Texas Franchise Tax Preempted by Federal Law – Introduction
A recent ruling by the Travis County District Court determined that the Texas franchise tax, as applied to American Airlines, Inc. (“American”), is preempted by the federal Anti-Head Tax Act (AHTA).
The court dismissed the Texas Comptroller‘s arguments that the franchise tax was not a gross receipts tax and that it did not apply to revenues from air commerce or transportation.
This ruling opens the door for further federal preemption challenges against the Texas franchise tax.
Background
American Airlines, a major airline based in Fort Worth, Texas, operates a vast fleet of around 1,000 aircraft, serving destinations across North America, the Caribbean, Latin America, Europe, and the Asia-Pacific region.
The case revolved around American’s franchise tax obligations for the 2015 reporting year, covering fiscal year 2014.
The Texas franchise tax is calculated based on the taxable margin of entities conducting business within the state.
A company’s taxable margin is either 70% of its total revenue or its total revenue minus specific deductions (e.g., $1 million, cost of goods sold, or compensation). This margin is then apportioned to Texas using a gross receipts factor, and the tax is calculated based on the applicable rate.
For the 2015 report, American chose to calculate its taxable margin by applying the 70% of total revenue option, excluding revenues from passenger ticket sales, baggage fees, and freight transportation.
American argued that these transportation-related revenues were not subject to the Texas franchise tax due to federal preemption under the AHTA, which prohibits states from taxing gross receipts derived from air commerce or transportation.
From 2009 to 2014, the Texas Comptroller agreed with American’s interpretation and excluded such transportation revenues from the franchise tax base.
However, the Comptroller later sought clarification from the U.S. Department of Transportation (DOT), which affirmed that the AHTA preempts state taxes on revenues from air transportation.
Despite this, the Comptroller encouraged American to pay its 2015 franchise tax under protest and pursue legal action to resolve the dispute. American complied, paid the tax under protest, and subsequently filed a lawsuit to challenge the Comptroller’s authority.
Court Decision
The court ruled in favour of American, concluding that the Texas franchise tax, as applied to the airline’s transportation receipts, is indeed a gross receipts tax preempted by the AHTA.
The court referenced similar rulings from other jurisdictions, including a U.S. Supreme Court decision, Aloha Airlines, Inc. v. Director of Taxation of Hawaii.
Consequently, American was entitled to exclude its transportation receipts from its franchise tax calculations for 2015, and the court ordered the Comptroller to issue a refund.
Implications
This ruling marks a significant victory for American Airlines and other air carriers operating in Texas, affirming that the AHTA overrides the application of the Texas franchise tax to revenues from air transportation.
The decision underscores the necessity for the Texas Comptroller to have a valid legal basis before altering its tax positions on similar matters.
Other businesses in Texas should consider whether federal laws, like the AHTA, could preempt the imposition of the franchise tax on their gross receipts.
Texas Franchise Tax Preempted by Federal Law – Conclusion
The court’s ruling in favour of American Airlines marks a significant precedent, affirming that the Texas franchise tax cannot be applied to revenues derived from air commerce or transportation due to federal preemption under the Anti-Head Tax Act (AHTA).
This decision not only secures a victory for American Airlines but also serves as a crucial reference point for other businesses in Texas that may be subject to similar federal protections against state-imposed taxes.
Final thoughts
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