Texas High Court Rejects Challenge to Franchise Tax

The Supreme Court of Texas on Friday struck down a challenge by Nestle Inc. and two other businesses targeting the state’s franchise tax.

Lawyers for Nestle and two Texas-based companies, Switchplace LLC and NSMBA, sued the state this year and argued that the tax violated the Texas Constitution’s statement that taxes must be “equal and uniform.”

The franchise tax was revised during a 2006 special session, part of a plan to create more funding for public schools. The revision expanded the kinds of businesses subject to the tax, and made eligible companies like Nestle who manufactured outside of Texas. Retail and wholesale businesses now pay one-half of a percent of their taxable margins, while manufacturers pay 1 percent.

But the Legislature designated companies like Nestle “unitary entities,” meaning that even if they did not manufacture in Texas, they should pay the higher rate.

According to a statement by Supreme Court of Texas staff attorney Osler McCarthy, Nestle argued that it was forced to pay double what it owes. It said the differentiation between manufacturing businesses and retailers violates both the U.S. Constitution’s commerce clause, because it discriminates against “interstate commerce,” and the Texas Constitution’s call for “uniformity.”

Six justices of the state’s Supreme Court, agreeing with lawyers for the comptroller and the attorney general, wrote that where the manufacturing happens does not matter in the context of the franchise tax. Because it is applied equally to manufacturers who do business in Texas, there is nothing wrong with Nestle’s being charged the higher rate. “Location is not the basis for different treatment because in-state companies that manufacture will pay the same rate as Nestle,” wrote Justice Nathan Hecht in the court’s opinion, “and out-of-state companies that do only wholesaling and retailing will qualify for the lower rate.

Justices Don Willett and Debra Lehrmann dissented from the opinion, explaining that the Supreme Court did not have jurisdiction to hear the case. “The Tax Code disallows taxpayer suits like this,” Willett wrote, “and as a prudential matter, deciding whether a statute is constitutional is simply not the stuff of mandamus,” or in other words, not the kind of thing the court should address.

McCarthy said that the aspects of the case addressed by the Texas Constitution can no longer be raised, but that the aspects related to the commerce clause of the U.S. Constitution could be appealed to federal courts. “This court relied on [U.S.] Supreme Court law, and if they decide the court got it wrong, it could be taken up,” he said.  

In the first two years after the revision, the tax brought in nearly $9 billion. Nestle paid nearly $8.7 million in 2012 (it had to pay before filing the suit). So if the Supreme Court had knocked down the tax on constitutional grounds, the Legislature would have had to scramble this session to replace the money.

Nevertheless, some members of the Legislature still think the tax needs to be revisited.

"While the ruling upheld the margins tax, the tax remains a flawed and unreliable source of funding for public education," state Sen. Carlos Uresti, D-San Antonio, a member of the Joint Committee on Public School Finance, said in a news release. "In the next session of the Legislature, the shortcomings of the margins tax should be addressed as part of a larger effort to reform the school finance system."