Hegar v. Sirius XM Radio, Inc.
| Decision Date | 01 May 2020 |
| Docket Number | NO. 03-18-00573-CV,03-18-00573-CV |
| Citation | 604 S.W.3d 125 |
| Parties | Glenn HEGAR, Comptroller of Public Accounts of the State of Texas; and Ken Paxton, Attorney General of the State of Texas, Appellants, Sirius XM Radio, Inc., Cross-Appellant v. SIRIUS XM RADIO, INC., Appellee, Glenn Hegar, Comptroller of Public Accounts of the State of Texas; and Ken Paxton, Attorney General of the State of Texas, Cross-Appellees |
| Court | Texas Court of Appeals |
Daniel H. Schlueter, Michael J. Kerman, Michael Boldt, Lino Mendiola III, Austin, Open Weaver Banks, Jeffrey A. Friedman, Austin, for Appellee.
Ari Cuenin, Pam Deitchle, for Appellants.
Before Justices Goodwin, Baker, and Kelly
This appeal arises from a suit filed by Sirius XM Radio, Inc. to recover franchise taxes paid under protest to Glenn Hegar, Comptroller of Public Accounts of the State of Texas. See Tex. Tax Code § 112.052. Following a bench trial, the trial court signed a judgment in favor of Sirius XM ordering the Comptroller to issue a refund. On appeal, the Comptroller challenges the methodology employed by Sirius XM and adopted by the trial court to calculate that portion of Sirius XM's revenue attributable to its business in Texas in tax years 2010 and 2011. See id. § 171.106(a). Specifically, the Comptroller challenges certain findings of fact and conclusions of law made by the trial court concerning where Sirius XM's services were performed and how the fair value of those services in Texas should be calculated. Sirius XM, by cross-appeal, asserts that the trial court erred in not allowing it to include certain expenses in its cost-of-goods-sold deduction. See id. § 171.1012. For the reasons that follow, we will reverse the trial court's judgment and render judgment in favor the Comptroller.
Texas imposes a franchise tax on each taxable entity that does business in this state or that is chartered or organized in this state. See Tex. Tax. Code § 171.001(a). Codified in Chapter 171 of the Tax Code, see id. §§ 171.0001-.908, the franchise tax represents a tax on the value and privilege of doing business in Texas. Combs v. Newpark Res., Inc. , 422 S.W.3d 46, 47 (Tex. App.—Austin 2013, no pet.). Generally, a taxable entity's franchise-tax liability is calculated by first determining the entity's "margin," which is the lesser of 70% of the taxable entity's total revenue, or the entity's total revenue minus certain expenditures as allowed by Chapter 171. See Tex. Tax Code §§ 171.101(a)(1) (), .1011(c) (calculation of total revenue). Pertinent to this appeal, Chapter 171 allows a taxable entity to subtract from its total revenue the cost of goods sold, sometimes referred to as the "COGS deduction."1 See id. §§ 171.101(a)(1)(B)(ii)(a)(1) (), .1012 (determination of cost of goods sold).
Next, the entity's "taxable margin" is determined by apportioning the entity's "margin" to its business in Texas. In re Nestle USA , 387 S.W.3d 610, 615 (Tex. 2012) (orig. proceeding); see Tex. Tax. Code. § 171.101(a)(2). Apportionment is accomplished by "multiplying a business's total margin by an apportionment factor." See Hallmark Mktg. Co. v. Hegar , 488 S.W.3d 795, 796 (Tex. 2016). In its simplest terms, an apportionment factor represents the percentage or fractional proportion of an entity's gross receipts from its business in Texas relative to its gross receipts from its business everywhere, including in Texas. See Tex. Tax Code § 171.106(a) (describing apportionment); Hallmark Mktg. , 488 S.W.3d at 796 (). Under this formula, "doing more business in Texas generally results in higher franchise taxes." OGCI Training, Inc. v. Hegar , No. 03-16-00704-CV, 2017 Tex. App. LEXIS 10096 at *3-4 (Tex. App.—Austin Oct. 27, 2017, no pet.) (mem. op.) (citing Southwestern Bell Tel. Co. v. Combs , 270 S.W.3d 249, 258 (Tex. App.—Amarillo 2008, pet. denied) ). Finally, the entity's franchise-tax obligation is determined by multiplying the "taxable margin" by the applicable tax rate. See Tex. Tax Code § 171.002 ("Rates; Computation of Tax").
In this case, the Comptroller's appeal centers on the apportionment step in the calculation of Sirius XM's franchise-tax liability for the tax years 2010 and 2011; Sirius XM's cross-appeal concerns the COGS deduction for the same tax years.
Sirius XM is a foreign corporation that provides a subscription-based satellite radio service, consisting of more than 150 channels of music, sports, news, talk, entertainment, traffic, and weather channels to subscribers throughout the United States.2 During the relevant tax years, Sirius XM's headquarters, transmission equipment, and production studios were located almost exclusively outside of Texas. Approximately 70 percent of Sirius XM's programming consisted of original content produced by Sirius XM specifically for its subscribers and could be obtained only by subscribing to Sirius XM's services. This original content was produced from multiple studios owned and operated by Sirius XM, primarily in New York City and Washington D.C. and in smaller remote studios in Cleveland, Los Angeles, Memphis, Nashville, and Orlando. Sirius XM's production from Texas was limited to a channel named "Willie's Place," transmitted five days a week for no more than five hours a day, from a location in Hillsboro, Texas, which Sirius XM did not own or lease. "Willie's Place" included programming from a host named "Billie Mack," who transmitted from his home in Fort Worth.
Sirius XM's primary source of revenue was subscription fees for its satellite-radio services, with most of its customers subscribing on an annual, semi-annual, quarterly, or monthly basis. Sirius XM subscribers received Sirius XM's programming using satellite-enabled radios, and most of Sirius XM's new subscription growth came from purchasers and lessees of new and used automobiles equipped with satellite-enabled radios. The integrated circuits, or "chip sets," for these satellite-enabled radios included the encryption, conditional access, and security technology necessary to exclusively access Sirius XM satellite radio.
Sirius XM did not manufacturer or provide the radios to its subscribers. Instead, subscribers typically purchased or leased vehicles with the radios already installed by the manufacturer or dealer. Sirius XM did, however, subsidize a portion of the radio manufacturing costs to reduce the hardware price to consumers. In addition, Sirius XM had agreements with major automakers to incentivize them to install the satellite-enabled radios as factory or dealer-installed equipment in their vehicles. Sirius XM refers to the payments it made pursuant to these agreements as "revenue shares and hardware subsidies," with "revenue shares" computed on a percentage of subscription revenue and "hardware subsidies" computed as a flat fee per vehicle.
Sirius XM timely filed Texas franchise-tax returns for tax years 2010 and 2011, in which it calculated its margin primarily from the total revenue generated by its subscriptions. For tax year 2010, Sirius XM calculated its taxable margin by subtracting its cost of goods sold from its total revenue. See Tex. Tax Code § 171.101(a)(1)(B). For tax year 2011, Sirius XM determined that the total cost of goods sold was less than 30% of Sirius XM's total revenue and, therefore, calculated its margin by deducting 30% of Sirius XM's total revenue. See id. § 171.101(a)(1)(A). Sirius XM then apportioned its reported subscription receipts for each year based on the locations where it produced its programming for broadcast and on the relative costs of those activities in Texas and outside Texas. See id. § 171.103.
The Comptroller subsequently audited Sirius XM's 2010 and 2011 returns and concluded that Sirius XM had incorrectly computed its tax liability. Specifically, the Comptroller's auditor determined that Sirius XM's apportionment of its subscription receipts was incorrect because, in the Comptroller's view, the service provided by Sirius XM in Texas was the "service of unscrambling the radio signal," not the production of satellite programming, and this service occurred "at the radio receiver." During the audit, Sirius XM informed the Comptroller that it had undercalculated its COGS deduction. In part, Sirius XM requested an adjustment to its COGS deduction to include the revenue share and hardware subsidies that it had paid to automobile manufacturers to install satellite-enabled radios.
At the conclusion of the audit, the Comptroller adjusted Sirius XM's apportionment factor to reflect the percentage of Sirius XM subscribers in Texas, which was approximately 8 percent of total subscribers to Sirius XM. In addition, while the Comptroller allowed Sirius XM to include certain requested costs in calculating its COGS deduction, it did not allow Sirius XM to include the revenue share and hardware subsidies. In sum, the audit resulted in an additional tax assessment of $738,898 for tax year 2010 and an additional tax assessment of $1,458,682 for tax year 2011. Sirius XM paid the additional tax and interest under protest and then filed suit in district court to obtain a refund. See id. § 112.052.
Following a bench trial, the trial court rendered a judgment in favor of Sirius XM and issued findings of fact and conclusions of law. In part, the trial court concluded that the Comptroller's adjustment to Sirius XM's apportionment factor was incorrect and that Sirius XM was entitled to a refund. However, the trial court upheld the Comptroller's decision to deny Sirius XM's request to include revenue share and hardware subsidies in its revised COGS deduction. These cross appeals followed.
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