Texas: Sales of Military Jets to Foreign Countries Sourced Outside Texas

The Texas Supreme Court recently addressed how receipts from the sale of F-16 fighter jets produced by a U.S. defense contractor that were delivered to foreign governments should be sourced for Texas franchise tax purposes. Pursuant to the Foreign Military Sales (FMS) program, which provides for federal involvement in sales of U.S.-manufactured military goods to foreign governments, the taxpayer entered into a contract with the U.S. government to produce jets based on the specifications of foreign governments. As required under the FMS program, the transactions involved two contracts: (1) a contract between the taxpayer and the U.S. government and (2) a contract between the U.S. government and the foreign government. After the taxpayer produced the jets in Texas, it transferred legal title to the U.S. government at its Texas facility, as mandated by the FMS program. The taxpayer then requested payment from the U.S. government, and was paid out of funds deposited by the foreign government buyer. The U.S. government then delivered the jet by flying it to the foreign government buyer using a U.S. government pilot. The taxpayer was required to aid with the delivery process. For the tax years at issue, the taxpayer originally sourced these receipts to Texas. Later, it filed a franchise tax refund claim on the basis that the receipts should have been sourced to the foreign locations where the jets were delivered. The refund was denied, and after exhausting all administrative remedies, the taxpayer brought suit. After a trial court and appeals court held in favor of the Comptroller, the taxpayer appealed.

Under Texas Franchise tax law during the tax years at issue, tax was imposed on a corporation’s earned surplus apportioned to Texas. Gross receipts from sales of tangible property were attributed to Texas if the property was delivered or shipped to a buyer in Texas “regardless of the FOB point or another condition of the sale.” The taxpayer argued that the “buyer” in the transaction at issue was the foreign country, and that delivery occurred at the location of the foreign buyer. The Comptroller, on the other hand, argued that the transactions essentially involved two buyers— a sale to the U.S. government and a subsequent sale to the foreign purchaser. The court agreed with the taxpayer, holding that the pertinent buyers in this case were the foreign governments for whom the aircraft were manufactured and to whom they were ultimately delivered.  In the court’s view, the U.S. government’s involvement was simply “a condition of the sale” to the foreign government that was disregarded for franchise tax apportionment purposes. The court next held that because the foreign governments were the “buyers” in the transaction, and “receipt, delivery, and transfer of possession” of the jets to the foreign government occurred in their respective country, the receipts were not sourced to Texas. Thus, the court concluded that the taxpayer was entitled to the franchise tax refund. For more information on Lockheed Martin Corp. v. Hegar, please contact Jeff Benson at 214-840-6911.