Glenn Hegar, Comptroller of Public Accounts of the State of Texas, and Ken Paxton, Attorney General of the State of Texas v. CGG Veritas Services (U.S.), Inc.

ACCEPTED 03-14-00713-CV 6156364 THIRD COURT OF APPEALS AUSTIN, TEXAS 7/21/2015 1:12:23 PM JEFFREY D. KYLE CLERK No. 03-14-00713-CV ____________________________ FILED IN IN THE COURT OF APPEALS 3rd COURT OF APPEALS AUSTIN, TEXAS THIRD JUDICIAL DISTRICT OF TEXAS7/21/2015 1:12:23 PM AT AUSTIN 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.

CGG Veritas Services (U.S.), Inc., Appellee.

FROM THE DISTRICT COURT OF TRAVIS COUNTY, 353RD JUDICIAL DISTRICT CAUSE NO. D-1-GN-12-001316, HONORABLE TIM SULAK PRESIDING

APPELLEE’S BRIEF

Amanda G. Taylor MARTENS, TODD, LEONARD, ataylor@textaxlaw.com TAYLOR & AHLRICH Texas Bar No. 24045921 301 Congress Avenue, Suite 1950 James F. Martens Austin, Texas 78701 jmartens@textaxlaw.com Tele: (512) 542-9898 Texas Bar No. 13050720 Fax: (512) 542-9899 Lacy L. Leonard lleonard@textaxlaw.com Texas Bar No. 24040561 ATTORNEYS FOR APPELLEE, Danielle Ahlrich CGG VERITAS SERVICES (U.S.), dahlrich@textaxlaw.com INC. Texas Bar No. 24059215

ORAL ARGUMENT REQUESTED

TABLE OF CONTENTS

TABLE OF CONTENTS .....................................................................................i INDEX OF AUTHORITIES .............................................................................. v RECORD ABBREVIATIONS ........................................................................... ix REQUEST FOR ORAL ARGUMENT................................................................ x RESPONSIVE ISSUES PRESENTED .............................................................. xi STATEMENT OF FACTS .................................................................................. 1

I. CGG PRODUCES AND SELLS SEISMIC DATA FOR USE IN OIL & GAS PROJECTS.................................................................................. 1

A. The Acquisition and Production of Seismic Data Requires Physical and Mental Effort that is Difficult and Costly. ............................................................................ 1

B. Seismic Data is Essential to Drilling Projects. ..................... 5

C. Sales to Proprietary Customers. .......................................... 7

D. Sales through Multi-Client Data Library (MCDL). ............ 8

II. PROCEDURAL HISTORY. .................................................................. 11

A. CGG Calculated its 2008 Franchise Taxes Using the COGS Deduction. ............................................................... 11

B. The Comptroller Denied the COGS Deduction and Assessed Additional Taxes Based on Incomplete Information. ....................................................................... 12

C. CGG Paid the Assessment Under Protest and Filed Suit...................................................................................... 14

i

D. The Comptroller’s Counterclaim Was Separately Resolved. ............................................................................ 16

E. CGG Has “Apportionment” Claims Separately Pending at the Administrative Level. ................................ 16

F. The Trial Court Entered a Final Judgment and Made Findings and Conclusions in Favor of CGG....................... 18

SUMMARY OF THE ARGUMENT ................................................................. 19 STANDARDS OF REVIEW .............................................................................22

I. STATUTORY CONSTRUCTION. ...........................................................22

II. FINDINGS OF FACT AND CONCLUSIONS OF LAW. ...............................23

ARGUMENT ...................................................................................................25

I. FRANCHISE (MARGIN) TAX CALCULATION. ......................................25

II. THE COGS DEDUCTION, SECTION 171.1012. .................................. 28

A. Does the Taxpayer Qualify for the COGS Deduction? ...... 28

B. What Costs are Allowed for the COGS Deduction? .......... 30

III. CGG QUALIFIES FOR THE COGS DEDUCTION. ................................ 30

A. CGG Qualifies as a “Deemed Owner.” ............................... 31

1. CGG furnishes labor and materials. .........................32

a. Labor. ............................................................. 33

b. Materials. ....................................................... 34

c. The Comptroller’s categorical attempt to separate “labor and materials” from “geological and geophysical” work misinterprets the statute. ...............................35

ii

d. The Comptroller’s argument that CGG’s work is a “service” that is not “fatiguing, difficult, or compulsory” enough to constitute “labor” is an improper recast of its previously-rejected “physical change” theory. .............................................. 40

e. The Comptroller’s two-sentence argument regarding “materials” is unavailing....................................................... 44

2. CGG’s activities are sufficiently connected to a real-property improvement project. ........................45

B. CGG Qualifies as an “Actual Owner.” ............................... 50

1. CGG owns and sells seismic data. ........................... 50

2. The seismic data is a “good” for purposes of the COGS deduction. ...................................................... 51

a. TPP for COGS is different than TPP for sales tax or apportionment. ........................... 54

b. CGG’s seismic data satisfies the definition in Section 171.1012(a)(3)(A)(ii)........................................ 57

IV. ALL OF CGG’S COSTS ARE ALLOWED FOR THE COGS DEDUCTION....................................................................................63

A. The Comptroller Waived Any Challenge to the Actual Costs Deducted. ..................................................................63

B. The Statute Does Not Require Parsing of Costs. ...............65 V. NO DEFERENCE IS OWED TO THE COMPTROLLER’S POSITIONS. ........ 68

iii PRAYER ..........................................................................................................70 CERTIFICATE OF COMPLIANCE ................................................................. 71 CERTIFICATE OF SERVICE .......................................................................... 72 APPENDIX:

1. P.Ex.4, p.D0062-68: August 2010 Auditor Dullum’s Notes

2. P.Ex.5: September 2010 Additional Tax Assessment

3. P.Ex.19: CGG’s COGS Calculation, Breakdown

4. P.Ex.48: CGG’s COGS Calculation, Overview

iv

INDEX OF AUTHORITIES

CASES

American Multi-Cinema, Inc. v. Hegar, No. 03-14-00397-CV, --S.W.3d --, 2015 WL 1967877 (Tex. App.—Austin Apr. 30, 2015, no. pet. h.) ............................ passim

Avis v. First Nat. Bank of Wichita Falls, 174 S.W.2d 255 (Tex. 1943) .................................................................51

City of Keller v. Wilson, 168 S.W.3d 802 (Tex. 2005 ................................................................ 60

Combs v. Newpark, 422 S.W.3d 46 (Tex. App.—Austin 2013, no pet.)....................... passim

Combs v. Roark Amusement & Vending, L.P., 422 S.W.3d 632 (Tex. 2013) ................................................... 23, 49, 68

DPRS 15th St., Inc. v. Texas Skyline, Ltd., No. 03-11-00101-CV, 2014 WL 4058796 (Tex. App.—Austin Aug. 13, 2014, no pet.) ........................................................................ 24

Graham Cent. Station, Inc. v. Pena, 442 S.W.3d 261 (Tex. 2014)................................................................ 24

Greater Houston P’ship v. Paxton, No. 13-0745, 2015 WL 3978138 (Tex. June 26, 2015) ........................ 22

Houston Fire & Cas. Ins. Co. v. Hales, 279 S.W.2d 389 (Tex. Civ. App.—Eastland 1955, writ ref’d n.r.e.) ...... 45

In re Bass, 113 S.W.3d 735 (Tex. 2003) ............................................................... 61

v

In re Nestle USA, Inc., 387 S.W.3d 610 (Tex. 2012).......................................................... 25, 27

McGalliard v. Kuhlmann, 722 S.W.2d 694 (Tex. 1986) ............................................................... 24

Murray v. Grayum, No. 03-10-00165-CV, 2011 WL 2533796 (Tex. App.—Austin June 24, 2011, pet. denied) ................................................................. 24

Roark Amusement & Vending, L.P. v. Combs, 2011 WL 255535 (Tex. App.—Austin Jan. 26, 2011), aff’d by 422 S.W.3d 632 (Tex. 2013) .................................................. 69

Sneed v. Webre, 12-0045, 2015 WL 3451653 (Tex. May 29, 2015) ............................... 38

TGS-NOPEC Geophysical Co. v. Combs, 340 S.W.3d 432 (Tex. 2011) ....................................................... passim

Titan Transp., LP v. Combs, 433 S.W.3d 625 (Tex. App.—Austin 2014, pet. denied) .......... 26, 27, 42

Upjohn Co. v. Rylander, 38 S.W.3d 600 (Tex. App.—Austin 2000, pet. denied)................. 69, 70

USA Waste Servs., Inc. v. Strayhorn, 150 S.W.3d 491 (Tex. App.—Austin 2004, pet. denied) ...................... 68

Vinson v. Brown, 80 S.W.3d 221 (Tex. App.—Austin 2002, no pet.) .............................. 24

W. L. MacAtee & Sons v. House, 153 S.W.2d 460 (Comm’n of App. adopted by Sup.Ct.) ...................... 45

vi

Zimmer US, Inc. v. Combs, 368 S.W.3d 579 (Tex. App.—Austin 2012, no pet.) ............................. 22

STATUTES & RULES

34 Tex. Admin. Code § 3.588 ...................................................... 29, 31, 51, 52 Tex. Gov’t Code § 311.005 ............................................................................ 38 Tex. Gov’t Code § 311.012............................................................................. 47 Tex. Gov’t Code Ch. 2001 ............................................................................ 42 Tex. R. App. P. 9.4 ........................................................................................ 71 Tex. R. App. P. 9.5........................................................................................ 72 Tex. R. App. P. 38.1 .................................................................................. x, 44 Tex. R. App. P. 39.1 ........................................................................................ x Tex. R. App. P. 43.4 ..................................................................................... 70 Tex. R. Civ. P. 139 ........................................................................................ 70 Tex. Tax Code § 112.052 ................................................................................15 Tex. Tax Code § 112.060 ...............................................................................15 Tex. Tax Code § 121.151 ................................................................................. 17 Tex. Tax Code § 151.0031 ............................................................................. 52 Tex. Tax Code § 151.009 ........................................................................ 54, 55

vii Tex. Tax Code § 171.051 ............................................................................... 69 Tex. Tax Code § 171.088............................................................................... 69 Tex. Tax Code § 171.103 ...............................................................17, 51, 54, 56 Tex. Tax Code § 171.1012 ...................................................................... passim Tex. Tax Code § 171.1013 .............................................................................. 26 Tex. Tax Code § 171.1014 ............................................................. 11, 27, 37, 66

OTHER AUTHORITIES

Merriam-Webster’s Collegiate Dictionary 765 (11th ed. 2012) ...................... 35

Texas Comptroller of Public Accounts, Letter Ruling 201504069L (April 23, 2015) .................................................................................. 67

Texas Comptroller of Public Accounts, Memorandum from Tax Policy Division, 201406920L (June 10, 2014) .............................................. 43

Webster’s Third New International Dictionary 1259, 2075 (Phillip Gove Ed. 2002) ............................................................. 33

viii

RECORD ABBREVIATIONS

Appellee uses the following abbreviated references to the record:

Abbreviation Reference CR Clerk’s Record (1 volume)

1.RR to 3.RR Volumes 1-3 of the Reporter’s Record, Trial Transcript

4.RR.P.Ex, Volumes 4-5 of the Reporter’s Record, Plaintiff’s 5.RR.D.Ex and Defendants’ Trial Exhibits

Excerpts from three depositions were admitted to be considered as part of the trial testimony (2.RR.10, 32-36).

4.RR.P.Ex.46: Sarah Pai, the Comptroller’s corporate representative.

5.RR.D.Ex.36: John Bastenagle, CGG’s regional marketing and sales manager.

5.RR.D.Ex.35: Kay Hanson-Clerc, CGG’s vice- president/multi-client controller worldwide.

1.Supp.RR Supplemental Reporter’s Record, Transcript of Hearing on Motion to Enter Judgment

ix

REQUEST FOR ORAL ARGUMENT

Appellee CGG Veritas Services (U.S.), Inc. respectfully requests that this Court grant oral argument to aid in the Court’s decisional process. Although this Court has previously analyzed portions of Texas Tax Code Section 171.1012 (i.e., the cost of goods sold (COGS) provision at issue here), CGG agrees with the Comptroller that this case presents additional issues of first impression beyond the Court’s prior holdings. Oral argument will assist the Court in understanding the statutory framework and reasonable interpretation of these provisions. Tex. R. App. P. 38.1(e), 39.1.

x

RESPONSIVE ISSUES PRESENTED

There is only one issue in this case: Did the trial court correctly decide that the Comptroller (Appellants) improperly disallowed the $567 million cost of goods sold (COGS) deduction claimed by CGG (Appellee) in calculating its margin for franchise tax report year 2008? The answer is yes and the judgment should be affirmed in full.

In response to the sub-issues raised by the Comptroller: 1. CGG correctly calculated its franchise taxes using the COGS deduction because it qualifies as an “owner of goods” under Texas Tax Code Section 171.1012(i). CGG qualifies as:

a. a “deemed owner” because it “furnishes labor or materials to a project for the construction or improvement of real property” by acquiring and producing seismic data that is an essential part of the oil and gas drilling process. [Responsive to Issues 3-4.]

b. an “actual owner” because it owns the seismic data that it sells through a “multi-client data library” (MCDL), and that data/images satisfies the definition of “goods” because the Legislature has chosen to treat this otherwise “intangible” property as an artificial form of “tangible personal property” exclusively for purposes of the COGS deduction. [Responsive to Issue 1.]

2. As a qualifying owner, the statute directs CGG to deduct all of the costs allowed under Sections 171.1012(c), (d), and (f), which total $567 million for report year 2008. The Comptroller failed to preserve any argument at trial that this amount should be parsed by business activity or by cost category. [Responsive to Issue 3.]

3. No deference is owed to the Comptroller’s positions because: (a) the statute is unambiguous, (b) the Comptroller’s arguments are unreasonable, and (c) the COGS deduction is akin to an “exclusion” rather than an “exemption” from tax. [Responsive to Issue 5.]

xi

STATEMENT OF FACTS

I. CGG PRODUCES AND SELLS SEISMIC DATA FOR USE IN OIL & GAS PROJECTS.

Appellee CGGVeritas Services (U.S.), Inc. (“CGG”) is “a fully-integrated geoseismic company.” (2.RR.73; CR.266 at FOF.2). CGG’s customers are “E&P companies”: companies that explore for and produce oil and gas. (2.RR.73-74; 5.RR.D.Ex.35, p.10; CR.266 at FOF.5). “CGG designs, acquires, processes, [and] occasionally interprets seismic data” in a manner that “aids in the construction of [its customers’] oil and gas wells.” (2.RR.74, 144; 4.RR.P.Ex.7, §§ 1, 4.1; 5.RR.D.Ex.3-12, 15; CR.265-66 at FOF.2-10).

A. The Acquisition and Production of Seismic Data Requires Physical and Mental Effort that is Difficult and Costly.

CGG produces seismic images by collecting “sound waves” and then “writ[ing] them out to some form of media.” (2.RR.76; CR.265 at FOF.3). A large crew of workers using powerful materials and equipment, which “make a physical impact on the property,” are required to create the sound waves. (2.RR.106, 111; 3.RR.9; 4.RR.P.Ex.22; 4.RR.P.Ex.47). CGG’s materials and equipment include dynamite, large vibroseis trucks that shake the ground, marine “airguns” that “make a large bang in the water,” and GPS satellites. (2.RR.76, 80-88, 134-35).

To shoot seismic on land, the dynamite is often placed 100-200 feet below the surface, with tens or hundreds of thousands of “shot hole” placements, by a crew of 75-100 people. (2.RR.82-83, 106; 3.RR.8-9). The vibroseis trucks weigh between 60,000 to 90,000 pounds, and there are normally five or six of them in the field. (2.RR.85, 106). The vibration created by these trucks leaves a four-inch indentation to the earth below. (2.RR.86, 106). For marine settings, CGG uses “as many as 50 airguns in an array” and a vessel “about 300 feet long.” (2.RR.87). For example:

Land, Dynamite

Land, Vibroseis

Marine (4.RR.P.Ex.47, p. 5, 7, 10) (in color, as admitted at trial).

CGG furnishes a variety of other materials in connection with the use of its large equipment. For example, in one of its customer’s projects, CGG was required to supply the following materials: (4.RR.P.Ex.9, p.12).

CGG’s labor generate sound waves that “illuminate the subsurface of the earth,” and allow CGG to “produce a three-dimensional image . . . to see below the surface.” (2.RR.76, 81; 3.RR.7-8; 5.RR.D.Ex.15; 5.RR.D.Ex.36, p.9-11; CR.265 at FOF.2, 4). The “seismic data in its raw form is written out onto some sort of media, like magnetic tapes or USB drives.” (2.RR.81; 3.RR.7).

This is an “extremely specialized” process. (2.RR.88; 3.RR.21-22; CR.265 at FOF.4). CGG does “[s]ome minor processing on site” at the intended drilling location but then turns the raw sound recordings into seismic images using “high-powered algorithms” at its processing center. (2.RR.89, 133; 3.RR.7; 5.RR.D.Ex.36, p.14). This requires complex hardware and software, and “a lot of highly-trained and experienced people.” (2.RR.90, 112-13; 3.RR.10; 4.RR.P.Ex.14, p.18). Generating seismic images is “a lot of science and somewhat of an art.” (2.RR.141). As one CGG employee described it by simplified analogy: “the raw data is like a black and white [photograph]. . . . I colorize it and I touch it up. And I print it out in a form that you can use.” (5.RR.D.Ex.36, p.26). Generally, “[t]he ultimate output is a high resolution digital image of the subsurface of the earth.” (2.RR.92). For example: *5 (4.RR.P.Ex.47, p.14) (in color, as admitted at trial).

The time spent by CGG’s workers to acquire seismic date and produce seismic images ranges from several months to several years. (2.RR.91, 137-39). This process is very expensive. The “average” cost is “tens of millions of dollars” and it can be as high as “hundreds of millions of dollars.” (3.RR.24-25).

B. Seismic Data is Essential to Drilling Projects.

The geo-seismic work performed by CGG “constitutes an integral part” of its customers’ oil and gas production business. (2.RR.102; CR.266 at FOF.6-7, 10). The contracts between CGG and its E&P customers expressly recognize that CGG’s work is performed for “the benefit of the [customer]”; that “[t]he work performed by [CGG] . . . is part of [the customer’s] trade, *6 business, or occupation”; and “[a]s such, [CGG’s] work constitutes an integral part of the [customer’s] business necessary to generate [customer’s] goods, products, and services.” (4.RR.P.Ex.7, §§ 1, 4.1). CGG’s work is “important to the entire drilling project.” (2.RR.130). All of CGG’s customers intend to use the seismic data to construct productive oil and gas wells. (3.RR.26-27). None of CGG’s customers pay for the acquisition and production of seismic data simply to ignore it and drill regardless of the information they see on the seismic images. (2.RR.130).

The purpose of the geophysical work performed by CGG is to locate oil and gas for drilling and production. (2.RR.101; CR.266 at FOF.6-7, 10). CGG’s seismic data provides a “roadmap” or a “blueprint for the project,” which its customers use “as a guide [for] where to drill the wells, [and] how deep to drill the wells.” (2.RR.75-76, 130). By demonstrating the “porosity, permeability, rock type, . . . [and] depth” of the earth’s subsurface, CGG’s seismic images allow petroleum companies “to identify fairly clearly potential places to drill.” (2.RR.94-96). The data can also show “geohazards,” like an “overpressurized zone[] . . . that would be dangerous to the drilling operations.” (2.RR.130). In these instances, the data helps a customer determine that it should drill elsewhere. (2.RR.130).

The subsurface of the earth is complex and non-uniform. There may be salt domes and other structures under the surface that would prevent one from reaching the oil and gas reservoirs if they were to just drill straight down without the use of a seismic data map. (2.RR.78-80, 93). “[Y]ou have to have a high-resolution image to be able to do that.” (2.RR.80). The seismic map (especially in 4-D format) can identify mineral resources that were otherwise compartmentalized and bypassed with prior methods. (2.RR.116-17; 3.RR.24; 4.RR.P.Ex.14, § 1.5).

C. Sales to Proprietary Customers.

CGG performs its work for both “proprietary” and “non-proprietary” customers. (2.RR.117; CR.265 at FOF.2). A proprietary customer is typically an E&P company that pays CGG to develop and sell it seismic images of an area designated by the customer for the customer’s exclusive ownership and use. (2.RR.117). Proprietary customers acquire all rights to the seismic data (both raw data and processed images). (2.RR.117, 134). This information is confidential and provides a valuable edge over competitors. (2.RR.117).

CGG enters a Master Agreement for Geophysical Services with its proprietary customers. (2.RR.101, 108-09; 4.RR.P.Ex.7; 4.RR.P.Ex.12). The contract states the basic scope of work and describes the labor and materials *8 to be furnished to the project, as illustrated above. (2.RR.105, 109, 111; see, e.g., 4.RR.P.Ex.7, p.1, 9, Schedules; 4.RR.P.Ex.9, p.12, 15-18).

CGG gets involved “early on” in the customer’s drilling project. (2.RR.75). By this point, the typical customer has identified a prospective drilling area based on “a lot of geologic work” and has “establish[ed] a lease position” that will allow them to drill there. (2.RR.75, 96). The customers specify the area where they want CGG to shoot seismic, the scope of CGG’s work, and the necessary timeline. (2.RR.97). In some cases, a customer may already own the raw data and provide it to CGG for processing. (2.RR.98, 141-42; 5.RR.D.Ex.36, p.12).

Because CGG’s seismic data is critical to the success of an oil and gas project, CGG must deliver its products timely and keep the customer informed. (2.RR.128; 3.RR.22-23). CGG provides frequent updates, and the customers often have on-site representatives. (2.RR.128-29; 3.RR.25). CGG may provide intermediate seismic images to help the customer make prompt decisions about when and where to drill. (2.RR.140; 3.RR.26).

D. Sales through Multi-Client Data Library (MCDL).

The non-proprietary division of CGG’s business is called the “multi-client data library” (MCDL). (2.RR.118; CR.266 at FOF.11). When a drilling area is “hot” with several E&P companies interested, CGG may choose to *9 fund the up-front cost of acquiring the data and producing the seismic images. (2.RR.118, 121; 4.RR.P.Ex.18). Sometimes, customers approach CGG requesting that it produce MCDL images for a certain area, and they help fund the project. (3.RR.19; 5.RR.D.Ex.36, p.12). Either way, to ensure the endeavor is profitable, CGG will generally not begin MCDL work unless it has a requisite minimum of “pre-commitments” from customers who want to use the images. (See 5.RR.D.Ex.13, p.23-24).

CGG then puts those products “on the shelf” and “try[s] to sell them to as many people as possible.” (2.RR.118-19; 3.RR.20; 4.RR.P.Ex.18; 5.RR.D.Ex.35, p.8, 12-13). The data available for any particular area can be delivered in several different mediums or “derivatives,” ranging from the raw sound recordings to a fully-processed image. (2.RR.118-19, 122; 3.RR.13-14; 4.RR.P.Ex.17; 5.RR.D.Ex.36, p.20).

The labor and materials necessary to acquire, process, and sell seismic data is the same for the MCDL products as it is for the proprietary customers. (5.RR.D.Ex.36, p.12-13, 17). The only difference is that, with proprietary customers, CGG sells the exclusive rights to the data to one customer, while with MCDL customers, CGG sells a non-exclusive license to use the data to as many customers as possible. (5.RR.D.Ex.35, p.13, 16-17).

CGG enters a “Master Geophysical Data-Use License Agreement” with MCDL customers. (2.RR.122, 124, 126; 4.RR.P.Ex.10; 4.RR.P.Ex.17; 5.RR.D.Ex.35, p.17). The customer purchases a “license to use” the seismic data product. (2.RR.123, 125, 134; 5.RR.D.Ex.35, p.11, 17). CGG maintains ownership of the underlying seismic data. (2.RR.123-24; 5.RR.D.Ex.36, p.13, 17, 19). The Agreement specifies what the customer can do with the data and places restrictions on the customer’s ability to share the information. (2.RR.125, 143; 5.RR.D.Ex.35, p.17; 5.RR.D.Ex.36, p.28-29). Supplements to the Agreement describe the medium of the data being licensed. (2.RR.126-28; 5.RR.D.Ex.35, p.17-18).

CGG’s goal is to sell its MCDL data “to as many people as [it] can,” regardless of the medium. (2.RR.119, 125; 3.RR.13; CR.267 at COL.13). Of the 11,854 oil and gas companies registered with the Texas Railroad Commission, CGG intends to sell its MCDL products to “[a]ll of them.” (2.RR.120; 4.RR.P.Ex.25). As of trial, CGG had actively worked with more than half (over 6,000) of those companies. (2.RR.120). It has licensed the same seismic image for a single area to as many as 114 companies. (3.RR.17; CR.266 at FOF.12). *11

II. PROCEDURAL HISTORY.

A. CGG Calculated its 2008 Franchise Taxes Using the COGS Deduction.

CGG timely filed its 2008 Texas Franchise Tax Report paying approximately $1.3 million in taxes. (3.RR.33; 4.RR.P.Ex.1; CR.267 at FOF.14). CGG calculated its taxable margin by first determining its revenue and then deducting its allowable costs of goods sold (“COGS”) from that amount. (3.RR.37-39); see infra, Argument I.

CGG is a “combined group” that is required to calculate its franchise taxes in accordance with Texas Tax Code Section 171.1014. (3.RR.34-37, 39). As such, CGG must “file[] a single tax report . . . elect[ing] to take the same general deduction [for] all members” of its integrated company. See Combs v. Newpark, 422 S.W.3d 46, 48 (Tex. App.—Austin 2013, no pet.). 1 Upon calculating the COGS amounts attributable to each of CGG’s members and summing them together, CGG’s total COGS amount for report year 2008 was $567,600,223 (hereafter, “$567 million”). (3.RR.41; 4.RR.P.Ex.1; 4.RR.P.Ex.19; CR.267 at FOF.15).2

1 The Comptroller does not raise any argument related to CGG’s combined group status as it did in Newpark, 422 S.W.3d at 52.

2 There is a typographical error in FOF.15(c): it should cite Section 171.1012(f) rather than subsection (e) regarding indirect or administrative overhead costs. (See 4.RR.P.Ex.1, line 12).

CGG’s tax department determined that it was eligible for the COGS deduction based on frequent communication with the project managers and personal knowledge about the nature of CGG’s business, including the facts underlying the revenues and expenses reported in CGG’s general ledger. (3.RR.40; 4.RR.P.Ex.21). They used this information to capture CGG’s costs, and included in the COGS calculation only the costs eligible for deduction under the statute. (3.RR.40-41, 48-52, 54-56; 4.RR.P.Ex.19; 4.RR.P.Ex.48; 5.RR.D.Ex.35, p.15); see Tex. Tax Code § 171.1012(c), (d), (e); infra, Argument IV. CGG’s federal and state tax director, Ms. Listya Diyah—who holds master’s degrees in both tax and finance, and has decades of corporate experience in these areas (3.RR.29-32)—personally reviewed the source documents and the calculations, and believes all of the numbers are accurate. (3.RR.42-43, 53).

B. The Comptroller Denied the COGS Deduction and Assessed Additional Taxes Based on Incomplete Information.

After CGG filed its tax report, it received a letter stating that the Comptroller was reviewing whether CGG qualified for the COGS deduction. (3.RR.44-45; 4.RR.P.Ex.2). The letter expressly stated that “[t]his review is not an audit” but it directed CGG to “complete the enclosed form” and return it within 15 days. (4.RR.P.Ex.2; see also 3.RR.81). The one-page form *13 requested only two pieces of information: (1) a description of the entity’s activities, and (2) a list of items included in the COGS calculation. (4.RR.P.Ex.3). CGG timely responded with this information. (3.RR.46-47; 4.RR.P.Ex.3). CGG anticipated that the Comptroller would then initiate a formal audit but it did not receive any further communications in that regard. (3.RR.47-48).

Instead, CGG received a letter stating that the Comptroller had completed his review of CGG’s 2008 franchise tax report, and “determined that [CGG] did not qualify for the [COGS] deduction.” (3.RR.48; 4.RR.P.Ex.5; CR.267 at FOF.16). The Comptroller included a bill assessing CGG an additional $1,301,568 (hereafter, “$1.3 million”) in tax plus interest. (3.RR.48, 54; 4.RR.P.Ex.5).

Mr. Gary Dullum, an auditor for the Comptroller, was responsible for reviewing CGG’s information, making the decision to deny its COGS deduction, and assessing CGG an additional $1.3 million in taxes. (3.RR.64, 78-79, 82-83; 4.RR.P.Ex.4-5). He did so as part of the Comptroller’s larger “Cost of Goods Sold Project,” which targeted taxpayers statewide whom the Comptroller believed to be “service providers” or “something other than . . . manufacturing or retail or wholesale” providers. (3.RR.80, 91-92).

In making his decision about CGG’s 2008 taxes, Dullum never spoke to CGG’s named representative, tax director Stephen Marshall. (3.RR.82; 4.RR.P.Ex.4, p.D0064). Dullum never visited CGG’s facilities nor otherwise examined the nature of CGG’s business (beyond the two pages of information provided by CGG in response to the Comptroller’s form and a “tour” of CGG’s website). (3.RR.83; see 4.RR.P.Ex.3; 4.RR.P.Ex.4, p.D0066). His notes reflect that he was not even aware of the work CGG performed for its proprietary customers. (4.RR.P.Ex.4, p.D0065). Dullum spent a total of 3 hours conducting a “limited” review before deciding to assess CGG an additional $1.3 million in taxes. (3.RR.83; 4.RR.P.Ex.4, p.D0062, 65).

Dullum’s incorrect conclusion was based on his misunderstandings that CGG is merely a “service provider” and that Section 171.1012(i) requires a taxpayer to “affect a physical change” to real property to qualify for the COGS deduction—a litigating position taken at trial but now publically abandoned by the Comptroller. (3.RR.80, 84-85, 88-89, 141; 4.RR.P.Ex.4, p.D0066; 4.RR.P.Ex.46, p.31); infra, Argument III.A.1.d.

C. CGG Paid the Assessment Under Protest and Filed Suit.

CGG paid $1,483,233 under protest covering the $1.3 million in additional taxes plus interest accrued through the date of payment. *15 (4.RR.P.Ex.6; CR.267 at FOF.17-18). CGG filed a protest letter with this payment explaining, inter alia, why it qualified for the COGS deduction in the full amount of $567 million. (4.RR.P.Ex.6). CGG thereafter filed suit asserting these same grounds and seeking a full refund with interest. (3.RR.54; CR.4-10, 265 at FOF.1); see also Tex. Tax Code §§ 112.052, 112.060. This claim was tried to the bench before the Honorable Tim Sulak in Travis County.

Although CGG maintains that it qualifies to deduct the full COGS amount and is entitled to a full refund on this basis, at trial it proved five alternative calculations based on its various business activities. (3.RR.52-55; 4.RR.P.Ex. 49). CGG also provided a break-down of all of the costs included in its COGS deduction by each category allowed for deduction under Sections 171.1012(c), (d), and (f). (3.RR.40-41, 48-52, 54-56; 4.RR.P.Ex.19; 4.RR.P.Ex.48).

At trial, the Comptroller challenged only whether CGG qualified for the COGS deduction under Section 171.1012(i). It preserved no argument about whether the specific costs included in CGG’s COGS calculation are allowed for deduction under subsections (c), (d), and (f). (See 2.RR.16; 3.RR.58-63, 91-98; CR.41-66); infra, Argument IV.A. The Comptroller rested without presenting any evidence. (3.RR.161). The court “rule[d] in favor of [CGG] *16 for the full amount of the refund sought” and requested that CGG prepare an appropriate order. (CR.217).

D. The Comptroller’s Counterclaim Was Separately Resolved.

The Comptroller counter-claimed that the amount of “research and development (R&D) credit” claimed by CGG for report year was too high. (CR.25-32). That claim was bifurcated and, following the COGS bench trial, it was resolved by a joint stipulation. (CR.35, 188-89). The parties stipulated that “the amount of the R&D carry-forward credit available for [CGG] to claim beginning with its 2008 Texas Franchise Tax Report is $782,268.” (CR.188-89).

E. CGG Has “Apportionment” Claims Separately Pending at the Administrative Level.

Following resolution of the only two claims in this lawsuit, both parties agreed that it was appropriate for the court to sign a final judgment that the Comptroller owes CGG a tax refund for report year 2008. (CR.194, 200, 202-03). However, the parties disagreed about how to calculate that refund in light of separately-pending administrative claims regarding the “apportionment factor” to be used in calculating CGG’s 2008 taxes. (CR.203-*17 07, 228-230); see Tex. Tax Code § 121.151 (requiring that CGG initiate these claims at the administrative level).3

If CGG prevails on its separate apportionment claims, it will further decrease the “tax due” amount shown on line 30 of its 2008 franchise tax report. (CR.206-07, 220). This, in turn, will impact how much of the R&D credit CGG applies to its 2008 taxes versus carries forward for application to future years because the credit is capped at 50% of the tax due amount for any given year. (CR.207, 220, 225; 1.Supp.RR.19). In combination, this could result in an additional refund owed to CGG of approximately $1 million. (CR.206; 1.Supp.RR.9, 11).

CGG was concerned that, if the judgment calculated a “final refund” amount, the Comptroller would later argue CGG was barred by res judicata or collateral estoppel from collecting any further refund for report year 2008. (1.Supp.RR.8-9). The Comptroller agreed it would not do so, and agreed that CGG would be entitled to seek an additional refund if it prevails on the apportionment claims. (1.Supp.RR.26-30).

3 “Apportionment” refers to the method by which CGG’s tax base is divided between Texas and locations outside of Texas. Tex. Tax Code § 171.103. “Because all of a company’s . . . taxable margin may not be attributable to business done in Texas, receipts must be apportioned between Texas and other jurisdictions. The tax code does this by multiplying an entity’s . . . taxable margin . . . by a fraction, the numerator of which consists of receipts from business done in Texas, . . . and the denominator of which consists of all receipts from business anywhere, including Texas.” TGS-NOPEC Geophysical Co. v. Combs, 340 S.W.3d 432, 437 (Tex. 2011).

F. The Trial Court Entered a Final Judgment and Made Findings and Conclusions in Favor of CGG.

The trial court entered a final judgment (1) concluding that CGG “is entitled to claim a [COGS] deduction in the amount of $567,600,223” for report year 2008; (2) incorporating the parties’ stipulation on the R&D credit amount; and ordering that (3) CGG’s tax due4 was $1,721,022.23; (4) the Comptroller shall issue an appropriate refund check with interest; and (5) CGG shall not be barred from seeking an additional refund upon final disposition of its apportionment claims. (CR.250-51).

The trial court also issued findings of fact (FOF) and conclusions of law (COL) in support of the judgment. (CR.265-270). These findings and conclusions confirm that CGG qualifies for the COGS deduction under Section 171.1012(i), and that all of the costs included in its COGS calculation were allowed by Sections 171.1012(c), (d), and (f). (CR.265-270).

4 The “tax due” amount (line 30) was calculated using the higher apportionment factor, which CGG disputes via its administrative claims.

SUMMARY OF THE ARGUMENT

The trial court correctly determined that CGG is entitled to claim a $567 million cost of goods sold (COGS) deduction in calculating its 2008 franchise taxes. Under the plain language of Texas Tax Code Section 171.1012, CGG qualifies to claim the COGS deduction because it is the actual and/or deemed owner of goods (per subsection (i)), and CGG incurred costs within the categories allowed for deduction (per subsections (c), (d), and (f)). The Comptroller, who raises only a couple of legal sufficiency complaints, has not demonstrated a complete absence of evidence to support any of the trial court’s findings. The Comptroller also has not proven that any of the court’s conclusions (which are fully supported by the underlying facts) are legally wrong. The judgment should be affirmed.

The Comptroller’s analysis, which begins by looking at the specific costs deducted, is convoluted. The threshold question is taxpayer eligibility. Once it is determined that a taxpayer qualifies as either an actual or deemed owner of goods to calculate its “margin” using the COGS deduction, then the taxpayer calculates the amount of its deduction by summing together all of the costs allowed by Section 171.1012.

To qualify as a “deemed owner,” a taxpayer need not actually own or sell “goods” as defined by Section 171.1012(a). Thus, the meaning of *20 “tangible personal property” is irrelevant to this analysis. Instead, a taxpayer who “furnishes labor or materials” to projects for the construction or improvement of real property is “considered to be the owner of that labor or materials,” which provides an alternative way to qualify for the COGS deduction. CGG satisfies this test under the analysis set forth in Combs v. Newpark, 422 S.W.3d 46, 49 (Tex. App.—Austin 2013, no pet.). In regard to both its proprietary and MCDL customers, CGG exerts physical and mental effort to acquire and produce seismic data, which is a critically important part of oil and gas drilling/production projects. The Comptroller’s contrary arguments (1) improperly conflate qualifying “activities” with allowable “costs,” and (2) construe Newpark in an overly-narrow manner based on the same principals underlying the Comptroller’s previously-rejected theory that a taxpayer must “effect a physical change” to the property.

To qualify as an “actual owner,” the taxpayer must actually own goods based on traditional incidents of ownership. It is undisputed that CGG owns the seismic data that it sells through the multi-client data library (MCDL). This data, although otherwise considered “intangible” for sales tax and apportionment purposes, is specially treated as “tangible personal property” exclusively for purposes of the COGS deduction. Thus, it satisfies the *21 definition of “goods” under Section 171.1012(a)(3)(A)(ii). The Comptroller’s argument is fundamentally flawed because it fails to appreciate the difference in treatment of this unique type of intellectual property for purposes of the COGS deduction, and his interpretation of the relevant definition is overly narrow.

Because CGG qualifies under subsection (i) as an actual and/or deemed owner, CGG is entitled to deduct all of its incurred costs allowed by the categories listed in subsections (c), (d), and (f). For report year 2008, this amount totaled $567 million, which was calculated for CGG’s entire business as a combined group pursuant to the analysis set forth by this Court in Newpark, 422 S.W.3d at 52. At trial, the Comptroller challenged only whether CGG qualified for the COGS deduction and preserved no complaint about the specific costs to be included in the calculation. In any event, CGG’s calculation is legally correct and supported by sufficient evidence.

Section 171.1012 is not ambiguous. Newpark, 422 S.W.3d at 56 n.9 Hence, there is no need to defer to the Comptroller’s contrary litigating position nor to add words or requirements into the statute that our Legislature did not intend. Moreover, the COGS deduction should be construed strictly against the Comptroller because it is akin to an “exclusion” rather than an “exemption” from tax.

STANDARDS OF REVIEW

I. STATUTORY CONSTRUCTION.

“The issues in this case primarily concern the proper construction of chapter 171 of the Tax Code.” Newpark, 422 S.W.3d at 49. Statutory construction is a question of law reviewed de novo. Id. The primary objective is to ascertain and give effect to the legislature’s intent by first considering the statute’s plain language. Id. Courts should reject any attempt to read words or requirements into the statute that were not intended by our Legislature. See Zimmer US, Inc. v. Combs, 368 S.W.3d 579, 587 (Tex. App.—Austin 2012, no pet.). “Undefined terms in a statute are typically given their ordinary meaning, but if a different or more precise definition is apparent from the term’s use in the context of the statute, we apply that meaning.” Greater Houston P’ship v. Paxton, No. 13-0745, 2015 WL 3978138, *5 (Tex. June 26, 2015) (quoting TGS–NOPEC Geophysical Co. v. Combs, 340 S.W.3d 432, 439 (Tex. 2011)).

If the statutory text is unambiguous, then “it is determinative of legislative intent, unless enforcing the plain meaning of the statute’s words would produce an absurd result.” Newpark, 422 S.W.3d at 49. “Only when the statutory text is ambiguous ‘do we resort to rules of construction or extrinsic aids.’” Id. (internal citations omitted).

Finally, “statutory determinations in tax disputes should reflect the economic realities of the transactions in issue.” Combs v. Roark Amusement & Vending, L.P., 422 S.W.3d 632, 637 (Tex. 2013). “And ‘[t]axing statutes are construed strictly against the taxing authority and liberally for the taxpayer.” Am. Multi-Cinema, Inc. v. Hegar, No. 03-14-00397-CV, --S.W.3d --, 2015 WL 1967877, *3 (Tex. App.—Austin Apr. 30, 2015, no. pet. h.) .

II. FINDINGS OF FACT AND CONCLUSIONS OF LAW.

The trial court entered findings of fact and conclusions of law in support of the judgment. (CR.265-270). The Comptroller specifically challenges: FOF.12-13 (Appellants’ Brief, p.37-38: arguing findings are irrelevant and supported by no evidence); COL.1, 2, 4, 5, 7 (id. p.29, 36, 42: arguing conclusions are legally incorrect).5

“[F]indings of fact [are reviewed] for legal and factual sufficiency of the evidence by the same standard applied to a jury verdict.” Am. Multi-Cinema, 2015 WL 1967877, at *4. “When a party attacks the legal sufficiency of an adverse finding on an issue on which it did not have the burden of proof, it must demonstrate on appeal that no evidence supports the adverse finding.” Graham Cent. Station, Inc. v. Pena, 442 S.W.3d 261, 263 (Tex.

5 The Comptroller also claims Finding 7 is “irrelevant” but otherwise concedes its accuracy. Id., p.29-30, 42, 49 n.10. Despite the Comptroller’s failure to specifically challenge Conclusions 8, 9, and 11, CGG interprets such a challenge to be within the scope of the Comptroller’s argument.

2014). The court must credit favorable evidence if a reasonable fact-finder could, and disregard contrary evidence unless a reasonable fact-finder could not. Id. “The trial court, acting as factfinder, is the sole judge of credibility of the witnesses and weight to be given to their testimony.” Newpark, 422 S.W.3d at 49.

“[C]onclusions of law [are reviewed] de novo to determine their correctness.” Am. Multi-Cinema, 2015 WL 1967877, at *4. But even an erroneous conclusion will not support reversal if the trial court rendered the proper judgment. Id.; see also Vinson v. Brown, 80 S.W.3d 221, 230 (Tex. App.—Austin 2002, no pet.).

Unchallenged fact findings are “binding on the appellate court unless the contrary is established as a matter of law, or if there is no evidence to support the finding.” McGalliard v. Kuhlmann, 722 S.W.2d 694, 696 (Tex. 1986). The court must disregard all contrary evidence and, if there is any remaining evidence in support of the finding, it must be upheld; and if that finding is sufficient to support the judgment, it should be affirmed. Id.; see also DPRS 15th St., Inc. v. Texas Skyline, Ltd., No. 03-11-00101-CV, 2014 WL 4058796, *5-6 (Tex. App.—Austin Aug. 13, 2014, no pet.); Murray v. Grayum, No. 03-10-00165-CV, 2011 WL 2533796, *5 (Tex. App.—Austin June 24, 2011, pet. denied).

ARGUMENT

The trial court properly determined that CGG qualifies for the COGS deduction as an actual or deemed owner of goods, and that CGG is entitled to deduct $567 million in COGS as a result. By allowing CGG to deduct its costs and arrive at a tax on net profits, the judgment comports with the overall goal of the franchise tax: to tax a business’s margin.

This Court should reject the Comptroller’s arguments because they arise from a misunderstanding of how Section 171.1012 operates, ignore ample evidence in the record to support the trial court’s conclusions, and ask this Court to read requirements into the statutory text not intended by our Legislature. The final judgment appropriately interprets and applies Section 171.1012 to CGG’s business. It should be affirmed in full.

I. FRANCHISE (MARGIN) TAX CALCULATION.

The franchise tax is a tax on the privilege of doing business in Texas. TGS-NOPEC, 340 S.W.3d 437. As amended in 2006, the tax is specifically designed to be imposed on a business’s margin, not on its revenue, net worth, or earned surplus. Id.; see also In re Nestle USA, Inc., 387 S.W.3d 610, 614, 622 (Tex. 2012). Margin is akin to net profits. See Tex. Tax Code § 171.101. To effectuate this purpose, the statute provides that every method *26 of calculating one’s franchise tax shall benefit from specified reductions to the taxpayer’s total revenue, as discussed below. (See 2.RR.41; 3.RR.68).6

“[T]he first step for all taxable entities and all methods of computing taxable margin is to calculate the taxpayer’s ‘total revenue.’” Titan Transp., LP v. Combs, 433 S.W.3d 625, 628 (Tex. App.—Austin 2014, pet. denied); Tex. Tax Code § 171.1011 (a)-(d). Taxpayers determine total revenue by subtracting statutory exclusions from the gross income reported on federal income tax returns. Id. §§ 171.1011(e)-(g)(11), (k), (m)-(n), (q)-(r), (u)-(x).

“After calculating total revenue, taxpayers may then employ the method of determining taxable margin that produces the lowest franchise-tax obligation.” Titan, 433 S.W.3d at 628; Tex. Tax Code § 171.101 (a). For report year 2008, the code offered three calculations using a specific deduction from revenue plus additional credits: (1) the cost of goods sold (COGS) deduction under Section 171.1012; (2) the compensation deduction under Section 171.1013; and (3) the 70% ceiling/30% default deduction under Section 171.101 (a)(1)(A). Titan, 433 S.W.3d at 628-29; Newpark, 422 S.W.3d at 47-48. 7

6 The Tax Code provisions applicable to this case are those in effect on January 1, 2008. For convenience, the citations herein are to the current version of the code unless specified to indicate a substantive change between the 2008 and the current version.

7 In 2008, there was also a “short form” calculation known as the “E-Z method,” providing a lower tax rate in lieu of any deductions and credits under Section 171.1016.

The total tax due is calculated as follows (with corresponding references to the 2008 franchise tax report, see 4.RR.P.Ex.1):

Total Revenue (calculated with applicable exclusions), items 1-10 — Deduction (1 of 3 methods), items 11-21 = Margin, item 22

Margin x Apportionment factor, items 23-25 = Apportioned margin, item 26

Apportioned margin — Other allowable deductions, item 27 = Taxable margin, item 28

Taxable margin x Tax rate (typically 1%; sometimes 0.5%), item 29 = Tax due, item 30

Tax due — Tax credits, item 31 — Discount, item 33 = Total Franchise Tax Due, item 34

In re Nestle, 387 S.W.3d at 614-616; Titan, 433 S.W.3d at 627-28. Because there is always some deduction from revenue, the resulting tax is one imposed on an entity’s margin, not its revenue. See Tex. Tax Code § 171.1014(d).

“Effective January 1, 2014, taxpayers not using the E-Z computation method [] also have the option to deduct a flat $1 million from total revenue if that sum is greater than the COGS, compensation, or 30% deductions.” Titan, 433 S.W.3d at 628.

II. THE COGS DEDUCTION, SECTION 171.1012.

The only relevant calculation method in this suit is the COGS deduction. The Comptroller’s analysis of Section 171.1012 is improperly inverted. The Comptroller argues that the Court should first determine whether CGG has any allowable costs to deduct as costs of goods sold (COGS) and then determine whether CGG qualifies for the deduction. See Appellants’ Brief, p.21, 25.

“That defies the logic of the statute.” (3.RR.155). The threshold inquiry is whether the taxpayer qualifies under Section 171.1012(i) to claim the COGS deduction. Once the taxpayer crosses that threshold test, the taxpayer is entitled to calculate its COGS deduction by including all the costs it incurred that are classified as allowable costs under subsections (c), (d), and (f).

A. Does the Taxpayer Qualify for the COGS Deduction?

Section 171.1012(i) begins by stating that “A taxable entity may make a subtraction under this section in relation to the cost of goods sold [i.e. qualify to claim the COGS deduction] only if that entity owns the goods.” Tex. Tax Code § 171.1012(i). A taxpayer can satisfy this test by being either an “actual” or “deemed” owner of goods. Id. As discussed in more detail below, these two terms mean:

 Actual owner: a taxpayer who is the “owner of goods . . . based on all of the facts and circumstances, including the various benefits and burdens of ownership vested with the taxable entity.” Id. § 171.1012(i), second sentence; see also 34 Tex. Admin. Code § 3.588(c)(8) (same).

 Deemed owner: a taxpayer who “furnish[es] labor or materials to a project for the construction, improvement, remodeling, repair, or industrial maintenance . . . of real property.” Tex. Tax Code § 171.1012(i), third sentence; see also 34 Tex. Admin. Code § 3.588(c)(8)(A)-(B) (same).8

The Comptroller devotes much of his argument to whether CGG’s seismic data satisfies the meaning of “goods,” as defined for purposes of COGS to include certain types of “tangible personal property.” See Tex. Tax. Code § 171.1012(a)(1), (3). These terms are relevant only to whether a taxpayer is an “actual owner.” The Comptroller’s argument about “tangible” property ignores the statute’s alternate provision entitling a taxpayer to qualify as a “deemed owner.” CGG first addresses the deemed owner provision, and then turns to the actual owner provision along with the proper interpretation of goods or “tangible personal property” for purposes of the COGS deduction.

8 The last sentence of Section 171.1012(i) provides another way to qualify as a “deemed owner,” which is not relevant here: “a taxable entity shall be treated as the owner of goods being manufactured or produced by the entity under a contract with the federal government. . . .” Id. Other subsections allow certain types of taxpayers to take the COGS deduction even if they are not “actual owners” of goods. See id. § 171.1012(k- 1) (regarding three types of rental or leasing companies), (k-2) (regarding pipeline entities who own or lease and operate pipelines transporting product they do not own).

B. What Costs are Allowed for the COGS Deduction?

Once a taxpayer crosses the threshold qualification for the COGS deduction (as either an actual or deemed owner of goods), the statute directs the taxpayer to calculate the dollar amount of its deduction by adding all of the costs it incurred under the categories allowed by subsections (c), (d), and (f). See Tex. Tax Code § 171.1012(i), first sentence (actual and deemed owners “may make a subtraction [of costs allowed] under this section”); third sentence (confirming deemed owners may “include the costs, as allowed by this section, in the computation of [COGS]”) (emphasis added); id. §§ 171.1012(c), (d), (f). Infra, Argument IV.

The costs allowed “by or under this section” include “all direct costs of acquiring or producing the goods,” and “up to 4% of its indirect or administrative overhead costs—such as legal, security, and accounting services—provided that it can demonstrate those costs ‘are allocable to the acquisition or production of goods.’” Newpark, 422 S.W.3d at 53.

III. CGG QUALIFIES FOR THE COGS DEDUCTION.

CGG qualifies for the COGS deduction as a “deemed owner” based on its proprietary and/or MCDL business activities. If this Court agrees, then the judgment should be affirmed regardless of whether CGG’s seismic images satisfy the definition of “goods” under Section 171.1012(a)(3)(A)(ii). *31 However, even if CGG were not a “deemed owner,” CGG would qualify as an “actual owner of goods” based on its MCDL business activity. This provides an alternative basis for affirming the final judgment in full.

A. CGG Qualifies as a “Deemed Owner.”

Under the third sentence of Section 171.1012(i), a taxpayer qualifies as a “deemed owner” if it “furnish[es] labor or materials to a project for the construction, improvement, remodeling, repair, or industrial maintenance . . . of real property.” Tex. Tax Code § 171.1012(i). A taxpayer engaged in such activity “is considered to be an owner of that labor or materials and may include the costs, as allowed by this section, in the computation of cost of goods sold.” Id.; see also 34 Tex. Admin. Code § 3.588(c)(8)(A)-(B) (same).

The Comptroller agrees with the concept of “deemed ownership” but disputes whether CGG’s activities qualify. Appellants’ Brief, p.5, 44-45, 50.9 As discussed below, CGG satisfies both elements of the deemed-owner test because (1) it furnishes labor or materials (2) in a manner that is sufficiently-connected to a real-property improvement project.

The deemed owner provision applies when a taxpayer does not actually own and sell “goods” as defined by subsection (a). The “labor or materials” furnished by the taxpayer is substituted in lieu of “ownership of goods.” In

9 The Comptroller also disputes what costs are allowed for deduction upon qualifying as a deemed owner. We address this issue separately. Infra, Argument IV.

Newpark, this Court recognized that the third sentence of subsection (i) would be rendered “meaningless” if the taxpayer had to actually own or sell goods to qualify for the COGS deduction as a deemed owner. Id. at 55.

As an initial matter, the Comptroller did not challenge Findings of Fact 8 and 9, which specifically state that CGG “furnishes labor” and “furnishes materials.” (CR.266). Nor did the Comptroller challenge Findings 2-4, which provide additional detail about the nature of CGG’s work, nor Findings 5-7 and 10, which confirm that CGG’s labor and materials are furnished for the purpose of oil and gas exploration and production. (CR.265-66). Relatedly, the Comptroller does not challenge Conclusion of Law 3, stating that “[o]il and gas wells constitute real property for purposes of [Section] 171.1012(i).” (CR.268). The unchallenged findings are binding on the Court because there is evidence in the record to support them, as described below. The judgment should be affirmed because Conclusions of Law 1 and 4 (concluding that CGG is eligible for the COGS deduction as a deemed owner) stand on the basis of these findings. Supra, Standard of Review II.

1. CGG furnishes labor and materials.

The first element to qualify as a deemed owner is that the taxpayer “furnish labor or materials.” Tex. Tax Code § 171.1012(i). A taxpayer is not *33 required to furnish both labor and materials to qualify as a deemed owner; either will suffice. Id. However, CGG furnishes both, and the judgment can be affirmed on either ground standing alone.

a. Labor.

Section 171.1012 does not define “labor.” This Court addressed the meaning of that term in Newpark, 422 S.W.3d at 56, which likewise involved a taxpayer’s activities related to the production of oil and gas. “‘Labor’ is a broad term that encompasses a wide range of activities, including ‘expenditure of physical or mental effort especially when fatiguing, difficult, or compulsory.’” Newpark, 422 S.W.3d at 56 (quoting Webster’s Third New International Dictionary 1259, 2075 (Phillip Gove Ed. 2002)). Because nothing in the statutory text indicates that “labor” for purposes of the COGS deduction has “a more limited meaning than its common definition,” this Court “presume[d] that the legislature intended to allow taxable entities to deduct a wide range of labor expenses.” Id. Under this definition, the postdrilling “transport and disposal of [] used drilling mud and other waste material” qualified as “labor.” Id. at 55, 57.

Just as in Newpark, CGG’s acquisition and production of seismic data and images satisfies the meaning of “labor” under Section 171.1012(i). As detailed in Statement of Facts I.A, CGG employs large crews to create sound *34 waves using specialized materials and equipment. CGG’s workers travel to and spend a considerable amount of time at the physical locations where their customers intend to construct wells for the production of oil and gas. The work required to acquire seismic data on these project sites is intense and requires specialized skills, such as drilling holes, blasting large swaths of dynamite, driving thousands of geophones into the earth, shaking the earth with a series of 60,000 to 90,000 pound vibrating trucks, and/or shooting an array of large airguns into the sea and through the ocean floor to create seismic sound waves. The second step of producing or processing seismic data likewise requires a hefty expenditure of effort, albeit more mental than physical. Here, highly-trained workers apply complicated algorithms and geophysical concepts, using specialized hardware and software. In total, this requires several months to several years of work.

CGG’s activities constitute the “expenditure of physical or mental effort.” The efforts regarding both the acquisition of data and production of seismic images are difficult, fatiguing, and require specialized skills. Thus, CGG’s activities satisfy the meaning of “labor” under Section 171.1012(i).

b. Materials.

The meaning of “materials” is not defined by Section 171.1012, was not at issue in Newpark, and has not otherwise been addressed by any appellate *35 court in the context of the COGS provision. As with “labor,” nothing in the statutory text indicates an intention for the term “materials” to have any narrower of a meaning than its common definition. See Tex. Tax Code § 171.1012(i). The common meaning of “material” is “elements, constituents, or substances of which something is composed or can be made.” Merriam-Webster’s Collegiate Dictionary 765 (11th ed. 2012). The definition also includes, “something (as data) that may be worked into a more finished form.” Id.

CGG furnishes materials in the form of dynamite, geophones, airguns, cables, trucks, batteries, and other miscellaneous parts used to create sound waves for the acquisition of seismic data, as well as the ultimate seismic data or images provided for use in the exploration and production of oil and gas. Supra, Statement of Facts I.A. These items satisfy the common meaning of materials as used in Section 171.1012(i).

c. The Comptroller’s categorical attempt to separate “labor and materials” from “geological and geophysical” work misinterprets the statute.

The Comptroller attempts to categorically dismiss the labor and materials furnished by CGG with a contrived argument that CGG’s activity cannot be “labor or materials” because subsection (c) contains separate provisions for “geological and geophysical costs” versus “labor” and *36 “material” costs. Appellants’ Brief, p.45-49. This argument fails for multiple reasons.

Section 171.1012(c) provides in relevant part:

The cost of goods sold includes all direct costs of acquiring or producing the goods, including:

(1) labor costs;

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

(3) cost of materials that are consumed in the ordinary course of performing production activities; . . . [and]

(10) geological and geophysical costs incurred to identify and locate property that has the potential to produce minerals.

Tex. Tax Code § 171.1012(c).

As an initial matter, the Comptroller claims—without any citation to the record—that the trial court “reject[ed]” CGG’s “argument that it was entitled to a COGS deduction under § 171.1012(c)(10).” Id., p.45. This represents a factual misunderstanding of what happened at trial, and it relates to the Comptroller’s legal misunderstanding of how Section 171.1012 operates. Infra, Arguments II, IV. CGG did not argue that it “qualifies” for the COGS deduction on the basis of subsection (c)(10). Rather, it claimed that having qualified for the deduction as an actual or deemed owner under *37 subsection (i), it is entitled to deduct all of its incurred costs as allowed by subsections (c), (d), and (f), including the costs specified under (c)(10). (2.RR.41-43; 3.RR.103, 155-56; CR.84).

The record conclusively demonstrates that the trial court accepted CGG’s argument that it was entitled to deduct the costs it incurred under subsection (c)(10) and all other subcategories of CGG’s proven costs. CGG’s tax director (Listya Diyah) testified about the costs incurred by CGG under subsection (c)(10), and two exhibits provide a breakdown of these costs. (3.RR.55-56; 4.RR.P.Ex.19, 48). This was sufficient evidence for the trial court to find that CGG’s calculation included approximately $674 million10 in subsection (c) costs (the total shown on CGG’s exhibits, including the full amount of its (c)(10) costs), and to conclude that “[e]ach of the costs that CGG included in its [COGS] deduction were allowed by [subsections] (c), (d), and (f),” and that “CGG is entitled to claim [the total amount of its COGS deduction] for Report Year 2008.” (CR.267-68 at FOF.15, COL.8-9). The trial court could not have made these determinations if it “rejected” CGG’s ability to include the (c)(10) costs in its COGS deduction. Moreover, Finding

10 The amount of subsection (c) costs is higher than CGG’s total COGS amount of $567 million because the total calculation includes approximately $1.2 million in intra- group eliminations, per the combined-reporting rules under Section 171.1014. (CR.267 at FOF.15(d)).

15 is binding on this Court because the Comptroller has not raised a sufficiency challenge to it, and it is supported by the record.

The Comptroller’s categorical argument also misinterprets the statutory text by conflating a description of activities with the costs incurred to perform certain activities. See Appellants’ Brief, p.46. Subsection (i) refers to the activities required for a taxpayer to qualify as a deemed owner of goods: furnish labor or materials. Tex. Tax Code § 171.1012(i). As discussed above, the statute does not limit the meaning of “labor” or “materials” beyond their broad, common definitions. Subsection (c) describes thirteen categories of direct costs that may be deducted by a taxpayer who qualifies under subsection (i). Id. § 171.1012(c).

Notably, this list is written in inclusive rather than exclusive terms. “‘Includes’ and ‘including’ are terms of enlargement and not of limitation or exclusive enumeration, and use of the terms does not create a presumption that components not expressed are excluded.” Sneed v. Webre, No. 12-0045, 2015 WL 3451653, *14 (Tex. May 29, 2015) (citing Tex. Gov’t Code § 311.005(13)). The list begins by identifying broad categories, such as the descriptions of general labor and material costs in (c)(1)-(3), and then delineates more industry-specific costs such as those in (c)(10). That does not mean a taxpayer who deducts costs under (c)(10) is prohibited from also *39 deducting costs under (c)(1)-(3). Instead, all categories are “included” as examples of the types of direct costs allowed for deduction by qualifying taxpayers. Subsection (c)(10) is not rendered meaningless by this interpretation.

This broad allowance of deductible costs does not limit the meaning of the underlying activities. Just because a taxpayer incurs costs “to identify and locate property that has the potential to produce minerals” does not prohibit a conclusion that the taxpayer has also “furnished labor and materials.” It would be illogical to conclude that a taxpayer who performs “geological and geophysical” work never “furnishes labor or materials” as part of that work. Stated another way, the activity of performing “geological and geophysical work” is not mutually exclusive of “furnishing labor or materials,” and vice-versa.

To the contrary, the statute’s express allowance of deductions for oilfield related costs, such as intangible drilling costs and geological and geophysical costs informs the court of the types of activities contemplated as those eligible for COGS. Under the Comptroller’s analysis, oil and gas drilling contractors would not be eligible to claim COGS for the reason that their costs include, by and large, intangible drilling costs, which the statute expressly allows under subsection (c)(7).

d. The Comptroller’s argument that CGG’s work is a “service” that is not “fatiguing, difficult, or compulsory” enough to constitute “labor” is an improper recast of its previously-rejected “physical change” theory.

The Comptroller next argues that CGG’s work does not constitute “labor” because it is a “service” that is “sophisticated—not fatiguing, difficult, or compulsory.” Appellants’ Brief, p.47. This argument misreads Newpark, ignores evidence in the record, and is merely a repackaged version of the Comptroller’s prior “physical change” argument, which has been twice rejected by this Court and publically-abandoned by the Comptroller.

As here, the Comptroller argued in Newpark that NES’s transport and disposal of used drilling waste were “clearly a service and not labor supplied for the improvement of real property.” 422 S.W.3d at 56-57. This Court rejected the argument, holding that that the meanings of “service” and “labor” are not “mutually exclusive,” and “the[ir] ordinary definitions . . . substantially overlap such that both definitions tend to refer to the words interchangeably.” Id. at 54. Notably too, certain “service” costs are expressly allowed for deduction under subsection (f), showing the Legislature’s intent that aspects of “service” can be provided as part of “furnishing labor or materials.” Tex. Tax Code § 171.1012(f); (3.RR.73, acknowledged by auditor Dullum). Hence, although an activity may have attributes of “service,” that *41 does not holistically prevent it from constituting “labor.” CGG’s activity qualifies as labor just as NES’s did.

Moreover, Newpark does not hold that a taxpayer’s activities are absolutely required to be “fatiguing, difficult, or compulsory” to satisfy the meaning of “labor.” Newpark holds that it will be “especially” clear that a taxpayer’s efforts qualify as labor where any one of those (or presumably similar) characteristics are present. 422 S.W.3d at 56. Newpark also holds that “mental” effort can satisfy the definition of labor—it does not have to be physical effort. Id. Granted, at some point, activities become “too far removed” from a real-property construction project to qualify under Section 171.1012(i). Infra, Argument III.A.2. Nevertheless, Newpark does not create a bright-line test that efforts must be “physical,” nor that they must be “fatiguing, difficult, or compulsory” to qualify. In any event, the record demonstrates that CGG’s activities satisfy the definition as described in Newpark. Supra, Argument III.A.1.

At trial, the Comptroller’s auditor, Gary Dullum, testified that the only reason he denied CGG the COGS deduction was because he considered CGG a “service provider” rather than the actual driller/producer of minerals. (3.RR.84-85). Dullum’s misunderstanding apparently arose from the Comptroller’s training that, to qualify for the COGS deduction as a “deemed *42 owner” of goods under Section 171.1012(i), a taxpayer must “physically work [on] and effect a change” to real property. (3.RR.88-89).

The Comptroller’s corporate representative, Sarah Pai, confirmed it was the agency’s “litigation position and . . . policy . . . that an entity must physically work on and effect a change to real property in order to be entitled to take the [COGS] deduction available under 171.1012(i).” (4.RR.P.Ex.46, p.31). She also confirmed that the only reason the Comptroller concluded CGG does not qualify as a deemed owner under Section 171.1012(i) is “because [CGG is] not physically working on the property and making a change.” (Id., p.46). She acknowledged that CGG is “physically present on the property and they’re working,” but claimed the “element they fail is that work does not effect a physical change.” (Id., p.174; see also 2.RR.64; CR.61-62).

After trial, the Comptroller publically-abandoned its “physical change” argument in recognition of the fact that this Court has repeatedly rejected it. In a June 2014 memorandum, the Comptroller’s office stated:

Based on the [Third Court’s] language and analysis in TITAN and NEWPARK, we are revising the policy with regard to subcontracting payments eligible for . . . deduction under Section 171.1012(i). . . .11 11 Although this memorandum changed the Comptroller’s internal policy, it did not establish a formal rule in the absence of public notice and comment. See Tex. Gov’t Code Ch. 2001 (Administrative Procedure Act regarding notice and comment rulemaking).

[W]e are expanding the interpretation of what is considered to be furnishing labor or materials to a [real property project] . . . and will no longer require an entity to actually physically touch the property or make a change to the property to qualify for the COGS deduction. . . .

Texas Comptroller of Public Accounts, Memorandum from Tax Policy Division, 201406920L (June 10, 2014) (STAR document available at http://cpastar2.cpa.state.tx.us/index.html) (emphasis added). This “change has immediate effect and a taxable entity may file an amended franchise tax report for years that are open within the statute of limitations.” Id. Thus, the change has retroactive application and must be applied to CGG in this case.

Despite this announcement, the Comptroller’s Brief returns to the same theory and underlying principles of the “physical change” argument, and simply recasts them as CGG’s activities being too “sophisticated” and “service” oriented, and not physically demanding (“fatiguing, difficult, or compulsory”) enough to be considered “labor.” See Appellants’ Brief, p. 25-26, 28-32, 47. Ultimately, this is the same argument, and it fails for the same reason: None of these requirements are contained within the plain statutory text requiring the taxpayer to “furnish labor or materials.” If the Legislature wished to limit the provision to entities actually performing construction or *44 other physical labor or affecting a physical change onsite, it would have left out the words “or materials” and “to a project,” which expand the scope of the provision.

Moreover, Section 171.1012(i) explicitly applies to entities furnishing labor or materials to a project for the industrial maintenance of real property, which is outside the scope of normal activity for a “construction company” and often would not result in any physical change to the property. Auditor Dullum admitted this. (3.RR.75).

e. The Comptroller’s two-sentence argument regarding “materials” is unavailing.

Beyond the Comptroller’s attempt to categorically dismiss CGG’s “furnishing of labor or materials,” his only argument for why CGG does not furnish materials is confined to two sentences without supporting legal or factual analysis. Appellants’ Brief, p.47. The Comptroller argues that CGG’s seismic data is not “consumed” in the drilling process. Id. To any extent this argument has been adequately briefed for preservation under Texas Rule of Appellate Procedure 38.1(i), it fails.

The Comptroller overlooks many of the other materials furnished by CGG beyond its seismic data, and the Comptroller utilizes an overly-narrow definition of “materials.” Supra, Argument III.A.1.b. The Comptroller relies on Section 171.1012(c)(3), which allows deductions for the “cost of materials *45 consumed in the ordinary course of performing production activities.” To any extent this cost category describes one type of material that could be furnished under subsection (i), it does not do so exclusively. The meaning of “materials furnished” is broader than the specific categories of material costs that can be deducted. Moreover, our supreme court has held that “consumption” of materials is not required to establish that they were “furnished” for purposes of a materialman’s lien. Houston Fire & Cas. Ins. Co. v. Hales, 279 S.W.2d 389, 392 (Tex. Civ. App.—Eastland 1955, writ ref’d n.r.e.) (citing W. L. MacAtee & Sons v. House, 153 S.W.2d 460 (Comm’n of App. adopted by Sup.Ct.)).

2. CGG’s activities are sufficiently connected to a real- property improvement project.

To qualify for the COGS deduction as a deemed owner, the labor or materials furnished by the taxpayer must be “to a project for the construction, improvement, [etc.] of real property.” Tex. Tax Code § 171.1012(i). “It is undisputed that the drilling and construction of oil and gas wells qualifies as construction or improvement to real property.” Newpark, 422 S.W.3d at 55; (see also 4.RR.P.Ex.46, p.115). Thus, the only question is whether CGG’s activities are sufficiently connected to projects for the drilling and construction of oil and gas wells.

In Newpark, this Court did not create a bright-line test. Instead, it held that satisfaction of this standard must be on a case-by-case basis. Id. at 56-57. There, the Court held that NES’s waste-disposal activity qualified based on three considerations. One, “it is difficult to view [the activity] as though it were not an essential and direct component of the drilling process.” Id. at 56. Two, the Legislature indicated that such activity should qualify by allowing deduction of “similar costs for scrap material and pollution control devices.” Id. And three, the evidence demonstrated that drilling activity could not continue without the waste removal and disposal activities provided by NES. Id.

CGG’s activity is likewise sufficiently connected to oil and gas drilling projects. In light of the uncontroverted testimony of Bob Montgomery and the contractual agreements stating that CGG’s acquisition and production of seismic data is an integral part of the customer’s drilling business, and considering the millions of dollars E&P companies are willing to pay for this critical work, it is difficult to view CGG’s activity as though it were not an essential and direct component of the drilling process. Supra, Statement of Facts I.B.

Second, the Legislature indicated that such activity should qualify by specifically allowing deduction of “geological and geophysical costs incurred *47 to locate property that has potential to produce minerals.” See Tex. Tax Code § 171.1012(c)(10). Contrary to the Comptroller’s argument, this category of costs expands upon rather than limits the type of labor and materials that should qualify under subsection (i). Supra, Arguments III.A.1.c, IV.B.

Third, the record demonstrates that drilling activity could not commence—or at least not do so successfully or in a manner that efficiently locates all producible mineral reserves—without the seismic data “blueprint” furnished by CGG. Supra, Statement of Facts I.B. These considerations sufficiently support the trial court’s conclusion that CGG furnishes labor or materials to a real-property construction or improvement project.

The Comptroller argues that CGG’s activities are “too far removed” because its customer’s drilling projects are only “potential” not “actual.” Appellants’ Brief, p.50-52. This argument reads words into the statute and ignores important evidence in the record. Nothing in the statute specifies the status of when a project “officially” begins, nor does the statute definitively require that the labor or materials be furnished to only one project rather than several. See Tex. Gov’t Code § 311.012(b) (In construing statutes, “[t]he singular includes the plural and the plural includes the singular.”).

Before CGG begins working with a proprietary customer, the customer has already done a substantial amount of “macro geology” to identify the general location they want to drill and have established lease rights on that location to enable drilling once the minerals are located by CGG’s seismic data. Supra, Statement of Facts I.C. Moreover, the customer is far enough into the project to specify the parameters of work for CGG, and they remain actively involved with CGG throughout the timeline of its work. Id. Sometimes a customer has gone so far as to obtain initial seismic data for CGG to process. This is sufficient evidence from which the trial court could conclude that CGG furnishes labor and materials “to a project.”

In regard to CGG’s MCDL customers, CGG does not begin the process of acquiring and producing seismic data in any location unless it is “hot” with interest by several E&P companies to drill there. Supra, Statement of Facts I.D. It would be far too costly of CGG to do otherwise. (See 5.RR.D.Ex.14, p.23-24: stating CGG’s policy of generally requiring a certain number of “pre-commitments” from customers before beginning the acquisition of MCDL data). Thus, at a minimum, the MCDL data is acquired and produced “for a project” that is reasonably anticipated to occur. Sometimes, customers approach CGG to shoot a specific area, akin to a proprietary customer but with a trade-off of less cost for non-exclusive *49 rights. (3.RR.19; 5.RR.D.Ex.36, p.12). Moreover, by the time customers are able to buy licenses “off the shelf,” they are presumably doing so for projects that are underway.

The Comptroller’s arguments that CGG’s seismic data does not qualify because it may indicate where not to drill, or because the drilling may not ultimately be successful, or because drilling may not occur in the same tax year, are all red herrings. Determining where to drill and not to drill are equally essential components of the project. Just because a customer may review the seismic map and decide to not drill in location A, but to instead drill in location B, or to avoid a dangerous blowout and not drill at all, does not mean CGG failed to furnish labor or materials “to a project.” Furthermore, nothing in the statute requires that a taxpayer maintain books and records that would somehow trace and parse its costs by the dates and ultimate successes of the customers’ drilling projects. Such an argument ignores the economic realities of business in direct contravention to the Texas Supreme Court’s holding in Combs v. Roark Amusement & Vending, L.P., 422 S.W.3d 632, 637 (Tex. 2013).

In Newpark the Comptroller vehemently argued NES’s activities were nothing more than that of a “garbage collector,” which was clearly a service and not the furnishing of labor or materials to a project for the construction *50 or improvement of real property. 422 S.W.3d at 55-57. Now, the Comptroller argues the opposite, contending that NES’s transporters “must rely heavily on human effort,” and that “mov[ing] drilling mud toward or away from an existing project site” is a qualifying activity. Appellants’ Brief, p.47, 51. Just as the Comptroller maintained an unreasonable argument for years against Newpark, the Comptroller does so here against CGG. CGG qualifies as a deemed owner for the COGS deduction just as NES/Newpark did, and the Comptroller’s attempts to distinguish that case are unavailing.

B. CGG Qualifies as an “Actual Owner.”

Alternatively, CGG qualifies for the COGS deduction as an actual owner of goods (i.e., an owner “based on all of the facts and circumstances, including the various benefits and burdens of ownership vested with the taxable entity”). See Tex. Tax Code § 171.1012(i), second sentence. Through its MCDL, CGG sells goods in the ordinary course of business.

1. CGG owns and sells seismic data.

There is no dispute that CGG owns the seismic data it licenses through its MCDL. (2.RR.123-24; 5.RR.D.Ex.36, p.13, 17, 19). The Comptroller also does not dispute that CGG’s licensing of seismic data constitutes a “sale.” See TGS-NOPEC Geophysical Co. v. Combs, 340 S.W.3d 432, 442 (Tex. 2011) (because the revenues from licensing seismic data derive from *51 conveyance and use of the underlying data, whereas the license itself is not a “revenue-producing asset,” the transaction constitutes a “limited sale” of property)12; see also Avis v. First Nat. Bank of Wichita Falls, 174 S.W.2d 255, 258 (Tex. 1943) (“This Court has definitely declared that an oil and gas lease is the same as a sale of real estate.”).

2. The seismic data is a “good” for purposes of the COGS deduction.

The only dispute regarding CGG’s qualification as an “actual owner” is whether the products sold by CGG satisfy the relevant definition of “goods.” See Appellants’ Brief, p. 25-41. CGG qualifies because the seismic data that it intends to license for mass distribution without substantial alteration through its MCDL satisfies a unique definition of “goods” applicable only to the COGS deduction. See id. § 171.1012(a)(3)(A)(ii).

“Goods” are defined to mean “real or tangible personal property sold in the ordinary course of business of a taxable entity.” Tex. Tax. Code § 171.1012(a)(1); see also 34 Tex. Admin. Code § 3.588(b)(3) (same). The legislature has defined three categories of property that shall be treated as “tangible personal property” exclusively for purposes of the COGS deduction:

12 The tax issue involved in TGS-NOPEC was “apportionment.” See Tex. Tax Code § 171.103. Although the nature of the transaction (i.e., the licensing of seismic data) should be consistently construed as a “sale” of property for purposes of both the COGS deduction and apportionment, the nature of the property is treated differently for these two purposes, as explained below.

(a) In this Section: . . .

(3)(A) “Tangible personal property” means:

(i) personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to the senses in any other manner;

(ii) films, sound recordings, videotapes, live and prerecorded television and radio programs, books, and other similar property embodying words, ideas, concepts, images, or sound, without regard to the means or methods of distribution or the medium in which the property is embodied, for which, as costs are incurred in producing the property, it is intended or is reasonably likely that any medium in which the property is embodied will be mass-distributed by the creator or any one or more third parties in a form that is not substantially altered; and

(iii) a computer program, as defined by Section 151.0031.

Tex. Tax Code § 171.1012(a)(3)(A)(i)-(iii); see also 34 Tex. Admin. Code § 3.588(b)(10)(A) (same). By using the language “In this Section”, the statute confined this specialized definition of ‘[t]angible personal property’ to Section 171.1012. In doing so, it excluded all other forms of (i) intangible property and (ii) services as being outside the definition of “goods” for purposes of the COGS deduction. Tex. Tax Code § 171.1012(a)(3)(B); see also 34 Tex. Admin. Code § 3.588(b)(10)(B) (same).

The first category covers property that is traditionally thought of as “tangible”: items that “can be seen, weighed, measured, felt,” etc. Tex. Tax. Code § 171.1012(a)(3)(A)(i). Neither party argues that CGG’s seismic data satisfies the first category.13

The second two categories cover property that is, in reality, “intangible” (i.e., not of physical form). Id. § 171.1012(a)(3)(A)(ii)-(iii). Nevertheless, for the particular tax purpose of allowing a COGS deduction, our Legislature has chosen to specially define or treat these specific types of intangible property as “tangible personal property” (TPP). (See 3.RR.106). It is a legal fiction employed to serve a special purpose—the allowance of a deduction for high-cost industries important to the State that do not otherwise produce traditionally “tangible” products. As such, categories (ii) and (iii) constitute “artificial TPP” solely for purposes of the COGS deduction. See TGS-NOPEC, 340 S.W.3d at 443 & n.11 (noting that Texas legislature and other state legislatures are able to and have chosen to identify certain types of intangible property for specialized tax treatment).

13 Consequently, the outcome of this case is not controlled by American Multi- Cinema, Inc. v. Hegar, No. 03-14-00397-CV, --S.W.3d --, 2015 WL 1967877, *6 n.4 (Tex. App.—Austin Apr. 30, 2015, no. pet. h.).

a. TPP for COGS is different than TPP for sales tax or apportionment.

It is important to understand the distinctions between TPP as defined for purposes of (1) the COGS deduction versus (2) the Texas sales and use tax and (3) the franchise tax code’s apportionment provision, which also employ the term “tangible personal property.” See Tex. Tax Code § 151.009, § 171.103. The Comptroller overlooks these distinctions and improperly conflates authorities interpreting the relevant statutes.

This matters for two reasons. First, the authorities relied on by the Comptroller to characterize CGG’s seismic data as “intangible” are based on sales tax or apportionment principles and, thus, do not control for purposes of the COGS deduction. See Appellants’ Brief, p.32-34. Second, the Court should be aware of the implications of characterizing property as “tangible” or “intangible” under these various statutes. Generally speaking, sales of “tangible” personal property are subject to sales tax, and revenues from such sales are apportioned by the location of use for franchise tax purposes, while sales of “intangible” property are not subject to sales tax, and their revenues are apportioned by the location of payor. See TGS-NOPEC Geophysical Co, v. Combs, 340 S.W.3d 432 (Tex. 2011). Because CGG has pending administrative claims regarding its apportionment factor, the Court’s discussion and holdings here should be limited to the treatment of CGG’s *55 seismic data for purposes of the COGS deduction and not inadvertently result in an advisory opinion about its treatment for apportionment purposes.

The definitions of “goods” and “tangible personal property” in Section 171.1012(a) are expressly limited to application “in this section.” Comptroller representative Sarah Pai agreed that “in this section” as used in Section 171.1012(a) refers exclusively to the COGS provision and not to the franchise tax code generally. (4.RR.P.Ex.46, p.120-21). She unequivocally agreed that the phrase “in this section” “confine[s] the[] definitions [provided under Section 171.1012(a)] to Section 171.1012 and [they] don’t extend into the apportionment rule.” (Id., p.128). On this basis, Pai further agreed that “if an item qualifies . . . as tangible personal property under (ii) of Section 171.1012[(a)(3)(A)], it is still correct to apportion that as an intangible, the sale of an intangible because the words ‘in this section’ confine the scope of those definitions to that Section 171.1012.” (Id., p.128-29).

For purposes of sales tax, TPP is defined as “property that can be seen, weighed, measured, [etc.]” and “includes a computer program and a telephone prepaid calling card.” Tex. Tax Code § 151.009. Thus, the definition overlaps with categories (i) and (iii) of TPP under the COGS *56 definition but notably leaves out category (ii), regarding the intellectual property at issue here.

The apportionment provision does not define TPP. See Tex. Tax Code § 171.103. However, the legislative history indicates a parallel treatment of TPP for purposes of sales tax and apportionment, distinct from the treatment of TPP for COGS purposes. The apportionment rules have remained largely unchanged since their amendment in 1997—a date when the Texas sales tax existed but vastly pre-dating the 2006 enactment of the current franchise tax. Because apportionment does not impact the calculation of one’s tax base, no major changes were made to that provision when the Legislature adopted the margin/franchise tax.

Considering that (1) the COGS provision did not even exist until a decade after the current apportionment provision was enacted, (2) no relevant change was made to apportionment upon adoption of the COGS provision, and (3) the legislature expressly limited the definition of TPP for purposes of COGS—it is not logical to conclude that the legislature intended for the meaning of TPP for apportionment purposes to be the same as for COGS purposes. Rather, it is more logical to interpret the meaning of TPP in the apportionment and sales tax rules consistently, with the important *57 distinction for COGS purposes being the intellectual property described by Section 171.1012(a)(3)(A)(ii).

Under this analysis, CGG agrees that for purposes of sales tax and apportionment—which do not include “sound recordings, film, . . . and other similar property” in their definitions of TPP—its seismic data should be treated as “intangible” property. See TGS-NOPEC, 340 S.W.3d at 444. However, that does not prevent the seismic data from qualifying as a “good” for purposes of the COGS deduction because the Legislature chose to treat this specific type of otherwise intangible property as a form of “artificial TPP” exclusively for this purpose, and CGG’s seismic data satisfies the applicable definition.

b. CGG’s seismic data satisfies the definition in Section 171.1012(a)(3)(A)(ii).

Section 171.1012(a)(3)(A)(ii) treats “films, sound recordings, . . . and other similar property” (i.e., intellectual property that is otherwise intangible) as an artificial form of TPP for purposes of the COGS deduction. CGG’s seismic data satisfies each element of the (A)(ii) definition because: (1) seismic data is the type of intellectual property described therein; and (2) at the time CGG incurs the costs to produce the data, CGG intends to mass distribute it (3) in a form that is substantially unaltered, regardless of the *58 means or methods of distribution or the medium in which it is distributed. See Tex. Tax Code § 171.1012(a)(3)(A)(ii).

First, CGG’s seismic data falls within the statute’s broad definition of intellectual property. The Legislature provided an expansive list, drafted in non-exclusive terms, of the types of property that qualifies, described by both type and characteristic: “films, sound recordings, videotapes, live and prerecorded television and radio programs, books, and other similar property embodying words, ideas, concepts, images, or sound.” CGG’s seismic data is “similar” to the described types of visual and sound recordings, which convey unique information that could not be organically duplicated by another creator.

The Comptroller claims that CGG’s seismic data “is nothing like the items listed” because it lacks “esthetic, narrative, musical, or artistic value.” Appellants’ Brief, p.40. This aligns with the Comptroller’s trial argument that the property had to be “creative” and could not be “scientific” to qualify under Section 171.1012(a)(3)(A)(ii). (3.RR.120; 4.RR.P.Ex.46, p.149, 158). Nothing in the statute expressly or impliedly limits the definition in the manner sought by the Comptroller. And, as the Comptroller’s counsel acknowledged regarding this theory, “I can’t prove it. I don’t have a precedent for you.” (3.RR.154). Moreover, this argument would disqualify *59 producers of documentaries from claiming the COGS deduction. Nothing in the language of the statute supports such a narrow reading.

Second, the record demonstrates that CGG intends to mass distribute the seismic images at the time it incurs the costs to produce them. CGG does not even consider undertaking the expense of funding the production of seismic images for purposes of the MCDL unless there is substantial interest by E&P companies for the geological information of a particular location. (2.RR.118, 121; 4.RR.P.Ex.18; 5.RR.D.Ex.14, p.16: “In developing our multi-client data library, we carefully select survey opportunities in order to maximize our return on investment.”). The entire purpose of CGG incurring these costs is to sell the data to “as many people as possible,” including all 12,000 of the Texas companies registered in the oil and gas drilling industry. (2.RR.118-20, 125; 3.RR.13, 17, 20; 4.RR.P.Ex.18; 4.RR.P.Ex.25; 5.RR.D.Ex.35, p.8, 12-13, 16-17). Comptroller representative Pai admitted that the “mass distribution” requirement is satisfied by a taxpayer’s intent to mass distribute, not its ability to actually do so: She agreed a taxpayer would qualify if it “intended to sell to as many people as possible [but] no one bought it.” (4.RR.P.Ex.46, p.157). On this record, the Comptroller cannot satisfy his burden of demonstrating that there is “no evidence” to support *60 Findings of Fact 12-13, especially when the evidence is viewed in favor of the judgment. See City of Keller v. Wilson, 168 S.W.3d 802, 807 (Tex. 2005).

The Comptroller defines “mass” as “a large number of individuals,” yet claims CGG’s intent to license its MCDL products to all 12,000 industry members is not enough. To the extent this argument is based on a belief that a taxpayer must intend to distribute its product to masses “of the general public” rather than a specific industry, this argument fails. Nothing in the statute provides such a limitation, and it is easy to understand how it would not be true for many types of niche musical or artistic products that the Comptroller admits qualify under Section 171.1012(a)(3)(A)(ii).14

The Comptroller’s remaining two “mass distribution” complaints are red herrings. Appellants’ Brief, p.38. First, just as discussed in regard to why CGG’s activities are sufficiently connected to drilling projects, the statute does not require a taxpayer to maintain accounting records and parse its costs based on the timing or success of a project. This argument should be rejected because it ignores the economic realities of CGG’s business.

14 The Comptroller argues that CGG’s sales to proprietary customers do not satisfy the “mass distribution” prong. Appellants’ Brief, p.37. CGG has never argued that it qualifies as an “actual owner” of goods based on its proprietary sales. But contrary to the Comptroller’s argument, this does not provide a basis to reverse the judgment. It is only necessary that CGG qualify to claim the COGS deduction under subsection (i) as an actual or deemed owner of goods based on some aspect of its business. Then, as a combined group making a single election for which deduction method to apply, CGG is entitled to deduct all of its allowable costs. Infra, Argument IV.B.

Supra, Argument III.A.2. Second, the Comptroller’s claim that “[o]ne would not expect data . . . regard[ed] as a ‘trade secret’ to be mass distributed” misses the point.15 CGG’s MCDL products are sold on a non-exclusive basis to whomever will pay for them. Just because the purchaser is prohibited from re-distributing those products (as is the purchaser of a copy of any movie, song, or image described by this section) does not show a lack of intent for the owner/seller of the product to mass-distribute it for profit.

Third, CGG intends to distribute the data in a form that is substantially unaltered. Here, it is critical to understand the difference between altering the underlying data versus providing that data by various means or on various mediums. The underlying data (originally captured as sound waves from the earth’s surface) never changes. Only its format changes. By applying algorithms and other techniques to interpret the underlying data, CGG is able to make that same data (originally captured as a sound recording) appear in the medium of a high-resolution image.

This is no different than taking the underlying text of a Shakespeare play, originally written with ink and paper, and reprinting it for sale as a hardback book, and then as a digital version, or performing it as a play, or

15 The Comptroller cites a case regarding a discovery dispute over the production of seismic data in a legal dispute, which is readily-distinguishable and has nothing to do with the treatment of such property as “tangible” or “intangible” for tax purposes. See In re Bass, 113 S.W.3d 735 (Tex. 2003).

making it into a movie. The underlying content of Shakespeare’s work remains substantially unaltered regardless of the medium or means of distribution, and he (or his heirs or assignees) remain the owners of that underlying intellectual property.

The statute expressly provides that a product will qualify as artificial TPP under Section 171.1012(a)(3)(A)(ii) “without regard to the means or methods of distribution or the medium in which the property is embodied,” and that the distribution can be intended in “any medium in which the property is embodied.” Comptroller representative Pai confirmed the purpose of the statute is to allow the taxpayer to distribute the product “through as many means as are - - are profitable to the distributer.” (4.RR.P.Ex.46, p.67; see also p.138-139 (agreeing that this was a reasonable interpretation as shown by 4.RR.P.Ex.34)).

Based on the foregoing, the record sufficiently supports the conclusion that the seismic data products sold through CGG’s MCDL are “goods” or “artificial TPP” within the definition of Section 171.1012(a)(3)(A)(ii). As such, the Legislature has placed these products outside of the definition of “intangible property” for purposes of the COGS deduction. *63 IV. ALL OF CGG’S COSTS ARE ALLOWED FOR THE COGS DEDUCTION.

Once a taxpayer qualifies as an actual or deemed owner of goods under Section 171.1012(i), it is instructed to calculate its total costs of goods sold as allowed “by this section,” including all of the direct and indirect costs allowed for deduction under subsections (c), (d), and (f). That is exactly the computation CGG performed to arrive at its COGS deduction of $567 million. The trial court correctly concluded that CGG was entitled to claim the COGS deduction in this full amount. (CR.250-51, 268 at COL.8-9).

For the first time on appeal, the Comptroller seeks to parse these costs between CGG’s lines of business (proprietary and MCDL), its activities (acquisition and processing), and/or the assorted categories of allowable costs under subsections (c), (d), and (f). Recognizing that it failed to preserve these arguments at trial, the Comptroller seeks a remand for a second bite at the apple to parse the amount of CGG’s deduction. Not only has this argument been waived, it is also legally incorrect and inconsistent with recent policy announced by the Comptroller.

A. The Comptroller Waived Any Challenge to the Actual Costs Deducted.

CGG provided evidence that classified all of the costs included in its COGS deduction into each of the categories allowed under Texas Tax Code *64 Sections 171.1012(c), (d), and (f). (3.RR.40-41, 48-52, 54-56; 4.RR.P.Ex.19, 48). The Comptroller limited its opposition to a holistic challenge of whether CGG qualified for the COGS deduction under Section 171.1012(i). The Comptroller preserved no argument that, assuming CGG qualifies, the specific costs included in its COGS calculation are not allowed for deduction (in whole or in part) under Section 171.1012(c), (d), or (f). (See 2.RR.16 (Comptroller’s counsel conceded that he was “not even fighting [CGG] on [its costs], except as to whether they’re eligible for [the COGS deduction of] them.”); 3.RR.58-63, 91-98 (Comptroller’s counsel asked no questions of relevant witnesses to challenge the allowance of specific costs under subsections (c), (d), or (f)); 3.RR.98; 4.RR.P.Ex.3, p.P000128 (Comptroller’s auditor agreed that he “did not challenge any of the categories or the amounts that are reflected on [CGG’s COGS calculation spreadsheet]”); CR.41-66 (Comptroller’s trial brief raises no challenge to allowance of specific costs under subsections (c), (d), or (f))).

Thus, the Comptroller has waived any challenge to which of CGG’s costs should be included in the calculation. The only question before this Court is the threshold issue of whether CGG qualified for the COGS deduction. Assuming that the Court agrees that CGG qualifies as an actual or deemed owner under Section 171.1012(i), then it should affirm the *65 judgment in full allowing CGG the full amount of its COGS deduction. There is no legitimate basis for a remand in this circumstance.

B. The Statute Does Not Require Parsing of Costs.

The Comptroller agrees that taxpayers who qualify for the COGS deduction as “actual owners” may deduct any of the costs allowed by (c), (d), and (f). Appellants’ Brief, p. 44-45. However the Comptroller argues that taxpayers who qualify as “deemed owners” should be treated differently under the same provision. Id., p.19, 43-49 (arguing that deemed owners are entitled to deduct only their “labor and material costs” and not the remainder of costs allowed by subsections (c), (d), and (f)). This contravenes the plain language of the statute and ignores the Comptroller’s own admissions at trial.

Regarding both “actual” and “deemed” owners, Section 171.1012(i) plainly states that the taxpayer may subtract the costs as provided “by” or “under” “this section.” Tex. Tax Code § 171.1012(i), first and third sentences. The reference to “this section” must mean the entirety of Section 171.1012 because the Legislature did not say “subsection,” which it knew how to do if that is what had been intended. See generally Tex. Tax Code § 171.1012 (containing 12 separate references to “subsections”).

The Comptroller’s auditor, Gary Dullum, agreed that “as allowed by this section” means all of the costs under (c), (d), and (f). (3.RR.72-73). The Comptroller’s prior letter rulings also support this interpretation. (4.RR.P.Ex.28, ¶ 4: explaining that the taxpayer is entitled to deduct all costs allowed by 171.1012(c), (d), and (f), not just labor and material costs; 4.RR.P.Ex.32: in regard to a deemed owner, explaining that “Section 171.1012(c), (d), and (f) lists the types of costs included in the COGS deduction for all types of businesses.”).

Additionally, nothing in the statute requires parsing of costs between business lines or activities. Instead, the taxpayer simply must qualify by some portion of its business activity to elect the COGS deduction under subsection (i), and then it may calculate all of the costs allowed by subsections (c), (d), and (e). This is equally true for single businesses as it is for integrated companies like CGG and Newpark, which report their taxes on a combined group basis, making a single election for the calculation method used. As this Court explained:

[I]t would be inconsistent [with the statutory purpose] to treat subsection 171.1014(e)(1) [regarding combined reporting] as an additional substantive limitation that would require each member’s business activity to be viewed in complete isolation from the combined group. This conclusion is directly supported by subsection 171.1014(d–1), which states that “[a] member of a combined group may claim as costs of goods sold those

costs that qualify under Section 171.1012 if the goods for which the costs are incurred are owned by another member of the combined group.” As this provision indicates, a member that does not sell any goods itself may nevertheless deduct as cost of goods sold those expenses it incurs to sell goods owned by another member of the combined group. . . .

It would be inconsistent with this framework to consider a combined group as a single taxable entity, require each member to take the same general deduction, but nevertheless treat each member as an isolated entity for purposes of determining eligibility to take the cost-of-goods-sold deduction. This conclusion would lead to the absurd result that a company that had no subsidiaries could take all costs-of-goods-sold deductions allowable under section 171.1012, but if that same company created subsidiaries it could potentially lose substantial cost-of-goods-sold deductions because each subsidiary might not sell goods in the ordinary course of its business.

Newpark, 422 S.W.3d at 52 (internal citations omitted) (emphasis added).

Finally, the Comptroller’s position that the includable costs are limited to only those associated with particular business activities is belied by his recent public pronouncement that businesses incurring research costs may deduct them as COGS even if the taxpayer doesn’t produce any of the goods it sells. See Texas Comptroller of Public Accounts, Letter Ruling 201504069L (April 23, 2015) (STAR document available at http://aixtcp.cpa.state.tx.us/opendocs/open32/201504069l.html). *68 V. NO DEFERENCE IS OWED TO THE COMPTROLLER’S POSITIONS.

As a default argument throughout his brief, the Comptroller contends that this Court must defer to his positions either because the Comptroller is charged with enforcement of the tax code or because the COGS deduction is an “exemption” rather than an “exclusion.” Both arguments lack merit.

“[A] precondition to deference to an agency’s interpretation of a statute is ambiguity.” Am. Multi-Cinema, Inc. v. Hegar, No. 03-14-00397-CV, --S.W.3d --, 2015 WL 1967877, *3-4 (Tex. App.—Austin Apr. 30, 2015, no. pet. h.) (citing Combs v. Roark Amusement & Vending, L.P., 422 S.W.3d 632, 635 (Tex. 2013) (describing agency-deference doctrine)). Section 171.1012 is not ambiguous, so no deference is owed to the Comptroller’s positions. Newpark, 422 S.W.3d at 56 n.9.

In any event, such deference is not required where the agency’s interpretation “is plainly erroneous or inconsistent” with the controlling statute. Combs v. Roark Amusement & Vending, L.P., 422 S.W.3d 632, 635 & n.10 (Tex. 2013); USA Waste Servs., Inc. v. Strayhorn, 150 S.W.3d 491, 494 (Tex. App.—Austin 2004, pet. denied). Consequently, this Court need not defer to the Comptroller’s flawed interpretations of Section 171.1012.

Finally, the Comptroller incorrectly asserts that this Court should interpret the COGS deduction as an exemption from tax and, on that basis *69 hold CGG to stricter rules of construction and a higher burden of proof. The COGS deduction is not an exemption. It is a method used to arrive at “margin,” the tax base adopted by the legislature, which is akin to an “exclusion.” “Exemptions,” on the other hand, make special reductions to that base after it is calculated (allowing a taxpayer to avoid paying the tax completely). These are specifically identified and treated separately in the code. See Tex. Tax Code §§ 171.051-.088. Because the same concerns of equality and uniformity do not arise with exclusions and deductions as they do with exemptions, the stricter rules applicable to exemptions should not be imposed on taxpayers claiming exclusions or deductions. Instead, this Court should construe the COGS deduction strictly against the Comptroller and liberally in favor of CGG, and require CGG to prove its entitlement by a preponderance of the evidence. See Am. Multi-Cinema, 2015 WL 1967877, at *3; Roark Amusement & Vending, L.P. v. Combs, 2011 WL 255535 (Tex. App.—Austin Jan. 26, 2011), aff’d by 422 S.W.3d 632 (Tex. 2013).

In urging otherwise, the Comptroller relies on an overly-broad interpretation of Upjohn Co. v. Rylander, 38 S.W.3d 600, 606 (Tex. App.— Austin 2000, pet. denied). Upjohn involved the former “earned surplus tax,” which is fundamentally different than the current “margin tax.” The taxpayer in Upjohn sought a special deduction, imposed after the calculation *70 of the tax base, which would have allowed it to avoid tax for food and health care supplies. Id. at 605. This was properly treated as an exemption. To the contrary, the COGS deduction, as a component of the tax-base calculation for all taxpayers, should be treated as an “exclusion.”

PRAYER

Based on the foregoing, Appellee CGG Veritas Services (U.S.), Inc. respectfully prays that this Court overrule each of the Comptroller’s issues and affirm the judgment in full.16 CGG further prays that this Court tax all costs against Appellees, in this Court and the court below, and award CGG any such other relief at law or equity to which it may be justly entitled. Tex. R. App. P. 43.4; Tex. R. Civ. P. 139.

16 There is no legitimate basis to remand this case to allow the Comptroller a new opportunity to attempt to parse the costs properly included in CGG’s COGS calculation. However, should a remand be ordered, CGG preserves its rights to present argument and evidence in support of its calculation.

Respectfully submitted,

MARTENS, TODD, LEONARD, TAYLOR & AHLRICH 301 Congress Ave., Suite 1950 Austin, Texas 78701 Telephone: (512) 542-9898 Telecopier: (512) 542-9899

By: /s/ Amanda G. Taylor Amanda Taylor ataylor@textaxlaw.com State Bar No. 24045921 James F. Martens jmartens@textaxlaw.com State Bar No. 13050720 Lacy L. Leonard lleonard@textaxlaw.com State Bar No. 24040561 Danielle V. Ahlrich dahlrich@textaxlaw.com State Bar No. 24059215

ATTORNEYS FOR APPELLEE CGG VERITAS SERVICES (U.S.), INC.

CERTIFICATE OF COMPLIANCE

I hereby certify that this Appellee’s Brief complies with the typeface requirements of Tex. R. App. P. 9.4(e) because it has been prepared in a conventional typeface no smaller than 14-point for text and 12-point for footnotes. This document also complies with the word-count limitations of Tex. R. App. P. 9.4(i) because it contains 14,696 words, excluding any parts exempted by Tex. R. App. P. 9.4(i)(1).

/s/ Amanda G. Taylor Amanda Taylor

CERTIFICATE OF SERVICE

Pursuant to the Texas Rules of Appellate Procedure, a true and correct copy of the foregoing was served via e-service on counsel listed below, on the 20th day of July, 2015. Tex. R. App. P. 9.5.

Joseph D. Hughes Assistant Solicitor General OFFICE OF THE ATTORNEY GENERAL P.O. Box 12548 (MC 059) Austin, Texas 78711-2548 (512) 936-2923 (512) 474-2697 [fax] jody.hughes@texasattorneygeneral.gov

Charles Eldred Assistant Attorney General OFFICE OF THE ATTORNEY GENERAL, FINANCIAL AND TAX LITIGATION DIVISION P.O. Box 12548 Austin, Texas 78711 (512) 463-1745 (512) 477-2348 [fax] charles.eldred@texasattorneygeneral.gov

/s/ Amanda G. Taylor Amanda Taylor

APPX.1 (P.Ex.4) APPX.1 (P.Ex.4) APPX.1 (P.Ex.4) APPX.1 (P.Ex.4) APPX.1 (P.Ex.4) APPX.1 (P.Ex.4) APPX.1 (P.Ex.4) APPX.2 (P.Ex.5) APPX.2 (P.Ex.5) APPX.2 (P.Ex.5) APPX.2 (P.Ex.5) APPX.2 (P.Ex.5) APPX.2 (P.Ex.5) APPX.3 (P.Ex.19) APPX.3 (P.Ex.19) APPX.3 (P.Ex.19) APPX.3 (P.Ex.19) APPX.3 (P.Ex.19) APPX.4 (P.Ex.48) § 171.1012. Determination of Cost of Goods Sold, TX TAX § 171.1012

  

      

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(a) In this section: (1) “Goods” means real or tangible personal property sold in the ordinary course of business of a taxable entity.

(2) “Production” includes construction, installation, manufacture, development, mining, extraction, improvement, creation, raising, or growth.

(3)(A) “Tangible personal property” means:

(i) personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to the senses in any other manner;

(ii) films, sound recordings, videotapes, live and prerecorded television and radio programs, books, and other similar property embodying words, ideas, concepts, images, or sound, without regard to the means or methods of distribution or the medium in which the property is embodied, for which, as costs are incurred in producing the property, it is intended or is reasonably likely that any medium in which the property is embodied will be mass-distributed by the creator or any one or more third parties in a form that is not substantially altered; and

(iii) a computer program, as defined by Section 151.0031.

(B) “Tangible personal property” does not include:

(i) intangible property; or

(ii) services.

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(b) Subject to Section 171.1014, a taxable entity that elects to subtract cost of goods sold for the purpose of computing its taxable margin shall determine the amount of that cost of goods sold as provided by this section.

(c) The cost of goods sold includes all direct costs of acquiring or producing the goods, including: (1) labor costs; (2) cost of materials that are an integral part of specific property produced; (3) cost of materials that are consumed in the ordinary course of performing production activities; (4) handling costs, including costs attributable to processing, assembling, repackaging, and inbound transportation costs; (5) storage costs, including the costs of carrying, storing, or warehousing property, subject to Subsection (e);

(6) depreciation, depletion, and amortization, reported on the federal income tax return on which the report under this chapter is based, to the extent associated with and necessary for the production of goods, including recovery described by Section 197, Internal Revenue Code;

(7) the cost of renting or leasing equipment, facilities, or real property directly used for the production of the goods, including pollution control equipment and intangible drilling and dry hole costs;

(8) the cost of repairing and maintaining equipment, facilities, or real property directly used for the production of the goods, including pollution control devices;

(9) costs attributable to research, experimental, engineering, and design activities directly related to the production of the goods, including all research or experimental expenditures described by Section 174, Internal Revenue Code;

(10) geological and geophysical costs incurred to identify and locate property that has the potential to produce minerals;

(11) taxes paid in relation to acquiring or producing any material, or taxes paid in relation to services that are a direct cost of production;

(12) the cost of producing or acquiring electricity sold; and

(13) a contribution to a partnership in which the taxable entity owns an interest that is used to fund activities, the costs of which would otherwise be treated as cost of goods sold of the partnership, but only to the extent that those costs are related to goods distributed to the taxable entity as goods-in-kind in the ordinary course of production activities rather than being sold.

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(d) In addition to the amounts includable under Subsection (c), the cost of goods sold includes the following costs in relation to the taxable entity's goods:

(1) deterioration of the goods; (2) obsolescence of the goods; (3) spoilage and abandonment, including the costs of rework labor, reclamation, and scrap;

(4) if the property is held for future production, preproduction direct costs allocable to the property, including costs of purchasing the goods and of storage and handling the goods, as provided by Subsections (c)(4) and (c)(5);

(5) postproduction direct costs allocable to the property, including storage and handling costs, as provided by Subsections (c)(4) and (c)(5);

(6) the cost of insurance on a plant or a facility, machinery, equipment, or materials directly used in the production of the goods;

(7) the cost of insurance on the produced goods; (8) the cost of utilities, including electricity, gas, and water, directly used in the production of the goods;

(9) the costs of quality control, including replacement of defective components pursuant to standard warranty policies, inspection directly allocable to the production of the goods, and repairs and maintenance of goods; and

(10) licensing or franchise costs, including fees incurred in securing the contractual right to use a trademark, corporate plan, manufacturing procedure, special recipe, or other similar right directly associated with the goods produced.

(e) The cost of goods sold does not include the following costs in relation to the taxable entity's goods: (1) the cost of renting or leasing equipment, facilities, or real property that is not used for the production of the goods; (2) selling costs, including employee expenses related to sales; (3) distribution costs, including outbound transportation costs; (4) advertising costs;

© 2015 Thomson Reuters. No claim to original U.S. Government Works. 3 § 171.1012. Determination of Cost of Goods Sold, TX TAX § 171.1012 (5) idle facility expense; (6) rehandling costs; (7) bidding costs, which are the costs incurred in the solicitation of contracts ultimately awarded to the taxable entity; (8) unsuccessful bidding costs, which are the costs incurred in the solicitation of contracts not awarded to the taxable entity;

(9) interest, including interest on debt incurred or continued during the production period to finance the production of the goods;

(10) income taxes, including local, state, federal, and foreign income taxes, and franchise taxes that are assessed on the taxable entity based on income;

(11) strike expenses, including costs associated with hiring employees to replace striking personnel, but not including the wages of the replacement personnel, costs of security, and legal fees associated with settling strikes;

(12) officers' compensation; (13) costs of operation of a facility that is:

(A) located on property owned or leased by the federal government; and

(B) managed or operated primarily to house members of the armed forces of the United States; and (14) any compensation paid to an undocumented worker used for the production of goods. As used in this subdivision:

(A) “undocumented worker” means a person who is not lawfully entitled to be present and employed in the United States; and

(B) “goods” includes the husbandry of animals, the growing and harvesting of crops, and the severance of timber from realty.

(f) A taxable entity may subtract as a cost of goods sold indirect or administrative overhead costs, including all mixed service costs, such as security services, legal services, data processing services, accounting services, personnel operations, and general financial planning and financial management costs, that it can demonstrate are allocable to the acquisition or production of goods, except that the amount subtracted may not exceed four percent of the taxable entity's total indirect or administrative

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overhead costs, including all mixed service costs. Any costs excluded under Subsection (e) may not be subtracted under this subsection.

(g) A taxable entity that is allowed a subtraction by this section for a cost of goods sold and that is subject to Section 263A, 460, or 471, Internal Revenue Code, may capitalize that cost in the same manner and to the same extent that the taxable entity capitalized that cost on its federal income tax return or may expense those costs, except for costs excluded under Subsection (e), or in accordance with Subsections (c), (d), and (f). If the taxable entity elects to capitalize costs, it must capitalize each cost allowed under this section that it capitalized on its federal income tax return. If the taxable entity later elects to begin expensing a cost that may be allowed under this section as a cost of goods sold, the entity may not deduct any cost in ending inventory from a previous report. If the taxable entity elects to expense a cost of goods sold that may be allowed under this section, a cost incurred before the first day of the period on which the report is based may not be subtracted as a cost of goods sold. If the taxable entity elects to expense a cost of goods sold and later elects to capitalize that cost of goods sold, a cost expensed on a previous report may not be capitalized.

(h) A taxable entity shall determine its cost of goods sold, except as otherwise provided by this section, in accordance with the methods used on the federal income tax return on which the report under this chapter is based. This subsection does not affect the type or category of cost of goods sold that may be subtracted under this section.

(i) A taxable entity may make a subtraction under this section in relation to the cost of goods sold only if that entity owns the goods. The determination of whether a taxable entity is an owner is based on all of the facts and circumstances, including the various benefits and burdens of ownership vested with the taxable entity. A taxable entity furnishing labor or materials to a project for the construction, improvement, remodeling, repair, or industrial maintenance (as the term “maintenance” is defined in 34 T.A.C. Section 3.357) of real property is considered to be an owner of that labor or materials and may include the costs, as allowed by this section, in the computation of cost of goods sold. Solely for purposes of this section, a taxable entity shall be treated as the owner of goods being manufactured or produced by the entity under a contract with the federal government, including any subcontracts that support a contract with the federal government, notwithstanding that the Federal Acquisition Regulation may require that title or risk of loss with respect to those goods be transferred to the federal government before the manufacture or production of those goods is complete.

(j) A taxable entity may not make a subtraction under this section for cost of goods sold to the extent the cost of goods sold was funded by partner contributions and deducted under Subsection (c)(13).

(k) Notwithstanding any other provision of this section, if the taxable entity is a lending institution that offers loans to the public and elects to subtract cost of goods sold, the entity, other than an entity primarily engaged in an activity described by category 5932 of the 1987 Standard Industrial Classification Manual published by the federal Office of Management and Budget, may subtract as a cost of goods sold an amount equal to interest expense. For purposes of this subsection, an entity engaged in lending to unrelated parties solely for agricultural production offers loans to the public.

(k-1) Notwithstanding any other provision of this section, the following taxable entities may subtract as a cost of goods sold the costs otherwise allowed by this section in relation to tangible personal property that the entity rents or leases in the ordinary course of business of the entity:

(1) a motor vehicle rental or leasing company that remits a tax on gross receipts imposed under Section 152.026;

© 2015 Thomson Reuters. No claim to original U.S. Government Works. 5 § 171.1012. Determination of Cost of Goods Sold, TX TAX § 171.1012 (2) a heavy construction equipment rental or leasing company; and (3) a railcar rolling stock rental or leasing company.

(k-2) This subsection applies only to a pipeline entity: (1) that owns or leases and operates the pipeline by which the product is transported for others and only to that portion of the product to which the entity does not own title; and (2) that is primarily engaged in gathering, storing, transporting, or processing crude oil, including finished petroleum products, natural gas, condensate, and natural gas liquids, except for a refinery installation that manufactures finished petroleum products from crude oil. Notwithstanding Subsection (e)(3) or (i), a pipeline entity providing services for others related to the product that the pipeline does not own and to which this subsection applies may subtract as a cost of goods sold its depreciation, operations, and maintenance costs allowed by this section related to the services provided.

(k-3) For purposes of Subsection (k-2), “processing” means the physical or mechanical removal, separation, or treatment of crude oil, including finished petroleum products, natural gas, condensate, and natural gas liquids after those materials are produced from the earth. The term does not include the chemical or biological transformation of those materials.

(l) Notwithstanding any other provision of this section, a payment made by one member of an affiliated group to another member of that affiliated group not included in the combined group may be subtracted as a cost of goods sold only if it is a transaction made at arm's length.

(m) In this section, “arm's length” means the standard of conduct under which entities that are not related parties and that have substantially equal bargaining power, each acting in its own interest, would negotiate or carry out a particular transaction.

(n) In this section, “related party” means a person, corporation, or other entity, including an entity that is treated as a pass- through or disregarded entity for purposes of federal taxation, whether the person, corporation, or entity is subject to the tax under this chapter or not, in which one person, corporation, or entity, or set of related persons, corporations, or entities, directly or indirectly owns or controls a controlling interest in another entity.

(o) If a taxable entity, including a taxable entity with respect to which cost of goods sold is determined pursuant to Section 171.1014(e)(1), whose principal business activity is film or television production or broadcasting or the distribution of tangible personal property described by Subsection (a)(3)(A)(ii), or any combination of these activities, elects to subtract cost of goods sold, the cost of goods sold for the taxable entity shall be the costs described in this section in relation to the property and include depreciation, amortization, and other expenses directly related to the acquisition, production, or use of the property, including expenses for the right to broadcast or use the property.

(p) to (s) [Blank].

(t) If a taxable entity that is a movie theater elects to subtract cost of goods sold, the cost of goods sold for the taxable entity shall be the costs described by this section in relation to the acquisition, production, exhibition, or use of a film or motion picture, including expenses for the right to use the film or motion picture.

© 2015 Thomson Reuters. No claim to original U.S. Government Works. 6 § 171.1012. Determination of Cost of Goods Sold, TX TAX § 171.1012

Credits Added by Acts 2006, 79th Leg., 3rd C.S., ch. 1, § 5, eff. Jan. 1, 2008. Amended by Acts 2007, 80th Leg., ch. 1282, §§ 14, 15, eff. Jan. 1, 2008; Acts 2013, 83rd Leg., ch. 1232 (H.B. 500), § 9, eff. Jan. 1, 2014; Acts 2013, 83rd Leg., ch. 1232 (H.B. 500), § 10(a), eff. Sept. 1, 2013.

Notes of Decisions (1)

V. T. C. A., Tax Code § 171.1012, TX TAX § 171.1012 Current through Chapters effective immediately through Chapter 46 of the 2015 Regular Session of the 84th Legislature

End of Document © 2015 Thomson Reuters. No claim to original U.S. Government Works.

© 2015 Thomson Reuters. No claim to original U.S. Government Works. 7 § 171.1012. Determination of Cost of Goods Sold, TX TAX § 171.1012

Editor's and Revisor's Notes (8)

HISTORICAL AND STATUTORY NOTES

2015 Main Volume

Acts 2007, 80th Leg., ch. 1282 in subsec. (a)(3)(A)(ii) inserted “live and prerecorded television and radio programs” following “videotapes,”, substituted “, without regard to the means or methods of distribution or the medium in which the property is embodied,” for “by the creator of the property” following “or sound”, and deleted “tangible” preceding “medium in which the property is embodied”; in subsec. (c)(6) inserted “reported on the federal income tax return on which the report under this chapter is based,”; rewrote subsec. (g); in subsec. (h) substituted “used on the federal income tax return on which the report under this chapter is based” for “permitted by federal statutes and regulations”; rewrote subsec. (k); and added subsec. (o). Prior thereto subsecs. (g) and (k) read:

“(g) A taxable entity that is allowed a subtraction by this section for a cost of goods sold and that is subject to Section 263A , 460 , or 471, Internal Revenue Code , shall capitalize that cost in the same manner and to the same extent that the taxable entity is required or allowed to capitalize the cost under federal law and regulations, except for costs excluded under Subsection (e), or in accordance with Subsections (c), (d), and (f). ”

“(k) Notwithstanding any other provision of this section, if the taxable entity is a lending institution that offers loans to the public and elects to subtract cost of goods sold, the entity may subtract as a cost of goods sold an amount equal to interest expense.”

Acts 2013, 83rd Leg., ch. 1232 (H.B. 500) added subsecs. (k-2), (k-3), and (t).

Section 10(b) of Acts 2013, 83rd Leg., ch. 1232 (H.B. 500) provides:

“ Section 171.1012(t), Tax Code , as added by this section, is a clarification of existing law and does not imply that existing law may be construed as inconsistent with the law as amended by this section.”

Section 19 of Acts 2013, 83rd Leg., ch. 1232 (H.B. 500) provides:

“This Act applies only to a report originally due on or after the effective date [Sept. 1, 2013] of this Act.”

© 2015 Thomson Reuters. No claim to original U.S. Government Works. 8 § 171.103. Determination of Gross Receipts from Business Done..., TX TAX § 171.103

  

      

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(a) Subject to Section 171.1055, in apportioning margin, the gross receipts of a taxable entity from its business done in this state is the sum of the taxable entity's receipts from:

(1) each sale of tangible personal property if the property is delivered or shipped to a buyer in this state regardless of the FOB point or another condition of the sale;

(2) each service performed in this state, except that receipts derived from servicing loans secured by real property are in this state if the real property is located in this state;

(3) each rental of property situated in this state; (4) the use of a patent, copyright, trademark, franchise, or license in this state; (5) each sale of real property located in this state, including royalties from oil, gas, or other mineral interests; and (6) other business done in this state.

(b) A combined group shall include in its gross receipts computed under Subsection (a) the gross receipts of each taxable entity that is a member of the combined group and that has a nexus with this state for the purpose of taxation.

(c) Repealed by Acts 2013, 83rd Leg., ch. 1232 (H.B. 500), § 15. (d) Repealed by Acts 2013, 83rd Leg., ch. 1232 (H.B. 500), § 15.

Credits Acts 1981, 67th Leg., p. 1697, ch. 389, § 1, eff. Jan. 1, 1982. Amended by Acts 1984, 68th Leg., 2nd C.S., ch. 31, art. 15, § 1, eff. Oct. 2, 1984; Acts 1991, 72nd Leg., 1st C.S., ch. 5, § 8.06, eff. Jan. 1, 1992; Acts 1997, 75th Leg., ch. 1185, § 5, eff.

© 2015 Thomson Reuters. No claim to original U.S. Government Works. 1 § 171.103. Determination of Gross Receipts from Business Done..., TX TAX § 171.103

Jan. 1, 1998; Amended and consolidated this section with V.T.C.A., Tax Code § 171.1032 by Acts 2006, 79th Leg., 3rd C.S., ch. 1, § 5, eff. Jan. 1, 2008; Acts 2007, 80th Leg., ch. 1282, § 20, eff. Jan. 1, 2008; Acts 2013, 83rd Leg., ch. 1232 (H.B. 500), § 15, eff. Jan. 1, 2014.

Notes of Decisions (49)

V. T. C. A., Tax Code § 171.103, TX TAX § 171.103 Current through Chapters effective immediately through Chapter 46 of the 2015 Regular Session of the 84th Legislature

End of Document © 2015 Thomson Reuters. No claim to original U.S. Government Works.

© 2015 Thomson Reuters. No claim to original U.S. Government Works. 2 § 171.103. Determination of Gross Receipts from Business Done in..., TX TAX § 171.103

Editor's and Revisor's Notes (36)

HISTORICAL AND STATUTORY NOTES

2015 Main Volume

Acts 2006, 79th Leg., 3rd C.S., ch. 1 rewrote this section, which prior thereto read:

Ҥ 171.103. Determination of Gross Receipts From Business Done in This State for Taxable Capital

“In apportioning taxable capital, the gross receipts of a corporation from its business done in this state is the sum of the corporation's receipts from:

“(1) each sale of tangible personal property if the property is delivered or shipped to a buyer in this state regardless of the FOB point or another condition of the sale, and each sale of tangible personal property shipped from this state to a purchaser in another state in which the seller is not subject to taxation;

“(2) each service performed in this state;

“(3) each rental of property situated in this state;

“(4) the use of a patent, copyright, trademark, franchise, or license in this state;

“(5) each sale of real property located in this state, including royalties from oil, gas, or other mineral interests; and

“(6) other business done in this state.”

Acts 2007, 80th Leg., ch. 1282 added subsecs. (c) and (d).

Section 38 of Acts 2007, 80th Leg., ch. 1282 provides:

“This Act applies only to a report originally due on or after the effective date [Jan. 1, 2008] of this Act.

“The legislature intends that each change in law made to the following sections of the Tax Code by this Act be considered as a clarification of existing law and not imply that the existing law may be construed as inconsistent with the law as amended by this Act:

“(2) 171.103(5);”

Acts 2013, 83rd Leg., ch. 1232 (H.B. 500), repealed subsecs. (c) and (d), which prior thereto read:

“(c) A taxable entity that is a combined group shall include in a report filed under Section 171.201 or 171.202, for each member of the combined group that does not have nexus with this state for the purpose of taxation:

“(1) the gross receipts computed under Subsection (a); and

“(2) the gross receipts computed under Subsection (a) that are subject to taxation in another state under a throwback law or regulation.

“(d) The information required by Subsection (c) may be used for informational purposes only. The comptroller shall adopt rules as necessary to enforce the reporting requirement prescribed by Subsection (c). ”

Section 19 of Acts 2013, 83rd Leg., ch. 1232 (H.B. 500) provides:

“This Act applies only to a report originally due on or after the effective date of this Act [Jan. 1, 2014]. ”

Prior Laws:

© 2015 Thomson Reuters. No claim to original U.S. Government Works. 3 § 171.103. Determination of Gross Receipts from Business Done in..., TX TAX § 171.103

Acts 1907, 30th Leg., 1st C.S., p. 503.

Rev.Civ.St.1911, art. 7393.

Acts 1919, 36th Leg., p. 100.

Acts 1930, 41st Leg., 5th C.S., p. 220, ch. 68, § 2.

Acts 1931, 42nd Leg., p. 441, ch. 265, § 1.

Acts 1941, 47th Leg., p. 269, ch. 184, art. 8, § 1.

Acts 1949, 51st Leg., p. 975, ch. 536, § 1.

Acts 1951, 52nd Leg., p. 695, ch. 402, § 9.

Acts 1954, 53rd Leg., 1st C.S., p. 3, ch. 2, art. 3, § 1.

Acts 1955, 54th Leg., p. 1080, ch. 404, art. 4, § 1.

Acts 1957, 55th Leg., p. 1179, ch. 394, § 1.

Vernon's Ann.Civ.St. art. 7084 .

Acts 1959, 56th Leg., 3rd C.S., p. 187, ch. 1.

Acts 1969, 61st Leg., 2nd C.S., ch. 1, art. 7, § 1.

V.A.T.S. Tax.-Gen. art. 12.02, § (1)(b).

© 2015 Thomson Reuters. No claim to original U.S. Government Works. 4 § 151.009. “Tangible Personal Property”, TX TAX § 151.009

  

      

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“Tangible personal property” means personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to the senses in any other manner, and, for the purposes of this chapter, the term includes a computer program and a telephone prepaid calling card.

Credits Acts 1981, 67th Leg., p. 1547, ch. 389, § 1, eff. Jan. 1, 1982. Amended by Acts 1984, 68th Leg., 2nd C.S., ch. 31, art. 6, § 2, eff. Oct. 2, 1984; Acts 1987, 70th Leg., 2nd C.S., ch. 5, art. 1, pt. 4, § 11; Acts 1997, 75th Leg., ch. 1040, § 16, eff. Sept. 1, 1997.

Notes of Decisions (9)

V. T. C. A., Tax Code § 151.009, TX TAX § 151.009 Current through Chapters effective immediately through Chapter 46 of the 2015 Regular Session of the 84th Legislature

End of Document © 2015 Thomson Reuters. No claim to original U.S. Government Works.

© 2015 Thomson Reuters. No claim to original U.S. Government Works. 1 § 151.009. “Tangible Personal Property”, TX TAX § 151.009

Editor's and Revisor's Notes (6)

HISTORICAL AND STATUTORY NOTES

2015 Main Volume

Prior Laws:

Acts 1941, 47th Leg., p. 269, ch. 184, art. 10, § 1.

Acts 1950, 51st Leg., 1st C.S., p. 10, ch. 2, art. 10, § 1.

Vernon's Ann.Civ.St. arts. 7047l, §§ 1, 1a, 1 1/2 ; 7047 l -1, § 1.

Acts 1959, 56th Leg., 3rd C.S., p. 187, ch. 1, arts. 20.01 to 20.20.

Acts 1961, 57th Leg., 1st C.S., p. 71, ch. 24, art. 1, § 1.

V.A.T.S. Tax.-Gen. art. 20.01, § (P).

© 2015 Thomson Reuters. No claim to original U.S. Government Works. 2 250 251 265 266 267 268 269 270 />7D[7\SH)UDQFKLVH@>'RFXPHQW7\SH/HWWHU0HPR@ KWWSDL[WFSFSDVWDWHW[XVRSHQGRFVRSHQOKWPO

Texas Comptroller of Public Accounts STAR System

201406920L

DATE: June 10, 2014

TO: Denise Stewart, Audit Division Robin Robinson, General Counsel

FROM: Teresa Bostick, Tax Policy Division

SUBJECT: Policy change based on TITAN and NEWPARK

ISSUE Based on the courts’ language and analysis in TITAN and NEWPARK, we are revising the policy with regard to subcontracting payments eligible for exclusion under Section 171.1011(g)(3) and qualifying activities for the COGS deduction under Section 171.1012(i).

BACKGROUND The court in TITAN found that Titan Transportation, L.P. (Titan), which is in the business of hauling, delivering, and depositing aggregate at real property construction sites, was entitled to exclude from revenue, pursuant to Section 171.1011(g)(3), payments the taxpayer made to its subcontractors providing this service for its customers.

Newpark Resources, Inc. (Newpark), an oil field service business, was the reporting entity for a combined group which included its subsidiary, Newpark Environmental Services, L.L.C. (NES). The court in NEWPARK found that Newpark was entitled to take a COGS deduction under Section 171.1012(i) for NES’s activities of removal and disposal of waste materials from oil and gas well drilling sites.

REVISED POLICY This change has immediate effect and a taxable entity may file an amended franchise tax report for years that are open within the statute of limitations.

Section 171.1011(g)(3) states, “A taxable entity shall exclude from its total revenue…only the following flow-through funds that are mandated by contract to be distributed to other entities: subcontracting payments handled by the taxable entity to provide services, labor, or materials in connection with the actual or proposed design, construction, remodeling, or repair of improvements on real property or the location of the boundaries of real property.”

Under the revised policy, subcontracting payments which qualify as flow-through funds under Section 171.1011(g) because they are mandated by contract to be distributed to other entities, and have a reasonable nexus to the actual or proposed design, construction, remodeling, or repair of improvements on real property or the location of boundaries of real property, may be excluded from revenue pursuant to Section 171.1011(g)(3). A payment is mandated by contract to be distributed to other entities if the taxable entity has a contract with

RI 30 201406920L [Tax Type: Franchise] [Document Type: Letter/Memo] http://aixtcp.cpa.state.tx.us/opendocs/open32/201406920l.html

its customers providing that subcontractors may be used and payment to the subcontractors, if used, must be made from the funds paid to the taxable entity. Please keep in mind that TITAN is being appealed on the basis that there was no contract in effect involving flow-through funds because the funds at issue were not mandated by contract to be distributed to other entities. Instead, the contract at issue was an ordinary contract between two parties for the provision of services in the regular course of business, as described in Section 171.1011(i).

With regard to the COGS deduction, Section 171.1012(i) states, “A taxable entity furnishing labor or materials to a project for the construction, improvement, remodeling, repair, or industrial maintenance of real property is considered to be an owner of that labor or materials and may include the costs, as allowed by this section, in the computation of costs of goods sold.”

Under the revised policy, we are expanding the interpretation of what is considered to be furnishing labor or materials to a project for the construction, improvement, remodeling, repair, or industrial maintenance of real property and will no longer require an entity to actually physically touch the property or make a change to the property to qualify for the COGS deduction, regardless of whether the entity is furnishing the labor or materials to a member of the entity’s combined group or if the entity is a single entity filer.

The policy changes are similar for both Sections 171.1011(g)(3) and 171.1012(i), but there are slight differences in how the policy will apply to the respective sections. For instance, the policy for both Sections will permit industries such as transportation companies delivering aggregate and other similar materials to a construction site, waste removal companies, demolition companies, and inspectors, among others, to claim either an exclusion from revenue – provided the transaction meets the contractual requirement of flow-through funds – or a COGS deduction. Although not new, one slight difference between the Sections is that Section 171.1011(g)(3) uses the term “proposed” – absent from Section 171.1012(i) – which may permit costs for activities performed by architects and engineers to qualify as exclusions from revenue, without regard to whether construction occurs.

Costs considered too far removed from the construction, improvement, remodeling, repair, or industrial maintenance of real property do not qualify for either an exclusion from revenue or a COGS deduction. Entities providing services that are defined as “service costs” under Rule 3.588(b)(9) are too far removed and do not qualify for either an exclusion from revenue or a COGS deduction. Examples of these costs include legal services and accounting services.

Further, the revised policy does not change the treatment of taxable entities renting or leasing equipment to others for use in or during such projects. Section 171.1012(k-1) still limits the COGS deduction to taxpayers renting or leasing certain items to others. Taxpayers who rent or lease equipment other than heavy construction equipment, such as fencing or port-a-potties, to others for use in projects for the construction, improvement, remodeling, repair or industrial maintenance of real property, are not eligible for the COGS deduction under Section 171.1012.

2 of 3 7/20/2015 3:36 PM 201406920L [Tax Type: Franchise] [Document Type: Letter/Memo] http://aixtcp.cpa.state.tx.us/opendocs/open32/201406920l.html

ACCESSION NUMBER: 201406920L SUPERSEDED: N DOCUMENT TYPE: L DATE: 06/18/2014 TAX TYPE: Franchise

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Texas Comptroller of Public Accounts STAR System

201504069L

Date: April 23, 2015

To: Denise Stewart, Director, Audit Division

From: Teresa Bostick, Director, Tax Policy Division

Subject: Tax Code Section 171.1012(c)(9) - Cost of Goods Sold for Research, Experimental, Engineering, and Design Activities

Issue

Whether a taxable entity that is not the producer of goods it sells, because it contracts out the manufacturing of the product, can include in costs of goods sold (COGS) expenses for research, experimental, engineering, and design activities related to those products.

Relevant Authorities

Texas Tax Code Section171.1012(c)(9) Internal Revenue Code Section 174 Treas. Regs. Section1.174-1 through 1.174-4

Discussion

Tax Code Section171.1012(c)(9) states, “the cost of goods sold includes all direct costs of acquiring or producing goods, including costs attributable to research, experimental, engineering, and design activities directly related to the production of the goods, including all research or experimental expenditures described by Section 174, Internal Revenue Code (IRC).”

Under prior policy COGS deductions for a taxable entity that was not the producer of the goods were limited to acquisition, storage, handling, and other costs specified in Tax Code Section171.1012(c) and (d) not related to production. Costs directly related to the production of goods that were typically allowed to a producer, such as research, experimental, engineering, and design activity costs, were not allowed as a COGS deduction for a taxable entity that was not the producer of the goods.

Upon further review, Tax Policy determined that a taxable entity who is eligible for COGS may claim as COGS all research and experimental costs described by Section 174 of the IRC, regardless of whether the taxable entity is considered the producer of the goods.

Section 174 of the IRC does not define research and experimental costs; however, related Treas. Reg. Section1.174-2 does provide a definition of research and experimental expenditures. Treas. Reg. Section1.174-2(a)(1) states, “The term research or experimental expenditures, as used in section

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174, means expenditures incurred in connection with the taxpayer’s trade or business which represent research and development costs in the experimental or laboratory sense.” Treas. Reg. Sections1.174-2(a)(1)-(2) also describe what costs are generally included in the term research and experimental expenditures and “…includes all such costs incident to the development or improvement of a product.”

Based on these authorities, regardless of whether the taxable entity is the producer of the good or not, the taxable entity may include in its COGS deduction research, experimental, engineering, and design activity costs, including all research or experimental expenditures described by Section 174 of the IRC relating to goods it sells.

This policy is effective for all open periods within the statute of limitations and future periods.

ACCESSION NUMBER: 201504069L SUPERSEDED: N DOCUMENT TYPE: L DATE: 04/24/2015 TAX TYPE: Franchise

2 of 2 7/20/2015 3:37 PM

Merriam- Webster's Collegiate' Dictionary Er-EVENTH EoITIoN

Merriam-'Webster, Incorporated Springfield, Massachusetts, U.S.A.

mat • maths 765 . provide wl1h n mn l or 1nn1- 8 Yll ~IATB RIAI.,, Pll VSICAI., COl\l'Ollll/\J.., l'llRNOMRN/\L, SS:NStlJ Lll, OD· 1 10 mcrrva menn o f or bclon~lng tt> uo1unl lty. MAT!lRIAL Imp lies' form11- g vi ( 1549) . (dirt nml fillh 11w11etl hor h nlr) ·-" tfl•I•tl n cnnalcddlll~ mass,...,, vi: 10 become mn11ud llon out or tnnglble mnllcr: u,cd In cont rnsf with .vplrl111aJ or lclvlll it 1114 ,...•,11, 1n11•1 • rorrn" • 16()~) 1 a/.>'O matte '" matt : ro may connote tl1c mu ndano. crnss. or gn.,ping (mmerlol value$). · n ..i_~. ~ol·lln9 < 11; 2 : 10 provide ( a pic1u rc) wilh t ' ..,.,.1 .,... .,, sJllSS· r color)"'" 0 PHYSICAi. applies to whBI Is perceived dlrcolly by l hc senses nod may <:-Ont.rast with nHmt11/, ~plrlt1wl. or lma11/11m·y (tht phy.i-lcal benents or exercise). CORPOlll!AI. Implies h11vinri 1ho t1tnglble qWllliJcs or n body ' . cd surface. fr, mat, ndj. - more at such 3!C shape, size. or rcsblnn<lC to force (arti~-i.< have portrayed o.n- .,., , ti ~to" u11(10li~und 11 picture between picture nnd gcts as corpon!al beings). PllRNOMRNAL applies to wha1 Is known or Juli j;O.-Jcr going perceived through the senses rnU1cr than by intuition or mllonal dc- j-1,I A thC ftllnlC duc..-i.ion (sclcnllsls conccn1ed with the pllttromenul world). Sl!NSlllLr• ..,...,,, ri.1:1. 2• Ir marar 10 kHI) (1681) : a bulln11111cr stresses the capllbility or readily or forcibly Impressing the :<ellSl'~ (the ill "\. 11br\ n IS~ wl;o kllls the bull In a bullOglu earth's rollltion i~ not ,fl'11slbll! to us). OllJllCTIVll may ~trc...,; mntcrlnl I ... '£11>~1 role a.n, (r OEgcm:ecca mhle, cqunl: akin 10 oe or Independent cxlstcncc a1»1n from I\ subJtct perccrving II (no ob}ee· 1•·'\M6 ml1C' Id, KP.) {b~f l.2e) 1 a : n pen.on nr thin& tfre evidence or domage). syn sec lu ndtlltion R£J.l!VANT h\~ _ n1ore •I M~ 0 ;10 nbl~ to c;ope with nnother c : nn 2 m a lerlal 11 (1556) 1 o ( I ): the clement<, cons1ituents, or ~ubstn nccs or jj., 111 ~·"!1 11t1cr lrbsuitnbly nssoclntcd <carpet nnd ~minlM which something Is composed or cnn be m ailc (2) : mnu or Umt h!L' " r-11 2 • pn 1 "«" t wu or more pnrtles <• -> goll " 11 • ""~1cst bo b . a cun1es1 (11~ In lennl,~ or volleybull) (r1 qunlllles which give II ln clivldunllty Md [)y Whlcli fl m ny be Clltegol'lwtl (sUok y "') (e1q, Josivc ""''') I> (I) : Romcl hl n~ (ns d.'ltn) Ih ut 11111y be - ~II ,ho111!1 1~ "'"',.~or side wins 11 ~P•~il'lcd 1\11111bcr ur sctNor worked lllto 11 mo rQ rtnl&hed form <- ror n h1ogropf)y) (2) : so1\1c- -l1tlit11 llllC p UY"'1on b: n pro~rectlvc partner In mnrrioi~ thlng 11soo for or m mJc lhc object or s 1udy <- for t he next sc111QSlc 1') u. J 111orrlllB0<1~~ou 11 nior ~ucees~lully ns nn oJJt ngonJst b I) (3) : 11 t>er fo r mer's rcpcrl(llrc (!\ Ctlmcdln11's -> c: M/\'rl'llR 3b d 1 ~1 1 11 : > >OSillon (2) : \o provide with a won 1y : Cl.O'nt e : a per~-011 1K>lt11l1111ly s u i1cd 10 ~ome pursuit (vnr:slty -> ' ..1111Jl'lllll0•11 ~ ~,f~•rl<nn 2 : 10 join or give In m arrinsc 3 0 (leadership -> 2 o : ap pnrt1IU$ 110CCSS.'lry for doing or making wmc• c: to ~c: ~sse..slns 'equni or harmon izin g nttribu1cs (2) th ing (writin g -..v) b : MATlll(ll.ll, rut In" 'IC \c1. srni• (--<td progrnms to l<K.'lll nee~) b ( I ) m a te-rl a l·lsa Brit 1'(1/' of MA1'1lRtAt.17.8 "'('(irl'l')~~ 0'r: nlw : to comp!l.n! favombly wllh (2) : to 0 0

m a ·ta·rl·al·ls m \m~'tlr-C.:.-,U-~m\ n (1733) 1 a: a theory that phys- "'un1crp j:idcel .....-1 1he pants) c : to provide with " ..1~: ~~~rovldc funds compl~mcntary ical matler Is the only or fundamental reality and that all being n11d !O (employers may processes and phenomena can be e>Cplnlnlld as mnnlfestotloM or resuh> ri colllrlbulion - 0 . J. Miller) 4 . 10 Ot together or of maucr b : n doc1rlno: thnt the only or the hialtest Vlllucs or objec- ·~>{.:;. nuina 1<>11c1hcr 5 a : to Olp or toss (colM) and com- tives Uc In ruatcrilll wcll-bclna ond in lhc (urthcrnnco: of ntJllcriul ;.,.{rotu b : to 1os~ coins with - »f: to be a countct'llart - progress c : n doctdn" thnt economic or social change Is matc1iully \'m 3 -cha-b.>I\ 1ttf/ - m atc h·e r " cnu,;ed - compare IUSTORICAI. MATt!RlALISM 2 : 8 preoccup111ion IMll rnllCt'li~. m<'<'t:ll~ cnncllewick. fr. AF '?'ec~e) (IS49) 1 : :• wit h or stress u.p 0n matcrlol rather 1hnn intellectual or :.plrllual thing~ il rciiared \\lck or C<lrd fCJT111crly used m firing llrcam1s or - m a .te.rl·al·lat )·lls1\ n Qr atQ - maole·rl·el·IB•tlc \·,llr-i!-~·'lls-1 lk\ ~ ~ 11 \horl slender plcO:c of 011.mmablc ruatcrllll (rus wood) uh~ combu>tlblc 1nlKt u rc thnt bur:m into nnmc w hen 5llghtly at(/- ma te rl a l S·tl·cal·IY \·tl·k(;>·)le\ ad• 0 0 0 0

1hrou~h friction ens by being scrntchcd ngainSl tl rt'>ugll 'urfnce) ma le rl a l·l·tY \m~·,llr-6·'n·l~-t~\ 1>, pf-ties (LS70l 1 : t he q uali ty or 0 0 0

boarll \'mnch· ,h6rd\ 11 (en. sta le or~b~ln1:1 m:ucdnl 2: som ethlny thut I&material tbMrdwllh u aroove cuc ~ ma te·ri ·Bl·l·zo tlon \ma.,1lr-e-;1·l~·'z.i-sho11\ 11 (1 843) 1 : Ille ncllon o r .. 0 0

e.1110 nnd 11 tonsuc idong ~ m:ucrinlizlng or beoomln11 111111erlnli1.cd 2 : something that h ns been mnu::l'lnllzed; CS/> : AJ>l'AJU'rlON '"Hlf!l111llnrly w "'' 10 r11 cut ~nugly wll h ~ ~ ma•IO•rl·ol·ize \m:.-' Ur-e-a-,lii\ vh · b:od; · l:r:-lng vt (17HI) 1 a : to bonrds k \·,bi'J k\ II ( 1937) : II r mnk'c nmlcrlnl : OllrllCTl l'V b : to cau>0 to appear in bodily form <- folder co111nlnlng ruws o r matchbos d me spirits o r lbc dead) 2 : to cause to be rnaicrlnlistic - vi 1 : to as- .....~ht<. sume bodily fom1 2 o : 10 ap1iear esp. ~uddenly b : to come into ex.- x hbftk'\ 11 (17861 : 11 box for matchc• isrcnc" - ma te·ri al·lz o r 110 0 0

·llu \-l;a\ mV (c:n. 1$30) : havin g no equal : FBBRJ..I!~~ (a ...... m o terlals science 11 ( 19$6): lhc scle11110c s1udy of tbe properties ond Ith< »•ll•Y) - motch·loss·IY atlv 11pplh:alions of mlllcrlals or construction or Dl3Uufacture (as cemml~. k \·,H\k\ n (ca. 1637) 1 : a muskel equipped with a mc1111$, p0lymen;, nnd com1><>5ltes) - m a terials s cientis t 11 k 2 : a slow-burning m atch lowered over a bole In the m o •te·rla med·l·c a \m:>-'tlr-C·:>·'me·dl·k~\ n CNL. Iii .. mcdiettl matlcr] ol a mlbkot to Ignite the charge (1663) 1 : sut»tancc.~ used In the compo.'ltlon or mlldical remcdl~ koer \·,mA·k•r\ n (1638) : one thnt arrnnges n match: esp : 011.uos. !l>tl!:DIO.NJl 2 a : a branch of medlcal science tlmt dents wilh "ho •rlcs lo bring two unn1orrkd individuals to(lclhcr In an at· t he sources. nature, proponleo<, an d 11reparat lon o f dru gs b : a trea tise JO f'OtnOte 11 marriage - m a lch·mak·f ng \·k lo\ 11 on matc:ria. medica ~I V ~ (1893): golf compctl1ion in which 1hc wh111cr Is the per· ma.te.rl·el or ma-te·rl·el \m~·,tir--!-'el\ n [F materiel, fr. materiel. adJ.J r•m Wlru1h1a tho srentcr number or hol es - compare S'rllOKB (1819): equipment. apparatws, a nd supplies used hy an organi:>:.ation o r institution 11f:lnl '[ ( 1?2 1\: ti Sltunllon (ns in tCJmls) In which One plflyer or me tor nol \mo-'t~r-n•t\ oq/ (M B, fr. M P & M I.; MF matcm el. fr. M L 0 0

.J.1)~~ t\,i e mn1ch by wlnnl1111 1he 11ex1 point: lllso : the point Itself m aramnlls, fr. L 11111t(fr1111.t( rr. 11111ter mo1 hcr - more at Mo1·1m11.J (I Sc) i·til, ~ mach·,~tJk\ 11 ( .179 1) ·1 : n slender f>iccc ~~fl· o f wood 1 : ()f, reln llng to, belo ng 118 to, or c h11m etcrlslic o( Q m o thur: M01'1<- n\to~~n 111ntuh I~ mode 2: somclhlng rese mbling n mn1ch31lck lll:n .Y 2 a : rolutcd through 11 m o ther (Ill~ ....., aunt) b : ln h orllcd ot •Up \ trn,e., (QUI n carrot Into ~s> •\l/o '~~,, n ,<1959) : ' MATCH d er ived fro m ll1e fe male p:11·e11t <- 11e11es) - ma ter•nOl•IY \-n• t-C\ 0

ad•' \'m~~ \-,1vud\11 (1786): ~mall pieces of wood : SPUNTeRg 1 me•ter·nl.ty \mo-'1or-n~·tt\ r1.11f-tlas (16 ll ) 1 a : the qu.al.hy or rnuc ~ill vt mot•ed; m o t.Ing [M l3, fr. AF mater, fr. mat, n.• check- of being a moth tr : M011 1nn11000 b : lhc quaUties or " mother "jl~)· !r· Ar11101(ln .r/Jt//J111<71)) (14c): CHBCKMATI! 2 : MOTllElUJNl!SS 2 : n h ospltnl fociliiy designed for the care of wom- ~ M • CHl!C'KMA1'R I ""'t r~rob, fr. MLO mtili ttkin to OE /l,l'mtrtta guest at one'• ta· 0) <ll - more IU MllATJ (14c) 1 a (I): ASSOCIATll, COMPAN· 2 en before nnd during chlldblnh nnd for t he care or newborn bnblcs motemlly atJi ( 1893) 1 : delilgned for wcnr during preanancy (a - dress) 2 : effective for the period close to and including childbirth fiJlv A:/11 1 B1i1 : an a-slnnnl to a m ore sknted worker : HBU'BR (-leave) b" : 1:ate1o10, a uuoy - oru:n used as a Lunlllar ronn of ad- mat·ey \ ' mii·tC\ aiQ (1915) cltlflfly Orie : COMPANIONAIJL!; - mat·ey- t::fhuJc: MATCll, l'llER 2 : a deck officer on a merchant ship noss \-n:is\ 11, d1lef/y Brit an~w lhe captain 3 : o ne of " pair: as a : cllher nrnmber or ' math \'matb\ n (ca. 1847): MATiiBMATICS II{ IJ\I"' C$.p. ~ nl(UTlcd couple b : either member or o brccdlna 2 math abbr m al11emu1tcal: mn1hcmntlclnn lb lllat n1s c : chh~r o r two mnlch~d objects m oth·e·mat·l·cal \, math·' mn-ll·k91, 1mn-1h,,_\ also math·e·maMc OJ n1 1 ·Od: mot·lng w (1509) 1 urcliaic: EQUAL, MATCH 2 : 10 \·tik\ aiQ [ME llllllhematlr".lla, fr. L marhemuticu.t, fr. Gk mathl· ft a 0&cther : COU~Lil 3 o : to join 1oge1her a8 m ares b : to matikos, rr. mothi!mr:t·, m111/1i!m11 lenmlng, ma 1hcmalics, rr. 111u111lw - l.\~nt~ ror - 1•/ 1 : In hecome m altd <aears that ,._, well) 2 11ei11 10 team; prob. 11kln co Co!h m11mlo11 to pay nt1entiou] (! Sc) 1 ~,~r·te \'111(1·/HI\ 11 CF & A n1crSp: F """ ' fr. A mcrSp mute : o f, rclntlng lo, or nccoi·dJna w ith mn1hu11111tlos 2 a: dgo ro nsly exacr : Pl\8ClSll b : CBR'fA1N 3 : pO!ISlhlc hut hig hly lm)ll'ohnblc (only n...., ~vcr:;uJor drink 1111 11, fr. Quechucu11111l v~s.~cll ( 1758) 1 : 11 tcn- t 1 m 11k esp. In So. A mcric1i 2 : "So. Amedcan ~hrub or ohnnc(')- math•o•mot·l•col·IY \· ti·kfo·)lc\ " dv !e:i; methematlcel expec tation 11 ( 11!38): BXPl!CTl!D VALUE d if:w·t1R11m·/~11sf~') o r the holly family whose te11ve.~ !lml stmot~ lot \' lllnkln11 mn ll\: also : t hese leaves n nd sboois (cQ ~~~-,10, 1111a·t:.-\ ,, er. rr. MP. rr. MD 111a11c11ou1, 111.. bctl- mathoma.tlcal Induction /1 (1838) : INt>ucnoN 2h mathematlcol loglc 11 (1853): llYMOOt.tc t..001c math•e-mB·ll•clan \,mntb·m:i-'tl-sh~1! 1 ,nia·lh:>-\ 11 (15c) : a spcd ttllS l .. .. ,,. 1019 \ 7) llr/t : M l l.OR or eltpcn In ma1hcmnllcs : a $le llla-t;i-'161, mn1-'l()1\ n [I'. Iii., sailor's wife, fr. rnatelot] (ca. m a th ·fl·mat·lca \ ,mnlh-'mn· llks. ,mn-th:>-\ 11 pl but u.r11 .rl11g 111 co11.11r r \' "made u:.u. or rish In n seasoned wini; sa u ce (1$73) 1 : the science or numbers and their operations, intcrrdottlon~. ·~~il·tQr\ 11 [L - more at MOTHER] (ca. 1859) clllt;Jly Brit comhlnMion.s. genenallzatlon~. &nd nb!.tmctions and of spn~-e coollHU· ~ ~"1flof,aa \.mA·l~r-fo-'mi·I~. ,ma·\ n [L, fr. mater+ /amilias, 1 mllo11> and their structure, me11.SurCJ11cn1, 1nul3fonnatlo11.-. ~nd gener- ,.~·or/um/flu hou<ehold - m ore at FJ\.'lcflJ..Y] (1756): a wo m- alizations 2 : n brnnch or. opcrRtlnn In, or use of mnthemutks (the - rt.81 tad o f a hou<chold or physical chemistry) 1 , rrl.\m;i..•ur+~I\ ntQ rME mmt!J'id, fr. MF & LL; MF, fr. LL. ma· math·e·ma 1f za tlo n \.mn1b-1m>·la·' zA·shon. ,nm-tho-\ /1 (1908) : re- , 0 0 0

, d · mater/a m atter - more m MATTER] (14c) 1 a (I) : relnt- duction tO mathemttllcal fonn - m o lh•O•m 8 °tlze \'1nal1Hn:>-,tf1, ' m11- trived from , or consisting qr maUer; esp : ~UYSICAJ.. (lhe ..._ lh:>-\ vb 1; (2): DOJ>ILY <-needs) b (I): of or rol ntlng 10mnt 1cr1111hcr maths \'mat11S\ 11111 (19 1 I) d1fcf/.y Brit: MA1'1t.nMATICS 11 a· ;} (..._. Cl\u~e) (2): or or relating to the su bject mottor or re11· ~J ~t 00 .,, : llMJ•111tCA1. <- knowled ge) 2 : having n:nl lm1>0rtnncc nt n1c(111en ccs (fuo1s ...., to die lnvc$1.lga Uo n) 3 a : being o f I\ \a\ ..hut \ 8 \ kitton. F table \ar\ furlher \a\ ll8h \ii\ ace \a\ mop, mar \au\ out \ch\ chin \e\ bet \ e\ easy \g\ go \l\ hit \i\ lee \j\Jol> · 1~0r \\1•)1•ldly 11n1111·c b : rcl:11ln11 lo or concerned with physicRl ~ ~ ari ~PlrJtunl o r Intellectual things ("'-' progress) - ma te rl· 0 0 \D\ ging \o\ go \6\ law \61\ hoy \lh \ thin \th\ the \il\ loot \u\ foot i>-IG\ adv - ma·te·rl•al•neaa 11 \y\ yet \:th\ vision, beigo \Is., •. oe, U>, >\.tee Guide lo Pronunciation