Texas Supreme Court holds that foreign military sales are not sourced to Texas

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June 2020

Overview

The Texas Supreme Court on May 1 ruled that sales of jets made through the Foreign Military Sales program, whereby a foreign country contracts with the US government for certain defense articles and the US government subsequently contracts with a private contractor, should not be sourced to Texas when the US government took possession of the jets in Texas.

The Court determined that, in the unique circumstances presented by the transactions, the pertinent ‘buyers’ for Texas franchise tax purposes are the foreign governments for whom the jets were manufactured and to whom they were ultimately delivered. Because the jets were delivered to ‘buyers’ outside of Texas, the receipts from the sales are not sourced to Texas.

Although the 2005 to 2007 tax years at issue involve the historical earned surplus base of the Franchise Tax, the apportionment statute and rules applied in the decision are substantially similar to those implemented under the current Margin Tax base and, therefore, the decision may be instructive for current Franchise Tax years.

The takeaway

Although this decision involves the historical earned surplus base of the Franchise Tax, the apportionment statute and rules applied are identical in application to those implemented under the current Franchise (i.e., Margin) Tax and, therefore, the decision is instructive for any open franchise tax years.  

In evaluating whether the sale of goods should be sourced to Texas, taxpayers need to determine the ‘market’ or ‘buyer’ of the goods prior to determining the location of delivery.  For sales where the contractual terms result in a delivery location or pick-up location different from that of the ‘market’ for the goods, the state or taxpayer may be able to assert that the ‘buyer’ had not taken possession of the goods upon the initial or intermediate transfer.  The Court in Lockheed Martin differentiated its ruling from a typical sale for resale transaction as discussed in Bullock v. Enserch Exploration, Inc., which looked at the location of delivery of the goods to an interstate pipeline company in Texas rather than the location of the ultimate consumers located outside of Texas.

Taxpayers with FMS sales or other similar fact patterns where an ‘intermediary’ takes possession of the goods on behalf of the ‘buyer’ should evaluate the economic substance of the transactions taking place in Texas and whether the rationale in the Lockheed Martin decision is applicable to their fact pattern.

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Peter Michalowski

State and Local Tax Leader, PwC US

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