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The Texas Supreme Court Holds that the Sale of Military Aircraft to the U.S. Government for Foreign Buyers Could not be Sourced to Texas for Franchise Tax Purposes

By David E. Colmenero and Alex J. Pilawski on May 20, 2020

In a recent decision involving the apportionment factor for Texas franchise tax purposes, the Texas Supreme Court held that the sale of certain military aircraft to the U.S. Government for ultimate delivery to foreign buyers could not be sourced to Texas, even though legal title and possession transferred in Texas, where the U.S. Government’s involvement was statutorily required under federal law. In so holding, the Court disclaimed deciding whether tangible personal property must be sold to a buyer located in Texas or simply delivered to a point in Texas before the sale can be sourced to Texas. See Lockheed Martin Corp. v. Hegar, 2020 WL 2089741 (Tex. 2020). As discussed below, the decision is potentially significant both with respect to what it holds and also what it expressly disclaims to hold.

At issue was a U.S. Government contract with Lockheed Martin Corp. (“Lockheed Martin”) to produce military jets for certain foreign buyers who had contracted with the U.S. Government to purchase those items. Under federal law, any foreign government wanting to buy certain military equipment from a private U.S. contractor is required to contract directly with the U.S. Government for the purchase of those items.  The U.S. Government in turn contacts with a private contractor to produce the items.  Legal title as well as possession and control of the jets transferred from Lockheed Martin to the U.S. Government in Fort Worth, Texas. The U.S. Government then had one of its own pilots fly the jets to the foreign buyer’s location, outside the U.S. 

Lockheed Martin argued proceeds from the sale should be sourced outside Texas. Under former Section 171.1032(a)(1), “gross receipts of a corporation from its business done in this state” for sourcing purposes included “each sale of tangible personal property if the property is delivered or shipped to a buyer in this state regardless of the FOB point or another condition of the sale.” While a key point of contention between the parties was whether “in this state” refers to the buyer or the point of delivery, Lockheed Martin argued that both the ultimate buyer (i.e., the foreign buyers) and the ultimate destination of the aircraft was outside the State.    The Comptroller argued that both the buyer (i.e., the federal government) and the point of delivery (i.e., Fort Worth) were in Texas and therefore the sale should be sourced to Texas.

The Supreme Court agreed with Lockheed Martin.  According to the Court, the “buyer” for franchise tax purposes were in fact the foreign buyers.  The Court stated the “federal mandate” requiring the federal government’s involvement in a sale to foreign buyers is a “statutory condition of the sale” that is disregarded for franchise-tax purposes.   In addition, the sale to the U.S. Government did not reflect a traditional sale for resale, as the Comptroller argued, because the (i) jets were custom built and uniquely designed to the foreign buyer’s specifications, (ii) Lockheed was paid either out of funds the foreign buyer had on deposit with the U.S. Government or by the U.S. Government on credit to the foreign buyer based on a “dependable undertaking” of the foreign buyer; and (iii) the U.S. Government made no profit and incurred no loss on the sale.   The Court also noted that its holding was consistent with the fact that the single-factor apportionment formula is “intended ‘to reflect the contribution of the market state to the taxpayer’s income.’ “ 

The Court further held that the jets were likewise delivered to the buyers outside the State, noting in particular (i) a U.S. Government pilot ferried the aircraft to the purchasing foreign government; and (ii) the receiving foreign government countersigned for the aircraft upon delivery to document receipt, delivery, and transfer of possession of the aircraft from the U.S. Government to the foreign government.  Notably, because the Court held that both the buyer and points of delivery were outside the State, the Court expressly disclaimed deciding whether the phrase “in this state” modifies “delivered or shipped” or “buyer.” 

The Court’s holding is significant particularly because, while the tax years at issue in this case (2005 through 2007) predate the current version of the franchise tax statute, the language at issue in the former Section 171.1032(a)(1)reads the same today in Section 171.103(a)(1). Initially, the Court’s holding seems to make clear that in some instances it may be appropriate to disregard a “reseller” in a transaction for purposes of deciding who the ultimate buyer is.  When exactly it is appropriate to do so outside of the particular facts at issue in Lockheed Martin may need to be resolved on a case-by-case basis.  The dissent summarized the Court’s holding as follows:  “According to the Court’s analysis, Lockheed Martin’s sale generates Texas receipts if the property is delivered to a buyer in Texas unless that sale is a condition of an ‘ultimate’ sale to a non-Texas buyer.”

Equally important is the fact that the Court expressly disclaimed deciding whether the buyer or the point of delivery must be in Texas for the sale of tangible personal property to be sourced to Texas.  Given the volume of transactions that occur every day involving the sale of tangible personal property, this is likely to be a significant, albeit unresolved, issue for many taxpayers. 

Any questions regarding this case can be directed to either David Colmenero at dcolmenero@meadowscollier.com or Alex Pilawski at apilawski@meadowscollier.com.  You can also reach both attorneys at (214)744-3700.