The Austin Court of Appeals has upheld the comptroller’s denial of a franchise tax refund in a case involving the calculation of “total revenue” for purposes of the tax.

Appellants, Hibernia Energy LLC; and Ryan, LLC, as Assignee//Cross Appellants, Glenn Hegar, Comptroller of Public Accounts of the State of Texas, and Ken Paxton, Attorney General of the State of Texas v. Appellees, Glenn Hegar, Comptroller of Public Accounts of the State of Texas, and Ken Paxton, Attorney General of the State of Texas//Cross Appellees, Hibernia Energy LLC; and Ryan, LLC, as Assignee (No. 03-21-00527-CV; filed April 21, 2023) arose from a dispute over franchise tax returns filed by Hibernia for tax-report years 2013 and 2015. Those returns reflected gains resulting from the sale in 2012 and 2014 of certain leasehold interests in oil-and-gas properties, which yielded about $95.8 million in 2013 and $295.8 million in 2015. Hibernia included the gains in its calculation of total revenue (after subtracting its cost basis) and paid the tax. In late 2015, Hibernia retained Ryan to represent it before the comptroller, filed for a refund of over $2.7 million for overpayments in 2013 and 2015, and filed amended tax returns for those years removing $391 million in gains previously reported in total revenue. After the informal review process, the comptroller rejected the refund claim, a decision upheld by the ALJ in the subsequent administrative hearing. Hibernia timely filed a motion for rehearing, which the comptroller denied. While the administrative process was playing out, Hibernia assigned its refund claim to Ryan. Litigation ensued. Both parties moved for summary judgment, Hibernia on its refund claim, and the comptroller on jurisdictional (lack of standing) and substantive law grounds. The trial court entered final judgment for the comptroller and denied Hibernia’s motion. Hibernia appealed, and the comptroller cross-appealed on the standing issue.

In an opinion by Justice Baker, the court of appeals rejected the comptroller’s plea to the jurisdiction but affirmed the trial court’s judgment denying the refund. As to the standing issue, the comptroller asserted that since Hibernia assigned its claim to Ryan prior to end of the administrative process, it did not exhaust its administrative remedies. Moreover, Ryan did not file a motion for rehearing and failed to timely file suit by not being added as a plaintiff until nearly six months after the denial of Hibernia’s motion for rehearing. The court did not buy these arguments as a matter of the law of assignment, which gives a trial court subject-matter jurisdiction regardless of whether the assignor or assignee files or prosecutes the action. In fact, under common law the assignee can prosecute the assignor’s claim without even becoming a party of record, just as the assignor may prosecute a claim in its own name without adding the assignee as a party. “We see no reason why the common-law rule that an assignor may continue to maintain a pending action after the rights to claims therein have been assigned should not also apply to administrative claims,” Justice Baker wrote. “Furthermore, because Ryan stepped into Hibernia’s shoes, all of Hibernia’s rights and remedies as to these refund claims were imputed to Ryan, including the timely filing of the MFR as a statutory prerequisite to suit and the timely filing of suit after the Comptroller denied the MFR” (citation omitted).

Turning to the substantive issue, the court engaged an analysis of relevant provisions of the Internal Revenue Code and Chapter 171, Tax Code (the franchise tax) and their associated tax forms to determine whether Hibernia properly excluded the gains from the sale of its interests. First, as the court noted, § 171.1011 “requires that ‘amounts reportable as income’ on the specified (federal) Form 1065 lines be summed as a first step in computing total revenue.” The line at issue in the case is found in Form 1065, Schedule K, line 11, which requires “a partnership [to] report ‘any other item of income’ not elsewhere reported on the information return.” For the tax years in question, however, Hibernia reported nothing on line 11. Hibernia argues that since federal income tax law did not require it to report the gains in Schedule K, it was likewise not required to include them in the calculation of total revenue for franchise tax purposes.

The comptroller, on the other hand, contended that Hibernia should have reported the gains on Form 1065 and that they should also have been included in the calculation of total revenue. The court agreed, reading IRC § 6031’s requirement “that a partnership ‘specifically’ state the items of its ‘gross income’” as “align[ing] with the wise net the IRC casts in defining ‘gross income’—the term broadly means ‘all income from whatever source derived, including… [g]ains derived from dealings in property…” (including gains from the disposition of an interest in oil, gas, geothermal, or other mineral properties). The court further noted that in the relevant tax years, Hibernia took advantage of the option to deduct intangible drilling and development costs (IDCs) in the year they are incurred, rather than amortizing the deduction. This disqualified Hibernia from later adjusting its basis when calculating gains from the sale of the interests. The court first rejected Hibernia’s semantic argument that Form 1065 does not require reporting of gain or losses for “the disposition of an interest” because the form does not say “gains or losses from the disposition of an interest.” This reading, according to the court, made no sense in the context of of the IRC’s “mandate that partnerships report all ‘gross income’—it would constrain logic and common sense for it to [exclude a type of gross income] in the middle of a list of types of income that must be reported.” The court further rejected Hibernia’s argument that it could not calculate its gains at all “because basis is tracked at only the partner level.” Nonsense, the court replied, since Hibernia already calculated its gains for purposes of the original franchise tax returns and it elected to deduct its IDCs all at once. “Because those basis adjustments were unavailable to Hibernia, its gain on the leasehold sales were simply its cost to purchase them less the amount realized on the sale.” Match goes to the comptroller.

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