Glenn Hegar, Comptroller of Public Accounts of the State of Texas And Ken Paxton, Attorney General of the State of Texas v. Autohaus LP, LLP

ACCEPTED

03-15-00427-CV

8232163

THIRD COURT OF APPEALS

AUSTIN, TEXAS

12/14/2015 5:15:01 PM

JEFFREY D. KYLE

CLERK

No. 03-15-00427-CV

__________________________________

FILED IN

In the Court of Appeals 3rd COURT OF APPEALS

AUSTIN, TEXAS

for the Third Judicial District12/14/2015 5:15:01 PM

Austin, Texas JEFFREY D. KYLE

Clerk

___________________________________

GLENN HEGAR, COMPTROLLER OF PUBLIC ACCOUNTS

OF THE STATE OF TEXAS, AND

KEN PAXTON, ATTORNEY GENERAL OF THE STATE OF TEXAS,

Appellants,

v.

AUTOHAUS LP, LLP,

Appellee.

____________________________________

On Appeal from the 419th Judicial District Court

Travis County, Texas

_____________________________________

APPELLANTS’ BRIEF

____________________________________________________

KEN PAXTON CYNTHIA A. MORALES

Attorney General of Texas Assistant Attorney General

State Bar No. 14417420

CHARLES E. ROY Financial Litigation and Charitable Trusts

First Assistant Attorney General Division

JAMES E. DAVIS OFFICE OF THE ATTORNEY GENERAL

Deputy Attorney General for Civil P.O. Box 12548

Litigation Austin, Texas 78711-2548

Telephone: (512) 475-4470

ROBERT O’KEEFE Telecopier: (512) 477-2348

Division Chief cynthia.morales@texasattorneygeneral.gov

Taxation Division

Counsel for Appellants

ORAL ARGUMENT REQUESTED

IDENTITY OF THE PARTIES AND COUNSEL

Appellants: Appellee:

Glenn Hegar Autohaus LP, LLP

Comptroller of Public Accounts of

the State of Texas

Counsel for Appellee at trial and

Ken Paxton on appeal:

Attorney General of the State of Texas

David Colmenero

State Bar No. 18347650

Counsel for Appellants at trial and

on appeal: Alex Pilawski

State Bar No. 24074899

Cynthia Morales

State Bar No. 14417420 MEADOWS, COLLIER, REED,

Assistant Attorney General COUSINS, CROUCH &

UNGERMAN, L.L.P.

OFFICE OF THE ATTORNEY 901 Main Street, Ste. 3700

GENERAL Dallas, TX 75202

Financial Litigation and Charitable Tel: 214-744-3700

Trusts Division Fax: 214-747-3732

P.O. Box 12548 (MC 17) dcolmenero@meadowscollier.com

Austin, Texas 78711-2548 apilawski@meadowscollier.com

Tel: (512) 475-4470

Fax: (512) 477-2348 Former additional counsel for

cynthia.morales@texasattorneygeneral.gov Appellee at trial:

Jason B. Freeman

State Bar No. 24069736

MEADOWS, COLLIER, REED,

COUSINS, CROUCH &

UNGERMAN, L.L.P.

Thomas L. Fahring

State Bar No. 24074194

P.O. Box 43

Anahuac, Texas 77514

i

TABLE OF CONTENTS

Identity of the Parties and Counsel ............................................................................ i

Table of Contents ...................................................................................................... ii

Index of Authorities ...................................................................................................v

Statement of the Case.................................................................................................x

Issues Presented ....................................................................................................... xi

Statement of Facts ......................................................................................................2

I. Statutory and Regulatory Background ............................................................2

A. Texas Tax Code Section 171.1012........................................................3

B. Comptroller Rule 3.588 .........................................................................4

II. Autohaus’s Tax Report and Suit......................................................................7

A. Autohaus’s 2009 Franchise Tax Report and the Comptroller’s

Audit ......................................................................................................7

B. Autohaus’s Protest Letter and Protest Payment ....................................8

C. Autohaus’s suit ....................................................................................10

Summary of Argument ............................................................................................14

Argument..................................................................................................................15

I. Autohaus’s Installation of Automotive Parts onto or into Customer-

Owned Automobiles During Repair or Maintenance Work Is Not the

“Production” of Those Parts Under Section 171.1012, and Therefore

the Labor Costs for Such Installation May Not Be Deducted as Costs

of Goods Sold. ...............................................................................................15

ii

II. Comptroller Rule 3.588(b)(7) Is Both Valid and Constitutional. .................15

A. Costs of goods sold under section 171.1012 include the cost of

acquiring or producing goods for sale, but excludes the cost of

providing services................................................................................16

B. Section 171.1012 is ambiguous in regard to transactions

involving both services and sales and in its use of the word

“installation” because the labor involved in installation can take

place either in the context of the production of a good for sale

(deductible) or in the context of services performed for another

(not deductible). Rule 3.588 addresses this ambiguity. ......................17

C. Autohaus does not “produce” purchased automotive parts when

it installs them onto or into customer-owned automobiles, but

rather it engages in a mixed transaction involving a sale of the

part and the provision of an automotive repair or maintenance

service. Autohaus may deduct as costs of goods sold its cost of

acquiring the automotive parts, but may not deduct labor costs

for “producing” the parts by installing them onto or into

customer-owned automobiles..............................................................20

D. Autohaus’s claim also fails under the application of Rule

3.588(b)(7), and the Rule is both valid and constitutional ..................25

III. Even If a Taxable Entity May Deduct Labor Costs for Installing

Automotive Parts onto or into Customer-Owned Automobiles During

Repairs as Costs of Goods Sold, Material Issues of Fact Preclude the

Granting of Summary Judgment and the Award of a Specific Refund

Amount on Autohaus’s Chapter 112 Claim. .................................................37

IV. The Trial Court Had No Jurisdiction to Consider Autohaus’s

Attempted Challenge Under the Uniform Declaratory Judgment Act to

Comptroller Rule 3.588(b)(7) or Its Request for Attorneys’ Fees and

Court Costs Because Autohaus’s Claim Did Not Fall Within the

Scope of the UDJA and Was, Apart From The Attorneys’ Fees and

Court Costs Request, Redundant of Its Chapter 112 Claim. .........................41

iii

A. A trial court may not grant a declaratory judgment regarding the

validity and constitutionality of a rule under the UDJA, and

therefore the trial court had no jurisdiction to grant a

declaratory judgment nor attorney’s fees or court costs under

the UDJA in this case. .........................................................................42

B. Autohaus did not raise a claim within the ultra vires exception.........47

C. While Texas Government Code section 2001.038 provides

courts with jurisdiction to grant declaratory judgments

regarding the validity of a rule, such provision does not provide

for the award of attorneys’ fees or court costs. Thus even if

Autohaus had raised such a claim, and the trial court had

jurisdiction under section 2001.038 to grant a declaratory

judgment on Rule 3.588(b)(7), it had no jurisdiction to award

attorneys’ fees or court costs. ..............................................................48

D. Autohaus may not recover attorneys’ fees or court costs for

redundant claims that fall under the exclusive jurisdiction of

Chapter 112. ........................................................................................49

E. Conclusion ...........................................................................................52

Prayer .......................................................................................................................53

Certificate of Compliance ........................................................................................54

Certificate of Service ...............................................................................................55

Appendix

iv

INDEX OF AUTHORITIES

Cases

BFI Waste Systems of N. America, Inc. v. Martinez Envtl. Grp.,

93 S.W.3d 570 (Tex. App.—Austin 2002, pet. denied) ................................26

City of El Paso v. Heinrich,

284 S.W.3d 366 (Tex. 2009) .............................................................44, 46, 47

City of McKinney v. Hank’s Rest. Grp., L.P.,

412 S.W.3d 102 (Tex. App.—Dallas 2013, no pet.) ...............................45, 46

City of San Antonio v. Shavano Ranch,

No. 04-13-00623-CV, 2014 WL 631484 (Tex. App.—San Antonio

Feb. 19, 2014, pet. denied) (mem. op.)..........................................................49

Combs v. Chapel Zenray, Inc.,

357 S.W.3d 751 (Tex. App.—Austin 2011, pet. denied) .............................30

Combs v. STP Nuclear Operating Co.,

239 S.W.3d 264 (Tex. App.—Austin 2007, pet. denied) ..............................33

El Paso Natural Gas Co. v. Strayhorn,

208 S.W.3d 676 (Tex. App.—Texarkana 2006, no pet.) ..............................40

Hilco Elec. Coop. v. Midlothian Butane Gas Co., Inc.,

111 S.W.3d 75 (Tex. 2003) .....................................................................22, 30

In re Nestle USA, Inc.,

359 S.W.3d 207 (Tex. 2012) ...................................................................51, 52

In re Nestle USA, Inc.,

387 S.W.3d 610 (Tex. 2012) .........................................................................33

Jackson v. State Office of Admin. Hearings,

351 S.W.3d 290 (Tex. 2011) ...................................................................50, 51

John G. and Marie Stella Kenedy Mem’l Found. v. Dewhurst,

90 S.W.3d 268 (Tex. 2002) ...........................................................................49

v

Kirby Lake Develop., Ltd. v. Clear Lake City Water Auth.,

320 S.W.3d 829 (Tex. 2010) .........................................................................29

MBM Fin. Corp. v. Woodlands Operating Co., L.P.,

292 S.W.3d 660 (Tex. 2009) ............................................................ 50, 51, 52

Myers v. State,

169 S.W.3d 731 (Tex. App.—Austin 2005, no pet.).............................. 27, 28

Nixon v. Mr. Prop. Mgmt. Co., Inc.,

690 S.W.2d 546 (Tex. 1985) ...................................................................37, 40

Patel v. Texas Dep’t of Licensing & Regulation,

469 S.W.3d 69 (Tex. 2015) ...........................................................................48

R.R. Comm’n of Tex. v. Texas Citizens for a Safe Future & Clean Water,

336 S.W.3d 619 (Tex. 2011) ...................................................................27, 32

Sanadco, Inc. v. Office of Comptroller,

No. 03-11-00462-CV, 2015 WL 1478200 (Tex. App.—Austin

March 25, 2015, pet. denied, motion for reh’g of pet.

filed November 12, 2015) .................................................................50, 51, 52

Stiles v. Resolution Trust Co.,

867 S.W.2d 24 (Tex. 1993) ...........................................................................33

Strayhorn v. Raytheon E-Sys., Inc.,

101 S.W.3d 558 (Tex. App.—Austin 2003, pet. denied) ..............................51

Texas Dep’t of Trans. v. Sefzik,

355 S.W.3d 618 (Tex. 2011) ...................................................................44, 46

Texas Entm’t Ass’n, Inc. v. Combs,

431 S.W.3d 790 (Tex. App.—Austin 2014, pet. denied) , cert. denied

sub nom, Texas Entm’t Ass’n Inc. v. Hegar, 135 S.Ct. 1568 (2015) ............ 33

Texas State Bd. of Vet. Med. Examiners v. Giggleman,

408 S.W.3d 696 (Tex. App.—Austin 2013, no pet.)..............................passim

vi

TGS-NOPEC Geophysical Co. v. Combs,

340 S.W.3d 432 (Tex. 2011) .............................................................22, 28, 30

Upjohn Co. v. Rylander,

38 S.W.3d 600 (Tex. App.—Austin 2000, pet. denied) ..........................32, 33

Zimmer US, Inc. v. Combs,

368 S.W.3d 579 (Tex. App.—Austin 2012, no pet.).........................18, 21, 26

Constitutional Provisions

Tex. Const. art. I, § 3 ......................................................................................... 32

Tex. Const. art. VIII, § 1(a) ................................................................................32

U.S. Const. amend. XIV, § 1 ..............................................................................32

Statutes

TEX. CIV. PRAC. & REM. CODE § 37.004 ......................................... 42, 43, 44, 46

TEX. CIV. PRAC. & REM. CODE § 37.006 ............................................... 43, 44, 46

TEX. CIV. PRAC. & REM. CODE § 37.009 ............................................................46

TEX. CIV. PRAC. & REM. CODE § 37.001 ..............................................................x

TEX. GOV'T CODE § 2001.038 ..................................................................... passim

TEX. TAX CODE § 111.002 ..................................................................................18

TEX. TAX CODE § 111.104 ..................................................................................39

TEX. TAX CODE § 112.051 ....................................................................................8

vii

TEX. TAX CODE § 112.052 .............................................................................. ix, 9

TEX. TAX CODE § 112.053 ..............................................................................9, 50

TEX. TAX CODE § 112.060 ................................................................................. 39

TEX. TAX CODE § 112.108 ..................................................................................51

TEX. TAX CODE § 171.001 ....................................................................................2

TEX. TAX CODE § 171.002 ....................................................................................3

TEX. TAX CODE § 171.101 ....................................................................................3

TEX. TAX CODE § 171.106 ....................................................................................3

TEX. TAX CODE § 171.1012 ........................................................................ passim

TEX. TAX CODE § 171.1016 ..................................................................................2

Rules

TEX. R. CIV. P. 166a(c) .......................................................................................37

Regulations

34 TEX. ADMIN. CODE § 3.588 .................................................................... passim

Other Authorities

32 Tex. Reg. 6788 (2007) .....................................................................................4

32 Tex. Reg. 10034 (2007) .................................................................... 4, 5, 6, 29

38 Tex. Reg. 3415 (2013) .....................................................................................5

viii

Legislative Enactments

Act of May 2, 2006, 79th Leg., 3rd C.S.,

ch. 1, § 5, 2006 Tex. Gen. Laws 1, 8 ......................................................... 3, 4, 29

Comptroller’s Decisions

Comptroller Decision 108, 124, STAR Accession No. 201309781H,

September 12, 2013 ............................................................................................28

Comptroller Decision 108, 125, STAR Accession No. 201309781H,

September 12, 2013 ............................................................................................28

Comptroller Decision 108, 126, STAR Accession No. 201309781H,

September 12, 2013 ............................................................................................28

ix

STATEMENT OF THE CASE

Nature of the This is a tax protest suit brought under section 112.052 of the

case: Tax Code and a suit for declaratory judgment.

Trial Court: 419th Judicial District Court, Travis County

The Honorable Darlene Byrne, presiding

Course of Appellee Autohaus LP, LLP (“Autohaus”) filed this lawsuit

Proceedings: against the Texas Comptroller (“Comptroller”) and Texas

Attorney General (collectively “Appellants”), on March 22,

2013. CR4. Autohaus filed a motion for summary judgment

and Appellants filed a response, cross-motion for summary

judgment, and plea to the jurisdiction. CR32–84, 93–177. On

July 22, 2014, the trial court issued an order granting

Autohaus’s motion for summary judgment and denying

Appellants’ motion for summary judgment and plea to the

jurisdiction. CR196–98. After a bench trial on the amount of

attorneys’ fees and court costs to be awarded, the trial court

signed a final judgment on April 29, 2015. CR344–49. A

motion for new trial was filed on May 29, 2015, and was

denied on July 9, 2015. CR350–64, 383. Notice of appeal was

filed on July 10, 2015. CR384–85.

Trial Court’s On April 29, 2015, the trial court entered a final judgment in

Disposition: favor of Autohaus, and ordered Appellants to issue a refund

of $14,227.09 of Texas franchise tax, plus statutory interest.

CR344–49. The trial court also declared that Comptroller

Rule 3.588(b)(7), as it applies to the term “production,” is

invalid and unconstitutional, and awarded attorneys’ fees and

court costs to Autohaus. CR346–48.

x

ISSUES PRESENTED

Section 171.1012 of the Tax Code permits a taxable entity to deduct as costs

of goods sold its direct costs of acquiring or producing goods that it sells to

customers. Taxable entities may deduct labor costs for producing goods for sale,

including installation labor. Comptroller Rule 3.588(b)(7) implements

section 171.1012 and clarifies that installation is production only if the installation

occurs during the manufacturing or construction process.

This appeal decides whether a taxable entity that purchases goods for sale

may, in addition to deducting its costs of acquiring such goods for sale, also deduct

labor costs for “producing” those same goods if it installs those goods onto or into

personal property belonging to a customer. The appeal also involves an attempted

challenge to Comptroller Rule 3.588(b)(7) under the Uniform Declaratory

Judgment Act (TEX. CIV. PRAC. & REM. CODE §§ 37.001, et. seq.)(“UDJA”), and

the award of attorneys’ fees thereunder. The specific issues in this appeal are:

1. Autohaus’s installation of automotive parts onto or into customer-

owned automobiles during repair or maintenance work is not the

“production” of those parts under section 171.1012, and therefore the

labor costs for such installation may not be deducted as costs of goods

sold.

2. Comptroller Rule 3.588(b)(7) is both valid and constitutional.

3. Even if a taxable entity may deduct labor costs for installing

automotive parts onto or into customer-owned automobiles during

repairs as costs of goods sold, material issues of fact preclude the

xi

granting of summary judgment and the award of a specific refund

amount on Autohaus’s Chapter 112 claim.

4. The trial court had no jurisdiction to consider Autohaus’s attempted

challenge under the Uniform Declaratory Judgment Act to

Comptroller Rule 3.588(b)(7) or its request for attorneys’ fees and

court costs because Autohaus’s claim did not fall within the scope of

the UDJA and was, apart from the attorneys’ fees and court costs

request, redundant of its Chapter 112 claim.

xii

No. 03-15-00427-CV

______________________________________

In the Court of Appeals

for the Third Judicial District

Austin, Texas

________________________________________

GLENN HEGAR, COMPTROLLER OF PUBLIC ACCOUNTS

OF THE STATE OF TEXAS, AND

KEN PAXTON, ATTORNEY GENERAL OF THE STATE OF TEXAS,

Appellants,

V.

AUTOHAUS LP, LLP,

Appellees.

__________________________________________

On Appeal from the 419th Judicial District Court, Travis County, Texas

__________________________________________

APPELLANTS’ BRIEF

__________________________________________

TO THE HONORABLE JUSTICES OF THE THIRD COURT OF APPEALS:

Autohaus seeks to deduct, as costs of goods sold, its labor costs for

“producing” purchased automotive parts when it installs those parts onto or into a

customer’s automobile during repairs or maintenance. Autohaus’s claim fails

because its installation of an automotive part onto or into a customer’s automobile

is not the “production” of that part and is not a cost of Autohaus “acquiring or

producing” that part for sale. Autohaus’s challenge to Comptroller

Rule 3.588(b)(7) likewise fails because the rule properly and constitutionally

1

implements the Legislature’s intent that services not be deductible as costs of

goods sold and that a business may only deduct installation labor as costs of

producing a good for sale when materials are installed onto or into personal

property that the business owns and is actually producing for sale.

Autohaus’s attempted declaratory judgment claim under the UDJA fails

because it does not fall within the scope of the UDJA and, apart from an improper

request for attorneys’ fees and court costs, it requests relief redundant of the issues

in its Chapter 112 claim.

The judgment of the trial court should be reversed, the declaratory judgment

portion dismissed for want of jurisdiction, and judgment rendered in favor of

Appellants or, alternatively, the case remanded for a new trial.

STATEMENT OF FACTS

I. STATUTORY AND REGULATORY BACKGROUND

The franchise tax imposes a tax on business entities in Texas for the

privilege of doing business in Texas. TEX. TAX CODE § 171.001(a). At the time at

issue in this appeal, for business entities with more than $10,000,000 in total

revenue1 like Autohaus, the determination of the amount of franchise tax due first

1

Businesses with less than $10,000,000 in revenue also had, and continue to have, the option of

using total revenue instead of margin as their tax base, but that provision is not relevant to this

appeal. See TEX. TAX CODE § 171.1016.

2

required the computation of the entity’s margin, which was the lesser of: (1) 70%

of total revenue; (2) an amount computed by subtracting cost of goods sold from

total revenue; or (3) an amount computed by subtracting compensation paid to

employees during the reporting period from total revenue. 2 Act of May 2, 2006,

79th Leg., 3rd C.S., ch. 1, § 5, 2006 Tex. Gen. Laws 1, 8 (former TEX. TAX CODE

§ 171.101(a)), current version at TEX. TAX CODE § 171.101(a)(1). While section

171.101(a) was amended to allow for an alternative means to determine margin,

the subtraction of costs of goods sold from total revenue remains as an option for

taxpayers. See TEX. TAX CODE § 171.101(a)(1)(B)(ii)(a)(1).

A. Texas Tax Code Section 171.1012

The calculation of cost of goods sold is governed by Tax Code section

171.1012, which permits a business to subtract certain of its costs to acquire or

produce the goods sold. TEX. TAX CODE § 171.1012(a)(1), (b), (c). “Goods” are

real or tangible personal property sold in the ordinary course of business of a

taxable entity, but do not include any services. TEX. TAX CODE § 171.1012(a)(1),

(a)(3)(B)(ii). The entity must own the goods that it sells in order to make a

subtraction for cost of goods sold. TEX. TAX CODE § 171.1012(i). Among the costs

2

Once the margin is calculated, a percentage of that margin is then apportioned to Texas, and

that portion of the margin is subject to tax at the rate of 0.5% for qualifying retailers and

wholesalers and 1.0% for all other taxable entities. TEX. TAX CODE §§ 171.106; 171.002(a), (b).

3

that may be included as cost of goods sold are labor costs to acquire the goods or to

produce the goods. TEX. TAX CODE § 171.1012(c)(1). If an entity produced the

goods that it sold, it may include its cost of materials that are an integral part of the

specific property produced or which are consumed in the ordinary course of

performing production activities. TEX. TAX CODE § 171.1012(c)(2), (c)(3).

Production includes “construction, installation, manufacture, development, mining,

extraction, improvement, creation, raising, or growth.” TEX. TAX CODE

§ 171.1012(a)(2).

The language of these subsections remains unchanged from the time of their

initial enactment in January 1, 2008. Cf. TEX. TAX CODE § 171.1012 to Act of

May 2, 2006, 79th Leg., 3rd C.S., ch. 1, § 5, 2006 Tex. Gen. Laws 1, 13–16.

B. Comptroller Rule 3.588

In September 2007, following the passage of the enacting legislation for

Section 171.1012, the Comptroller proposed Rule 3.588 to implement section

171.1012. See 32 Tex. Reg. 6288, 6288–92 (2007). The rule was adopted on

December 28, 2007, and it went into effect on January 1, 2008, the same day as

section 171.1012. See 32 Tex. Reg. 10034, 10034–38 (2007).

Among the provisions of Rule 3.588 that are relevant to this appeal are the

following subsections, in pertinent part:

4

(b) Definitions. The following words and terms, when used in this

section, shall have the following meanings, unless the context clearly

indicates otherwise.

(3) Goods—Real or tangible personal property sold in the

ordinary course of business of a taxable entity.

(7) Production—Construction, manufacture, installation

occurring during the manufacturing or construction

process, development, mining, extraction, improvement,

creation, raising, or growth;

(10) Tangible personal property—

(B) does not include:

(ii) services.

(c) General rules for determining costs of goods sold.

(7) Mixed transactions. If a transaction contains elements of

both a sale of tangible personal property and a service, a

taxable entity may only subtract as cost of goods sold the

costs otherwise allowed by this section in relation to the

tangible personal property sold;

(8) Owner of goods. A taxable entity may make a subtraction

under this section only if that entity owns the goods.

34 TEX. ADMIN. CODE § 3.588(b)(3), (b)(7), (b)(10)(b)(ii), (c)(7), (c)(8). These

subsections have been in force and unchanged, apart from some renumbering,

since January 1, 2008. Cf. 32 Tex. Reg. at 10035–36 to 38 Tex. Reg. 3415, 3417–

18 (2013). Also pertinent are subsections (d)(1), (d)(2), and (d)(3), which were

amended in 2013 for clarity and to better conform with applicable federal law and

section 171.1012. See 38 Tex. Reg. at 3416, 3419. As originally enacted and in

effect at the time of Autohaus’s claim, those subsections read:

5

(d) Costs of goods sold. The cost of goods sold includes all direct costs of

acquiring or producing the goods, including:

(1) labor costs including W-2 wages, IRS Form 1099 wages,

temporary labor, payroll taxes and benefits;

(2) cost of materials that are an integral part of specific

property produced; [and]

(3) cost of materials that are consumed in the course of

performing production activities[.]

32 Tex. Reg. at 10036–37 (2007) (current version at 34 TEX. ADMIN. CODE

§ 3.588(d)(1), (d)(2), (d)(3)). 3

3

Those sections currently read:

(d) Direct costs. The cost of goods sold includes all direct costs of acquiring or producing the

goods. Direct costs include:

(1) Labor costs. A taxable entity may include in its costs of goods sold

calculation labor costs, other than service costs, that are properly allocable to the

acquisition or production of goods and are of the type subject to capitalization or

allocation under Treasury Regulation Sections 1.263A-1(e) or 1.460-5 as direct

labor costs, indirect labor costs, employee benefit expenses, or pension and other

related costs, without regard to whether the taxable entity is required to or actually

capitalizes such costs for federal income tax purposes;

(2) Incorporated materials. A taxable entity may include in its costs of goods sold

calculation the cost of materials that are an integral part of specific property

produced.

(3) Consumable materials. A taxable entity may include in its costs of goods sold

calculation the cost of materials that are consumed in the ordinary course of

performing production activities.

34 TEX. ADMIN. CODE § 3.588(d)(1), (d)(2), (d)(3).

6

II. AUTOHAUS’S TAX REPORT AND SUIT

A. Autohaus’s 2009 Franchise Tax Report and the Comptroller’s

Audit

Autohaus is an automobile dealership. CR56. It both sells and repairs

automobiles, hiring subcontractors to do some of its repair work. CR56.

In 2009, Autohaus filed its franchise tax report for Report Year 2009

covering its business activities from January 1, 2008 to December 31, 2008, and

applied a cost-of-goods-sold deduction in the amount of $122,210,985 to calculate

a taxable margin in the amount of $17,334,147. CR59. Using such deduction,

Autohaus reported that it owed franchise taxes in the amount of $86,564. CR60.

Autohaus’s claimed cost-of-goods deduction included costs incurred in selling

automobiles (“Selling Costs”), costs of labor and materials to repair automobiles

(“Repair Costs”), and costs of subcontracted labor and materials to repair

automobiles (“Subletting Costs”). CR57.

In the spring of 2012, the Comptroller conducted an audit of Autohaus’s

2009 franchise tax report. CR127. Autohaus was requested to provide records

necessary to conduct the audit, including cost-of-goods-sold workpapers. CR127.

During the conduct of the audit, it was determined that Autohaus was deducting

labor costs (both for its own employees and for its subcontractors) for maintenance

and repairs on customer-owned automobiles as cost of goods sold. CR128. The

Comptroller disallowed those deductions, but allowed cost-of-goods-sold

7

deductions for both labor and automobile parts when Autohaus provided

documentation that the work was part of production activity on a car owned by

Autohaus prior to offering it for sale in the ordinary course of business. CR128.

The Comptroller also allowed cost-of-goods-sold deductions for the cost of any

automobile parts used in any repair performed by Autohaus or its subcontractors

when Autohaus provided supporting documentation. CR128.

On December 5, 2012, following the audit of Autohaus’s 2009 franchise tax

report, the Comptroller disallowed a portion of the claimed cost-of-goods-sold

deduction, totaling $2,481,302, and adjusted the cost-of-goods-sold deduction to

$119,729,683, resulting in additional franchise tax due by Autohaus of $12,384.18.

CR68, 139–40, 142. The disallowed costs were in five categories labeled by

Autohaus as follows: (1) SRV CUST LBR MB; (2) SRV WARR LAB M/B; (3)

SRV SUBLET RPR M/B; (4) CUST LBR-MECH L/T; and (5) 4Y/50K MAINT

MB. CR70, 140.

B. Autohaus’s Protest Letter and Protest Payment

On January 14, 2013, Autohaus tendered to the Comptroller a protest

payment of the additional franchise tax assessed and the interest due thereon, a

total of $14,227.09, along with a written protest letter. CR148, 13–16, 71–76,

153–58; see TEX. TAX CODE § 112.051 (requiring payment of taxes at issue due

along with written protest as a prerequisite for filing suit under Subchapter B of

8

Chapter 112 of the Tax Code); TEX. TAX CODE § 112.052 (permitting the filing of

a suit against the state to recover taxes required to be paid to the state if the person

has first paid the tax at issue under protest); TEX. TAX CODE § 112.053(b) (limiting

the issues to be determined in the suit to those arising from the reasons expressed

in the written protest as originally filed).

In its protest letter, Autohaus explained that its costs-of-goods-sold

deduction included costs incurred in selling automobiles (“Selling Costs”), in

repairing automobiles (“Repair Costs”), and in subletting such repair work to

others (“Subletting Costs”). CR13, 71, 153. Autohaus specified that the only

matters at issue were the disallowed costs-of-goods-sold deductions for Repair

Costs and Subletting Costs incurred in repairing automobiles. CR14, 72, 154.

Under the “Statement of Grounds for Protest” section of its protest letter,

Autohaus asserted generally that it was entitled to include as costs of goods sold:

(1) “all of its Repair Costs, including labor costs, and all of its

Subletting Costs, including labor costs and costs of materials;”

or alternatively,

(2) “the costs of materials that were included in its Subletting

Costs.”

CR14, 72, 154. Autohaus also listed twelve additional specific assertions in the

protest letter under its “Statement of Grounds for Protest”, including that:

 the Comptroller’s Rule 3.588(b)(7) “does not properly reflect

legislative intent and is therefore invalid” (No. 5);

9

 the Comptroller’s denial of “[Autohaus’s] right to include” the Repair

Costs and Subletting Costs at issue as costs of goods sold, “while

permitting other similarly situated taxpayers to includes such costs as

costs of goods sold”

o “results in the disparate treatment of taxpayers within the same

class” in violation of the equal and uniform taxation

requirement of “Section 1 of Article VIII of the Texas

Constitution” (No.8);

o “constitutes the imposition of unequal rights among taxpayers

and the granting of an exclusive separate privilege to certain

taxpayers in violation of Section 3 of Article I of the Texas

Constitution” (No.9);

o “constitutes a violation of [Autohaus’s] rights under the Equal

Protection Clause of the United States Constitution” (Nos.10

and 11); and

o “constitutes a violation of [Autohaus’s] rights under the Due

Process Clause of the United States Constitution” (No.12).

CR14–16, 72–74, 154–56. Autohaus tendered with its letter a protest payment of

$14,227.09. CR17–18, 157–58.

C. Autohaus’s suit

On March 22, 2013, Autohaus filed suit against Appellants “pursuant to

Chapters 112 and 171 of the Texas Tax Code,” and raised five claims:

• “Plaintiff is Entitled to Include Labor Costs in its Cost of

Goods Sold Deduction;”

• Plaintiff is Entitled to Include Subletting Costs in its Cost

of Goods Sold Deduction;”

• “The Comptroller’s Assessment of Tax Violates

Plaintiff’s Rights Under the Texas Constitution;”

10

• “The Comptroller’s Assessment of Tax Violates

Plaintiff’s Rights Under the U.S. Constitution;” and

• “Plaintiff is Entitled to Declaratory Judgment and

Recovery of Attorney’s Fees under the Texas Uniform

Declaratory Judgment Act.”

CR4, 6, 8, 9, 11, 151, 163, 165, 166, 168. As relief, Autohaus prayed for:

(1) a judgment for a refund of the $14,227.09 in taxes and interest that

were paid under protest;

(2) statutory interest on the same;

(3) costs of court;

(4) declarations under the Texas Uniform Declaratory Judgment Act

(“UDJA”) that:

(a) “[Autohaus] is entitled to a refund of the $14,227.09 in

franchise tax and interest it paid under protest;”

(b) “The Comptroller’s collection of tax is invalid because the

Comptroller has denied [Autohaus’s] rights to equal protection

and equal and uniform taxation;”

(c) “The Comptroller’s collection of tax violates [Autohaus’s]

equal protection and due process rights under the United States’

Constitution and is therefore invalid;” and

(d) “The Comptroller’s collection of tax violates the equal and

uniform taxation provision of the Texas Constitution and is

therefore invalid;”

(5) “Recovery of attorney’s fees as authorized by Tex. Civ. Prac. & Rem.

Code § 37.009;”

11

along with “[s]uch other relief as to which Plaintiff is justly entitled in law or

equity.” CR11, 12, 168, 169.

Autohaus filed Plaintiff’s Motion for Summary Judgment and Incorporated

Brief on May 23, 2014. CR32–84. Appellants filed Defendants’ Response to

Plaintiff’s Motion for Summary Judgment, Defendants’ Cross-Motion for Summary

Judgment and Defendants’ Plea to the Jurisdiction on June 17, 2014. CR93–177.

The trial court heard both sets of motions on July 9, 2014, and on July 22, 2014

issued orders granting Autohaus’s motion for summary judgment and denying

Appellants’ cross-motion for summary judgment and plea to the jurisdiction.

CR196–98.

In its order granting Autohaus’s motion for summary judgment, the trial

court ordered that Autohaus was entitled to: (1) “include all of its labor costs

associated with Repair Costs and all of its labor costs and materials costs

associated with Subletting Costs involved in the installation of automotive parts in

its cost of goods sold deduction;” (2) “a refund of the $14,227.09 in franchise tax

that it paid in protest;” (3) “[statutory] interest accruing on the amount of

[Autohaus’s] refund claim;” and (4) “attorneys’ fees.” CR197–98. The trial court

also ruled that “Texas Comptroller Rule 3.588(b)(7) as it applies to the term

“production” is unconstitutional and invalid[.]” CR197. Appellants filed a motion

for reconsideration that was denied on October 30, 2014. CR260.

12

A bench trial was held on April 21, 2015 to determine the amount of

attorneys’ fees and court costs to be awarded. CR344–45; 2RR5–7. Following the

hearing, the trial court signed a “Proposed Final Judgment,” CR337–41, but later

vacated it and issued a final judgment signed on April 29, 2015. CR344–49. The

Court’s final judgment, which incorporated its July 22, 2014 rulings, ordered that

Autohaus recover from Appellants “the following specific relief:

A. Plaintiff is entitled to include all of its labor costs associated with

Repair Costs and all of its labor costs and materials costs associated

with Subletting Costs involved in the installation of automotive parts

in its cost of goods sold deduction.

B. Texas Comptroller Rule 3.588(b)(7) as it applies to the term

‘production’ is unconstitutional and invalid.

C. Plaintiff is entitled a refund of the $14,227.09 in franchise tax that it

paid in protest.

D. Plaintiff is entitled to interest accruing on the amount of its refund

claim as provided under Texas Tax Code § 112.060 and Texas Tax

Code § 112.058(a)(4)[.]”

CR346–47. The court also awarded Autohaus court costs in the amount of $274.80

and “reasonable and necessary attorneys’ fees incurred in pursuing its claim for

declaratory relief” in certain specified amounts for trial and appeal. CR347.

Appellants filed a motion for new trial on May 29, 2015, which was denied,

and notice of appeal was filed on July 10, 2015. CR 350–64, 383, 384–85.

13

SUMMARY OF ARGUMENT

Autohaus’s Chapter 112 claim fails because its labor costs for installing

purchased automotive parts into or onto customers’ automobiles during repairs are

not costs of “acquiring or producing” the automotive parts. Autohaus purchases the

parts for resale and so may deduct its costs of acquiring the parts; it does not

produce the parts and so cannot deduct production costs. Autohaus’s installation of

the parts is not production of the parts, but rather a mixed transaction involving a

sale of goods (automotive parts), and the provision of services (repairs). For

installation labor to be a production cost, an entity must be installing materials onto

or into property that it owns and is producing for sale. Autohaus does not own the

customer’s automobiles onto or into which the automotive parts are installed nor is

it producing the customer’s automobiles for sale.

Autohaus’s challenge to Rule 3.588(b)(7) fails because the rule validly and

constitutionally implements the Legislature’s intent in Tax Code section 171.1012,

and Autohaus provided no evidence supporting its constitutional challenges.

Autohaus’s attempted UDJA claim fails because a challenge to the

constitutionality or validity of an administrative rule does not fall within the scope

of the UDJA, and Autohaus’s claim was redundant of, and preempted by, its

Chapter 112 claim. The court had no jurisdiction to grant any declaratory

judgment or award attorneys’ fees and costs.

14

ARGUMENT

I. AUTOHAUS’S INSTALLATION OF AUTOMOTIVE PARTS ONTO OR INTO

CUSTOMER-OWNED AUTOMOBILES DURING REPAIR OR MAINTENANCE

WORK IS NOT THE “PRODUCTION” OF THOSE PARTS UNDER SECTION

171.1012, AND THEREFORE THE LABOR COSTS FOR SUCH INSTALLATION

MAY NOT BE DEDUCTED AS COSTS OF GOODS SOLD.

II. COMPTROLLER RULE 3.588(b)(7) IS BOTH VALID AND CONSTITUTIONAL.

(Argued Jointly)

In its Tax Code Chapter 112 claim for a refund of franchise taxes paid under

protest, Autohaus seeks to deduct labor costs for repair work performed on

customer-owned automobiles as costs of goods sold when automotive parts are

installed during the repair. Autohaus asserts that when repair work includes the

installation of an automobile part, it is not a repair service to the customer, but the

act of producing an automotive part for sale, and therefore both the actual cost of

the part and the labor costs of the repair are deductible as costs of producing the

automotive part.

But while Autohaus is correct that it may deduct its costs of acquiring the

automotive parts that it later sells as part of a repair to a customer-owned

automobile—i.e., its actual costs to purchase the part—it may not also deduct labor

costs for “producing” that same part when installing it onto or into a customer’s

automobile during those repairs. All of the labor costs that are at issue in this case

were incurred by Autohaus when providing a mechanic to perform the service of

15

repairing customer’s automobiles. Autohaus does not “produce” the automotive

parts that its mechanics install during repairs of customer’s vehicles; its only costs

of “acquiring or producing” the parts for sale are its costs of purchasing those

parts. It is therefore not entitled to deduct repair services labor as costs of goods

sold.

Comptroller Rule 3.588(b)(7) clarifies that only installation done as a part of

manufacturing or construction can be considered “production.” Contrary to

Autohaus’s contentions, the Rule does not conflict with either Tax Code section

171.1012 or the Texas or U.S. Constitutions. Moreover, even without the

application of Rule 3.588(b)(7) to Autohaus’s claim, Autohaus’s Chapter 112

claim fails because Autohaus does not produce the automotive parts that it

purchases for sale to its customers as part of its repair services.

A. Costs of goods sold under section 171.1012 include the cost of

acquiring or producing goods for sale, but excludes the cost of

providing services.

At its most fundamental level, section 171.1012 creates certain threshold

requirements for the deduction of costs as costs of goods sold.

Firstly, a taxable entity must have sold “goods”—i.e., real or tangible

personal property, but not services—in the ordinary course of its business. TEX.

TAX CODE § 171.1012(a)(1), (a)(3)(A), (a)(3)(B).

16

Secondly, the taxable entity must have had costs of “acquiring or producing”

the goods that it sold, because it is the direct costs of the entity in acquiring or

producing these goods for sale that are deductible as costs of goods sold. TEX. TAX

CODE § 171.1012(c).

The more detailed descriptions under section 171.1012 of what specific costs

qualify to be deducted must be considered in light of these two threshold

requirements. Consistent with these threshold requirements, the Legislature

requires that the taxable entity be the actual owner of the “real or tangible personal

property” that will be “sold in the ordinary course of business.” TEX. TAX CODE

§ 171.1012(a)(1), (a)(3), (i). Thus, a taxable entity may not deduct as costs of

goods sold either the costs of performing services or the costs of acquiring or

producing goods that it does not own or that it does not sell. TEX. TAX CODE

§ 171.1012(a)(1), (a)(3)(B)(ii), (i).

B. Section 171.1012 is ambiguous in regard to transactions involving

both services and sales and in its use of the word “installation”

because the labor involved in installation can take place either in

the context of the production of a good for sale (deductible) or in

the context of services performed for another (not deductible).

Rule 3.588 addresses this ambiguity.

Section 171.1012(c) allows the deduction of all direct costs for “acquiring or

producing the goods” sold, including labor costs and “materials that are an integral

part of specific property produced” or “materials that are consumed in the ordinary

course of performing production activities.” TEX. TAX CODE § 171.1012(c)(1), (2),

17

(3). Section 171.1012(a)(2) defines “production” as including “construction,

installation, manufacture, development, mining, extraction, improvement, creation,

raising, or growth.” TEX. TAX CODE § 171.1012(a)(2).

However, section 171.1012 does not detail how “mixed transactions” that

may involve both the sale of a good and the provision of a service—such as auto

repairs, hair styling, and medical care—are to be handled. Likewise, section

171.1012 does not define the term “installation.” This creates a latent ambiguity as

personal property can be installed either onto or into property owned by another

party during the rendition of a service for that party (e.g., the installation of hair

extensions onto a person’s hair during styling of a customer’s hair), or onto or into

property owned by the business entity in the course of producing a good for sale by

that entity (e.g., installing hair, beads, or feathers onto a hair extension which will

then be sold to a customer). Both of these ambiguities in the administration of the

statute can be addressed by an administrative rule promulgated by the Comptroller.

See Zimmer US, Inc. v. Combs, 368 S.W.3d 579, 586 (Tex. App.—Austin 2012, no

pet.)(holding that Comptroller may address ambiguity in administration of statute

by administrative rule and noting that “[T]he legislature does not need to include

every specific detail or anticipate all unforeseen circumstances.”) (internal

quotations and citations omitted); see also TEX. TAX CODE § 111.002(a) (providing

18

Comptroller authority to adopt rules for enforcement of Tax Code provisions and

collection of taxes).

The Comptroller addressed both of these ambiguities in Rule 3.588,

specifically in subsections (c)(7)(“Mixed transactions”)—providing that if “a

transaction contains elements of both a sale of tangible personal property and a

service, a taxable entity may only subtract as cost of goods sold the costs otherwise

allowed by this section in relation to the tangible personal property sold”—and in

(b)(7), which specifies that installation in the context of production means

“installation occurring during the manufacturing or construction process.” 34 TEX.

ADMIN. CODE § 3.588 (b)(7), (c)(7).

Subsections (b)(7) and (c)(7) of Rule 3.588 clarify that where there is a

mixed transaction involving a service that includes the installation of a product

owned by a business onto or into property owned by a customer, the installation

labor retains its character as a service to the customer and so is not deductible as a

cost of goods sold; rather, only the cost of the actual product owned by the

business and sold to the customer is deductible as a cost of goods sold. See 34 TEX.

ADMIN. CODE § 3.588(b)(7), (c)(7). If, however, the business itself installs a

product owned by the business onto or into property owned by the business for

purposes of producing a good for sale in the ordinary course of business, the

19

installation labor in that case is part of the production of the good for sale and so

deductible as a cost of goods sold. See 34 TEX. ADMIN. CODE § 3.588 (b)(7).

C. Autohaus does not “produce” purchased automotive parts when it

installs them onto or into customer-owned automobiles, but

rather it engages in a mixed transaction involving a sale of the

part and the provision of an automotive repair or maintenance

service. Autohaus may deduct as costs of goods sold its cost of

acquiring the automotive parts, but may not deduct labor costs

for “producing” the parts by installing them onto or into

customer-owned automobiles.

The Texas Legislature, recognizing that some businesses purchase goods for

sale and others produce goods for sale, permits a taxable entity to deduct as costs

of goods sold its direct costs of “acquiring or producing” the goods that it sells.

TEX. TAX CODE § 171.1012(c). Autohaus purchases automotive parts for resale to

its customers as part of repairs and so is entitled to deduct its direct costs of

acquiring automotive parts that it sold. See TEX. TAX CODE § 171.1012(c). The

Comptroller recognized this in its audit and allowed such deduction for any

amount that Autohaus established as purchase costs for automotive parts sold.

CR128. The Comptroller has always maintained that Autohaus is entitled to a cost-

of-goods-sold deduction for its costs of purchasing automotive parts that it sold in

the ordinary course of business, including parts sold as part of repair and

maintenance work, and it provided Autohaus an opportunity to present those costs

during the audit. CR128.

20

Autohaus, however, claims that it is entitled to deductions for both costs of

“acquiring” the automotive parts (their purchase price), and costs of “producing”

those same purchased automotive parts. Autohaus theorizes that because section

171.1012(a)(2) states that “‘Production’ includes . . . installation,” Autohaus’s act

of installing the purchased automotive parts onto or into customer’s automobiles

during repairs is “producing” those parts for sale, and it may deduct its labor costs

for those repairs as costs of “production.” Autohaus misunderstands and misapplies

section 171.1012.

Firstly, section 171.1012(c) provides for the deduction of costs of “acquiring

or producing” the goods that an entity sells—in other words, the cost to buy or the

cost to make those goods. TEX. TAX CODE § 171.1012(c)(emphasis added).

Autohaus does not make the automobile parts that it sells; it purchases them.

CR57, 128. As discussed infra, the act of installing them onto or into a customer’s

automobile does not render Autohaus the “producer” of those purchased parts.

Secondly, section 171.1012(a)(2) does not state that every occasion of every

act named therein is the production of a good for sale, nor is it reasonable to apply

such a broad interpretation. See TEX. TAX CODE § 171.1012(a)(2). Not every act of

“improvement,” or “growth,” or “raising,” for example, is the production of a good

for sale. Rather, the subsection names acts that may be “include[d]” in the

21

production of goods for sale for those entities that make rather than buy goods for

sale. See id.

Words must be interpreted in their statutory context. TGS-NOPEC

Geophysical Co. v. Combs, 340 S.W.3d 432, 441 (Tex. 2011). The scope of a

general word is therefore constrained by its statutory context. When a statute uses

“words of a general nature” in connection with “particular objects or classes of

persons or things, the meaning of the general words will be restricted to the

particular designation.” Hilco Elec. Coop. v. Midlothian Butane Gas Co., Inc., 111

S.W.3d 75, 81 (Tex. 2003). Thus “installation,” as used in the context of

“production” in section 171.1012, should not be construed as applying to

installations that are not a part of actually producing a good for sale.

This is particularly significant in the case of installation. The distinction

between installing personal property onto or into property owned by a customer, or

onto or into property owned by the business, is critical in determining whether the

installation labor is a service by the business, and so not deductible, or part of

production costs for the business, and therefore deductible. Section 171.1012

highlights this distinction by specifying that a business may only “make a

subtraction under this section in relation to the cost of goods sold only if that entity

owns the goods” which are sold. TEX. TAX CODE § 171.1012(a)(1), (i). Section

171.1012 further makes clear that in the context of the production of goods, the

22

business must own the property onto or into which materials are being installed in

order for the installation to be “production” because, in order to be direct costs of

producing a good, materials must be “an integral part of specific property

produced.” TEX. TAX CODE § 171.1012(c)(2).

In the context of installation of parts onto or into an automobile, the item or

“good” being “produced” by the “installation” of “materials” is the automobile—

not the automotive part which, in the context of “installation,” is the “material”

being installed onto or into the “good.” Thus, in order to deduct the costs of

installing automotive parts onto or into an automobile as costs of producing the

good (the automobile), Autohaus must own the automobile onto or into which the

parts are being installed. See TEX. TAX CODE § 171.1012(a)(1), (a)(2), (c)(2), (i).

Here Autohaus is seeking the deduction of labor for repairs only on customer-

owned automobiles. Its installation of parts in that context is a service installation,

which is not deductible under section 171.1012, and not a production cost for the

production of an automobile that Autohaus owns and is preparing for sale.

Autohaus asserts that the good that it is “producing” is the automotive parts,

but its argument that it “produces” automotive parts by installing them is a

tautology. Installed materials must be “an integral part of the specific property

produced” in order to be deductible as costs of “producing” a good. See TEX. TAX

CODE § 171.1012(c)(2). Thus if the “goods” being produced are the automotive

23

parts, then the material “installed”—here, the automotive parts—must be an

integral part of the automotive parts being produced. In other words, the

automotive parts must be installed onto or into themselves and be an integral part

of themselves. Autohaus’s contention that it may “produce” a good by installing

that same good is an unreasonable construction of subsections 171.1012(a)(2) and

(c)(1).

Rather, for Autohaus to be able to receive a deduction for “installation”

relative to the “production” of an automotive part, it must be installing some

material onto or into that automotive part which becomes an integral part of the

automotive part. For example, if Autohaus made a refurbished engine for the

purpose of selling that engine to a customer, and in the course of making that

engine it installed screws which became an integral part of that engine, Autohaus

could claim the costs of the screws as materials used in the production of the

engine and could claim the costs of labor to make that engine, including the labor

to install the screws.

But that is not the case here. Autohaus did not install anything onto or into

the automotive parts to “produce” them; it simply acquired them by purchase.

Autohaus’s act of installing purchased automobile parts onto or into customers’

automobiles as part of repairs is not the “production” of the automotive parts, but

rather simply a mixed transaction involving both the sale of a good (the automotive

24

part) and the rendering of a service (the repair labor). Under the plain language of

Comptroller Rule 3.588(c)(7), which was not challenged in this case, if “a

transaction contains elements of both a sale of tangible personal property and a

service, a taxable entity may only subtract as cost of goods sold the costs otherwise

allowed by this section in relation to the tangible personal property sold”—in this

case, its actual cost of purchasing the automotive parts. 34 TEX. ADMIN. CODE

§ 3.588(c)(7).

Autohaus’s claim for a cost-of-goods-sold deduction for labor costs in

“producing” automotive parts by installing them onto or into customer-owned

automobiles should be denied. The portion of the trial court’s judgment granting

Autohaus’s Chapter 112 claim seeking a refund of franchise taxes paid in protest

and all relief granted thereunder should be reversed and a take-nothing judgment

entered in favor of Appellants.

D. Autohaus’s claim also fails under the application of Rule

3.588(b)(7), and the Rule is both valid and constitutional

The above analysis demonstrates that Autohaus’s Chapter 112 claim fails

even without the application of Comptroller Rule 3.588(b)(7) which Autohaus

challenges. Autohaus’s claim also fails when the language of Comptroller Rule

3.588(b)(7) is applied, as Autohaus’s installation of the automotive parts did not

occur “during the manufacturing or construction process” of the automotive parts,

but during the course of repairs to customer’s automobiles. See 34 TEX. ADMIN.

25

CODE § 3.588(b)(7); CR 56; BFI Waste Systems of N. America, Inc. v. Martinez

Envtl. Grp., 93 S.W.3d 570, 575 (Tex. App.—Austin 2002, pet. denied) (holding

that valid agency rules have same force and effect as statutes). For this reason

also, the portion of the trial court’s judgment on Autohaus’s Chapter 112 claim and

all relief thereunder should be reversed and a take-nothing judgment entered in

favor of Appellants.

The trial court also declared that “Texas Comptroller Rule 3.588(b)(7) as it

applies to the term “production” is unconstitutional and invalid.” CR 197, 346. As

demonstrated infra in Issue IV, the trial court had no jurisdiction to consider

Autohaus’s attempted declaratory judgment claim and that claim should be

dismissed for want of jurisdiction. However, even if the trial court had jurisdiction

to consider such claim, Autohaus’s challenges to the validity and constitutionality

of the Rule fail on the merits.

1. Autohaus’s challenge to the Rule’s validity

Autohaus argues that Rule 3.588(b)(7) is invalid because it includes the

clarifying language “occurring during the manufacturing or construction process”

in reference to “installation”—words which do not appear in the language of

section 171.1012(a)(2).

But, as discussed supra, the term “installation” as used in section

171.1012(a)(2) is ambiguous, the Comptroller may adopt rules that reasonably

26

clarify the terms used in a statute, and an adopted rule does not contradict a statute

by the mere addition of words not existing in the statute. See Zimmer US, Inc., 368

S.W.3d at 586; Myers v. State, 169 S.W.3d 731, 735 (Tex. App.—Austin 2005, no

pet.). Governmental agencies have a “unique understanding” of the statutes they

administer, and a court will generally uphold an agency’s interpretation of a statute

it is charged with enforcing so long as the construction is reasonable and does not

contradict the plain language of the statute. R.R. Comm’n of Tex. v. Texas Citizens

for a Safe Future & Clean Water, 336 S.W.3d 619, 625, 629 (Tex. 2011). The

court “need not consider whether the Commission's construction is the only—or

the best—interpretation in order to warrant [the court’s] deference,” but only

whether the “agency’s interpretation of a statute it is charged with administering to

be reasonable and in accord with the statute's plain language.” Id. at 628. “It is

precisely when a statutory term is subject to multiple understandings that [a court]

should defer to an agency’s reasonable interpretation” and thus where a “statutory

scheme is subject to multiple interpretations, [a court] must uphold the enforcing

agency’s construction if it is reasonable and in harmony with the statute.” Id. at

628, 629.

In determining whether an agency’s interpretation is reasonable, a court

begins with the language in the statute itself. Id. at 628. In determining legislative

intent, a court must consider the statute’s meaning in the context of the entire

27

statute, not merely review words, phrases, or clauses in isolation. Id.; Myers, 169

S.W.3d at 733. Furthermore, courts should not construe a provision in a manner

inconsistent or out of harmony with other provisions of the statute even though the

provision might be susceptible to such a construction standing alone. Myers, 169

S.W.3d at 733–34. Words in a statute cannot be interpreted apart from their

context, and in interpreting statutory terms, a court should consider the term’s

meaning in the context of the entire statute. TGS-NOPEC Geophysical Co, 340

S.W.3d at 441.

The existing ambiguity in section 171.1012 regarding the term “installation”

could be argued to allow businesses to deduct the costs of services to customers as

costs of goods sold, in contravention to the fundamental principles of section

171.1012 prohibiting the inclusion of services as part of a cost-of-goods-sold

deduction. Indeed, this is precisely what Autohaus is attempting to do—deduct its

costs for labor for maintenance and repair services on customer-owned

automobiles as costs of goods sold.

The Comptroller, anticipating such potential misapplications of the statute,

adopted Rule 3.588(b)(7) to ensure that the Legislative intent of subsection

171.1012(a)(3)(B)(ii), prohibiting the inclusion of services as costs of goods sold,

28

was carried out. 4 The Comptroller has upheld that interpretation in Comptroller

Decision 108, 124, Comptroller Decision 108, 125, and Comptroller Decision 108,

126, STAR Accession No. 201309781H, September 12, 2013 (holding that a

taxpayer may not deduct labor charges for repair services as costs of goods sold,

but may deduct labor related to producing body parts that it sells to end-use

customers).

Although “services” is not defined in the Tax Code, the Texas Supreme

Court has recognized that it “includes generally any act performed for the benefit

of another under some arrangement or agreement whereby such act was to have

been performed.” Kirby Lake Develop., Ltd. v. Clear Lake City Water Auth., 320

S.W.3d 829, 839 (Tex. 2010) (internal quotations and citations omitted). Rule

3.588(b)(7) effectively precludes labor costs for installations performed “for the

benefit of another,” i.e., installation services, from being deducted as costs of

goods sold. This is in accordance with the legislative mandate that costs of

providing services may not be deducted as cost of goods sold and ensures that

4

This rule has been in effect as long as section 171.1012 itself. See 32 Tex. Reg. 10034, 10034–

38 (2007); Act of May 2, 2006, 79th Leg., 3rd C.S., ch. 1, § 5, 2006 Tex. Gen. Laws 1, 13–16.

The Legislature, although amending section 171.1012 in other respects in the interim, has never

enacted any amendment that would negate the Comptroller’s interpretation of installation for the

purposes of production as being only installation occurring during the manufacturing or

construction process.

29

installation labor costs are only included as costs of goods sold when they are not

performed as a service.

Additionally, including the clarifying phrase “during the manufacturing or

construction process” to the term installation as used in the context of production,

ensures that the term installation will be interpreted in the same manner as the

other actions included in “production”—construction, manufacture, development,

mining, extraction, improvement, creation, raising, or growth—all of which

describe actions in which the producer is bringing forth a product that it owns for

ultimate sale, not an action performed as a service on behalf of another on property

belonging to another. See TGS-NOPEC Geophysical, 340 S.W.3d at 441–42

(discussing the principle of statutory construction known as noscitur a sociis, or “it

is known by its associates” that directs that similar terms be interpreted in a

similar manner and applying it to terms in a statute); Hilco Elec. Coop., 111

S.W.3d at 81(“[W]hen words of a general nature are used in connection with the

designation of particular objects or classes of persons or things, the meaning of the

general words will be restricted to the particular designation.”); Combs v. Chapel

Zenray, Inc., 357 S.W.3d 751, 758–60 (Tex. App.—Austin 2011, pet. denied)

(discussing the interpretation of the words “attach” and “attaching” in the context

of a tax statute and rejecting taxpayer’s “plain meaning” argument in favor of

Comptroller’s narrow construction). Thus Rule 3.588 does not conflict with section

30

171.1012(a)(2), but rather acts to ensure that the interpretation of “installation” is

consistent with the other provisions of section 171.1012, and is therefore a

reasonable interpretation of section 171.1012 and a valid rule.

Autohaus also argues that Rule 3.588(b)(7) is invalid because it contends

that the Legislature, in section 171.1012(a)(2), intended for a taxable entity’s

installation of an item onto or into another party’s personal property to constitute

the “production” of that item for sale. As discussed supra, this argument is without

merit because it relies on a misinterpretation of section 171.1012(a)(2) and (c)(1)

that ignores the distinction between acquiring and producing a good for sale, the

prohibition against deducting the cost of providing services, and most critically, the

Legislature’s requirement that in the context of the production of goods, the

business must own the property onto or into which materials are being installed in

order for installation to constitute production. See TEX. TAX CODE

§171.1012(c)(2), (a)(3)(B)(ii), (i). Rule 3.588(b)(7) does not conflict with section

171.1012 in this regard either, but rather serves to implement the Legislature’s

intent by ensuring that only the labor costs of installing of materials into personal

property owned by the business, and which is being produced for ultimate sale by

the business, can be deducted as costs of goods sold.

Because Rule 3.588(b)(7) is a reasonable interpretation of section 171.1012

and does not contradict the language of the statute, it is valid and must be upheld

31

and accorded deference by this Court. Texas Citizens, 336 S.W.3d at 628. Under

the application of such Rule, Autohaus is not entitled to a refund of any franchise

taxes for labor costs on customer-owned automobiles and its Chapter 112 claim

fails. Additionally, Autohaus’s challenge to the validity of the Rule is without

merit. Thus even if jurisdiction exists for a declaratory judgment regarding the

Rule’s validity, the trial court’s judgment on this claim must be reversed and

judgment rendered for Appellants.

2. Autohaus’s Constitutional Challenges to the Rule

In its order granting summary judgment, and in its final judgment, the trial

court also declared Rule 3.588(b)(7), as it applied to the term “production,” to be

“unconstitutional,” without specifying which constitutional provisions the Rule

violated. CR 197, 346. Autohaus’s motion for summary judgment contended that

the Comptroller’s disallowance of Autohaus’s cost-of-goods-sold deduction for its

labor costs in repairing customer-owned automobiles violates the Equal and

Uniform Taxation Clause of the Texas Constitution (Tex. Const. art. VIII, § 1(a)),

the Equal Protection Clause of the Texas Constitution (Tex. Const. art. I, § 3), the

Equal Protection Clause of the United States Constitution (U.S. Const. amend.

XIV, § 1), and the Due Process Clause of the United States Constitution (U.S.

Const. amend. XIV, § 1). CR47–50. As these were the only constitutional

challenges raised by Autohaus in its summary judgment motion, the trial court at

32

most could only have found that the Rule violated one or more of those

constitutional provisions. See Stiles v. Resolution Trust Co., 867 S.W.2d 24, 26

(Tex. 1993)(holding that appellate court may not affirm summary judgment on

ground not asserted in summary judgment motion).

In reviewing taxation laws, courts indulge a strong presumption of

constitutional validity. Upjohn Co. v. Rylander, 38 S.W.3d 600, 609 (Tex. App.—

Austin 2000, pet. denied). The mandate under the Texas Constitution that all taxes

be equal and uniform “requires only that all persons falling within the same class

be taxed alike.” Id. Therefore, a litigant raising an equal and uniform taxation

challenge must show that the State’s classification at issue has no rational basis.

Texas Entm’t Ass’n, Inc. v. Combs, 431 S.W.3d 790, 800 (Tex. App.—Austin

2014, pet. denied), cert. denied sub nom, Texas Entm’t Ass’n Inc. v. Hegar, 135

S.Ct. 1568 (2015). The requirements under Equal Protection Clause of the United

States Constitution and Equal and Uniform Taxation under the Texas Constitution

are substantially the same and if a litigant’s Equal and Uniform Taxation challenge

fails, so does any challenge based on the Equal Protection Clause of the U.S.

Constitution or on the Equal Protection Clause of the Texas Constitution. Upjohn

Co., 38 S.W.3d at 609; In re Nestle USA, Inc., 387 S.W.3d 610, 624 (Tex. 2012);

Combs v. STP Nuclear Operating Co., 239 S.W.3d 264, 275 (Tex. App.—Austin

2007, pet. denied)(holding that challenges under Texas’s Equal Protection Clause

33

are evaluated using the same standard applied to challenges under the Equal

Protection Clause of the U.S. Constitution).

Autohaus asserted that disallowance of its claimed deduction violated its

equal and uniform tax and equal protection rights because it created an irrational

tax classification, not related to the differences in doing business that affect the

value of privilege of doing business, and caused Autohaus to pay significantly

more in franchise tax than other similarly situated taxpayers who produce tangible

property for sale in the state. CR 8–9, 47–49. But Autohaus did not identify the

“similarly situated taxpayers” it alleged were paying significantly less in franchise

tax for performing services, nor did it present any evidence to support its

constitutional contentions. As discussed supra, the Comptroller’s interpretation of

section 171.1012, as applied in Rule 3.588(b)(7), implements the Legislature’s

intent that businesses providing services cannot deduct service costs as costs of

goods sold and that deductions for the production of goods are limited to the

owners of the good being produced for sale in the ordinary course of business. All

of the taxable entities that are similarly situated to Autohaus and provide mixed

services by installing parts during the course of providing repair services on

property belonging to their customers are treated equally and all such taxpayers are

subject to the requirements of Rule 3.588(b)(7) and the Comptroller’s

interpretation of section 171.1012.

34

If Autohaus is attempting to argue that it is being treated differently from

taxpayers that install parts onto or into goods that such taxpayers own and produce

for sale, this comparison will not lie because these are not similarly situated

taxpayers. A taxpayer who owns a product and who installs materials onto or into

that product as part of finalizing production so that the product may be sold in the

ordinary course of business is clearly producing a product for sale as contemplated

by section 171.1012 of the Tax Code and may therefore deduct its labor costs of

producing the product. As discussed supra, Autohaus is not producing a product

property for sale when it installs a purchased automotive part into a customer’s

automobile during repair services, and so has no costs of production, but only costs

of acquisition. The Legislature’s distinctions in section 171.1012 between those

who purchase goods for sale and so have acquisition costs and those who produce

goods and so have production costs, as well as its distinction between the sale of

goods and the sale of services, are rational distinctions that directly affect the value

of the privilege. The Comptroller’s application of Rule 3.588(b)(7) implements the

purposes of section 171.1012, groups similar things and differentiates dissimilar

things, and relates to differences in doing business that affect the value of the

privilege. Rule 3.588(b)(7) therefore does not violate either the Equal and Uniform

Taxation Clause of Texas Constitution or the Equal Protection Clauses of either the

U.S. Constitution of the Texas Constitution.

35

Autohaus’s Due Process claim was based on its contention that “the

Comptroller’s disparate treatment requires Plaintiff to pay more in tax than other

taxpayers for the same right to do business enjoyed by other companies, which

constitutes an unconstitutional deprivation of Plaintiff’s property without due

process of law.” CR 50. However, as in its arguments regarding equal and uniform

protection and equal protection, Autohaus did not identify what taxpayers would

pay less in taxes, much less establish this by any evidence, nor did it identify how

it was being treated disparately or being deprived of property without due process

of law. As noted supra, Rule 3.588(b)(7) is based on section 171.1012, which

makes rational distinctions between businesses which acquire goods for sale and

those who produce goods for sale, and between producers of goods and service

providers, and treats like-situated taxpayers similarly. Rule 3.588(b)(7) does not

violate the Due Process Clause of the U.S. Constitution.

Thus Rule 3.588(b)(7) does not violate any of the constitutional provisions

complained of by Autohaus. It should be upheld, accorded deference by this court,

and applied to Autohaus’s Chapter 112 claims, which fail thereunder.

Additionally, because Autohaus’s constitutional challenges to the Rule are without

merit, even if jurisdiction exists for a declaratory judgment regarding the Rule’s

constitutionality, the trial court’s judgment on this claim must be reversed and

judgment rendered for Appellants.

36

III. EVEN IF A TAXABLE ENTITY MAY DEDUCT LABOR COSTS FOR INSTALLING

AUTOMOTIVE PARTS ONTO OR INTO CUSTOMER-OWNED AUTOMOBILES

DURING REPAIRS AS COSTS OF GOODS SOLD, MATERIAL ISSUES OF FACT

PRECLUDE THE GRANTING OF SUMMARY JUDGMENT AND THE AWARD OF A

SPECIFIC REFUND AMOUNT ON AUTOHAUS’S CHAPTER 112 CLAIM.

Summary judgment is only proper when the evidence shows that there are

no issues of material fact and that movant is entitled to judgment as a matter of

law. TEX. R. CIV. P. 166a(c). It is the movant’s burden to establish that there is no

genuine issue of material fact and that it is entitled to judgment as a matter of law.

Nixon v. Mr. Prop. Mgmt. Co., Inc., 690 S.W.2d 546, 548 (Tex. 1985). In

determining whether a disputed material fact issue exists, a trial court is to take as

true all evidence favorable to the non-movant and indulge every reasonable

inference and resolve all doubts in favor of the non-movant. Id. at 548–49. In this

case, Autohaus failed to establish that it was entitled to summary judgment on the

amount of refund that it sought. A material fact issue exists as to the existence and

amount of the amount of both labor and material costs that were involved in the

installation of automotive parts and thus the amount of any tax refund due.

Autohaus’s Controller’s affidavit, an exhibit to Autohaus’s motion for

summary judgment, unambiguously recognizes that there was some “de minimus

amount” of labor costs that were not part of the costs of installing new or

replacement automotive parts. CR57. That affidavit affirmatively acknowledges

that part of the labor costs claimed in its costs-of-goods-sold deduction were not

37

deductible. CR57. There was also a conflict between that affidavit, which implies

that costs of materials were disallowed, CR57, and that of the Comptroller’s

auditor, Exhibit 1 to the Appellants’ cross-summary judgment motion, which

stated that all costs of materials for which documentation was provided were

allowed in the audit. CR128. Because material facts remains in dispute—the

actual amount of deductible labor and the costs of materials which were disallowed

and so subject to refund—summary judgment awarding the entire sum paid in

protest is precluded.

Moreover, the disallowed costs information provided by Autohaus on

summary judgment—described as (1) SRV CUST LBR MB, (2) SRV WARR

LAB M/B, (3) SRV SUBLET RPR M/B, (4) CUST LBR-MECH L/T, and (5)

4Y/50K MAINT MB with accompanying totals, see CR70—is insufficient to

support the amount claimed by Autohaus as costs of goods sold as it does not

specify what costs are included in such figures (labor, materials, other deductible

costs, nondeductible costs?), nor does it segregate the labor costs involved in the

installation of automotive parts from those labor costs that were not involved in the

installation of automotive parts. Rather it simply lists all of the (unspecified) costs

expended by Autohaus for service, labor, or maintenance performed on all

customer automobiles by Autohaus or one of its subcontractors during the time

period. While some of the costs in Autohaus’s categories may be labor and

38

material used in the installation of automobile parts, it is impossible to determine

from the evidence presented on summary judgment what portion of the total costs

in each category that is. Autohaus’s Controller’s affidavit likewise suggests that

other costs are included in these broad categories as it refers to “all labor costs

included” and “all material costs included,” in the Repair Costs and Subletting

Costs, but does not specify what those amounts are nor does it state that the Repair

Costs and Subletting Costs are exclusively comprised of labor and material costs.

CR57.

Autohaus therefore, failed to produce evidence of a vital fact and precisely

quantify those labor and material costs that actually qualified for the cost-of-goods-

sold deduction under its own theory of the case. By failing to segregate labor and

material costs involving the installation of parts from labor or other costs that do

not, and instead simply presenting all of its costs for service, maintenance, and

repair of customer’s automobiles and seeking a refund for the same, Autohaus

failed in its burden to establish the proper amount of refund and a material issue

remains regarding what amount, if any, is due and payable. See TEX. TAX CODE

§§ 112.060(a)(refund is limited to portion of money paid under protest which was

unlawfully demanded and belongs to taxpayer); 111.104(a)(refund is limited to an

amount of tax, penalty, or interest that has been unlawfully or erroneously

collected). Further, conflicting evidence exists between the affidavits of the

39

Comptroller’s auditor and Autohaus’s Controller regarding whether there were any

remaining disallowed material costs, and Autohaus’s Controller admitted that not

all of the disallowed labor costs involved the installation of materials. Thus even

Autohaus’s evidence establishes that the amount sought, and awarded to Autohaus,

as a refund for costs of goods sold and accompanying interest, $14,227.09,

includes some unspecified amount which was properly due and owning as tax, and

therefore is not subject to refund.

Taking as true all evidence favorable to the non-movant, and indulging

every reasonable inference and resolving all doubts in favor of the non-movant, see

Nixon, 690 S.W.2d at 548–49, a disputed material fact issue exists as to the amount

of refund, if any, that is due. Where a disputed material fact issue exists as to the

existence or amount of a tax refund, summary judgment is precluded. See El Paso

Natural Gas Co. v. Strayhorn, 208 S.W.3d 676, 686 (Tex. App.—Texarkana 2006,

no pet.).

Autohaus failed to do more than raise a contested fact question as to the

amount of any refund due, as it provided no factual support for its contentions that

all of the disallowed labor costs involved the installation of materials and that the

costs of any materials were disallowed, a claim contradicted by the Comptroller’s

evidence. As a material fact exists, summary judgment for Autohaus on the amount

of refund was not proper. Therefore, if this Court holds that Autohaus should

40

prevail on its Chapter 112 claim, the Court should reverse the trial court’s refund

award on such claim and remand the case for a new trial on the proper amount of

any refund.

IV. THE TRIAL COURT HAD NO JURISDICTION TO CONSIDER AUTOHAUS’S

ATTEMPTED CHALLENGE UNDER THE UNIFORM DECLARATORY

JUDGMENT ACT TO COMPTROLLER RULE 3.588(B)(7) OR ITS REQUEST FOR

ATTORNEYS’ FEES AND COURT COSTS BECAUSE AUTOHAUS’S CLAIM DID

NOT FALL WITHIN THE SCOPE OF THE UDJA AND WAS, APART FROM THE

ATTORNEYS’ FEES AND COURT COSTS REQUEST, REDUNDANT OF ITS

CHAPTER 112 CLAIM.

The trial court’s summary judgment order and final judgment include a

declaration that “Texas Comptroller Rule 3.588(b)(7) as it applies to the term

‘production’ is unconstitutional and invalid,” and granted Autohaus attorneys’ fees.

CR197–98, 346–47. Neither specifies the legal basis for the declaratory judgment

or award of attorneys’ fees or costs, however, the only basis under which

Autohaus’s declaratory judgment and attorneys’ fees and costs were sought was

the UDJA. Autohaus claims that “[t]here is simply no other way to overturn an

invalid regulatory provision” than an action under the UDJA. CR379 –80.

But a challenge to the validity and constitutionality of an administrative rule

does not fall within the scope of the UDJA. Nor is a challenge to the validity and

constitutionality of a rule an ultra vires claim. The trial court therefore had no

jurisdiction to grant declaratory relief, attorney’s fees, or court costs under the

UDJA. Autohaus could have brought an action under section 2001.038 of the

41

Government Code, which explicitly provides for a declaratory judgment challenge

to an administrative rule. But Autohaus chose not to do so, precluding declaratory

relief on such basis. However, even if it had, the trial court would have had no

jurisdiction to award any attorneys’ fees or court costs. Finally, Autohaus’s

declaratory judgment claims were, aside from a request for an award of attorneys’

fees and court costs, redundant of its Chapter 112 claim, and so Autohaus was not

entitled to declaratory relief under the UDJA or any award of attorneys’ fees or

court costs.

The trial court’s ruling on Autohaus’s attempted declaratory judgment claim

and its award of attorneys’ fees and court costs should be reversed, and the

attempted declaratory judgment claim should be dismissed for want of jurisdiction.

A. A trial court may not grant a declaratory judgment regarding the

validity and constitutionality of a rule under the UDJA, and

therefore the trial court had no jurisdiction to grant a declaratory

judgment nor attorney’s fees or court costs under the UDJA in

this case.

This Court granted Autohaus’s requested declaratory relief, finding that

“Texas Comptroller Rule 3.588(b)(7) as it applies to the term ‘production’ is

unconstitutional and invalid.”

However, the UDJA, by its very terms, does not provide for the grant of a

declaratory judgment regarding the validity of rules. See TEX. CIV. PRAC. & REM.

CODE § 37.004(a). Section 37.004 relates exclusively to the construction or validity

42

of an “instrument, statute, ordinance, contract, or franchise and obtain a declaration

of rights, status, or other legal relations thereunder.” Id.; Texas State Bd. of Vet.

Med. Examiners v. Giggleman, 408 S.W.3d 696, 708 (Tex. App.—Austin 2013, no

pet.). Further, to the extent that the UDJA applies to declaratory judgments against

the State of Texas, it is limited to proceedings involving the validity and

constitutionality of a “statute, ordinance, or franchise.” See TEX. CIV. PRAC. &

REM. CODE § 37.006.

Autohaus asserted below that because the trial court had to review and

interpret tax statutes, particularly section 171.1012(a)(2), in making its

determination on the validity of Rule 3.588(b)(7), Autohaus’s action seeking a

declaratory judgment on the validity of a rule is governed by section 37.004.

However, the mere fact that a court must review and construe a statute in the

course of making a legal ruling does not convert such an action into a declaratory

action that falls under the UDJA. See Giggleman, 408 S.W.3d at 708. Indeed, in

ruling on Autohaus’s Chapter 112 claim, the trial court was required to review and

construe section 171.1012, but that did not convert Autohaus’s Chapter 112 claim,

for which no attorney’s fees may be awarded, into a UDJA action for which

attorney’s fees may be awarded. This Court has roundly rejected similar

arguments, calling such attempts the “very use of the UDJA—i.e., as a vehicle for

43

obtaining otherwise impermissible attorney’s fees—that the Texas Supreme Court

squarely held impermissible[.]” Id.

Even assuming arguendo that Autohaus’s interpretation of section 37.004 is

correct and that any action in which a court must construe a statute falls within the

scope of the UDJA, the Legislature has not waived sovereign immunity for all

actions against the State that might fall within the scope of section 37.004. Rather,

as against the State, the language of section 37.004 is further limited by that of

section 37.006, which provides:

In any proceeding that involves the validity of a municipal ordinance

or franchise, the municipality must be made a party and is entitled to

be heard, and if the statute, ordinance, or franchise is alleged to be

unconstitutional, the attorney general of the state must also be served

with a copy of the proceeding and is entitled to be heard.

TEX. CIV. PRAC. & REM. CODE § 37.006(b). The Supreme Court has

explained that section 37.006 waives sovereign immunity for challenges to the

validity of an ordinance or statute. See Texas Dep’t of Trans. v. Sefzik, 355 S.W.3d

618, 622 (Tex. 2011); City of El Paso v. Heinrich, 284 S.W.3d 366, 373 n.6 (Tex.

2009). Autohaus did not challenge the validity of any statute or ordinance in this

case, but rather argued that it is entitled to relief under the UDJA because “the

Court determined a question of construction related to Texas Tax Code

171.1012(a)(2), which involves the associated Comptroller rule 3.588(b)(7).”

CR231–32. This contention is incorrect. Autohaus did not seek a declaration on the

44

construction of a statute, and the trial court did not grant a declaration on the

construction of a statute, but even if it had, the UDJA does not waive immunity for

actions against the governmental entities which seek only the interpretation or

construction of statutes or ordinances and do not challenge the validity of the

statute or ordinance at issue. City of McKinney v. Hank’s Rest. Grp., L.P., 412

S.W.3d 102, 111–12 (Tex. App.—Dallas 2013, no pet.).5

Thus even if Autohaus’s action seeking a declaration on the validity of a rule

could be recharacterized, as Autohaus asserted, as an action seeking a declaration

on the construction of a statute, and even if the trial court’s ruling on the validity

and constitutionality of a rule could be recharacterized as a declaratory ruling on

the construction of a statute, Autohaus would not be entitled to any declaratory

judgment regarding the construction of any statute under the UDJA, nor any

attorney’s fees or costs for such an action, because there is no waiver of sovereign

immunity under the UDJA for an action seeking a declaratory judgment on the

construction of a statute nor for any attorney’s fees or costs for such an action. See

5

City of McKinney v. Hank’s Restaurant Group, L.P. involved a municipality so governmental

immunity, not sovereign immunity was involved, but as is clear from the Court’s discussion,

there is no difference in the analysis as applied to either sovereign or governmental immunity.

See City of McKinney v. Hank’s Rest. Grp., L.P., 412 S.W.3d 102, 111–12 (Tex. App.—Dallas

2013, no pet.).

45

TEX. CIV. PRAC. & REM. CODE § 37.006(b); City of McKinney, 412 S.W.3d at 111

–12; Giggleman, 408 S.W.3d at 708–09.

Sovereign immunity is waived under Texas Government Code section

2001.038(a) for actions seeking a declaratory judgment on the validity of a rule.

TEX. GOV’T CODE § 2001.038(a). Sovereign immunity is not waived under the

UDJA for actions seeking a declaratory judgment on the validity of a rule or for

actions seeking a declaratory judgment on the construction, rather than the validity,

of a statute. See TEX. CIV. PRAC. & REM. CODE §§ 37.004(a), 37.006(b); City of

McKinney, 412 S.W.3d at 111–12; see also Sefzik, 355 S.W.3d at 622; Heinrich,

284 S.W.3d at 373, n.6. Since Autohaus sought relief only under the UDJA,

sovereign immunity was not waived for the declaration that the trial court granted

regarding the validity and constitutionality of Rule 3.588(b)(7).

It follows then that if the trial court had no jurisdiction to render a

declaratory judgment regarding the validity or constitutionality of Rule 3.588(b)(7)

under the UDJA, it likewise had no jurisdiction to award attorney’s fees under

section 37.009. See Giggleman, 408 S.W.3d at 708–09; TEX. CIV. PRAC. & REM.

CODE § 37.009. Therefore the portion of the trial court’s judgment declaring Rule

3.588(b)(7) invalid and unconstitutional and awarding attorneys’ fees and court

costs should be reversed and Autohaus’s claims seeking declaratory judgment and

attorneys’ fees and court costs should be dismissed for want of jurisdiction.

46

B. Autohaus did not raise a claim within the ultra vires exception.

The trial court likewise had no jurisdiction over Autohaus’s declaratory

judgment claim under the ultra vires exception and its final judgment did not

render a declaratory judgment on any ultra vires action. A declaratory judgment

that a rule is invalid is not a declaratory judgment that a particular state officer has

“acted without legal authority or failed to perform a purely ministerial act.” See

discussion of ultra vires actions in Heinrich, 284 S.W.3d at 372. It is simply a

declaratory judgment that a rule is invalid. The Legislature has provided a specific

cause of action and waiver of sovereign immunity for a party that seeks to overturn

an administrative rule—an action under Texas Government Code section

2001.038. Autohaus simply chose not to bring such an action.

Furthermore, to the extent that Autohaus asserts that it was actually raising

an ultra vires complaint that the Comptroller acted without legal authority or failed

to perform a purely ministerial act, Autohaus provided no arguments, evidence, or

authorities in the summary judgment proceedings to support such a complaint, but

rather asserted that that (1) the Rule is invalid and unconstitutional (which does not

raise a complaint about any particular action by any particular state actor); and (2)

the Comptroller unconstitutionally disallowed its deduction and assessed additional

tax liability against it. But any complaints regarding the Comptroller’s

disallowance of Autohaus’s deduction and assessment of additional tax liability

47

would be wholly redundant of Autohaus’s complaints under its Chapter 112 claims

and thus declaratory judgment on such complaints would not have been proper. See

Giggleman, 408 S.W.3d at 707–09; and discussion infra in Section IV.D.

Furthermore, the Texas Supreme Court recently clarified that a complaint that

challenges a rule does not fall within the ultra vires exception. See Patel v. Texas

Dep’t of Licensing & Regulation, 469 S.W.3d 69, 76–77 (Tex. 2015).

C. While Texas Government Code section 2001.038 provides courts

with jurisdiction to grant declaratory judgments regarding the

validity of a rule, such provision does not provide for the award of

attorneys’ fees or court costs. Thus even if Autohaus had raised

such a claim, and the trial court had jurisdiction under section

2001.038 to grant a declaratory judgment on Rule 3.588(b)(7), it

had no jurisdiction to award attorneys’ fees or court costs.

Texas Government Code section 2001.038 explicitly provides courts with

jurisdiction to enter a declaratory judgment regarding the validity of an agency

rule. TEX. GOV’T CODE § 2001.038 (providing that the “validity or applicability of

a rule . . . may be determined in an action for declaratory judgment if it is alleged

that the rule or its threatened application interferes with or impairs, or threatens to

interfere with or impair, a legal right or privilege of the plaintiff.”). Nevertheless,

none of Autohaus’s pleadings raised any request for a declaratory judgement under

section 2001.038, and Autohaus expressly disavowed seeking any declaratory

relief under section 2001.038, asserting that it only raised declaratory judgment

claims under the UDJA. CR232–33. Thus the trial court would have had no

48

jurisdiction to grant declaratory relief regarding the validity and constitutionality of

Rule 3.588(b)(7) under Government Code section 2001.038.

However, even if Autohaus had raised a claim challenging Rule 3.588(b)(7)

under section 2001.038, and such claim was not redundant of its Chapter 112

claims (see discussion infra), the claim would have been without merit for the

reasons discussed supra in II.D. Furthermore, section 2001.038, “unlike the UDJA,

does not authorize attorney’s fees.” Giggleman, 408 S.W.3d at 708; see TEX.

GOV’T CODE § 2001.038; see also discussion in City of San Antonio v. Shavano

Ranch, No. 04-13-00623-CV, 2014 WL 631484, at *4–5 (Tex. App.—San Antonio

Feb. 19, 2014, pet. denied)(mem. op.)(holding that even if a statute expressly

provides for declaratory relief against State, a party bringing a declaratory

judgment claim under that statute may not recover attorneys’ fees under the

UDJA). Thus, even assuming arguendo that Autohaus had pled a section 2001.038

claim, and such claim was not redundant of its Chapter 112 claims, the trial court

was not authorized to award attorneys’ fees or court costs.

D. Autohaus may not recover attorneys’ fees or court costs for

redundant claims that fall under the exclusive jurisdiction of

Chapter 112.

Additionally, the claims actually raised in Autohaus’s petition were

redundant of its claims under Tax Code Chapter 112. Autohaus may not recover

attorneys’ fees or court costs for declaratory actions which are inherently part of,

49

incidental to, or arise out of statutory claims for which the recovery of attorney’s

fees was not permitted. See Jackson v. State Office of Admin. Hearings, 351

S.W.3d 290, 301 (Tex. 2011); MBM Fin. Corp. v. Woodlands Operating Co., L.P.,

292 S.W.3d 660, 669–71 (Tex. 2009); and John G. and Marie Stella Kenedy

Mem’l Found. v. Dewhurst, 90 S.W.3d 268, 289 (Tex. 2002). Furthermore,

Chapter 112 “provides exclusive remedies for relief from assessed taxes on any

basis.” Sanadco, Inc. v. Office of Comptroller, No. 03-11-00462-CV, 2015 WL

1478200, at *4 (Tex. App.—Austin March 25, 2015, pet. denied, motion for reh’g

of pet. filed November 12, 2015)(emphasis in original).

The Legislature has waived sovereign immunity for Chapter 112 claims.

Autohaus could and did raise its complaints about constitutional violations in its

Chapter 112 claim. Autohaus also raised a complaint under Chapter 112 regarding

the validity of Rule 3.588, and the trial court could rule on the validity of Rule

3.588(b)(7) as part of its determination of Autohaus’s Chapter 112 claims. CR 14

(Autohaus’s protest letter raising grounds for Chapter 112 claims); TEX. TAX CODE

§ 112.053(b) (limiting the issues to be determined in the suit to those arising from

the reasons expressed in the written protest as originally filed). The Legislature has

also provided a specific waiver of sovereign immunity for plaintiffs seeking to

challenge a regulatory provision that affects a plaintiff’s rights—Government Code

section 2001.038.

50

But the Legislature did not provide a waiver of sovereign immunity for an

award of attorney’s fees for claims under either Tax Code Chapter 112 or

Government Code section 2001.038. To the extent that Autohaus has attempted to

recast its Chapter 112 claims and its rule challenge or Rule 3.588(b)(7) as

challenges under the UDJA, its efforts are no different than those by plaintiffs that

were condemned by this Court and the Texas Supreme Court for misuse of the

UDJA. See Jackson, 351 S.W.3d at 301; MBM Fin. Corp., 292 S.W.3d at 669–71;

Giggleman, 408 S.W.3d at 708; Strayhorn v. Raytheon E-Sys., Inc., 101 S.W.3d

558, 571–73 (Tex. App.—Austin 2003, pet. denied).

Furthermore, this Court has also recently held that attempts to be relieved of

tax liability and penalties fall under the exclusive remedies of Chapter 112, even

when framed as declaratory judgment challenges to rules, statutes, or ultra vires

actions. Sanadco, 2015 WL 1478200, at *5. This Court explained that Chapter 112

provided three statutorily-permitted suits—suit after payment in protest, suit for

injunction after paying or posting a bond, and a refund suit—and that aside from

these three avenues of relief, Chapter 112 “‘allows no actions to challenge or seek

refund of the taxes to which it applies,’ including declaratory judgment actions.”

Id., quoting In re Nestle USA, Inc., 359 S.W.3d 207, 209–10 (Tex. 2012); see also

TEX. TAX CODE § 112.108. This Court concluded that actions under the UDJA

were preempted by Chapter 112. Id. at *4.

51

Thus, to allow Autohaus to receive declaratory relief under the UDJA and

recover its attorneys’ fees and court costs in seeking a declaratory judgment

regarding the validity and constitutionality of Rule 3.588(b)(7) in this case would

not only be without statutory authority, but would permit the Autohaus to “frustrate

the limits” that the Legislature intended by not permitting the recovery of

attorneys’ fees or court costs for Chapter 112 claims and section 2001.038 claims,

and allow Autohaus to do precisely what was expressly condemned by the Texas

Supreme Court in MBM Financial, “to use the [UDJA] as a vehicle to recover

otherwise impermissible attorney’s fees.” MBM Fin. Corp., 292 S.W.3d at 670,

669. Moreover, it would conflict with the Texas Supreme Court’s and this Court’s

decision holding that the “only means by which a taxpayer may challenge the

‘applicability, assessment, collection, or constitutionality’” of a state tax is through

a Chapter 112 action, not an action under the UDJA. Sanadco, 2015 WL 1478200,

at *5 (emphasis in original), quoting Nestle, 359 S.W.3d at 209.

E. Conclusion

This Court should therefore reverse the trial court’s judgment granting a

declaratory judgment on Rule 3.588(b)(7) and its grant of attorneys’ fees and court

costs, and dismiss Autohaus’s declaratory judgment claims for want of jurisdiction.

Alternatively, if this Court determines Autohaus’s declaratory judgment claim was

not redundant of its Chapter 112 claim, or otherwise preempted by Chapter 112,

52

and that the trial court had jurisdiction to consider Autohaus’s rule challenge under

Texas Government Code section 2001.038, this Court should reverse the trial

court’s declaratory judgment ruling for the reasons set out supra in II.D, and

reverse its award of attorneys’ fees and court costs, dismissing Autohaus’s claim

for attorneys’ fees and court costs for want of jurisdiction.

PRAYER

For the foregoing reasons, Appellants pray this Court to reverse the

judgment of the trial court, dismiss Autohaus’s declaratory judgment claims for

want of jurisdiction, and render judgment against Autohaus on its Chapter 112

claim, or alternately remand for a new trial to determine the amount of any refund.

In the alternative, if this Court does not reverse the trial court’s judgment on

Autohaus’s Chapter 112 claim, Appellants pray this Court to reverse the portion of

the judgment related to Autohaus’s declaratory judgment claims and dismiss

Autohaus’s declaratory judgment claims for want of jurisdiction or, alternatively,

dismiss Autohaus’s claims for attorneys’ fees and court costs for want of

jurisdiction and modify the judgment accordingly.

Respectfully submitted,

KEN PAXTON

Attorney General of Texas

CHARLES E. ROY

First Assistant Attorney General

53

JAMES E. DAVIS

Deputy Attorney General for Civil Litigation

ROBERT O’KEEFE

Division Chief

Taxation Division

/s/ Cynthia A. Morales

CYNTHIA A. MORALES

Assistant Attorney General

Financial Litigation and Charitable Trusts Division

State Bar No. 14417420

P.O. Box 12548

Austin, Texas 78711-2548

Telephone: (512) 475-4470

Telecopier: (512) 477-2348

cynthia.morales@texasattorneygeneral.gov

Counsel for Appellants Glenn Hegar, Comptroller

of Public Accounts of the State of Texas, and Ken

Paxton, Attorney General of the State of Texas

CERTIFICATE OF COMPLIANCE

In compliance with Texas Rule of Appellate Procedure 9.4(i)(2), this brief

contains 12,554 words, excluding the portions of the brief exempted by

Rule 9.4(i)(1), as determined by the computer program used to prepare this

document.

/s/ Cynthia A. Morales

Cynthia A. Morales

Assistant Attorney General

54

CERTIFICATE OF SERVICE

On December 14, 2015, this Appellants’ Brief was served electronically

through the electronic filing manager and/or via email as shown below:

David E. Colmenero dcolmenero@meadowscollier.com

Alex Pilawski apilawski@meadowscollier.com

MEADOWS, COLLIER,

REED, COUSINS, CROUCH

& UNGERMAN, L.L.P.

/s/ Cynthia A. Morales

Cynthia A. Morales

Assistant Attorney General

55

APPENDIX

APPENDIX

TABLE OF CONTENTS

Final Judgment (CR344–49) ..................................................................................... A

Order Granting Plaintiff’s Motion for Summary Judgment (CR197–98) ................ B

Order Denying Defendants’ Motion for Summary Judgment and

Plea to the Jurisdiction (CR196) ............................................................................... C

Affidavit of Autohaus Controller (CR56–57)........................................................... D

Affidavit of Comptroller’s auditor (CR127–29)....................................................... E

Listing of Disallowed Costs (CR70) ......................................................................... F

Autohaus’s Protest Letter (CR71–74)....................................................................... G

Tex. Tax Code § 171.1012 ........................................................................................ H

34 Tex. Admin. Code § 3.588 .................................................................................... I

Tex. Tax Code § 112.052 ........................................................................................... J

Tex. Tax Code § 112.053 .......................................................................................... K

Tex. Tax Code § 112.060 .......................................................................................... L

Tex. Tax Code § 111.104 ......................................................................................... M

Tex. Const. art. VIII § 1 ........................................................................................... N

Tex. Const. art. I § 3.................................................................................................. O

U.S. Const. amend. XIV, § 1 .................................................................................... P

Tex. Civ. Prac. & Rem. Code § 37.004 .................................................................... Q

Tex. Civ. Prac. & Rem. Code § 37.006 .................................................................... R

Tex. Civ. Prac. & Rem. Code § 37.009 .................................................................... S

Tex. Gov’t Code § 2001.038..................................................................................... T

Tex. Tax Code § 112.108 .......................................................................................... U

APPENDIX A

Final Judgment

DC BK15125 PG47

Filed in The District Court

of Travis County, Texas

APR 29 2015 ~

Cause No. D-1-GN-13-000989 At l...{ ~ Y ;} fM.

Velva L. PriCe, District Clerk

AUTOHAUS LP, LLP §

IN THE DISTRICT COURT

§

Plaintiff, §

§

v. §

§ 419th JUDICIAL DISTRICT

GLENN HEGAR, COMPTROLLER OF §

PUBLIC ACCOUNTS OF THE STATE §

OF TEXAS, AND KEN PAXTON, §

ATTORNEY GENERAL OF THE §

STATE OF TEXAS §

§

Defendants. § TRAVIS COUNTY, TEXAS

FINAL JUDGMENT

On July 22, 2014, the Court granted Plaintiffs Motion for Summary Judgment and

entered an Order that Plaintiff is entitled to: (1) include all of its labor costs associated with

Repair Costs and all of its labor costs and materials costs associated with Subletting Costs

involved in the installation of automotive parts in its cost of goods sold deduction; (2) a refund of

the $14,227.09 in fi·anchisc tax that it paid in protest; (3) interest accruing on the amount of its

refund claim in accordance with Texas Tax Code Section 111.064; and (4) attorneys' fees. The

Court also detennined that Texas Comptroller Rule 3.588(b)(7) as it applies to the term

"production" is unconstitutional and invalid. On that same date, the Court denied Defendant's

Motion for Summary Judgment and Defendant's Plea to the Jurisdiction. Following the Court's

Order of July 22, 2014, Defendants filed their Motion for Reconsideration of Trial Court's

Rulings on Plaintiffs Motion for Summary Judgment, Defendants' Cross-Motion for Summary

Judgment, and Defendants' Plea to the Jurisdiction, which was denied by the Court on October

30, 2014.

On the 21st day of April, 2015, a trial was held before the Court to determine the amount

Final Judgment- Page I

Case # D-1-GN-13-000989

lllllllllllllllllllllllllllllllllllllllllllllllllllllll

004006590

344

DC BK15125 PG48

of attorneys' fees to be awarded, the amount of court costs, if any, to be awarded, and the

statutory basis for any award of interest on the refund of $14,227.09 in franchise tax paid in

protest. After receiving evidence and hearing arguments, the Court found that the following

amounts of attorneys' fees were reasonable and necessary in pursuing Plaintiff's claim for

declaratory relief at trial or are reasonable and necessary to defend the grant of Plaintiff's claim

for declaratory relief on appeal:

(1) $ 100,000 for amounts incurred through April19, 2015;

(2) $ 1,600 for attorneys' fees associated with the trial on the amount of Plaintiff's

award of Attorneys' Fees;

(3) In the event Defendants file a Notice of Appeal and appeal this judgment to the

Austin Court of Appeals and include an issue challenging the declaratory relief

granted, $ 45,000 for responding to that issue and for oral argument on that issue

if granted;

(4) In the event that the Austin Court of Appeals denies relief on an issue challenging

the declaratory relief granted and Defendants file a Petition for Rehearing or

Petition for Rehearing En Bane with the Austin Court of Appeals seeking a

rehearing or rehearing en bane on the appellate court's ruling on declaratory

relief, $ 5,000 for responding to the pmtion of the Petition for Rehearing or

Petition for Rehearing En Bane regarding the ruling on the challenge of the

declaratory relief granted.

(5) In the event Defendants file a Petition for Review with the Texas Supreme Court

and raise an issue for review challenging the declaratory relief granted, $ 6,000

for preparing and filing a Response to the issue raised in the Petition for Review

challenging the declaratory relief granted.

(6) In the event the Texas Supreme Court orders full briefing on an issue raised in the

Petition for Review challenging the declaratory relief granted, $ 18,000 to brief

such issue.

(7) If the Texas Supreme Court requires oral argument on an issue raised in the

Petition for Review challenging the declaratory relief granted, $ 6,000 to prepare

and argue such issue.

Final Judgment-· Page 2

345

DC BK15125 PG49

(8) In the event Defendants file a Petition for Rehearing or Petition for Rehearing En

Bane with the Texas Supreme Court seeking a rehearing or rehearing en bane on

an issue raised for review challenging the declaratory relief granted, $ 6,000 for

responding to such issue.

(9) All appellate attorneys' fees awarded herein are expressly conditioned on Plaintiff

prevailing on the respective appeal.

The Court further found that court costs in this case were $274.80 and awarded Plaintiff

that amount in court costs.

The Court further found that the proper statutory basis for any award of any interest on

the refund of$14,227.09 in franchise tax paid in protest, is Texas Tax Code§ 112.060 and Texas

Tax Code§ 112.058(a)(4).

Based on the Court's June 22, 2014 ruling on Plaintiffs Motion for Summary Judgment,

its ruling on April 21, 2015, regarding reasonable and necessary attorney's fees, court costs, the

proper statutory basis for any award of interest on the refund of $14,227.09 in franchise tax paid

in protest, and the legal and equitable powers of the Court, Final Judgment is hereby rendered

against Defendants, Glenn He gar, successor to Susan Combs, Comptroller of Public Accounts of

the State of Texas and Ken Paxton, successor to Greg Abbott, Attorney General of the State of

Texas and in favor of Plaintiff Autohaus LP, LLP.

It is therefore ORDERED, ADJUDGED, AND DECREED that Plaintiff have and

recover from Defendants the following specific relief:

A. Plaintiff is entitled to include all of its labor costs associated with Repair Costs

and all of its labor costs and materials costs associated with Subletting Costs involved in the

instAllAtion of Antomo1iw~ pilrts in its cost of' ennrls solei rlerlnc:tion.

B. Texas Comptroller Rule 3.588(b)(7) as it applies to the term "production" is

unconstitutional and invalid.

Final .Judgment- Page 3

346

DC BK15125 PG50

C. Plaintiff is entitled a refund of the $14,227.09 in franchise tax that it paid in

protest.

D. Plaintiff is entitled to interest accruing on the amount of its refund claim as

provided under Texas Tax Code§ 112.060 and Texas Tax Code§ 112.058(a)(4).

E. Plaintiff is awarded court costs in the amount of$274.80.

F. Plaintiff is awarded reasonable and necessary attomeys' fees incuned in pursuing

its claim for declaratory relief through the entry of Final Judgment of$ 100,000 for amounts

incurred through April 19, 2015. In addition, Plaintiff is entitled to an additional $ 1,600 for

attomeys' fees associated with the trial on the amount of its award of Attorneys' Fees.

G. In the event Defendants file a Notice of Appeal and appeal this judgment to the

Austin Court of Appeals and include an issue challenging the declaratory relief granted, Plaintiff

is awarded additional reasonable and necessary attorneys' fees of$ 45,000 for responding to that

issue and oral argument on that issue if granted. In the event that the Austin Comi of Appeals

denies relief on an issue challenging the declaratory relief granted and Defendants file a Petition

for Rehearing or Petition for Rehearing En Bane with the Austin Comi of Appeals seeking a

rehearing or rehearing en bane on the appellate court's ruling on declaratory relief, Plaintiff is

awarded additional reasonable and necessary attorneys' fees of $ 5,000 for responding to the

portion of the Petition for Rehearing or Petition for Rehearing En Bane regarding the ruling on

the challenge of the declaratory relief granted. In the event Defendants file a Petition for Review

with the Texas Supreme Court and raise an issue for review challenging the declaratory relief

granted, Plaintiff is awarded additional reasonable and necessary attorneys' fees of $ 6,000 for

preparing and filing a Response to the issue raised in the Petition for Review challenging the

declaratory relief granted. In the event the Texas Supreme Court orders full briefing on an issue

Final Judgment- Page 4

347

DC BK15125 PG51

raised in the Petition for Review challenging the declaratory relief granted, Plaintiff is awarded

additional reasonable and necessary attorneys' fees of$ 18,000 to brief such issue. If the Texas

Supreme Court requires oral argument on an issue raised in the Petition for Review challenging

the declaratory relief granted, Plaintiff is awarded additional reasonable and necessary attorneys'

fees of $ 6,000 to prepare and argue such issue. In the event Defendants file a Petition for

Rehearing or Petition for Rehearing En Bane with the Texas Supreme Court seeking a rehearing

or rehearing en bane on an issue raised for review challenging the declaratory relief granted,

Plaintiff is awarded additional reasonable and necessary attorneys' fees of$ 6,000 for responding

to such issue. All appellate attorneys' fees awarded herein are expressly conditioned on Plaintiff

prevailing on the respective appeal.

All other relief not expressly granted herein is denied. This judgment finally disposes of

all claims and all parties and is appealable.

IT IS SO ORDERED.

SIGNED this ~ qday of..,.,L-------ir:r---=---'' 2015.

:L-4- \~ ~ur-\-'r.e.r orde..'e~ -\-~a.-\- +~e_'''Pc-oros~O.. F~("\Q,\

-:::Ju.d?\rt\e.f\-\- ~ s\~'1\ed. o~ -\"'e_ Co~c-\- oC"\ ~\ \ '2. \ 20\5

\ ~ '\fP\(_1\\Et5 .

Final Judgment- Page 5

348

DC BK15125 PG52

APPROVED AS TO FORM ONLY; DEFENDANTS DISAGREE WITH THE SUBSTANCE

OF THE JUDGMENT AND INTEND TO CHALLENGE THE JUDGMENT ON APPEAL:

Cynthia A. Morales

State BarNo. 14417420

Assistant Attorney General

Financial Litigation, Tax, and Charitable Trusts Division

P.O. Box 12548

Austin, Texas 78711-2548

(512) 475-4470- Direct Line

(512) 477-2348 -Fax

cynthia.morales@texasattorneygeneral.gov

ATTORNEYS FOR DEFENDANTS

State Bar No. 24074194

JASON B. FREEMAN

State Bar No. 24069736

AI"EX .J. PILA WSKI

State Bar No. 24074899

MEADOWS, COLLIER, REED,

COUSINS, CROUCII & UNGERMAN, L.L.P.

901 Main Street, Suite 3700

Dallas, TX 75202

(214) 744-3700 Telephone

(214) 747-3732 Facsimile

dcolmenero@meadowscollier.com

tfarhing@meadowscollier.com

jfreeman@meadowscollier.com

apilawski@meadowscollier.com

ATTORNF.YS FOR PT,ATNTTFF

Final JLidgmcnt- Pc1ge 6

349

APPENDIX B

Order Granting Plaintiff’s Motion

for Summary Judgment

Notice sent: €!Jfo1 Interlocutory None

DC BK14205 PG1331

Disp Parties: ~

Disp code:(@CLS-"~.~

=!:WJJ-=--\;-Q--

Redact pgs: filed In The District Coun

@~Travis County, Texas

Judge-tl'(~-·- C1erk::tf)

Cause No. D-1-GN-13-000989

AUTOHAUS LP, LLP §

§

Plaintiff, §

§

v. § 419th JUDICIAL DISTRICT

§

SUSAN COMBS, §

COMPTROLLER OF PUBLIC §

ACCOUNTS OF THE STATE OF §

TEXAS and GREG ABBOTT, § TRAVIS COUNTY, TEXAS

ATTORNEY GENERAL OF THE §

STATE OF TEXAS §

§

Defendants. §

ORDER GRANTING PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT

Before the Court is Plaintiff Autohaus LP, LLP's Motion for Summary Judgment. Upon

consideration of the same, Defendants' Response, Plaintiffs Reply, and the arguments of

counsel, the Court is of the opinion that the motion is meritorious, and should be GRANTED in

its entirety.

IT IS THEREFORE ORDERED that

(i) Plaintiff is entitled to include all of its labor costs associated with Repair Costs

and all of its labor costs and materials costs associated with Subletting Costs

involved in the installation of automotive parts in its cost of goods sold deduction;

(ii) Plaintiff is entitled to a refund of the $14,227.09 in franchise tax that it paid in

protest;

(iii) Texas Comptroller Rule 3 .588(b)(7) as it applies to the term "production" IS

unconstitutional and invalid;

(iv) Plaintiff is entitled to interest accruing on the amount of its refund claim as

I

197

DC BK14205 PG1332

provided under Texas Tax Code Section 111.064; and

(v) Plaintiffs is entitled to attorneys' fees.

Signed this the~ day o

JUDGE PRESIDING

445995

2

198

APPENDIX C

Order Denying Defendants’ Motion

for Summary Judgment and Plea to the Jurisdiction

- --- ------- - - - - - - - - - - - - - -

Notice sent: Final Interlocutory

DC BK14206 PG4

Disp Parties: filed in The District Court

----------~----

Disp code: CVD I CLS (f)f Tl!'avis Countyl Texas

--r--- CAUSE NO. D-1-GN-13-000989

Redact pgs: _ _

Judge \)'{6 --=-Cl/~\';;;-q-

AUTOHAUS LP, LLP § IN THE

Plaintiffs §

§

v. § OF TRAVIS COUNTY, TEXAS

§

SUSAN COMBS, COMPTROLLER OF §

PUBLIC ACCOUNTS OF THE STATE §

OF TEXAS, and GREG ABBOTT, § 419TH JUDICIAL DISTRICT

ATTORNEY GENERAL OF TEXAS

Defendants.

ORDER DENYING DEFENDANTS' MOTION FOR

SUMMARY JUDGMENT AND PLEA TO THE JURISDICTION

On July 9, 2014, the Court heard Plaintiffs Motion for Summary Judgment and

Defendant's Response to Plaintiffs Motion for Summary Judgment, Cross Motion for

Summary Judgment and Plea to the Jurisdiction. After due consideration, the Court

issued a separate order on Plaintiffs Motion for Summary Judgment dated today and the

Court rules as follows on Defendant's Cross Motion for Summary Judgment and Plea to

the Jurisdiction:

It is hereby ORDERED that Defendants' Objection to Plaintiffs Exhibit 1 ~ 6-11

is OVERRULED.

It is further ORDERED that Defendants' Motion for Summary Judgment and

Defendants' Plea to the Jurisdiction are hereby DENIED.

IT IS SO ORDERED.

SIGNED on th~day of July, 2014.

DARL 'NE BYRNE

PRESIDING JUDGE

196

APPENDIX D

Affidavit of Autohaus Controller

Cause No. D-1-GN-13-000989

AUTOHAUS LP, LLP § IN THE DISTRICT COURT

§

Plaintiff, §

§

v. § 419th JUDICIAL DISTRICT

§

SUSAN COMBS, §

COMPTROLLER OF PUBLIC §

ACCOUNTS OF THE STATE OF §

TEXAS and GREG ABBOTT, § TRAVIS COUNTY, TEXAS

ATTORNEY GENERAL OF THE §

STATE OF TEXAS §

§

Defendants. §

AFFIDAVIT OF RICHARD BURGER

STATE OF TEXAS §

§

COUNTY OF DALLAS §

Before me, the undersigned authority, on this date Richard Burger, and being duly sworn,

stated under oath:

1. My name is Richard Burger. I am of sound mind, capable of making this affidavit, and

personally acquainted with the facts herein stated:

2. I am the Controller atAutohaus LP, LLP.

3. Autohaus LP, LLP is an automotive dealership organized as a limited liability partnership

and headquartered in Plano, Texas. t'

~..

4. Autohaus LP, LLP computed its Texas franchise tax for the 2009 report year by

!·

deducting cost of goods sold. A true and correct copy of Autohaus LP, LLP's 2009 Texas ~;

Franchise Tax Report is attached as Exhibit "A" to this affidavit.

5. Autohaus LP, LLP's cost of goods sold deduction for the 2009 report year included costs r

!

1

incurred in selling automobiles C'Sales Costs"), costs incurred in repairing automobiles i.

;·'··

("Repair Costs"), and costs incurred in subcontracting such repair work to others [:

("Subletting Costs"). i

I

I

L.

I

1

442312 I

!

Ex. 1 56

I

••••• ·-···. ·-·-·•• ·.·-·- • : ••• ·.;.;._. ·.:; .:·.·>:-::: ·.

I_ __.:__• :·.~.-.·· ··: .. ·-:-:;.. :! : :·:-:-:-:··,·_.·.·.·

6. Autohaus LP, LLP's Repair Costs for the 2009 report year encompassed costs

attributable to labor and materials.

7. Autohaus LP, LLP's Subletting Costs for the 2009 report year encompassed costs

attributable to subcontracted labor and materials.

8. Except for de minimis amounts, all of Autohaus LP, LLP's labor costs included in Repair

Costs represent the costs of installing new or replacement automotive parts.

9. Except for de minimis amount, all of Autohaus LP, LLP's subcontracted labor costs

included in Subletting Costs represent the costs of installing new or replacement

automotive parts.

10. Autohaus LP, LLP's labor costs attributable to installing new or replacement automotive

parts involves integrating automotive parts into automobiles so that the parts are set up

and ready for use in the automobiles.

11. All of Autohaus LP, LLP's materials costs included in its Repair Costs and Subletting

Costs represent costs of acquiring and producing goods that were sold.

SUBSCRIBED AND SWOR;N TO BEFORE ME on this J, 2 day of May, 2014, to certify

which, witness my hand and official seal.

i~.~~~'?,/1,,,__ TONYA LEANNE FOREMAN

ff"~~1o~ Notary Public, state of Texas

%vi.·~P~./!f!f

"'-lJ;r,;<r,~;~~~~

My Commission Expires

April 03, 2016

~~/

Notary Public in and for the

State of Texas

My Commission Expires:

I~VUv\iJJl

Printed e of Notary Public

2

442312

57

APPENDIX E

Affidavit of Comptroller’s Auditor

CAUSE NO. D~l-GN- 13...000989

AutoHaus lP, LLP, IN THE DISTRICT COURT OF

Plaintiff,

v.

TRAVIS COUNTY, TEXAS

Susan Combs, Comptroller of Public

Accounts of the State of Te)[B.S, and

Greg Abbott, Attorney Oeneral of the

State ofTexas, 419111 JUDICIAL DISTRICT

Defendants.

THE STATE OF TEXAS

COUNTY OF DALLAS

Affidavit of Gem Zhao

Before me, the undersigned notary, on this day personally appeared Gem Zhan, the

affiant. After I administered an oath lD affiant, affiant testified:

"1. My name is Gem Zhan. l1:1m over 18 years of age. I have· never been convicted

of a crime of moral turpitude; and 1am otherwise fully competent to provide this affidavit. l have

personal knowledge of an facts and matters stated in this affidavit, and they are all true and

correct,••

6

'2. I am an Auditor employed by the Texas Comptroller of PubLic Accounts. I work

at the Dallas Audit Office. I have worked for the Comptroller since June 8, t 999. l am a certified

public accountant."

"3. In the months of April and May, 2012, I visited AUTOHAus•s offices in Plano.

During the perfonnance of my audit, t worked directly with the taxpayer,s Principal and Chief

Financial Officer Mary Hutchison ~Ms. Hutchison') to determine taxpayer's compliance with

Texas ftanchise tmrcodes for Report Year 2009.''

"4. I requested from M.s. Hutchison aU of the records necessary to conduct my audit

See attached document marked as •'Exhibit A." AUTOHAUS's 2009 franchise tax report was

based upon the taxpayer's business activities for the year ending December 31, 2008. ("Tax

Period''). See attached. document marked as "Texas Franchise Tax Report, and "Exhibit B.n

••s. After confinning taxpayer's compliance on franchise tax report components like

total revenue. apportionment factor, and tax rate, I focused. my efforts on the cost..of-goods-sold

deduction.

EXHIBIT 1

127

"6. Ms. Hutchison and I focused the audit investigation specifically upon the service

labor provided by AUTOHAUS to repair or install automobile parts upon custornerooOwned

vehicles at the taxpayer's service department. Ms. Hutchison brought to my attention that some

ofthe repair was done by sub-contractors.

"1. The Comptroller auditor training r have taken during my employment has

emphasized that the Texas Franchise Tax Code tax is based on a taxpayer~s business activities.

The costooOf~goocJs..sold deduction under Texas TIUC Code § 171.1012 is limited to costs incurred

as a result of"'acquiring or producing goods" for sale. Based on my understanding from training,

when a service departmen~ either directly or through a subcontractor, repairs an automobile or

installs automobile parts and other tangible personal property on a customer~wned motor

vehicle, it has perfonned a service activity under the Texas Tax Code and the labor for such

repair is not deductible as a cost of goods sold because the automobile is not then sold to the

customer by the service department. However, the automobile partS and other tangible personal

property used in that repair are eUgible to be included in a cost~f-goods--sold deduction because

the automobile parts and other tangible property used in the repair are sold to the customer (sale

of acquired goods)."

"8. ln my review of AUTOHAUS' business activities and·records for the Tax Period,

I determined that auto repair perfonned by AUTOHAUS was considered mixed transactions as

defined under 34 Texas Administrative Code § 3.588(c) (1) by providing a service, repairs to

customer-owned motor vehicles. and selling goods in the form of automobile parts and other

tangible personal property to its customers under Texas Tax Code§ l7l.IOI2(a), Therefore. in

my audit, I allowed AUTOHAUS to include in its cost-of-goods-sold deduction all of the costs

of acquiring and reselling the automobile parts and other tangible personal property that it and its

subcontractors had used during the tax periods including those used in the performance of its

repair and installation services, where AUTOHAUS provided supporting documentation."

"9. Further, I granted AUTOHAUS the oost..af•goods-.sold deduction fur both labor

and automobile parts and other tangible personal property used where Ms. Hutchison was able to

provide documentation or other proofto show that the work was not performed as a semce, but

was rather performed as a production activity for work on a motor vehicle that AUTOHAUS

owned prior to offering the motor vehicle for sale in the ordinary course ofits business."'

"1 0. After I exhausted all of the documents and other material Ms. Hutchison

presented to me to calculate and detennine the service labor expenses for work AUTOHAUS

performed on customer vehicles and included in its calculation of the cost..of-goods-sold

deduction for Report Year 2009, I finalized my tax adjustment summary and supporting exam as

shown in exhibit C. No adjustments were made in any components other thPn cost of goods sold.

The results of my audit, as shown in Exam B and on the summary pages of my report, show that

AUTOHAUS improperly included the service labor used to perform automotive repair and

installation services upon motor vehicles belonging to its customers in its cast-of.-goods-sold

deduction for Report Vear 2009. See attached document matked as '•Summary Schedule'* and

"Exhibit C."

128

''11. Based upon tbe business records and facts generated during the audit, the

Comptroller provided AUTOHAUS With notification of audit results and assessed the taxpayer

the sum of$12,384.18 in taxes for Report Year2009. With interest through the statement date of

December 5, 2012, the total additional amount due for Report Year 2009 was $14, 170.93." See

attached document marked as "Texas Notification of Audit Results" and "Exhibit D.,

Further affiant sayeth not.

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129

APPENDIX F

Listing of Disallowed Costs

AUTOHAUS LP, LLP EXAMB

PLANO,TX PAGE 1 OF l

AUDITED COST OF GOODS SOLD TP#: 32036876442

ltBPORT YEAR 2b09 . >...

ACCOUNTING YEAR ENDING 12/31/200&

****************************************;***** **** ***************** ***************************;;¥;;;;;;;;~********************

REPORTED COST OF GOODS SOLD $122,21 0,985

===========~~======~~======~===~

--·------·----FROM THE FRANCHISE TAX REPORTS---··-------··

DISALLOWED COSTS

SRV CUST LBR MB 1,105,775

SRV WARR LBR M/8 352,454

SRV SUBLET RPR M/B 746,582

CUST LBR-MECH Ltr 173,933

4Y/50KMAINTMB 102,559

TOTAL DISALLOWED COSTS 2,481,302

AUDITED COST OF GOODS SOLD $119,729,683

====---======!::::

---·---·------·---FORWARD TO TAX ADJUSTMENT SUMMARY----------·······

********************************************** **** ***************** ***********************************************************

COMMENTS:

o AMOUNTS ARE FROM TRIAL BALANCE SHEETS AND COST OF GOODS SOLD WORKPAPERS.

70

APPENDIX G

Autohaus’s Protest Letter

MEADOWS, COLLIER, REED, COUSINS CROUCH & UN GERMAN, L.L.P.

ATIORNEYS IITLIIIV

A REGISIERED LUvfiTED JJ/\BILJTY PARTNiiRSHJP lN.cLUDlNG PROFESSlONAL CORPORATIONS

901 MAIN STREET, SUITE 3700

DALLAS, TEXAS 75202

(214) 744-3700

www.meadowscollier.com

DAVID E. COLMENERO, P.C. FAX (214) 747-3732

Partner WATS (800) 451-0093

dcolmenero@meadowscollier.com

January 14, 2013

Texas Comptroller of Public Accounts

Dallas Northeast Enforcement Office

Attn: Cynthia Molina

9221 LBJ Freeway

Suite 100

Dallas, Texas 75243

Re: Letter Conveying Payment Under Protest

Taxpayer: Autohaus LP, LLP

Taxpayer No.: 32036876442

Exam Period: 2009

Dear Sir/Madam;

Enclosed is a check in the amount of $14,227.09, submitted on behalf of

Autohaus LP, LLP ("Taxpayer"). This payment is remitted as full payment of the amount

owed in accordance with the enclosed Texas Notification of Audit Results dated December

5, 2012. Taxpayer makes this payment under protest. For the reasons that follow,

Taxpayer maintains that the Texas Comptroller's assessment of franchise tax was

incorrect. A Power of Attorney appointing David E. Colmenero as representative for

Taxpayer is also enclosed.

Please file stamp the attached copy of this letter and check showing receipt of this

letter.

Background

Taxpayer is an automotive dealership located in Plano, Texas. In its franchise tax

report for 2009, Taxpayer claimed a cost-of-goods-sold deduction. Taxpayer's cost-of-

goods-sold deduction included costs that it incurred in selling automobiles ("Sales

Costs"), costs that it incurred in repairing automobiles ("Repair Costs"), and costs that it

incurred in subletting such repair work to others ("Subletting Costs"). Only Taxpayer's

Ex. 3 71

Repair Costs and Subletting Costs are at issue here. Both Taxpayer's Repair Costs and

Taxpayer's Subletting Costs included labor costs and costs of materials.

The Comptroller assessed a total amount due of $14,170.93, including state and

local tax of $12,384.18 and interest of $1,786.75. This assessment was based on the

Comptroller's erroneous determination that Taxpayer could not include as cost of goods

sold that portion of its Repair Costs attributable to labor and that Taxpayer could not

include as cost of goods sold any of Taxpayer's Subletting Costs. ·

Statement of Grounds for Protest

Taxpayer is entitled to include as cost of goods sold all of its Repair Costs,

including labor costs, and all of its Subletting Costs, including labor costs and costs of

materials. Alternatively, Taxpayer is entitled to include as cost of goods sold the costs of

materials that were included in its Subletting Costs. Without limiting the generality of

the preceding statements; Taxpayer provides the following additional information:

1) Under the Texas franchise tax, a taxpayer may elect to deduct the amount of its cost

of goods sold from its total revenue in order to calculate its taxable margin. See Tex.

Tax Code Ann.§ 171.101(a)(1)(B)(ii)(a).

2) The cost-of-goods-sold deduction includes all direct costs of acquiring or producing

goods. Tex. Tax Code Ann. § 171.1012(c). Labor costs and costs of materials are

specifically included as costs of goods sold. Id. § 171.1012(c)(l),(2),(3).

3) "Production" for purposes of the cost-of-goods-sold deduction "includes construction,

installation, manufacture, development, mining, extraction, improvement, creation,

raising, or growth." Tex. Tax Code Ann.§ 171.1012(a)(2) (emphasis added).

4) Because replacement of automotive parts necessarily involves the installation of

tangible personal property, labor costs associated with the replacement and/or

installation of automotive parts are cost of goods sold. See Tex. Tax Code §

171.1012(a)(2), (c)(1). Therefore, Taxpayer is entitled to include as costs of goods

sold the costs attributable to labor in both its Repair Costs and its Subletting Costs.

5) The Comptroller's Rule 3.588(b)(7), which interprets the term "installation" that

qualifies as production to include only "installation occurring during the

manufacturing or construction process" does not properly reflect legislative intent and

is therefore invalid. See 34 Tex. Admin. Code sec. 3.588(b)(7).

6) The Texas Comptroller has recognized in at least one other context that an

automotive repair service company is·in fact engaged in both selling and installing

automotive parts. See Comptroller Hearing No. 103,786 (May 10, 20ll)("Petitioner

provided automotive repair services such as the sale and installation of automotive

exhaust systems, transmissions, mufflers, brake linings, glass, and other items from

various outlets in Texas."). Indeed, this factual fmding has led the Comptroller to

72

conclude that such entities may not qualify for the reduced .5% rate. See id

("Establishments primarily engaged in both selling and installing automotive parts are

considered to be engaged in services ....").

7) In addition, because replacement of automotive parts necessarily ·involves the

installation of tangible person property, costs of materials used in the replacement

and/or installation of automotive parts are also clearly costs of goods sold. See Tex.

Tax Code § 171.1012(a)(2), (c)(2), (3). Therefore, Taxpayer is entitled to include as

costs of goods sold all the costs of materials included in its Subletting Costs.

8) The Comptroller's denial of Taxpayer's right to include as cost of goods sold all of its

labor costs and costs of materials used in the production oftangible personal property

for sale, while permitting other similarly situated taxpayers to include such costs as

cost of goods sold, results in the disparate treatment of taxpayers within the same

class -i.e., businesses producing tangible personal property for sale to customers -in

violation of the "equal and uniform taxation" requirement of Section 1 of Article 8 of

the Texas Constitution. See Tex. Const. art. VIII,§ 1; In re Nestle USA, Inc., No. 12-

0518, 2012 WL 5073315, at *6 (Tex. Oct. 19, 2012). The Comptroller's unequal

application of the cost-of-goods-sold deduction is in violation of the "equal and

uniform taxation" requirement in the Texas Constitution because it is arbitrary and

not rationally related to any difference that affects the value of the privilege of doing

business within Texas. See Nestle, 2012 WL 5073315, at* 7; Bullockv. Sage Energy

Co., 728 S.W.2d 465,467-68 (Tex. App.-Austin 1987, writ refdn.r.e.).

9) The Comptroller's denial of Taxpayer's right to include as cost of goods sold all of its

labor costs and costs of materials used in the production of tangible personal property

for· sale, while allowing other similarly situated taxpayers to include such costs as

costs of goods sold, constitutes the imposition of unequal rights among taxpayers and

the granting of an exclusive separate privilege to certain taxpayers in violation of

Section 3 of Article 1 of the Texas Constitution. Tex. Const. art. 1, § 3.

10) The Comptroller's denial of Taxpayer's right to include as cost of goods sold all ~fits

labor costs and costs of materials used in the production of tangible personal property

for sale, while permitting other similarly situated taxpayers to include such costs as

cost of goods sold, constitutes a violation of Taxpayer's rights under the Equal

Protection Clause of the U.S. Constitution because it arbitrarily results in Taxpayer

paying more tax than other similarly situated taxpayers. U.S. Canst. amend. XIV, §

1.

11) The Comptroller's denial of Taxpayer's right to include as cost of goods sold all of its

labor costs and costs of materials used in the production of tangible personal property

for sale, while permitting other similarly situated taxpayers to include such costs as

cost of goods sold, constitutes a violation of Taxpayer's rights under the Equal

Protection Clause of the U.S. Constitution because Comptroller's disparate treatment

of Taxpayer is based on a classification among taxpayers that is not supported by any

rational basis and is arbitrary, capricious and unreasonable. Id.

73

12) The Comptroller's denial of Taxpayer's right to include as cost of goods sold all of its

labor costs and costs o

This text is long and has been trimmed here. Open the source document for the complete record.