On March 2, 2018, the Texas Supreme Court decided EXLP Leasing LLC et al. v. Galveston Central Appraisal District, reversing the Fourteenth Court of Appeals and rendering judgment in favor of Baker Botts’ client Archrock. (Archrock was previously known as “Exterran,” which is the name used in the Supreme Court’s opinion.) The dispute concerned the constitutionality of a special appraisal statute for the valuation of heavy equipment inventory for tax purposes, which involved over $66.2 million in aggregate tax benefits to Archrock from 2012-2017. Those unfamiliar with this area may fairly wonder why valuation of inventory is so hard or why the decision is so significant. The Legislature has been working for over two decades to reform the system of inventory taxation. The statute at issue in Friday’s decision is simply its most recent effort.
Archrock is in the business of leasing natural gas compressors, which are large gas-powered pieces of equipment used throughout Texas to assist in the extraction of oil and gas. In 2011, the Texas Legislature amended the Texas Tax Code to streamline the appraisal process for all “heavy equipment inventory” that is held by a dealer for sale or lease. Archrock complied with the new statute, but the Galveston Central Appraisal District (GCAD), like over 100 other Texas appraisal districts, refused to accept Archrock’s heavy equipment tax filings. The appraisal districts argued that the heavy equipment statute did not tax heavy equipment inventory at fair market value, and thus violates Article VIII, Section 1 of the Texas Constitution. According to the appraisal districts, the new statute resulted in a 97% decrease in tax revenue on oil field compressors compared to prior traditional methodologies for determining “market value.”
Friday’s decision secured the special inventory valuation statutes, and unambiguously rejected the appraisal districts’ constitutional arguments. The Court instead adopted Archrock’s argument that, because the Texas Constitution expressly requires that all personal property be valued “as may be provided by law,” the Legislature may prescribe methods for valuation that are binding on appraisal districts. “[W]hile many of the tax code’s valuation methodologies are based on market value, . . . the legislature’s reliance on market valuation for the vast majority of property does not create a constitutional imperative that is do so in all instances.” The heavy equipment amendments replaced a cumbersome, complicated, and expensive appraisal system with a far simpler method that ensures all dealers are taxed in exactly the same way—based exclusively on the amount of income their inventory generates. The new statute severely penalizes any dealer who seeks to hide or underreport its sales or leases, and eliminates prior county-by-county discrepancies. All of this, the Court said, was well within the Legislature’s constitutional authority.
This decision will affect hundreds, even thousands, of lawsuits pending across Texas. Since 2012, Baker Botts alone has filed over 800 lawsuits, suing more than 100 Texas appraisal districts that have refused to follow the statute.
The ruling is particularly significant because, if Galveston Central Appraisal District had prevailed, the Court would have told the Legislature that there was no flexibility when it comes to taxing inventory, essentially locking down old methods that cost more and are less effective. It would have thrown some 25 years of reform statutes into doubt. The Court’s message was that the framers of our Constitution were more far-sighted than that. When they drafted our current Constitution in 1876, they expressly left it to the Legislature to make these decisions because it is the Legislature’s duty to account for changes that come with new technology, new forms of property, new economic realities, and the needs of the Texas people. And beyond that, the Court demonstrated again that Texas courts will not reject valid state and local tax-planning techniques just because they significantly reduce taxpayers’ liability.
The Baker Botts team was led by Houston Tax partner, Renn Neilson. The team included Austin Partner, Evan Young, who argued the appeal both in the Fourteenth Court of Appeals and before the Texas Supreme Court; Paul Elliott (Houston, Partner), who handled the district court litigation and advised on the appeals; Thomas R. Phillips (Austin, Partner); and Ben Geslison (Houston, Senior Associate) from the Litigation Department. From the Tax Department, in addition to Mr. Neilson, were Matt Larsen (Dallas, Partner); and Derek Young (Associate, New York).