes paid with respect to the bulk paper because the paper was a nontaxable raw material transformed into another item before reaching Texas, basing this conclusion on the Austin Court of Appeals decision in Sharp v. Morton Buildings, Inc., 953 S.W.2d 300 (Tex. App. - Austin 1997, pet. denied). May’s request for a refund of the taxes paid with respect to the printing charges was rejected by the Comptroller. After denial of its refund request related to the taxes assessed against the printing services, May appealed to the Travis County District Court. The District Court granted summary judgement in favor of the Comptroller without stating the grounds therefore.

The Comptroller based its assessment on Rule 3.346(b)(3)(A) which provides that use tax is due on taxable items purchased outside of Texas by a person engaged in business in Texas if the taxable items are delivered at the direction of the purchaser to recipients in Texas as designated by the purchaser. In this situation, the Rule provides that the purchaser owes use tax based upon the purchase price of the items delivered into Texas. At the Court of Appeals, May challenged both the application and the validity of these provisions as contrary to the scope of the Texas use tax statutes.

Because May’s challenge of the assessment was based primarily upon statutory grounds, the Court began its analysis with a discussion of the standards to be applied in construing a tax statute. Generally, courts must look to the plain and common meaning of the statute’s words if that meaning is unambiguous. Courts should also determine the legislative intent behind a statute from the entire act being interpreted and not simply from isolated portions. The analysis should read every word, phrase, and expression in a statute as if it were deliberately chosen and presume the words excluded from the statute are done so purposefully.

Based upon these principles, the Court examined the purpose and application of the Texas use tax. According to the Court, the use tax is a tax on the enjoyment in Texas of that which was purchased out-of-state. The tax complements the sales tax by preventing avoidance of the Texas sales tax by the purchase of goods in another state. The use tax is also intended to place retailers in the state upon an equal footing with out-of-state companies. Bearing these principles in mind, the Court turned to May’s first assertion that Rule 3.346(b)(3)(A) was invalid because it imposed a use tax upon taxable items delivered to Texas recipients.

The Court noted that the Comptroller’s authority for amending Rule 3.346(b)(3)(A) to encompass taxable items delivered into Texas was the United States Supreme Court’s decision in D. H. Holmes v. McNamara, 486 US 24 (1988), wherein the Supreme Court held that the State of Louisiana could impose its use tax on the delivery of catalogs printed out-of-state and then mailed to Louisiana residents. May argued that the Comptroller could not rely upon the D. H. Holmes decision because the Louisiana use tax statute specifically included "distribution" in its enumeration of taxable uses while the Texas use tax statute does not list "distribution" as an incident of use. The Austin Court rejected this argument stating that the Supreme Court’s decision in the D. H. Holmes case did not turn on the question of distribution since the Court accepted the lower court’s construction that the use tax statute encompassed distribution.

May next asserted that Rule 3.346(b)(3)(A) conflicts with the Texas Tax Code in that the definition of "use" in the statute does not include "distribution." The Court rejected this argument and stated that the Rule comports with the plain meaning of the Tax Code. The Texas Tax Code includes two statutory presumptions: One being that the sale of a taxable item for delivery in Texas is for storage, use or consumption within the state, and the second presumption is that tangible personal property that is shipped or brought into Texas by a purchaser is, similarly, for storage, use or consumption within the state. The Court reasoned that since the Rule imposes taxability upon taxable items purchased outside of Texas and delivered at the direction of the purchaser, it does not conflict with the statutory presumptions contained within the Tax Code. The Court also noted that the Rule’s mandate that the items be delivered at the direction of the purchaser to recipients located in Texas comes within the statutory definition of use as the "exercise of a right or power incidental to the ownership of property."

May also argued that the charges for the printing services were not subject to the use tax because the imposition did not meet the requirements of Tax Code Section 151.101(a). Under that section, a use tax may be imposed when a taxable item is purchased from a retailer for use or other consumption within Texas. May contended that it did not: (1) purchase a taxable item; (2) use the printing in Texas; and (3) the purchase was not from a retailer. The Court addressed all three of these concerns.

As to whether the printing services constituted a taxable item, the Court found that such services were properly classified as a taxable item. In its analysis, the Court first addressed whether the taxation of the printing met the requirements of the Tax Code. Under Tax Code Section 151.005, a sale or purchase is defined to include the "production, fabrication, processing, printing, or imprinting of tangible personal property for consumers who directly or indirectly furnish the materials to be used in the production, fabrication, processing, printing, or imprinting," when done for consideration. May had argued that this provision of the Tax Code was only applicable to the imposition of the Texas sales tax and not the use tax. The Court specifically disagreed with this contention, noting that Tax Code Section 151.005 appeared in Subchapter A of the Tax Code, which were the general provisions relating to all assessments of sales and use taxes. Further, the Court noted that the definition pertained to both sales and purchases. Since the Texas use tax was applicable to the storage, use or consumption in Texas of taxable items purchased from a retailer for storage, use or consumption within the State, the inclusion of the printing as a taxable item was within the reach of the Tax Code.

Under the Tax Code, a taxable item is defined as either tangible personal property or taxable services. The Comptroller considered printing to be the sale or purchase of tangible personal property under the essence of the transaction doctrine. This doctrine looks to what the purchaser really desires in entering a transaction. As to printing services, if the purchaser is really desirous of receiving the fruits of the printing services (i.e., catalogs, business cards, etc.) as opposed to the printing services in their own right, the Comptroller will consider the furnishing of the printing services to be the sale or purchase of a taxable item. Because the Tax Code includes printing services in its definition of a sale or purchase for use tax purposes, the purchase of the printing services in this matter constituted the purchase of a taxable item.

May then argued that it did not use the printing in Texas or purchase the printing for use in Texas. In reliance on the Morton Buildings decision, May argued that, because the transformation of rolls of paper into advertising materials occurred outside of Texas, May could not use the printing operations in Texas. The Court determined that the Comptroller was actually taxing the transformation (i.e., the printing) and not the raw materials, as the Comptroller had asserted in the Morton Buildings decision. The Court held that May’s arguments attempted to separate the printing services from the advertising materials. However, without the printing services, the advertising materials would not exist and such a distinction was not warranted. In addition, the Court noted that it was the printer, and not May, who transformed the raw materials into the advertising materials. This case was markedly different than the case presented in Morton Buildings where the taxpayer, and not some third party, actually transformed the raw materials into the building components. As such, the situation presented by May was not analogous to the fact scenario presented in Morton Buildings and that decision could not be sited as controlling.

The Texas Tax Code defines "use" as the "exercise of a right or power incidental to the ownership of tangible personal property over tangible personal property." Based upon this statutory definition, the Court determined that May used the printing in Texas, which produced the advertising materials, by directing either the printer or a mailing company in Texas to mail the materials to prospective customers in the state, using the advertising materials to promote sales at its Texas stores and by physically taking possession of coupons contained in the advertising materials at its Texas stores.

May also argued that it did not purchase the printing from a retailer, asserting instead that it manufactured the advertising materials outside of Texas by subcontracting the printing to a printer. The Court rejected this argument stating that the Tax Code contains a statutory presumption that all tangible personal property brought into Texas for use or consumption has been purchased from a retailer. Because May introduced no evidence to refute this presumption, the Court ruled that May purchased the printing services from a retail printer and that the assessment was proper.

Finally, the Court turned to an analysis of the Texas Legislature’s 2003 amendment of the statutory definition of "use." After amendment, the Tax Code’s definition of "use" excluded from the realm of tangible personal property that could be used in Texas printed material that had been processed, fabricated, or manufactured into other property or attached to or incorporated into other property transported into the state. The Court reasoned that by expressly excluding "printed material" from the definition of tangible personal property as it pertains to use, the Texas Legislature must have been aware of a prior construction that included printed material and deliberately limited the scope of the Tax Code in this area.

This case is interesting to note for the fact that the Court correctly states that, when interpreting a taxing statute, courts must presume that all words included within a statute were intended by the legislature while those words excluded from the statute were done so purposefully. Despite this, the Court then immediately proceeds to go against this principle and read the word "distribution" into the definition of a taxable use. This determination is made in spite of the fact that nowhere within the Tax Code is the term "distribution" included within the enumeration of taxable uses that can be made of taxable items in Texas. The Tax Code’s definition of use has been amended several times since the United States Supreme Court’s ruling in D. H. Holmes. None of these amendments have sought to add the term "distribution" to the Tax Code’s definition of "use." By interpreting the Tax Code as including "distribution" as an incident of use, the Court seems to reject a long standing principle of statutory construction.

This case is not yet final. In late July, the Comptroller filed a motion for rehearing because it was concerned about some of the language used by the Court in its decision regarding the presumption accorded legislative amendments to tax statutes. May used this opportunity to reargue its case in its response to this motion. No decision on the rehearing had been announced at press time. Assuming that May obtains no relief on rehearing, its next step will be to appeal to the Texas Supreme Court, which has discretion as to whether or not to hear the case.

Taxpayers considering purchasing items outside of Texas and transporting those items into the State for any purpose should pay special heed to this decision as well as the mandates of Rule 3.346(b)(3)(A). Other factors not enumerated in Rule 3.346(b)(3)(A) such as the place where title and possession to the materials pass should also be considered. Taxpayers should also consult the Austin Court’s decision in Morton Buildings. By attempting to place a particular fact scenario more in line with the facts of the Morton Buildings decision, taxpayers may be able to alleviate potential assessments based upon Rule 3.346(b)(3)(A). Ideally, this analysis should take place before the items are either purchased or manufactured so that a more palatable fact scenario may be developed.

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