The Texas Supreme Court Denies Government Exemption to Independent Contractor but Finds "Oddity" in Texas Comptroller Rule

In a recently issued decision, the Texas Supreme Court provided a holding on two important matters applicable to exemptions from tax. See GEO Grp., Inc. v. Hegar, No. 23-0149, 2025 WL 852414 (Tex. Mar. 14, 2025). The first of its holdings addresses the proper evidentiary standard applicable to establishing qualifications for an exemption in district court. Id at *2. The second addresses whether a private, for-profit corporation qualifies as an “agent” or “instrumentality” of the federal or state government for purposes of the Texas sales and use tax exemption in Texas Tax Code §151.309. Id at *4.

The taxpayer was GEO Group, Inc. (“GEO Group”), which owns and operates correctional facilities throughout the United States for detaining federal and state inmates. Id at *1. It argued that it could purchase various supplies deemed necessary to operate those facilities tax free because it qualified as an “agent” or “instrumentality” of the government under Texas Tax Code §151.309 and Texas Comptroller Rule 3.322(c). Id at *4. It also argued that the Texas Comptroller had erroneously denied its exemption by applying the heightened “clear and convincing evidence” standard rather than applying a “preponderance of the evidence” standard. Id at *2.

The Court agreed with GEO Group that it was only required to prove by a preponderance of the evidence its eligibility for exemption. Id at *3. According to the Court, Comptroller Rule 3.322(a)(2) which states that a taxpayer must prove its eligibility for exemption by clear and convincing evidence applies only to the administrative process. Id. The Court observed that Comptroller’s Rule 3.322 itself states that “‘the section is administered’ using that standard ….” Id. But the Court held that, once a lawsuit has been filed, a court will apply the preponderance of the evidence standard in situations where the Texas Tax Code specifies that the manner of review is trial de novo. Id at *4.

The Court also stated that this reading comports with the scope of the Texas Comptroller’s authority which “does not extend to dictating the standard of proof to be applied in court.” Id at *3. The Court found further support for applying the higher evidentiary standard only to administrative matters in the very first section of the Comptroller’s Rules (i.e., Rule 1.1(a)), which limits matters subject to those rules to “‘contested cases that may be referred to the jurisdiction of the State Office of Administrative Hearings.’” Id at *4. According to the Court, “A taxpayer suit brought after all administrative remedies have been exhausted cannot be referred to the State Office of Administrative Hearings; ‘[t]he district courts of Travis County have exclusive, original jurisdiction of a taxpayer suit.’” Id.

The Court also stated that it recognized the “oddity” created by the Texas Comptroller’s Rule which applies a heightened “clear and convincing evidence” standard to administrative matters. Id. But the Court noted that the Texas Comptroller’s choice to apply this higher standard to administrative matters was unchallenged in this case.

Applying the lower preponderance of the evidence standard, the Court ruled that GEO Group did not qualify for exemption as an agent or instrumentality of the federal or state government. Id at *7. Citing the rule of statutory construction noscitur a sociis, the Court held that the Comptroller’s rule referencing agencies or instrumentalities of a government intends to cover entities “that have either been ‘explicitly and unequivocally’ declared to be a qualifying agency or instrumentality by the government (whether by statute or by contract) or those that could reasonably be viewed as an arm of the government as opposed to merely performing a governmental function.” Id. The Court noted that GEO Group’s contracts with its government clients included language specifically stating that it acted as an independent contractor and that no principal-agent relationship was created. Id. It also noted that those same contracts stated that GEO Group would be responsible for any taxes imposed on the facilities and related property. Id.

While the taxpayer did not prevail in this case, the evidentiary standard enunciated by the Court is noteworthy and potentially beneficial to taxpayers. The Court seems to make clear that the Texas Comptroller may not dictate the evidentiary standard to be applied by a court. But in citing to Texas Comptroller Rule 1.1 for that proposition, which is the first of many Texas Comptroller rules by number, the Court’s holding may also call into question the applicability of other Texas Comptroller standards set out in those rules where a case is tried on a de novo basis in court.

If you have questions regarding the information disclosed above or on any other state tax related matter, please contact David Colmenero at dcolmenero@meadowscollier.com or Alex Pilawski at apilawski@meadowscollier.com. To contact them by phone, please call (214)744.3700.