The Texas Supreme Court held that a defense contractor was entitled to a refund of franchise tax because it had incorrectly sourced certain sales of military aircraft made to foreign governments to Texas on its originally-filed returns for the 2005 through 2007 tax years. The contractor produced military aircraft in Texas, which it sold to the US government as well as certain foreign governments. Under federal arms-control laws, defense contractors are not permitted to sell certain products directly to foreign governments. Instead contractors must make these sales through the federal government, which acts as an intermediary by contracting with the foreign government and taking title to the property before it delivers the property to the foreign government. The contractor argued that these sales did not constitute Texas gross receipts because the foreign government was its customer, despite the fact that legal title in the aircraft transferred from the contractor to the US government at the contractor’s facility in Texas. The Comptroller argued that the transactions consisted of two distinct sales: one from the contractor to the US government and a second from the US government to the foreign purchaser. The Comptroller further argued that even if the foreign governments were the relevant buyers of the aircraft at issue, these aircraft were delivered in Texas and thus the receipts from such sales were properly sourced to Texas.
The Texas Supreme Court agreed with the contractor, holding that the US Government’s involvement as intermediary in sales of aircraft to foreign governments was a “condition of sale” and thus disregarded for franchise tax purposes under Texas’ statute, which was modeled on the Uniform Division of Income for Tax Purposes Act provisions governing the sale of tangible personal property. In particular, the Court found that under the “unique circumstances” presented by the contractor’s transactions, the pertinent customers for Texas franchise tax purposes were the foreign governments for whom the aircraft were manufactured and to whom they were ultimately delivered. The Court did not address the secondary question raised in the case, regarding whether Texas is a place of delivery state or an ultimate destination state. Instead, the Court ruled that the sales were sourced outside of Texas under either interpretation because the buyer was the foreign government and the jets were delivered to the foreign governments outside of Texas.