Inova Diagnostics, Inc. v. Strayhorn

• Decision Date: 26 May 2005
• Docket Number: No. 03-04-00503-CV.,03-04-00503-CV.
• Citation: 166 S.W.3d 394
• Parties: INOVA DIAGNOSTICS, INC., Appellant, v. Carole Keeton STRAYHORN, Comptroller of Public Accounts of the State of Texas and Greg Abbott, Attorney General of the State of Texas, Appellees.
• Court: Texas Supreme Court

166 S.W.3d 394

INOVA DIAGNOSTICS, INC., Appellant, v. Carole Keeton STRAYHORN, Comptroller of Public Accounts of the State of Texas and Greg Abbott, Attorney General of the State of Texas, Appellees.

No. 03-04-00503-CV.

Court of Appeals of Texas, Austin.

May 26, 2005.

Gilbert J. Bernal Jr., David J. Sewell, Stahl, Bernal & Davies, LLP, Austin, for Appellant.

Christine Monzingo, Asst. Atty. Gen., Austin, for Appellees.

Before Chief Justice LAW, Justices B.A. SMITH and PEMBERTON.

OPINION

BEA ANN SMITH, Justice.

When INOVA, a California corporation, hired a salesperson in this state, the Texas Comptroller informed the company that it was required to pay the state franchise tax. INOVA paid the taxes under protest and filed suit in the district court for a refund. The trial court ruled in favor of the Comptroller.

INOVA argues that Public Law 86-272 (15 U.S.C. §§ 381-84 (West 1997)) exempts INOVA from paying any portion of the franchise tax measured by earned surplus and that the portion of the franchise tax imposed on capital cannot be separated from the portion imposed on earned surplus. Even if the franchise tax contains two distinct components, INOVA insists that net taxable capital is measured in part by surplus earnings and it is thus exempt. In the alternative, INOVA contends it lacks a substantial nexus with this state to be subject to the franchise tax under the Commerce Clause. We reject all of INOVA's challenges and affirm the district court's judgment denying the refund.

BACKGROUND

INOVA is a California corporation based in San Diego. It develops and manufactures products used in medical testing. INOVA has only one employee in Texas, who was hired in 1996. That employee is a salesperson who works an average of seven to ten days per month in Texas. His activities in Texas are limited to visiting existing and prospective customers, providing promotional materials, and demonstrating INOVA products. All orders are placed directly with INOVA in California and delivered via mail or common carrier.

In 1998, INOVA completed a business tax questionnaire at the Comptroller's request. Based on the questionnaire, the Comptroller informed INOVA that it was required to pay the Texas franchise tax for the years following INOVA's employment of a salesperson in Texas. INOVA initially refused to pay the tax but ultimately paid the taxes under protest when the Comptroller notified INOVA that it had forfeited its corporate privileges in Texas. INOVA submitted claims for refunds of franchise taxes paid for the years 1999 through 2003. The Comptroller denied these claims and INOVA filed suit in the district court. After a bench trial, the district court entered judgment in favor of the Comptroller. This appeal followed.

STATUTORY AND ADMINISTRATIVE PROVISIONS

Our resolution of INOVA's issues involves the interaction of the Texas franchise tax, Public Law 86-272, and the Comptroller's rules for assessing the franchise tax. Accordingly, it is useful to briefly review the relevant statutes and rules before discussing INOVA's issues.

The franchise tax

Texas imposes a tax on corporations for the privilege of doing business in the state. See Tex. Tax Code Ann. § 171.001(a) (West Supp.2004-05); Anderson-Clayton Bros. Funeral Home, Inc. v. Strayhorn, 149 S.W.3d 166, 169 (Tex.App.-Austin 2004, pet. filed); Rylander v. Fisher Controls Int'l, Inc., 45 S.W.3d 291, 293 (Tex.App.-Austin 2001, no pet.). The tax is imposed annually on "each corporation that does business in the state or is chartered in the state." Tex. Tax Code Ann. § 171.001(a). Before 1991, the franchise tax had been assessed solely on a corporation's taxable capital. See General Dynamics Corp. v. Sharp, 919 S.W.2d 861, 863-64 (Tex.App.-Austin 1996, writ denied) (discussing history of franchise tax). The tax code was amended in 1991 to add taxation of a corporation's taxable earned surplus or its taxable capital, whichever is higher under the statutory formula. See Act of Aug. 12, 1991, 72d Leg., 1st C.S., ch. 5, § 8.02, 1991 Tex. Gen. Laws 134, 152.¹ This amendment corrected an inequity of the prior law in which capital-intensive industries bore the brunt of the tax, while less capital-intensive service industries did not pay as much even when they generated large profits. See Anderson-Clayton Bros. Funeral Home, 149 S.W.3d at 169; General Dynamics Corp., 919 S.W.2d at 863. The tax on capital is set at the lower rate of .25 percent of a corporation's net capital, while franchise tax on earnings is set at 4.5 percent of net earned surplus.

Public Law 86-272

Congress enacted Public Law 86-272 in 1959 in response to a United States Supreme Court decision that indicated that the federal constitution does not prohibit individual states from imposing an income tax on out-of-state corporations, even when their only business activity in the state is solicitation of purchases. See Wisconsin Dep't of Revenue v. William Wrigley, Jr. Co., 505 U.S. 214, 220-21, 112 S.Ct. 2447, 120 L.Ed.2d 174 (1992) (discussing opinion in Northwestern States Portland Cement Co. v. Minnesota, 358 U.S. 450, 452, 79 S.Ct. 357, 3 L.Ed.2d 421 (1959)). Less than a year after the Northwestern States Portland Cement opinion, Public Law 86-272 was passed to create minimum standards for business activity required within a state before that state may impose state income tax on an out-of-state corporation. See William Wrigley, Jr. Co., 505 U.S. at 223, 112 S.Ct. 2447. Specifically, the statute prohibits a state from imposing a net income tax if the foreign taxpayer's only business activity in the state is the solicitation of orders. See 15 U.S.C. § 381(a). The statute defines net income tax as "any tax imposed on, or measured by, net income." Id. § 383.

Administrative rules

The Comptroller agrees that it may not impose the net earned surplus component of the franchise tax on an out-of-state corporation whose only activity in the state is solicitation of orders. See 34 Tex. Admin. Code §§ 3.546, 3.554 (2005). However, for more than ten years, the Comptroller has held that Public Law 86-272 does not exempt an out-of-state corporation from the payment of franchise tax based on its net taxable capital. See id. § 3.546 (adopted 1992); id. § 3.554 (adopted 1994). Section 3.546 of the rules explains that "a corporation may be subject to the taxable capital component [of the franchise tax], but not subject to the earned surplus component, because of Public Law 86-272." 34 Tex. Admin. Code § 3.546(b). Section 3.554 provides that:

If the only business activity within this state is the solicitation of orders for sales of tangible personal property . . . then the corporation is not subject to the earned surplus component of the franchise tax, even if the corporation has obtained a certificate of authority. Only the sale of tangible personal property is afforded immunity under Public Law 86-272; therefore, the leasing, renting, licensing, or other disposition of tangible personal property, intangibles, or any other type of property is not immune from taxation by reason of Public Law 86-272. This subsection does not apply to a corporation chartered in Texas.

Id. § 3.554(b). Section 3.554 also contains detailed provisions defining solicitation and discussing what business activities will subject a corporation to the earned surplus component of the franchise tax. See id. § 3.554(c), (d), (e), and (f).

DISCUSSION

The parties do not dispute the underlying facts of the case; they agree that INOVA only engages in the solicitation of orders in Texas for the purposes of Public Law 86-272. The resolution of this case turns on questions of law that we review de novo. See Tex. Dep't of Transp. v. Needham, 82 S.W.3d 314, 318 (Tex.2002). INOVA raises two issues contending that Public Law 86-272 prevents the Comptroller from imposing the taxable capital component of the state franchise tax. First, it contends that the franchise tax is a single integrated tax and may not be separated into components for the purpose of avoiding the application of Public Law 86-272. Second, INOVA contends that even if the taxable capital component stands alone, INOVA is exempted from that portion of the franchise tax as well because the capital component is imposed on, or measured by, net income. Finally, INOVA contends that it lacks a substantial nexus with Texas under the Commerce Clause to permit state taxation.

May the Comptroller impose franchise tax on net capital alone?

Although the practical effect of the present franchise tax is to assess the greater of a 4.5 percent tax on net taxable earned surplus or a .25 percent tax on net taxable capital, the legislature chose to express this tax in a more complicated formula. See Tex. Tax Code Ann. § 171.002(b). The tax is calculated by adding the tax on net taxable capital and the difference between the tax on net taxable earned surplus and the tax on net taxable capital. See id.² INOVA contends in its first issue that the Comptroller may not ignore that formula and assess only the capital taxable component of the tax in order to avoid the application of Public Law 86-272.

This contention requires us to construe section 171.002 of the tax code to determine whether the legislature intended for the franchise tax to be imposed on net taxable capital when a corporation is exempt from paying tax on earned surplus under Public Law 86-272.³ Our primary goal in statutory construction is to ascertain and effectuate the legislature's intent. Albertson's, Inc. v. Sinclair, 984 S.W.2d 958, 960 (Tex.1999). When construing a statute, we ascertain the intent of the legislature from the plain meaning of the actual language used. Lenz v. Lenz, 79 S.W.3d 10, 19 (Tex.2002). Every word, phrase, clause, and sentence of a statute should be given effect. Strasburger Enters., Inc. v. TDGT Ltd. P'ship, 110 S.W.3d 566, 570 (Tex.App.-Austin 2003, no pet.). Additionally, the primary rule in statutory...