United States: Texas ALJ Affirms Combined Reporting Requirement For Commonly-Owned Brother-Sister Entities

A Texas Administrative Law Judge (ALJ) recently affirmed that the requisite controlling interest for filing combined group reports may be held by a set of several common owners in accordance with the legal definition of an "affiliated group" for Revised Texas Franchise Tax (RTFT) purposes.1 Common ownership was determined under a plain reading of the RTFT statutes even though none of the common owners held more than a 50 percent ownership interest.


The taxpayer was a taxable entity2 formed in Texas that provided medical services to patients. Company A, an entity related to the taxpayer, was a Nevada entity authorized to conduct business in Texas that performed management services for the taxpayer including accounting services, maintaining medical records, leasing office space, purchasing office equipment and medical devices, hiring and paying employees, and billing and collecting for medical services provided by the taxpayer. For the 2008-2011 tax years that were at issue, the taxpayer and Company A originally filed separate RTFT reports, each on a combined group basis and each serving as the reporting entity for the corresponding reports. More than 50 percent of both the voting power and beneficial interest of the taxpayer and Company A was collectively owned by the same persons, although none of the owners independently held over 50 percent of these interests.

The taxpayer and Company A later filed amended RTFT reports for the 2008-2011 tax years, asserting that they were members of the same affiliated group under a controlling interest owned by common owners, and conducted a single unitary business. As a result of eliminating intercompany transactions on the amended reports, the taxpayer claimed a total refund of $778,895 for the 2008-2011 tax years.

The Texas Comptroller of Public Accounts denied the taxpayer's refund claims, contending that the taxpayer and Company A were not members of the same affiliated group and, thus, were ineligible to file as members of the same combined group. According to the Comptroller, no single shareholder in either entity, at any time during the refund period, controlled over 50 percent of the total combined voting power of all classes of stock in both taxable entities, or owned directly or indirectly more than 50 percent of the beneficial ownership interest in the voting stock of both taxable entities. The Comptroller did not question that the two entities were engaged in a unitary business. In response to the Comptroller's denial, the taxpayer and Company A timely filed a request for a refund hearing to appeal the denial.

Since there was no factual dispute between the Comptroller and the taxpayer, the central issue in the hearing was statutory construction. The ALJ was asked to determine whether the RTFT statutes require that a single owner hold the requisite controlling interest as construed by the Comptroller for combined reporting to apply, or whether combined reporting is required when the requisite controlling interest is held by a set of common owners who collectively own the requisite controlling interest in each entity.

Applicable Statutory Definitions

Under Texas law, taxable entities that are part of an affiliated group engaged in a unitary business are required to file a combined group report in lieu of individual reports based on the combined group's business.3 An "affiliated group" means a group of one or more entities in which a controlling interest is owned by a common owner or owners, either corporate or non-corporate, or by one or more of the member entities.4 The controlling interest in a corporation consists of either more than 50 percent, owned directly or indirectly, of the total combined voting power of all classes of stock of the corporation, or more than 50 percent, owned directly or indirectly, of the total beneficial ownership interest in the voting stock of the corporation.5 Similar provisions exist for partnerships and limited liability companies.6

The Comptroller's corresponding rule defining the term "affiliated group" replaces the words "common owner or owners" with "a common owner."7 This interpretation is reinforced by an example in the Comptroller's rule:

Individual A and Individual B each owns 50% of Partnership X.
Individual A and Individual B each also owns 50% of Partnership Y.
Individual A and Individual B are not husband and wife. Since neither
individual owns more than 50% of each partnership, neither individual
has a controlling interest in the partnerships.8

The Comptroller did not refer to any authority in support of its restrictive interpretation of the statute. However, the Comptroller's Web site includes FAQs that explicitly reflect this restrictive interpretation and policy.9

ALJ Affirms Taxpayer's Refund Claim

The ALJ noted that despite the plain language in the RTFT statute, the Comptroller construed the provision as restricting ownership of the controlling interest to a single common owner. Therefore, the ALJ mentioned, the focus of the hearing was on construing the use of the term "owners" in Tex. Tax Code Ann. Sec. 171.0001(1). In the hearing, the taxpayer argued as a matter of common usage, the word "owners" refers to more than one owner. In deciding for the taxpayer, the ALJ indicated that, by including the term "owners" in the statute, the legislature clearly contemplated that the controlling interest in the taxable entities could be held by the same two or more persons. Thus, according to the ALJ, Tex. Tax Code Ann. Sec. 171.0001(1) covered the situation in which the same persons held the required controlling interest in both the taxpayer and Company A throughout the entire refund period.10

As the ALJ concluded that common owners held a controlling interest in both the taxpayer and Company A during the years at issue, the taxpayer and Company A constituted a single affiliated group. Since the Comptroller did not question that the two entities were engaged in a unitary business and conceded over 50 percent of the ownership in each of the two entities was owned by the same individuals, the entities were required to file a single combined report during the years at issue. The ALJ held that the taxpayer's refund claim should be granted.


The tax law provisions at issue in this hearing reinforce the significant differences between Texas's definitions of "affiliated group," "common ownership" and "controlling interest," as discussed above, and the Internal Revenue Code's definitions of "affiliated group," "control" and "constructive ownership" for federal consolidated return purposes.11

Taxpayers in Texas have anxiously awaited further guidance with respect to interpretations of the RTFT relating to combined reporting. The definition of a "unitary business" is the source of much controversy in every state that requires or allows combined reporting of related entities. Some clarity is provided in the ALJ's decision with respect to the terms "affiliated group," "controlling interest" and "common owner or owners." The Comptroller's 2014 letter ruling regarding the continuation or termination of combined groups, for purposes of the temporary credit for business loss carryforwards12 provides some direct and indirect guidance on continuations and terminations of, and changes to, affiliated groups subject to ownership changes.

Substantive related matters, however, remain to be clarified, including the concept of what actually constitutes a unitary business. The Comptroller's rule in this area is not particularly helpful:

Other factors. In addition, the comptroller may consider other factors that may be applicable, including guidelines in Supreme Court decisions that presume activities are unitary. All affiliated entities are presumed to be engaged in a unitary business.13

To presume unity is to ignore the statute defining a "unitary business."14 In the instant case, the ALJ definitively took the Comptroller to task for such an approach. The Comptroller's rule appears to allow the Comptroller to "cherry-pick" U.S. Supreme Court decisions that should control and to ignore the definition of a "unitary business" provided by the Texas Tax Code.

In arguing its case, the Comptroller stated that considering the commonality of all ownership interests under the plain language of the law renders "combined reporting impossible to administer." The same challenge may confront taxpayers with complex ownership structures. Also, the application of this decision will not always be to the benefit of taxpayers, as an increased RTFT liability may result from combination. Presumably, the effect of the decision is retroactive and prospective.

It should be noted that the Comptroller must approve ALJ tax decisions and has the authority to modify such decisions. The Comptroller issued the final decision after considering a Proposal for Decision (PFD) prepared by the ALJ. The State Office of Administrative Hearings does not constitute a court of law and its decisions do not have judicial authority. However, the Comptroller is expected to apply its conclusion (absent any subsequent controlling developments).

The Comptroller has yet to announce any change in policy as a result of the decision. The 2016 RTFT Report instructions, issued after this decision became final, have been altered from prior years in the discussion of an "affiliated group" to reflect the holding of this decision.15

In any event, taxpayers that are or may be subject to combined reporting should consider the prospective effects of this development and potentially revisit the composition of their combined groups in years that are still open under the statute of limitations.


1 Decision, Hearing Nos. 109,672, 109,673, 109,674 and 109,675, Texas Comptroller of Public Accounts, June 23, 2015 (released Oct. 2015).

2 The legal form of the entities was not specified in the hearing.

3 TEX. TAX CODE ANN. § 171.1014(a).

4 TEX. TAX CODE ANN. § 171.0001(1).

5 TEX. TAX CODE ANN. § 171.0001(8)(A).

6 TEX. TAX CODE ANN. § 171.0001(8)(B), (C).

7 34 TEX. ADMIN. CODE § 3.590(b)(1).

8 34 TEX. ADMIN. CODE § 3.590(b)(4)(B)(vii).

9 See Texas Comptroller, "Combined Reporting (Rule 3.590) FAQ," Questions 5 and 8 at http://comptroller.texas.gov/taxinfo/franchise/faq_comb_rpt.html#comb.

10 In reaching this conclusion, the ALJ invoked a litany of Texas court case decisions and statutory rules of construction. For example, "[e]very word used in a statute is presumed to have been used for a purpose." Cameron v. Terrell & Garrett, Inc. 618 S.W.2d 535, 540 (Tex. 1981). "Words and phrases shall be read in context and construed according to the rules of grammar and common usage." TEX. GOV'T CODE ANN. § 311.011(a). The ALJ explained that the "[t]he meaning of the statute is unambiguous" and "[t]here are no special terms of art that require special or technical expertise in construing the statute." Also, the ALJ clarified that "[t]he construction of an unambiguous statute is controlled by the 'plain and common meaning of the statute's words.'" Fitzgerald v. Advanced Spine Fixation Sys., Inc., 996 S.W.2d 864, 865 (Tex. 1998) (quoting Liberty Mut. Ins. Co. v. Garrison Contractors, 966 S.W.2d 482, 484 (Tex. 1998)). Finally, "an agency rule may not impose additional burdens, conditions, or restrictions in excess of or inconsistent with the relevant statutory provisions." Southwestern Bell Tel. Co. v. Pub. Util. Comm'n, 888 S.W.2d 921, 926 (Tex. Ct. App. 1994), writ denied.

11 IRC §§ 1504, 1551(b) and 1563, respectively.

12 Letter No. 201411985L, Texas Comptroller of Public Accounts, Nov. 20, 2014.

13 34 TEX. ADMIN. CODE § 3.590(b)(6)(B).

14 TEX. TAX CODE ANN. § 171.0001(17).

15 Form 05-903, 2016 Texas Franchise Tax Report Information and Instructions (Nov. 2015). The 2015 report instructions referred to only a single "common owner." Form 05-902, 2015 Texas Franchise Tax Report Information and Instructions (Rev. Jan. 2015).

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