PR Newswire: news distribution, targeting and monitoring
Oct 26 2012

DALLAS, Oct. 26, 2012 /PRNewswire/ -- The Texas Supreme Court ("Court") has turned away yet another constitutional challenge to the revised Texas franchise tax (also known as the "Margins Tax") in the case of In Re: Nestle USA, Inc. (No. 12-0518 – Tex., October 19, 2012).The Court previously held that the Margins Tax does not violate the "Bullock Amendment" to the Texas Constitution, which provides that the state may not impose a net income tax on natural persons without the approval of a majority of registered voters. See In Re: Allcat Claims Service, L.P. et al, 356 S.W.3d 455 (Tex. 2011).


Nestle contended that the Margins Tax bears no "reasonable relationship" to the value of the privilege of doing business in Texas, because of its many deductions and exemptions, and that the tax treats similarly situated taxpayers differently. Accordingly, Nestle contended that the Margins Tax violates the Texas Constitution's requirement of equal and uniform taxation (Tex. Const. art. VIII, § 1(a)) and the Fourteenth Amendment's Equal Protection and Due Process guarantees (U.S. Const. amend. XIV, § 1). In addition, Nestle contended that the Margins Tax is higher for manufacturers located outside of Texas, thus discriminating against interstate commerce in violation of the Commerce Clause (U.S. Const. art. I, § 8).

First, the Court held that the Margins Tax does not violate the requirement of equal and uniform taxation. Acknowledging that the Margins Tax classifies different types of business activities differently, the Court held that differentiation among different classes of taxpayers is not prohibited, provided that tax classifications are rational, and that they group similar things together while differentiating "dissimilar" things. With respect to the Margins Tax, the Court wrote that the "tax's classifications must relate to differences in doing business that affect the value of the privilege" of doing business in Texas. Although Nestle pointed out numerous examples of differential treatment (e.g., allowing a deduction for employee wages but not payments to independent contractors; excluding rental expenses of heavy construction equipment from Cost of Goods Sold), the Court observed a rational justification for each distinction based on the different business activities of each affected taxpayer. Ultimately, the Court held that the differential treatment actually promoted uniformity by appropriately valuing different types of taxpayers' privilege of doing business in Texas.

Having held that the Margins Tax does not violate the equal and uniform taxation provision of the Texas Constitution, the Court held that it likewise does not violate the U.S. Constitution's Equal Protection clause.

The Court further held that Nestle's Due Process challenge failed. The Court wrote: "Due Process requires that 'the taxing power exerted by the state bears fiscal relation to protection, opportunities and benefits given by the state.'" Although taxpayers engaged in business outside Texas may in certain circumstances owe more Margins Tax than taxpayers engaged in business exclusively in Texas, this is insufficient to invalidate the tax. Citing Ford Motor Co. v. Beauchamp, 308 U.S. 331 (1939), the Court noted that in "a unitary enterprise, property outside the state, when correlated in use with property within the state, necessarily affects the worth of the privilege within the state."

Finally, the Court turned away Nestle's Commerce Clause challenge to the Margins Tax. The Court applied the four-part test of Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977), under which a tax violates the Commerce Clause if it: (1) applies to an activity lacking a substantial nexus to the taxing state; (2) is not fairly apportioned; (3) discriminates against interstate commerce; or (4) is not fairly related to the services provided by the state. Nestle paid the 1.0% Margins Tax rate because its manufacturing business in other states disqualifies Nestle from the 0.5% rate on taxpayers engaged primarily in wholesale or retail trade. Nestle noted that its Texas activities are entirely wholesale and retail trade, but it nevertheless pays the higher rate. The Court held that this result does not discriminate against interstate commerce because the different rate stems from the nature of Nestle's activities rather than the location where they are performed. Furthermore, the higher tax rate for manufacturers is fairly related to the taxpayer's presence or activities in Texas. The Court wrote: "It is enough that manufacturing outside of the state will often increase the value of doing business within the state . . ."

At the time this was written, it was not known whether Nestle would appeal to the U.S. Supreme Court with respect to the alleged violations of the U.S. Constitution.




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