Detailed Texas Development
A Texas Appeals court recently addressed whether a taxpayer properly included gross proceeds from sales of securities in its sales factor denominator. Under Texas law, generally only net proceeds from the sale of loans or securities are included in the sales factor. An exception to this general rule applies if a loan or security is treated as inventory of the seller for federal income tax purposes. In that case, the gross proceeds from the sale of that loan or security are considered gross receipts included in the sales factor. The taxpayer at issue held certain securities (e.g., commodity futures contracts and options on commodity futures contracts) for the purpose of managing risks associated with price fluctuations. It did not hold these securities as inventory. Nevertheless, the taxpayer maintained that its non-inventory securities were “treated as” inventory securities for federal income tax purposes because it elected under IRC section 475(e) and (f) to apply mark-to-market accounting to these securities and the proceeds from the sales were treated as ordinary income. Inventory securities held by dealers in securities are accounted for using the mark-to-market method and proceeds from the sale of inventory securities are likewise treated as ordinary income. As such, the taxpayer argued that the “tax treatment” of its securities transactions was equivalent to these transactions in terms of being “treated as inventory of the seller for federal income tax purposes.”
The appeals court, affirming the trial court, disagreed. The plain language of the statute made clear that only gross proceeds from securities that the Internal Revenue Code classifies as inventory of the seller are included in the apportionment factor. In the court’s view, the phase “treated as inventory of the seller for federal income tax purposes” referred only to securities that have the unique characteristics of inventory securities; i.e., those that are bought from and sold to customers in the ordinary course of the taxpayer's business. The term did not capture any security that happens to share the “tax treatment” of an inventory security either automatically or by election. Because it was undisputed that securities at issue were not the taxpayer’s inventory as defined by the Internal Revenue Code for federal income tax purposes, the court concluded that the gross proceeds of the sale of those securities could not be considered gross receipts for purposes of the taxpayer’s apportionment calculation. Please contact Jeff Benson with questions on CITGO Petroleum Corporation v. Hegar.
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