Summary of Citgo
In Citgo,1 the Texas Third Court of Appeals held that receipts from the sale of non-inventory securities, which the taxpayer elected to be treated as inventory using mark-to-market accounting for federal tax purposes under I.R.C. §475(e) and 475(f), were properly included in the company’s franchise tax apportionment factor at net rather than at gross. Generally, Texas law requires a taxpayer to include receipts from the sale of securities at net.2 However, Texas’s statute provides an exception for receipts for the sale of a security that “is treated as inventory of the seller for federal income tax purposes.” For these sales, the gross proceeds of the sale are included in the taxpayer’s apportionment factor.3
The taxpayer in Citgo did not argue that its securities were actually inventory for federal tax purposes, but rather argued that, due to its mark-to-market elections, its securities were treated as inventory for federal income tax purposes. The Court of Appeals rejected this argument, holding that only receipts from the sale of securities that are actually inventory for federal income tax purposes (i.e., held for sale to customers in the ordinary course of business) may be included in the apportionment factor on a gross basis. The taxpayer petitioned the Texas Supreme Court for review of the Court of Appeals’ decision, which the Texas Supreme Court denied on September 30, 2022.
Takeaways from Citgo
Although the Texas Supreme Court denied review in Citgo, that does not necessarily mean the issue is over. Another recent case, Conagra, presents a similar interpretation question regarding the treatment of non-inventory securities.4 Just as in Citgo, the Court of Appeals held that only receipts from the sale of actual inventory securities are included in the apportionment factor at gross. The taxpayer in Conagra has until November 9, 2022 to file its petition for review. If the taxpayer does file a petition, it may attempt to distinguish its case from Citgo on factual grounds or highlight the significance of the legal question.
One point that not fully addressed by Citgo is how to distinguish between inventory and non-inventory securities. In a footnote, the Court of Appeals suggested that a taxpayer with both securities dealing activities and securities trading activities that were the subject of a mark-to-market election would need to treat the receipts from dealing at gross and the receipts from trading at net, but the Court did not explain how to distinguish between the two activities because the taxpayer in Citgo had not disputed that the receipts at issue were from the sale of non-inventory securities.