Playing Without Paying In Texas

August 1, 2014
Summary.  The Texas pay to play rule is one of the reasons that Texas often ranks near the bottom of scorecards ranking the states on the fairness of their tax appeal processes.  The rule generally requires a taxpayer to pay disputed tax as a prerequisite to a court appeal.  However, recent decisions in Richmont Aviation v. Combs[1] and EVO Inc. v. Combs[2] have recognized that the open courts provision of the Texas Constitution creates a right to play without paying in Texas.  Most state constitutions have some form of open courts provision, so this protection might be available in other states with pay to play rules.

The Texas Pay to Play System.  The Texas Tax Code provides three methods to litigate a tax case in court:  (1) a refund lawsuit - a taxpayer can pay the disputed tax to the Comptroller, file a refund claim, obtain a final order denying the refund claim, and then file a refund lawsuit in district court;[3] (2) a protest lawsuit - a taxpayer can pay the disputed tax to the Comptroller under protest accompanied by a statement of grounds and then file a protest lawsuit in district court;[4] or (3) an injunction lawsuit - a taxpayer can file a statement of grounds with the Texas Attorney General, post a bond with the Comptroller sufficient to guarantee payment of twice the taxes, fees, and penalties, and then file an lawsuit to enjoin the Comptroller from collecting the tax.[5]  However, a taxpayer may be excused from the prepayment requirement if the taxpayer files and oath of inability to pay and the court concludes after a hearing that prepayment would constitute an unreasonable restraint on the party’s right of access to the courts.

The District Court Decision in Richmont Aviation. The dispute began when the Comptroller assessed Texas sales tax on the purchase of an aircraft.  Richmont requested a redetermination claiming the sale for resale exemption, but the Comptroller upheld the assessment.  Richmont then filed an injunction lawsuit in district court without posting the requisite bond.  Following a preliminary hearing, the district court found that “Richmont did not submit sufficient evidence that prepaying the tax or submitting a bond would constitute an unreasonable restraint on its right of access to the courts” and the court granted the Comptroller’s plea to the jurisdiction.

The Appellate Decision in Richmont Aviation.  The Austin Court of Appeals reversed and remanded on the ground that the Texas Tax Code violated the open courts provision of the Texas Constitution and imposed unreasonable financial barriers to court access even though the statute excused prepayment for indigent taxpayers.  The remand indicated that Richmont could proceed without posting a bond or proving that it was unable to post a bond.

Commentary on Richmont Aviation.  The Richmont Aviation decision recognized that a taxpayer may appeal an assessment without paying the assessment or posting a bond.  However, the remedy is not perfect.  The Texas Tax Code provides that if a redetermination or jeopardy determination becomes final without payment, an additional 10 percent penalty is added to the determination.[6]  And interest will continue to accumulate at the prime rate plus one percent.[7]  Litigation without payment raises the stakes for the taxpayer.

Also, the Texas Attorney General could file a collection action during the pendency of the taxpayer’s lawsuit to permanently enjoin collection.[8]  The taxpayer could then seek a temporary injunction, but, ironically, the Texas Rules of Civil Procedure require the applicant to post a temporary injunction bond in an amount fixed by the district court.[9]  The resolution of this Catch-22 situation is not clear.  It may be that a taxpayer is required to post a bond to obtain a temporary injunction even though the taxpayer is not required to post a bond to obtain a permanent injunction.

Finally, if the unpaid tax is franchise tax, the Comptroller will commence proceedings to forfeit the taxpayer’s right to transact business in Texas.[10] Thus, the Richmont Aviation solution is not perfect.

The District Court Decision in EVO.  The dispute began after EVO sought a taxability ruling and the Comptroller’s Tax Policy Division determined that EVO’s wellbore video inspections constituted the taxable sale of tangible personal property rather than the nontaxable sale of an information service.  EVO filed a protest payment lawsuit on two representative transactions, but the Comptroller returned the protest payments because EVO did not file tax returns and did not report tax on all similar transactions.  After various pleas to the jurisdiction and pleading amendments, the parties ultimately agreed to proceed solely on an injunction lawsuit without a bond being posted.  The district court held a bench trial and ruled for EVO on the merits.  The Comptroller filed a notice of appeal and then withdrew the notice so that the district court judgment is now final.

Commentary on EVO.  The EVO decision established that it is possible to obtain a judicial declaratory ruling on taxability without paying the disputed tax.  This outcome was particularly important to EVO because its competitors were not charging sales tax on similar products.  If EVO had followed the informal advice of the Comptroller’s Tax Policy Division and started charging sales tax, EVO would have been at a competitive disadvantage.  Under the Tax Code as written, EVO’s only remedy would have been to charge and remit the tax, request an administrative refund hearing, and then file a refund lawsuit, during which time it would have been losing business to competitors.

The EVO solution has its limitations.  The issues must be “ripe” for adjudication, which means that facts are sufficiently developed so that an injury has occurred or is likely to occur, rather than being contingent or remote.[11]  Ripeness in a tax case may require a definitive agency ruling that is applicable to the taxpayer.  In the EVO case, the Comptroller contended that an email exchange between the taxpayer and Tax Policy was insufficient.  To resolve the issue, the parties agreed to abate the litigation until the Comptroller issued a formal taxability ruling on the transaction at issue.

Furthermore, for the litigation to be worthwhile, the taxpayer must be engaged in singular high-dollar transactions or multiple low-dollar transactions with essentially the same facts.  In EVO’s case, all of its down-hole videos are similar in that they are used for diagnostic purposes, which was the key to the ruling that EVO was providing a nontaxable information service.  So a judicial ruling on two transactions should be applicable to all transactions.

For future applicability, the Texas injunction statute is helpful because it provides that in granting an injunction, the court “shall determine whether the amount of the assessment or collection of which the applicant seeks to prohibit is due and owing.”[12]  Ordinarily, findings of fact are not recited in a judgment, but this statute seems to permit a judgment to include a “determination” of taxability.

If a taxpayer attempts to use the judgment as precedent for future transactions, the Comptroller may argue that the judgment does not apply if the facts are different.  But taxpayers may face that argument any time they attempt to use a prior decision as precedent, whether it be a judicial decision or an agency ruling.

Applicability in other states.  Many state constitutions have some form of open courts provision.[13]  These open courts provisions, including the Texas provision tend to be general.  The Texas provisions states:  "All courts shall be open, and every person for an injury done him, in his lands, goods, person or reputation, shall have remedy by due course of law."[14]  Accordingly, state jurisprudence must also be reviewed to determine how broadly the courts have applied the protection. The states have adopted a “daunting variety of remedy guarantee interpretations.”[15]  Nevertheless, the Texas experience may give credence to the application of the open courts provisions to tax cases in other states.

Conclusion.  The Texas Comptroller has a petition for review of the Richmont case pending before the Texas Supreme Court.  The Texas Supreme Court, like the United States Supreme Court, had discretionary review, so it may or may not act on the case.  Unless and until the Richmont decision is reversed, Texas taxpayers can, at least in some circumstances, play without paying, as evidenced by the EVO litigation.



[1] Richmont Aviation, Inc. v. Combs, Cause No. 03-11-00486-CV (Tex. App. – Austin 2013) (mem. op.) (pet. pending).
[2] EVO Incorporated v. Combs, Cause No D-1-GN-12-002969; In the 126th Judicial District Court of Travis County, Texas (2014).
[3] Tex. Tax Code §112.151, et seq.
[4] Tex. Tax Code § 112.051, et seq.
[5] Tex. Tax Code § 112.101, et seq.
[6] Tex. Tax Code §§ 111.0081 (deficiency determinations) & 111.022 (jeopardy determinations).
[7] Tex. Tax Code § 111.060.
[8] See Tex. Tax Code § 111.010.
[9] Tex. R. Civ. P. 684.
[10] See Tex. Tax Code § 171.251, et seq.
[11] E.g., Waco Independent School Dist. v. Gibson, 22 S.W.3d 849, 852 (Tex. 2000).
[12] Tex. Tax Code § 112.1011(b).
[13]See, http://en.wikipedia.org/wiki/List_of_U.S._state_constitutional_provisions_allowing_self-representation_in_state_courts.
[14] Tex. Const. Art. 1 § 13.
[15] David Schuman, “The Right to a Remedy,” 65 Temp. L. Rev. 1197, 1202 (1992).
The information in this article and any attached or referenced pages have been written or gathered for informational purposes only, are not legal advice, and may now be outdated. Persons receiving information from this article should not act upon the information without seeking professional legal counsel.

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