Court Opinion

ID: 4067413
Source: CourtListenerOpinion
Date Created: 2016-09-29 23:16:59.32897+00
Date Added: 2024-06-11T14:32:37.822773
License: Public Domain

ACCEPTED
                                                                                 03-14-00713-CV
                                                                                         4960817
                                                                      THIRD COURT OF APPEALS
                                                                                 AUSTIN, TEXAS
April 20, 2015                                                              4/20/2015 5:07:17 PM
                                                                               JEFFREY D. KYLE
                                                                                          CLERK
                                No. 03-14-00713-CV

                     In the Court of Appeals
                  for the Third Judicial District
                          Austin, Texas

       GLENN HEGAR, COMPTROLLER OF PUBLIC ACCOUNTS OF THE STATE OF
      TEXAS, AND KEN PAXTON, ATTORNEY GENERAL OF THE STATE OF TEXAS,
                                           Appellants,
                                        v.

                      CGG VERITAS SERVICES (U.S.), INC.,
                                             Appellee.

                             On Appeal from the
             353rd Judicial District Court of Travis County, Texas

                                APPELLANTS’ BRIEF

     KEN PAXTON                       SCOTT A. KELLER
     Attorney General of Texas        Solicitor General

     CHARLES E. ROY                   APRIL L. FARRIS
     First Assistant Attorney         Assistant Solicitor General
     General                          State Bar No. 24069702

                                      OFFICE OF THE ATTORNEY GENERAL
                                      P.O. Box 12548 (MC 059)
                                      Austin, Texas 78711-2548
                                      Tel.: (512) 936-2923
                                      Fax: (512) 474-2697
                                      april.farris@texasattorneygeneral.gov
     Oral Argument Requested          COUNSEL FOR APPELLANTS
                IDENTITY OF PARTIES AND COUNSEL

Appellants
Glenn Hegar, Comptroller of Public Accounts of the State of Texas,
Ken Paxton, Attorney General of Texas

Lead Appellate Counsel                   Additional Appellate and
April L. Farris                          Trial Counsel
Assistant Solicitor General              Charles K. Eldred
State Bar No. 24069702                   Assistant Attorney General
OFFICE OF THE ATTORNEY GENERAL           State Bar No. 00793681
P.O. Box 12548 (MC 059)                  P.O. Box 12548 MC 017-6
Austin, Texas 78711-2548                 Austin, Texas 78711-2548
Tel.: (512) 936-2923                     Tel.: (512) 475-2301
april.farris@texasattorneygeneral.gov    charles.eldred@
                                         texasattorneygeneral.gov
Appellee
CGG Veritas Services (U.S.), Inc.

Lead Appellate Counsel                   Additional Appellate and
Amanda Taylor                            Trial Counsel
State Bar No. 24045921                   Stacie L. Bennett
James F. Martens                         State Bar No. 2476984
State Bar No. 13050720                   Danielle V. Ahlrich
Lacy Leonard                             State Bar No. 24059215
State Bar No. 24040561                   MARTENS TODD LEONARD &
MARTENS TODD LEONARD & TAYLOR            TAYLOR
301 Congress Ave., Suite 1950            301 Congress Ave., Suite 1950
Austin, Texas 78701                      Austin, Texas 78701
Tel.: (512) 542-9898
Fax: (512) 542-9899
ataylor@textaxlaw.com
jmartens@textaxlaw.com
lleonard@textaxlaw.com

                                    ii
                                      TABLE OF CONTENTS

Identity of Parties and Counsel .............................................................. iii

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

Statement of the Case .............................................................................. ix

Statement Regarding Oral Argument ...................................................... x

Issues Presented...................................................................................... xii

Introduction ............................................................................................... 1

Statement of Facts .................................................................................... 1

        I.      The Tax Code’s Framework for Calculating the Cost of
                Goods Sold and the Franchise Tax ......................................... 1

        II.     CGG Veritas’s Business Model ............................................... 5

        III.    CGG’s 2008 Franchise Tax Filing and Lawsuit ................... 11

Summary of Argument ............................................................................ 15

Standard of Review ................................................................................. 20

Argument ................................................................................................. 21

        I.      The District Court Misinterpreted Either the Law or the
                Legal Standard in Ruling that CGG Veritas’s Costs
                Qualify for the COGS Deduction. ......................................... 21

        II.     CGG Veritas’s Business Costs Are Not Eligible for the
                COGS     Deduction            Pursuant             to        Tax         Code
                § 171.1012(a)(1) . ................................................................... 25

                A.       The District Court Found that CGG Veritas
                         Provides “Services,” But Erroneously Allowed It to
                         Deduct the Costs of These Services under
                         § 171.1012(a)(1). ........................................................... 28
                                              iii
                 B.      The District Court Erred By Failing to Interpret
                         the Statutory Term “Intangible Property” to
                         Include CGG Veritas’s Data Products. ........................ 32

                 C.      CGG Veritas’s Data and Services are not “Tangible
                         Personal Property” Under §171.1012(a)(3)(A)(ii). ....... 35

        III.     CGG Veritas Does Not Furnish Labor or Materials to a
                 Project for Construction of Real Property, So Its Costs
                 Do Not Qualify for the COGS Deduction under
                 § 171.1012(i). ......................................................................... 41

                 A.      CGG Veritas Does Not Furnish “Labor” or
                         “Materials.” .................................................................. 45

                 B.      CGG Veritas’s Services Are Too Far Removed from
                         a “Project” for the Construction of Real Property to
                         Qualify for the COGS Deduction under
                         § 171.1012(i). ................................................................ 50

Prayer ...................................................................................................... 52

Certificate of Service ............................................................................... 54

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

                                                      iv
                                   INDEX OF AUTHORITIES

Cases

AHF-Arbors at Huntsville I, LLC v. Walker Cnty. Appraisal Dist.,
    410 S.W.3d 831 (Tex. 2012)............................................................ 23

Baker v. Bullock,
     529 S.W.2d 279 (Tex. Civ. App.—Austin 1975,
     writ ref’d n.r.e.) .............................................................................. 31

Bullock v. Nat’l Bancshares Corp.,
     584 S.W.2d 268 (Tex. 1979)...................................................... 22, 23

City of Austin, et al. v. Sw. Bell Tel. Co.,
      92 S.W.3d 434 (Tex. 2002).............................................................. 20

Combs v. Chevron,
    319 S.W.3d 836 (Tex. App.—Austin 2010, no pet.) ....................... 21

Combs v. Home & Garden Party, Ltd.,
    No. 03-09-00673-CV, 2010 WL 4367054 (Tex. App.—Austin
    2010, no pet.) (mem. op.) ................................................................ 21

Combs v. Newpark Res., Inc.,
    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)....................................................... 20-21

Duvall v. Texas Dept. of Human Servs.,
    82 S.W.3d 474 (Tex. App.—Austin 2002, no pet.) ......................... 49

First Am. Title Ins. Co. v. Combs,
      258 S.W.3d 627, 632 (Tex. 2008) ................................................... 21

Fredericksburg Care Co., L.P. v. Perez,
     13-0573, 2015 WL 1035343 (Tex. Mar. 6, 2015) ............................ 20

                                                   v
Geomap Co. v. Bullock,
    691 S.W.2d 98 (Tex. App.—Austin 1985, writ refd n.r.e) .............. 32

GTE Sw. Inc. v. Combs,
    03-08-00561-CV, 2010 WL 2218662 (Tex. App.—Austin
    June 3, 2010, pet. denied) (mem. op.) ............................................ 22

Hawkins v. Dallas Cnty. Hosp. Dist.,
    150 S.W.3d 535 (Tex. App.—Austin 2004, no pet.) ....................... 48

Houston First Am. Sav. v. Musick,
     650 S.W.2d 764 (Tex. 1983)............................................................ 30

In re Bass,
      113 S.W.3d 735 (Tex. 2003)................................................ 33, 35, 38

In re Hall,
      286 S.W.3d 925 (Tex. 2009)...................................................... 39, 42

In re Nestle USA, Inc.,
      387 S.W.3d 610 (Tex. 2012).......................................................... 1, 2

Kirby Lake Develop., LTD v. Clear Lake City Water Authority,
     320 S.W.3d 829 (Tex. 2010) ........................................................... 26

Marks v. St. Luke’s Episcopal Hospital,
    319 S.W.3d 658 (Tex. 2010)............................................................ 39

N. Alamo Water Supply Corp. v. Willacy Cnty. Appraisal Dist.,
     804 S.W.2d 894 (Tex. 1991)...................................................... 22, 23

Reservoir Sys., Inc. v. TGS-NOPEC Geophysical Co., L.P.,
     335 S.W.3d 297 (Tex. App.—Houston [14 Dist.] 2010,
     pet. denied) ..................................................................................... 33

Roark Amusement & Vending, L.P. v. Combs,
     No. 03-10-00105-CV, 2011 WL 255535 (Tex. App.—Austin,
     Jan. 26, 2011) (mem. op.) (citation omitted), aff'd on other
     grounds, 422 S.W.3d 632 (Tex. 2013) ............................................ 24

                                                   vi
State v. $1,760.00 in US Currency,
      406 S.W.3d 177 (Tex. 2013) (per curiam) ...................................... 39

State v. Shumake,
      199 S.W.3d 279 (Tex. 2006)............................................................ 20

Strayhorn v. Raytheon E-Sys., Inc.,
     101 S.W.3d 558 (Tex. App.—Austin 2003, pet. denied)................. 23

TGS-NOPEC Geophysical Co. v. Combs,
    340 S.W.3d 432 (Tex. 2011)........................ 20, 27, 32, 33, 34, 35, 42

Upjohn Co. v. Rylander,
     38 S.W.3d 600 (Tex. App.—Austin 2000, pet. denied)................... 24

Statutes

TEX. GOV’T CODE § 311.021(2) ................................................................. 48

TEX. GOV’T CODE §§ 403.203 et. seq. ......................................................... ix

TEX. TAX CODE §§ 112.051 et. seq. ............................................................ ix

TEX. TAX CODE § 171.101(a)(1)(B)(ii)(a)(1) ................................................ 2

TEX. TAX CODE § 171.1012 ................................................................. x, 1, 2

TEX. TAX CODE § 171.1012(a) .................................................................. 25

TEX. TAX CODE § 171.1012(a)(1) ...................................................... passim

TEX. TAX CODE § 171.1012(a)(3)(A) ........................................................... 3

Tex. Tax Code § 171.1012(a)(3)(A)(ii) ............................................. passim

TEX. TAX CODE § 171.1012(a)(3)(B) ........................................... 3, 4, 29, 49

TEX. TAX CODE § 171.1012(a)(3)(B)(i)-(ii) ................................................ 16

TEX. TAX CODE § 171.1012(a)(3)(B)(i) ................................................. xi, 26
                                               vii
TEX. TAX CODE § 171.1012(a)(3)(B)(ii) .......................................... xi, 26, 32

TEX. TAX CODE § 171.1012(c) ................................................. 16, 43, 44, 49

TEX. TAX CODE § 171.1012(c)(1) .................................................... xi, 44, 46

TEX. TAX CODE § 171.1012(c)(1)-(13) ....................................................... 44

TEX. TAX CODE § 171.1012(c)(10).................................................. xi, 19, 46

TEX. TAX CODE § 171.1012(c)(2) .................................................... xi, 44, 46

TEX. TAX CODE § 171.1012(c)(3).................................................... xi, 44, 46

TEX. TAX CODE § 171.1012(d) .................................................................. 16

TEX. TAX CODE § 171.1012(e) ................................................................... 16

TEX. TAX CODE § 171.1012(i) ........................................................... passim

TEX. TAX. CODE § 171.1012(a)(3)(B)(i) ................................................. x, 26

Other Authorities

MERRIAM-WEBSTER ONLINE, http://www.merriam-
    webster.com/dictionary/mass (last visited April 14, 2015)............ 37

Ray Andrews Brown, THE LAW OF PERSONAL PROPERTY 11
     (3d ed., Walter B. Raushenbush ed. 1975) ................................... 27

Webster’s Third New International Dictionary 1259 (Phillip Gove
    Ed. 2002)......................................................................................... 47

                                                  viii
                         STATEMENT OF THE CASE

Nature of the Case:               CGG Veritas filed suit under Texas
                                  Tax Code §§ 112.051 et seq. and
                                  Texas Government Code §§ 403.203
                                  et. seq. to recover tax amounts paid
                                  under protest. CR.5. At issue is the
                                  Comptroller’s disallowance of CGG
                                  Veritas’s cost-of-goods-sold
                                  deduction. CR.6-7, 15.

Course of Proceedings:            The district court conducted a two-
                                  day bench trial in February 2014 on
                                  the issue of whether CGG Veritas
                                  may include the costs of its seismic
                                  services and products in its cost-of-
                                  goods-sold deduction. CR.250-51.

Trial Court:                      The Honorable Tim Sulak, 353rd
                                  District Court, Travis County, Texas.
                                  CR.269.

Trial Court Disposition:          CGG Veritas prevailed on both of its
                                  theories supporting its claim that it
                                  was entitled to claim a cost-of-goods-
                                  sold deduction in the amount of
                                  $567,600,223. CR.268. The district
                                  court entered judgment that it was
                                  entitled to claim a cost-of-goods-sold
                                  deduction in that amount. CR.250.
                                  The Court ordered that CGG
                                  Veritas’s tax due for Report Year
                                  2008 was $1,721,022.23, and ordered
                                  the Comptroller to issue an
                                  appropriate check including
                                  appropriate statutory interest.
                                  CR.250.

                                  ix
              STATEMENT REGARDING ORAL ARGUMENT

     State Defendants request oral argument because this case presents

an issue of first impression regarding the proper construction of several

subsections of Texas Tax Code § 171.1012. Argument would provide the

opportunity to fully explore the intended meanings of these subsections.

                                   x
                           ISSUES PRESENTED

     1. Do CGG Veritas’s seismic services and products constitute
“tangible personal property,” so as to qualify for the cost-of-goods-sold
(COGS) deduction under Texas Tax Code § 171.1012(a)(1)?

         a. CGG Veritas pleaded, and the district court found, that it
     provides “services.” CR.7, 266. The Legislature has explicitly
     excluded “services” from the definition of “tangible personal
     property.” TEX. TAX CODE § 171.1012(a)(3)(B)(ii). Did the district
     court err by allowing CGG Veritas to deduct the costs of these
     services under § 171.1012(a)(1)?

         b. The Legislature has explicitly excluded “intangible property”
     from    the    definition   of   “tangible    personal    property.”
     § 171.1012(a)(3)(B)(i). To the extent that CGG Veritas sells
     products, are those products intangible property?

     3. Do CGG Veritas’s “geological and geophysical” products and
 services constitute “labor” or “materials,” so as to allow CGG Veritas to
 be deemed an owner of its clients’ goods for purposes of § 171.1012(i)?
 Compare § 171.1012(c)(10) with § 171.1012(c)(1), (c)(2) and (c)(3).

     4. If CGG Veritas furnishes “labor” or “materials,” are its activities
 nevertheless too far removed from an oil or gas drilling “project” to be
 deductible under § 171.1012(i)?

     5. Is the COGS deduction a tax exemption, such that doubts
regarding eligibility must be construed against the claimant?

                                    xi
                             INTRODUCTION

     The district court erred as a matter of law when it ruled that

Appellee CGG Veritas was entitled to claim a statutory cost-of-goods-sold

(COGS) deduction of $567,600,273 for franchise tax Report Year 2008.

     The essential facts are undisputed. The parties are in agreement

regarding what work CGG Veritas’s geo-sciences business actually

performs. They disagree as to what statutory label should apply to its

business activities. The question whether CGG Veritas’s costs meet the

criteria for the COGS deduction turns on the meaning of the terms that

the Legislature chose in enacting Texas Tax Code §171.1012.

                         STATEMENT OF FACTS

I.   THE TAX CODE’S FRAMEWORK FOR CALCULATING              THE   COST   OF
     GOODS SOLD AND THE FRANCHISE TAX

     The franchise tax is a tax payment for “the value of the privilege of

doing business in Texas.” In re Nestle USA, Inc., 387 S.W.3d 610, 612

(Tex. 2012); see Combs v. Newpark Res., Inc., 422 S.W.3d 46, 47 (Tex.

App.—Austin 2013, no pet.). Since the 2006 restructuring of the Tax

Code, the franchise tax owed by an entity has been “calculated according

to the following formula”:
     	

−             	                     :           	           	   ℎ 	        ,           ,   	30%

="            																													

×$                        	    	            	           	        	    %   	&

=    % & 	"

×    %	           	       	.5%	         	           	                )	 	*ℎ    	   	       , 1%	   	   	 ℎ

=,        ℎ           	       %	

In re Nestle USA, 387 S.W.3d at 614-15.

      At issue here is the statutory COGS deduction. TEX. TAX CODE

§ 171.101(a)(1)(B)(ii)(a)(1) (COGS deduction determined by subtracting

from total revenue the “cost of goods sold, as determined under Section

171.1012”). Section 171.1012 of the Tax Code, entitled “Determination of

Cost of Goods Sold,” “allows a company to deduct all direct costs of

acquiring or producing goods,’ some indirect costs like insurance,

utilities, and quality control, and up to 4% of other ‘indirect or

administrative overhead costs.” Combs v. Newpark Res., Inc., 422 S.W.3d
46, 48 (Tex. App.—Austin 2013, no pet.). That section also defines the

COGS deduction’s contours and limits, and it restricts the COGS

deduction’s applicability in two primary ways.

                                                                2
     First, Section 171.1012 sets hard limits on what items qualify as

“goods” for purposes of the COGS deduction. Section 171.1012(a)(1)

restricts the meaning of the term “goods” to only “real or tangible

personal property sold in the ordinary course of business.” Id.

§ 171.1012(a)(1). The term “tangible personal property,” in turn, means:

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

     (ii)   [f]ilms, 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;

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

§ 171.1012(a)(3)(A).

     By contrast, § 171.1012 excludes from the definition of “tangible

personal property” both “intangible property” and “services.” Id. §

171.1012(a)(3)(B). An entity may not claim a COGS deduction for the

                                     3
costs of producing or acquiring any intangible property or services that it

sells. Id.

      The second way in which §171.1012 restricts the COGS deduction’s

eligibility is by mandating that only the owners of goods may deduct the

cost of any particular goods at issue. That provision dictates that

      (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. . . .

Id. § 171.1012(i). Mere possession of the goods cannot confer eligibility to

deduct their cost. If the taxable entity does not own the goods at issue,

then that entity may not take a COGS deduction for the cost of those

particular goods. Id.

      Section 171.1012(i) recognizes three different routes by which a

taxable entity may establish the requisite ownership relationship for

purposes of the COGS deduction. The first route is traditional ownership,

which is “based on all of the facts and circumstances, including the

various benefits and burdens of ownership vested with the taxable

entity.” Id.

      The second route is by “furnishing labor or materials to a project for

the construction, improvement, remodeling, repair, or industrial

                                        4
maintenance (as the term ‘maintenance’ is defined in 34 T.A.C. Section

3.357) of real property.” Id. By furnishing such labor and materials, the

entity may be “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. The third route is deemed ownership of “goods

being manufactured or produced by the entity under a contract with the

federal government.” Id. Only the first two paths are implicated in this

case.

II.     CGG VERITAS’S BUSINESS MODEL

        CGG Veritas is a geo-sciences company that performs seismic data

acquisition and data processing services for clients on both a proprietary

and non-proprietary basis. 2RR.117; CR.265. CGG Veritas creates and

uses “sound waves” to “collect [] raw seismic data,” and it then engages

in sophisticated processing of that data to “produce a three-dimensional

image that allows [it] to see below the surface of the earth.” 2RR.77.

CGG’s clients consist of oil-and-gas-well exploration and production

companies. CR.265; 2RR.46.

        At trial, CGG Veritas’s senior project manager for its multi-client

data library (MCDL), Bob Montgomery, testified extensively to CGG

                                      5
Veritas’s business activities. 2RR.72. He explained that CGG Veritas

acquires seismic data by creating audio recordings using tools and

devices that impact the earth’s surface and sub-surface. 2RR.133-

34;CR.265. With such tools as dynamite, geophones, air-guns, marine

vessels, and vibroseis trucks, CGG Veritas employees create a sound

wave that disturbs the earth’s surfaces and sub-surfaces. CR.266;

2RR.134. The company captures the effect of those disturbances as

“seismic sound recordings” by “record[ing] the sound waves that are

coming back up.” 2RR.135, CR.265. CGG’s seismic-data-acquisition

services range from very small projects, lasting only a “couple of weeks,”

to large acquisition projects lasting 150 to 300 days just to collect the raw

seismic data. 2RR.137-38.

     Despite the energies expended to collect these sound waves,

Montgomery acknowledged that these sound files, or “raw” seismic data,

are “really sort of useless until you process them.” 2RR.89. Montgomery

explained that these sound recordings—which sound only like a “low

rumble,” a “high whine,” an “engine running,” or a “big boom” depending

upon the tool used to create the sound wave—are rarely listened to, even

by CGG employees. 2RR.136. Rather, starting from the earliest stages of

                                     6
the seismic-data-acquisition process, when the vibroseis truck operator

is monitoring the acquisition of the seismic data in the field while he is

still in the field, the sound data is already transformed into a picture

format for visual monitoring. 2RR.135-36.

     This raw seismic data, likewise, is of limited value to CGG’s oil-and-

gas clients. 2RR.142. Montgomery testified that “before the oil and gas

company can use it extensively, it has to have processing applied to it.”

Id. CGG Veritas provides these processing services using sophisticated

computer programs and proprietary algorithms to process the seismic

sound files into visual renderings of the earth’s subsurface. CR.265.

     CGG Veritas’s processing procedure consists of “taking the raw

seismic data and transforming that into a three-dimensional image or a

seismic image, something that we can use.” 2RR.89. Although collecting

the seismic data may be time consuming, processing that data takes

longer. 2RR.139-140. For small data-acquisition projects, Montgomery

estimated that CGG Veritas would take three weeks to a month to

process the data into the three-dimensional picture that the client would

view. 2RR.138-139. By contrast, for large projects, CGG Veritas could

                                    7
take up to 18 months to process the project to a final image, although the

company would release intermediate images along the way. 2RR.140.

     CGG Veritas’s complex process of transforming raw sound waves

into the end-result images relies on a combination of its “highly

specialized algorithms,” 2RR.89, and the expertise of its “highly trained

and experienced people” who operate CGG Veritas’s complex software

and hardware systems. 2RR.90. In Houston alone, the processing team

consists of 200 geoscientists, most of whom have Ph.D.s in the hard

sciences. Id. Montgomery explained that “it’s really sort of high level

work to be able to do this;” the company could not simply “dump it in and

turn a crank.” Id.

     Montgomery explained that the processing was “somewhat of an

art” because it entails a “subjective” component that could result in CGG

Veritas’s competitors producing a slightly different image from the same

raw data. Id. Montgomery explained that the raw seismic data “really

doesn’t look like anything like a final image” that “the oil and gas

company would be looking at.” 2RR.92.

     CGG Veritas profits from these efforts in two ways. First, “oil and

gas producers will hire Veritas to assign crews to perform geophysical

                                    8
data acquisition services” on a proprietary basis. CR.7. CGG Veritas

acquires seismic data and processes that data into an appropriate image

for individual proprietary customers, who purchase exclusive rights in

the data and image. See 2RR.97-98, 117. When CGG performs

“proprietary work,” it provides the client with both “data acquisition and

processing” “the majority of the time.” 2RR.109. The contract includes the

names and qualifications of the processors, because “the company that’s

contracting for this wants to make sure that the people that are doing

this have enough experience and expertise to be able to carry out the

work.” 2RR.112-13.

     CGG Veritas also has a separate, non-proprietary revenue stream

generated by its MCDL. CR.266. From “time to time,” CGG Veritas will

survey a prospective area, process the raw data, and put the data and

resulting images on its MCDL. 2RR.118-19. The seismic data on the

MCDL is licensed on a per-product basis to clients who do not have

proprietary ownership rights in that data. 3RR.12. CGG Veritas “owns

the data,” and the MCDL clients get a license to use the data product that

the client selects. 2RR.124-25.

                                    9
     Clients license the MCDL items on a per-product basis. 3RR.12. A

product may typically be an image of a particular geographic area, such

as the “Bessie” location in East Texas. 3CR.16. These data products are

licensed “off the shelf,” and are not typically created for any particular

client. Large projects may be licensed by a number of persons, while small

ones may not be licensed as much. 3RR.18. CGG Veritas “intend[s]” or

“hope[s]” that each of the nearly 12,000 registered oil and gas companies

will purchase or license its products from the MCDL. 2RR.120.

Montgomery, however, testified that the largest number of licensees for

any MCDL product was 114, to his knowledge. 3RR.17.

     On occasion, CGG Veritas will process raw data that it did not

collect when a customer brings its own raw data and requests that CGG

process it. 2RR.141-42.

     CGG Veritas’s clients use the data as a guide to where to drill for

oil and gas. Montgomery testified that its data could also be used to

decide not to drill, at least not in a particular location like an

“overpressured” zone that would cause a “big blowout.” 2RR.130.

                                   10
III. CGG’S 2008 FRANCHISE TAX FILING AND LAWSUIT

     For franchise tax Report Year 2008, CGG Veritas claimed a COGS

deduction consisting of $567,600,223 in costs that CGG Veritas alleges

were incurred in producing its recordings and processed images during

2008. CR.267. In claiming that amount, CGG Veritas did not distinguish

between the costs to produce the recordings versus the processed images,

nor did it differentiate between the costs it incurred in producing for its

MCDL-licensing revenue stream versus its sold-content revenue stream.

Id. Applying that deduction, CGG originally paid $1,251,645.11 in

franchise tax. Id.

     In 2010, the Comptroller issued a notice disallowing CGG’s cost-of-

goods-sold deduction in its entirety, and assessed $1,301,568.86 in

additional franchise tax due, plus $93,357.68 in interest. Id. On April 17,

2012, following the dismissal of an administrative suit, the Comptroller

issued an updated notice that increased the interest due to $179,850.42.

Id. On May 2, 2012, CGG paid $1,483,232.96 to the Comptroller under

protest, an amount that constituted the additional franchise-tax

assessment with all interest due as of that date. Id.

                                    11
      CGG Veritas filed suit the same day, challenging the disallowance

of its COGS deduction and seeking a refund of the amount that it paid

under protest. See CR.9. State Defendants answered, and also asserted a

counterclaim that a portion of CGG Veritas’s claimed research and

development Credit on its 2008 Texas Franchise Return lacked

foundation, resulting in an underpayment by CGG Veritas of

$991,285.11. CR.26. The parties then agreed to a bifurcated non-jury trial

the trial on the claim and the counterclaim. CR.35. The parties later

stipulated to the appropriate amount of the credit that was the subject of

the counterclaim. CR.250. That credit is not at issue here.

      In February 2014, the trial court held a two-day bench trial on CGG

Veritas’s COGS-deduction claim. CR.250. The trial culminated in a final

judgment allowing CGG to deduct its entire $567,600,223 in costs

pursuant to the statutory COGS deduction. CR.250. The Court ordered

that CGG Veritas’s tax due for Report 2008 was $1,721,022.23,1 and

ordered the Comptroller to issue an appropriate check, including

statutory interest. CR.250.

1 The judgment also noted that the parties had stipulated that the amount of the
research and development carry forward credit available for CGG Veritas to claim
with its 2008 Texas Franchise Tax Report is $782,268. R.250.

                                      12
     CGG Veritas then submitted proposed findings of fact and

conclusions of law, and State Defendants submitted objections. CR.255-

263. The trial court made a number of determinations that it labeled as

findings of fact, including:

     2. CGG is a fully-integrated geo-sciences company that
     performs exploratory testing to produce seismic sound
     recordings and images that CGG sells on both a proprietary
     basis and licenses on a multi-client basis.

     4. CGG processes the seismic sound recordings [that it
     creates] into visual images of the Earth’s subsurface, using
     sophisticated computer programs and proprietary algorithms.

     6. Customers purchase, license, and use CGG’s seismic sound
     recordings and images to determine where to explore and drill
     for oil and gas.

     7. CGG’s seismic services and products are an integral,
     essential, and direct component of the oil and gas drilling
     process.

     8. In performing seismic work, CGG furnishes labor, including
     the expenditure of employee effort to acquire seismic data and
     to create seismic surveys and images.

     10. CGG creates and furnishes seismic sound recordings and
     images to customers for use in oil and gas drilling projects.

     11. CGG’s non-proprietary seismic sound recordings and
     images are held for licensure to the public through its multi-
     client data library (“MCDL”).

     13. At the time that costs are incurred to produce seismic
     sound recordings and images to be sold through CGG's multi-
                                  13
     client data library, CGG intends or believes it reasonably
     likely that any medium in which its seismic product will be
     embodied will be mass-distributed by CGG for licensure to as
     many customers as possible in a form that is not substantially
     altered.

     14. For Franchise Tax Report Year 2008, CGG originally paid
     $1,251,645.11, which was calculated using a cost-of-goods-
     sold deduction of $567,600,223.

CR. 265-67 (citations omitted).

     The trial court also issued a number of conclusions of law,

including:

     1. CGG furnishes labor and materials to projects for the
     construction, improvement, remodeling, repair, or industrial
     maintenance of oil and gas wells within the meaning of Tex.
     Tax Code § 171.1012(i).

     2. CGG’s seismic sound recordings and images qualify as
     “tangible personal property” under Tex. Tax Code
     § 171.1012(a)(3)(A)(ii).

     3. Oil and gas wells constitute real property for purposes of
     Tex. Tax Code § 171.10 12(i).

     4. CGG is eligible for the cost-of-goods-sold deduction under
     the third sentence of Tex. Tax Code § 171.1012(i).

     5. CGG’s seismic sound recordings and images contained
     within its multi-client data library constitute “tangible
     personal property” under Tex. Tax Code § 171.1012(3)(A)(ii).

     6. Through its multi-client data library, CGG licenses “goods”
     in the ordinary course of business within the meaning of Tex.
     Tax Code § 171.1012(a)(l).
                                  14
     7. CGG is eligible for the cost-of-goods-sold deduction under
     Tex. Tax Code § 171.1012(a)(l), 171.1012(a)(3)(A)(ii), and
     171.1012(i).

     8. Each of the costs that CGG included in its cost-of-goods-sold
     deduction were allowed by Tex. Tax Code § 171.1012(c), (d)
     and (f).

     9. CGG is entitled to claim a cost-of-goods-sold deduction in
     the amount of $567,600,223 for franchise tax Report Year
     2008.

CR.268.

     The trial court made no conclusions as to whether the relevant

statutory provisions were ambiguous, or whether State Defendants’

interpretations of those provisions were reasonable. The court did note,

however, that “any finding of fact that is more properly characterized as

a conclusion of law shall be considered a conclusion of law.” CR.267.

     After the entry of the findings of fact and conclusions of law, State

Defendants perfected this appeal.

                       SUMMARY OF ARGUMENT

     CGG Veritas is not entitled to take a COGS deduction for the costs

that it incurs in providing sophisticated geological imaging services and

seismic data to oil and gas companies. The Comptroller correctly

interpreted the Tax Code as disallowing CGG Veritas’s $567,600,223,

                                    15
million COGS deduction.2 The district court’s judgment allowing the

deduction should be reversed for two reasons.

      First, the judgment should be reversed because the COGS statute

does not allow CGG Veritas to deduct its costs of doing business. CGG

Veritas’s services and products are not “tangible personal property,” and

so do not meet the criteria for deduction under § 171.1012(a)(1) (defining

“goods” for purposes of the COGS deduction). Rather, they are “services”

and “intangible” property, respectively. The Legislature has explicitly

excluded both services and intangible property from the definition of

“tangible personal property,” and also from COGS-deduction eligibility

under § 171.1012(a)(1). TEX. TAX CODE § 171.1012(a)(3)(B)(i)-(ii).

      The district court ignored the text of the statute and concluded that

CGG was eligible to deduct its costs under subsection (a)(1)—despite

CGG Veritas’s pleading of the fact that it is hired to provide “services,”

and despite the district court’s own finding that CGG Veritas provides

2 That figure is a total of CGG Veritas’s categories of costs (under Texas Tax Code §
171.1012(c), (d), and (e), and (f) respectively) and its subtracted intra-group
eliminations. CR.267, FOF 15. Because the costs deducted under subsections (d) and
(e), and (f) are dependent upon there being eligible costs under subsection (c), those
costs are not eligible for deduction if State Defendants prevail on their argument here
that CGG Veritas was not entitled to deduct any costs under subsection (c). This brief
shall refer to the approximately $568 million total figure for convenience.

                                          16
such “services.” CR. 7, 266. The district court also found that CGG Veritas

sells “products,” but that product is intangible seismic data. Courts

across the state, including the Texas Supreme Court, have declared

seismic data to be an “intangible asset,” a “trade secret,” and “intellectual

property.” It is intangible in the truest sense.

     CGG Veritas, however, creatively attempts to avail itself of the

COGS deduction under §171.1012(a)(3)(A)(ii). That provision allows an

entity to deduct as “tangible personal property” the costs of producing

“sound recordings” or “other similar property” that is intended to be

“mass-distributed” in a “form that is not substantially altered”—like a

record company’s music. Id. This argument falls flat.

     Although CGG Veritas commences its seismic-data-acquisition

process by creating and capturing sound waves, it acknowledges that

those big booms and low rumblings are rarely listened to, and are “sort

of useless” before they are processed into pictorial seismic data. 2RR.89,

136. It then uses sophisticated computer algorithms and technology to

process these sound files into 3D or 4D graphic renderings of the Earth’s

subsurface that are nothing like the sound files. They are substantially

altered.

                                     17
     Regardless, neither the sound files themselves nor the images

painstakingly derived from those recordings are ever “mass distributed”

like a Taylor Swift album, or even like the ill-fated Playing with Fire

album from Kevin Federline. On the contrary, for Report Year 2008, CGG

Veritas produced most of its seismic data for proprietary sales to single

clients who then own all rights in the data—the very antithesis of mass

distribution. And simply hoping to license its expensive data products to

as many clients as possible is not the same as intent to distribute any

particular product on a mass scale.

     In any event, the judgment allowing the $568 million COGS

deduction on this theory must be reversed to the extent that CGG Veritas

has failed to distinguish its non-qualifying costs from its qualifying costs,

assuming arguendo that even some of its costs properly qualified.

Although CGG Veritas has distinguished the costs of its proprietary

revenue stream and its MDCL stream, it has not distinguished all of its

raw-data collection costs from its processed-data costs, or its service costs

from its data-product costs. Therefore, if any of these undistinguished

costs do not qualify for the COGS deduction, then CGG Veritas has not

                                     18
carried its burden of proving the exact amount of the tax refund to which

it is entitled, and judgment must be rendered for State Defendants.

      Second,     CGG    Veritas’s other   theory   supporting   a   COGS

deduction—that it is “furnishing labor or materials to a project for the

construction . . . of real property”—fares no better. TEX. TAX CODE

§ 171.1012(i). Section 171.1012 explicitly addresses “geological and

geophysical” services of the sort that CGG Veritas provides, id.

§ 171.1012(c)(10), but the Legislature does not consider them to be either

“labor” or “materials”—the only costs that qualify for deduction under

§ 171.1012(i). Even if this were otherwise, the services and products that

CGG Veritas provides are too far removed from any drilling “project” to

qualify under § 171.1012(i). Indeed, the seismic data that CGG Veritas

produces may well convince a company not to commence a drilling project

at all.

          Although § 171.1012 enables an oil or gas company to take a COGS

deduction for its seismic-data service costs, no statutory provision

authorizes a geo-sciences company like CGG Veritas to do the same.

Accordingly, the judgment allowing the COGS deduction should be

reversed.

                                     19
                          STANDARD OF REVIEW

     Because the “decisive issues in this case concern the appropriate

interpretation of provisions of the franchise-tax statute as applied to the

undisputed evidence about [CGG Veritas’s business],” the “dominant

issue in this case concerns a matter of statutory construction,” which is

reviewed de novo. State v. Shumake, 199 S.W.3d 279, 284 (Tex. 2006).

     When construing a statute, the court’s “primary objective is to

ascertain and give effect to the Legislature’s intent” as discerned by

considering the statute “as a whole.” TGS-NOPEC Geophysical Co. v.

Combs, 340 S.W.3d 432, 439 (Tex. 2011). The court “determine[s]

legislative intent from the entire act and not just isolated portions.”

Fredericksburg Care Co., L.P. v. Perez, 13-0573, 2015 WL 1035343, at *4

(Tex. Mar. 6, 2015). The Court “avoid[s] construing a statutory provision

in isolation from the rest of the statute,” but instead “consider[s] the act

as a whole, and not just single phrases, clauses, or sentences.” City of

Austin, et al. v. Sw. Bell Tel. Co., 92 S.W.3d 434, 442 (Tex. 2002).

     The language emerging from the legislative process “constitutes the

law, and when a statute’s words are unambiguous and yield but one

interpretation, the judge’s inquiry is at an end.” Combs v. Roark

                                    20
Amusement & Vending, L.P., 422 S.W.3d 632, 635 (Tex. 2013) (citation

and internal quotation marks omitted).

     If the statutory language does not unambiguously require a

particular outcome, the Court applies dominant rules of statutory

construction, including that the Court give “serious consideration” to the

construction of a statute by the administrative agency charged with its

enforcement. First Am. Title Ins. Co. v. Combs, 258 S.W.3d 627, 632 (Tex.

2008); Combs v. Home & Garden Party, Ltd., No. 03-09-00673-CV, 2010
WL 4367054, at *2 (Tex. App.—Austin 2010, no pet.) (mem. op.)

(deferring to Comptroller’s reasonable interpretation). Comptroller

decisions that are interpretations of Comptroller administrative rules are

likewise entitled to deference unless the Comptroller’s decision is

inconsistent with the statute’s text. See Combs v. Chevron, 319 S.W.3d
836, 841-42 (Tex. App.—Austin 2010, no pet.).

                               ARGUMENT

I.   THE DISTRICT COURT MISINTERPRETED EITHER THE LAW OR THE
     LEGAL STANDARD IN RULING THAT CGG VERITAS’S COSTS
     QUALIFY FOR THE COGS DEDUCTION.

     The district court erred as a matter of law in concluding that CGG

Veritas was entitled to claim a COGS deduction in the amount of

                                   21
approximately $568 million under Texas Tax Code §§171.1012(a)(1),

171.1012(a)(3)(A)(ii), and 171.102(i). CR.268. In reaching that conclusion,

the district court did not explain whether it had found those provisions

to be unambiguous, or whether it had resolved the ambiguity by adopting

CGG Veritas’s interpretations of those provisions. Id.

     Regardless of which path the court chose, the resulting decision was

incorrect.   As   explained   below,     the   statutory   COGS-deduction

qualifications are unambiguous. CGG Veritas’s costs simply do not meet

those qualifications. Alternatively, if the statutory provisions were

ambiguous, any doubts must be resolved against CGG Veritas because it

is claiming a statutory tax exemption.

     It is well established that where exemption eligibility is at issue,

“all doubts are resolved in favor of the taxing authority and against the

claimant,” and the claimant must “clearly show that it comes within the

statutory exemption.” See, e.g., Bullock v. Nat’l Bancshares Corp., 584
S.W.2d 268, 272 (Tex. 1979); N. Alamo Water Supply Corp. v. Willacy

Cnty. Appraisal Dist., 804 S.W.2d 894, 899 (Tex. 1991); GTE Sw. Inc. v.

Combs, 03-08-00561-CV, 2010 WL 2218662, at *2 (Tex. App.—Austin

June 3, 2010, pet. denied) (mem. op.) (“The burden of proof for showing

                                    22
the exemption applies lies with the claimant. An exemption must

affirmatively appear in the statute, and all doubts are resolved in favor

of the taxing authority.” (citation omitted)); Strayhorn v. Raytheon E-

Sys., Inc., 101 S.W.3d 558, 565, 567 (Tex. App.—Austin 2003, pet. denied)

(stating that the claimant “has the burden” of showing with “clear

evidence” that it is “entitled to the exemption”).

     Tax exemptions are “not favored by the law and will not be

favorably construed.” N. Alamo, 804 S.W.2d at 899. Indeed, the Texas

Supreme Court has cautioned that

     [s]tatutory exemptions from taxation are subject to strict
     construction since they are the antithesis of equality and
     uniformity and because they place a greater burden on other
     taxpaying businesses and individuals. An exemption cannot
     be raised by implication, but must affirmatively appear, and
     all doubts are resolved in favor of taxing authority and
     against the claimant. Simply stated, the burden of proof is on
     the claimant to clearly show that it comes within the statutory
     exemption.

AHF-Arbors at Huntsville I, LLC v. Walker Cnty. Appraisal Dist., 410
S.W.3d 831, 838 n. 30 (Tex. 2012) (quoting Bullock, 584 S.W.2d at 271-72

(Tex. 1979)).

      This Court has held that it reaches the question whether a

statutory provision is a tax exemption only when the statute is found to

                                    23
be ambiguous. Combs v. Newpark Res., Inc., 422 S.W.3d 46, 56 n.9 (Tex.

App.—Austin 2013, no pet.). Should this Court conclude that the

provisions here are ambiguous, this Court should reach the question and

hold that the COGS deduction is a franchise-tax exemption and not a

franchise-tax exclusion. This is so for two reasons.

     First, in decisions interpreting the repealed franchise tax, this

Court has held that “[t]ax provisions authorizing a deduction are

tantamount to an exemption.” Upjohn Co. v. Rylander, 38 S.W.3d 600,

606 (Tex. App.—Austin 2000, pet. denied). Nothing about the new

franchise-tax statute warrants a change in reasoning.

     Second, in interpreting the Tax Code, this Court has credited the

Comptroller’s longstanding position that “an exemption carves out an

otherwise taxable item, whereas as an exclusion is an item that is simply

not taxed by the code.” Roark Amusement & Vending, L.P. v. Combs, No.

03-10-00105-CV, 2011 WL 255535, at *4 (Tex. App.—Austin Jan. 26,

2011) (mem. op.) (citation omitted), aff’d on other grounds, 422 S.W.3d
632 (Tex. 2013). Section 171.101 (a) provides that the margin of a taxable

entity is computed by calculating 70 percent of the taxable entity’s total

revenue, subtracting cost of goods sold from its total revenue, or

                                    24
subtracting compensation from its total revenue, whichever is less. Thus,

the COGS deduction is a franchise tax exemption. It allows a taxpayer to

subtract otherwise-taxable revenue.

      In short, the provisions of § 171.1012 are unambiguous and compel

the conclusion that CGG Veritas’s costs are not eligible for the COGS

deduction. But if this Court finds that those provisions are susceptible to

multiple meanings, then the court must construe any doubts regarding

exemption eligibility against CGG Veritas and should defer to the

Comptroller’s reasonable interpretation.

II.   CGG VERITAS’S BUSINESS COSTS ARE NOT ELIGIBLE FOR THE
      COGS DEDUCTION PURSUANT TO TAX CODE § 171.1012(A)(1) .

      CGG Veritas’s business costs do not qualify for the COGS deduction

under § 171.1012(a)(1) and § 171.1012(a)(3)(A)(ii) of the Tax Code. The

district court’s judgment to the contrary must be reversed for three

reasons.

      First, this case of turns on the plain meaning of the definitions of

the terms “services” and “intangible property,” which have been used by

the Legislature to establish two exclusions from the term “goods” as

defined in Texas Tax Code § 171.1012(a). Although the term “services” is

not defined in the Tax Code, the Texas Supreme Court has recognized

                                    25
that it “includes generally any act performed for the benefit of another

under some arrangement or agreement whereby such act was to have

been performed.” Kirby Lake Dev., LTD v. Clear Lake City Water Auth.,

320 S.W.3d 829, 839 (Tex. 2010). CGG Veritas pleaded and the district

court found that at least some of CGG Veritas’s $568 million in costs

correspond to its “services,” but § 171.1012 explicitly excludes “services”

from the definition of “goods” whose costs are eligible for the COGS

deduction. TEX. TAX CODE § 171.1012(a)(3)(B)(ii). CGG Veritas is bound

by its pleading and cannot deduct the value of these services as though

they were “goods.”

     Second, CGG Veritas’s data products constitute “intangible

property,” but the Legislature has excluded such intangible property

from § 171.1012(a)(1)’s definition of “goods.” Id. § 171.1012(a)(3)(B)(i).

Intangible property includes things that are “owned,” and such

ownership can be asserted over rights that are of value even when the

rights do not arise from things that are tangible—such as claims against

third persons which may be enforced by action, and, if the law permits,

be assigned for a price, are of value and thus entitled to be termed

property in the broader sense. Bank accounts, debts generally, corporate

                                    26
stock, patents and copyrights are common instances of this class of

property. See Ray Andrews Brown, THE LAW OF PERSONAL PROPERTY 11

(3d ed., Walter B. Raushenbush ed. 1975); see TGS-NOPEC, 340 S.W.3d

at 439.

     In the present case, CGG Veritas, as the creator and owner of

certain intangible assets consisting of sound files that are convertible into

images and the generated images, has sold its intangible property under

licenses and thereby conveyed limited rights to its customers that are

legally enforceable during the franchise tax period at issue. In TGS-

NOPEC, the Texas Supreme Court has held that such property is

“intangible.” TGS-NOPEC, 340 S.W.3d at 444. Although a different

portion of the Tax Code was there at issue, the Legislature has not

excluded seismic data from the meaning of the term “intangible property”

in §171.1012. See id. TGS-NOPEC controls, so CGG Veritas cannot claim

that any of its data products constitute “goods” for purposes of the COGS

deduction.

     Third, CGG Veritas’s business costs do not qualify as “tangible

personal property” under § 171.1012(a)(3)(A)(ii), so they are not eligible

for deduction under § 171.1012(a)(1). CGG Veritas’s services and data

                                     27
products are not similar to the listed items in that provision, and they do

not meet the statutory requirement of being intended for distribution on

a large scale to a large number of clients.      CGG Veritas’s contrary

argument is basically simply that its raw and processed seismic data can

be seen or heard by its customers. But if this were enough, then any

number of service providers and intangible property producers could take

COGS deductions for their costs simply by pointing to some final product

that can be experienced by its customers’ senses. Nothing in the statute

suggests that the Legislature intended to make the COGS deduction so

expansive. The judgment should be reversed and the Court should find

that CGG Veritas is not entitled to a COGS deduction or any

corresponding tax refund.

     A.    The District Court Found that CGG Veritas Provides
           “Services,” But Erroneously Allowed It to Deduct the
           Costs of These Services under § 171.1012(a)(1).

     In the Tax Code provision that governs the determination of an

entity’s COGS deduction, the Legislature defined the “goods” qualifying

for deduction 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). The Legislature has explicitly determined that

                                    28
“‘tangible personal property’ does not include . . . services.” Id.

§ 171.1012(a)(3)(B)(ii).

      The district court found that CGG Veritas provides both “services

and products” to its clients. CR.266, FOF 7. Despite the statute’s explicit

exclusion of “services” from the definition of “tangible personal property,”

the district court nevertheless proceeded to conclude that CGG Veritas

was “eligible3 for the [COGS] deduction under § 171.1012(a)(1) and

§ 171.1012(a)(3)(A)(ii) (defining “tangible personal property”). CR.268,

COL 7.

      CGG Veritas’s own pleadings demonstrate the need to reverse on

the ground that at least some of its costs (for which it claimed a COGS

deduction under § 171.1012(a)(1)) were incurred in providing “services”

as opposed to “tangible personal property.” Here, CGG Veritas pleaded

that, with respect to its proprietary-sales revenue stream, “oil and gas

producers will hire [CGG] Veritas to assign crews to perform geophysical

3 Although the court did not specifically rule that it was including the cost of CGG
Veritas’s “services” in this eligibility, this Court should find that it did so for two
reasons. First, CGG did not distinguish which of its $568 million in costs were
incurred in providing “services” as opposed to providing “products.” Second, CGG
Veritas has argued that its business is generally eligible for a COGS deduction under
§ 171.1012(a)(1), and has never suggested that it has certain service-related costs
that would not qualify.

                                          29
data acquisition services.” CR.7, ¶6. Thus, according to CGG Veritas, the

essence of these proprietary-sale contracts are “geophysical data

acquisition services.” Id. (emphasis added). This assertion is binding upon

CGG Veritas, and prevents it from deducting the costs of these services

under § 171.1012(a)(1). Houston First Am. Sav. v. Musick, 650 S.W.2d
764, 769 (Tex. 1983).

     Other evidence likewise supports the district court’s determination

that CGG Veritas provides its clients with “services.” CR.266, FOF 7. The

company’s name is CGG Veritas Services, (U.S.), Inc. Its “Master

Agreement for Geophysical Services” describes the “nature of the work”

contracted for as “conducting geophysical surveys.” Plf’s Ex. 7, 4RR.83

     CGG Veritas also views its processing work as “services.” 2RR.104

(acknowledging that data acquisition is a “service[]” it provides); 2RR.114

(acknowledging that a Master Processing Order is a “contract to –for a

processing service”); 5RR35 (data transformation services). Its contracts

include the names and qualifications of the individual processors, most

of whom have advanced science degrees, 2RR.112-113, thus emphasizing

the credentials of the persons providing the services. CGG also describes

                                    30
its business as including “services” throughout its Securities and

Exchange Commission Form 20-F. 5RR.55-227 (Defs’ Ex. 14)

      The district court therefore erred by allowing CGG Veritas to

deduct its costs of providing these “services” under § 171.1012(a)(1).

Although CGG Veritas emphasizes the service-nature of its business in

order to argue that it provides “labor” under § 171.1012(i), the same

business activities cannot simultaneously be “services” for purposes of

that subsection and “not services” for purposes of § 171.1012(a)(1). The

finding that CGG Veritas offers “services” is fatal to its recovery of costs

for those services under § 171.1012(a)(1).4

      In a suit for a tax refund, a taxpayer must conclusively establish

that a tax was overpaid and the exact amount of that overpayment. Baker

v. Bullock, 529 S.W.2d 279, 281 (Tex. Civ. App.—Austin 1975, writ ref’d

n.r.e.). Because CGG Veritas provided no evidence capable of

distinguishing which of its costs related to “services” as opposed to its

4 As explained in Part III, services are deductible under § 171.1012(i) if they are
“labor,” but CGG Veritas’s services are not “labor.”

                                        31
“products,” CGG Veritas has not met its burden of proving the exact

amount of tax refund to which it is entitled.5

      B.     The District Court Erred By Failing to Interpret the
             Statutory Term “Intangible Property” to Include CGG
             Veritas’s Data Products.

      Like “services,” the Legislature has likewise explicitly excluded

“intangible property” from the definition of “tangible personal property.”

TEX. TAX CODE § 171.1012(a)(3)(B)(ii). Here, the statutory term

“intangible property” includes CGG’s gathering, interpreting, licensing,

and selling of seismic and geophysical data. Id. § 171.1012(a)(1).

      To the extent that CGG Veritas sells a “product” as opposed to a

“service,” that product is geophysical or seismic “data.” See, e.g., 2RR.76,

4RR.321-23 (Plf’s Ex. 22); 5RR.20, 28-30 (Defs’ Ex. 4). See TGS-NOPEC,
340 S.W.3d at 435 (“This appeal arises from a franchise tax dispute

involving the apportionment of receipts from the licensing of geophysical

and seismic data to customers in Texas”); Geomap Co. v. Bullock, 691
S.W.2d 98, 99 (Tex. App.—Austin 1985, writ refd n.r.e) (“Geomap is a

5CGG Veritas’s chart at Plaintiffs’ Exhibit 49, 4RR.710, does not distinguish between
which costs relate to “services” as opposed to “products.” Alternatively, if this Court
concludes that the chart adequately distinguishes them, remand is appropriate so
that the district court can determine the amount of refund owed, if any.

                                          32
Texas corporation engaged in the business of selling its interpretations

of geological data to the oil and gas industry.”); Reservoir Sys., Inc. v.

TGS-NOPEC Geophysical Co., L.P., 335 S.W.3d 297, 300 (Tex. App.—

Houston [14 Dist.] 2010, pet. denied) (“TGS records and processes

geophysical seismic data, primarily offshore, and sells the data to oil and

gas companies.”). This is true of both of its “raw” data, which

encompasses the unprocessed sound files that are obtained by recording

the sound waves from the manipulations of the earth, and also the

resulting processed data consisting of the visual images that interpret

the raw seismic data. In re Bass, 113 S.W.3d 735, 741 (Tex. 2003)

(referring to the “data obtained from the seismic shoot,” “data and data-

interpretations,” and the “3-D geological seismic data” as “data.”).

     The Texas Supreme Court has already held that such data

constitutes “intellectual property,” and that receipts from such licensed

data are from the “sale of an intangible asset” for purposes of the

franchise tax. TGS-NOPEC Geophysical, 340 S.W.3d at 442. This holding

controls here. At the very least, it compels the conclusion that the

Comptroller’s interpretation of “intangible property” as including CGG

                                    33
Veritas’s data is a reasonable one, and any doubt must be resolved

against CGG Veritas.

     In TGS-NOPEC, the Texas Supreme Court considered how to

characterize the revenue that the company received from its business

activities, which consisted of (1) gathering, interpreting, and marketing

“seismic and geophysical data regarding subsurface terrains worldwide

with sophisticated seismic equipment and software technology,” and (2)

then licensing that data through its master library to customers who use

the licensed data to evaluate that data to evaluate oil and gas

formations.” Id. at 435. Although the case did not involve § 171.1012, the

issue was whether the receipts from these licensures “should be

categorized as receipts from the use of a license or as receipts from the

sale of an intangible asset.” Id.

     The Texas Supreme Court there agreed with the company’s position

that its receipts were from the use of “an intangible asset”—“geophysical

data.” Id. at 441, 443-44. The Court reasoned that “revenue TGS receives

from conveying its geophysical data is not derived from the use of a

license but from the use of the underlying intellectual property, the data.”

Id. at 442. The Court also noted that the master license agreement

                                    34
described TGS’s data as “proprietary information and as valuable and

highly confidential trade secrets.” Id. at 435; see also In re Bass, 113
S.W.3d at 740 (noting industry wide practice of “treating seismic data as

trade secrets”).

     Given the Supreme Court’s description of this seismic data as an

“intangible asset,” “intellectual property” and a “trade secret,” the

statutory term “intangible property” must be interpreted to include CGG

Veritas’s seismic data. At the very least, these findings raise enough

doubt to require the exemption to be construed against CGG Veritas.

CGG Veritas’s response is that the Legislature carved out seismic data

in §171.1012(a)(3)(A)(ii) from the definition of “intangible property.” That

interpretation, however, is untenable because its products are neither

similar to the statute’s listed forms of tangible property nor intended for

distribution on a large scale. See infra Part II.C. CGG Veritas’s

intangible-property costs therefore are not “tangible personal property”

for purposes of that provision.

     C.    CGG Veritas’s Data and Services are not “Tangible
           Property” Under §171.1012(a)(3)(A)(ii).

     The district court misinterpreted § 171.1012(a)(3)(A)(ii) in

concluding that CGG Veritas’s products are “tangible personal property”

                                    35
that meet the COGS-deduction criteria in § 171.1012(a)(1). CR.266-68,

FOF 12, 13, COL 2, 5. That provision defines “tangible personal property”

to include

     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.

TEX. TAX CODE §171.1012(a)(3)(A)(ii) (emphasis added).

     The statute does not support CGG Veritas’s efforts to deduct its

costs under this provision for three reasons. First, as to all of CGG

Veritas’s costs for which its 2008 COGS deduction was claimed, it is not

“intended or is reasonably likely” that the corresponding data products

would “be mass-distributed by the creator.” Id. Here, it is undisputed

that CGG Veritas never mass-distributes any of the data that it sells

through its proprietary-sale revenue line—the costs of which are included

in its $568 million. 2RR.45-46, 48. CGG Veritas has even pleaded as

much. CR.7 (“[a]ny data acquired belongs exclusively to the customers

                                   36
who hired the crews”). Proprietary sales are the very opposite of mass

distribution.

     This reason is enough to reverse the district court’s judgment. CGG

Veritas acknowledges that if its proprietary-sales revenue lines do not

qualify for the COGS deduction, and it must rely on its MCDL line alone,

then CGG Veritas is not entitled to a tax refund at all. See Plfs’ Ex. 49,

4.RR.710.

     Its MCDL costs fare no better in terms of mass distribution The

district court misinterpreted the statute’s intended-mass-distribution

requirement as requiring only that CGG Veritas “intend[] or believe[]”

that its seismic product “will be mass-distributed by CGG for licensure to

as many customers as possible.” CR.267, FOF 13. This does not follow.

“Mass” means “participated in by or affecting a large number of

individuals,” or “having a large-scale character.” MERRIAM-WEBSTER

ONLINE, http://www.merriam-webster.com/dictionary/mass (last visited

April 14, 2015). Neither of the trial court’s findings on this point—that

“multiple” customers have licensed the same product from the MCDL,

and that CGG Veritas intends for its products to be licensed to “as many

                                   37
customers as possible”—is relevant to whether it intends for any product

to reach a large number of businesses or persons. CR.267, FOF 12, 13.

     Even if this were a fact issue, there is no evidence to support a

finding of intended or actual mass-distribution in the relevant time

frame. CGG Veritas’s MCDL clients license its products on a per-item

basis, but there is no evidence that CGG Veritas distributed even a single

product corresponding to its 2008 franchise-tax report to a large number

of persons or businesses.

     Moreover, Montgomery testified that the largest number of clients

to license a single product (out of these thousands of companies) was 114,

to his knowledge. 3RR.17. There is no evidence that this particular

product corresponds to CGG Veritas’s 2008 Texas franchise-tax report.

This is unsurprising, given that CGG Veritas’s data value lies in its

relative exclusivity. CGG Veritas tightly restricts its licensed data clients

from sharing CGG Veritas’s data with other entities. 2RR.125. One would

not expect data that the industry regards as a “trade secret” to be mass

distributed. In re Bass, 113 S.W.3d at 740

     Second, CGG Veritas’s business costs do not fall within the

definition of “tangible personal property” because its seismic data is not

                                     38
“similar” to the comparison items listed in that statute: films, sound

recordings, videotapes, television and radio programs, and books. TEX.

TAX CODE § 171.1012(a)(3)(A)(ii). These items are distributed to large

numbers of persons in a variety of forms, whether over cable subscription,

on DVD, on Blu-Ray, off the shelf, or on a Kindle. The statute also

describes “similar property” as embodying “words, ideas, concepts,

images, or sound.”

     Courts must apply the traditional canon of construction noscitur a

solis—or “it is known by its associates”—to construe terms within a series

of terms. State v. $1,760.00 in US Currency, 406 S.W.3d 177, 180- 81 (Tex.

2013) (per curiam). Courts will not give an undefined term a meaning

that is out of harmony or inconsistent with other terms in the statute. In

re Hall, 286 S.W.3d 925, 929 (Tex. 2009). “[I]f a different, more limited,

or precise definition is apparent from the term’s use in the context of the

statute,” the court applies that meaning. Id. Also, the principle of

ejusdem generis warns against expansive interpretations of broad

language that immediately follows narrow and specific terms, and

counsels courts to construe the broad in light of the narrow. Marks v. St.

Luke’s Episcopal Hospital, 319 S.W.3d 658, 663 (Tex. 2010).

                                    39
      CGG Veritas’s data is nothing like the items listed in

§171.1012(a)(3)(A)(ii).     Whereas      “sound     recordings”      are   typically

purchased for their musical or narrative content, CGG Veritas’s raw-data

sound files are “sort of useless” and are not typically listened to even by

its own employees.6 2RR.89, 136. Rather, CGG Veritas transforms these

files into visual data at the very earliest stage, even while the raw data

is still being collected in the field. 2RR.89, 135. Nor are its processed-

data images “similar” to the listed items. Montgomery likened its

processed data to a “roadmap.” 2RR.75. A roadmap does not share the

listed items’ esthetic, narrative, musical, or artistic value. Even if there

were room for doubt, the doubt must be resolved against exemption

eligibility.

      Third, even if CGG Veritas’s raw-data sound files are “similar” to

the listed items, that raw data is “substantially altered” by the time a

client purchases or licenses the processed data in a 3D or 4D image. CGG

6CGG Veritas distinguished between “data acquisition” and “data processing” for its
proprietary sale line, but did not do so for its MCDL line. It is not clear that “data
acquisition” refers to raw-data acquisition only, as opposed to raw and processed data
acquisition. Even if the reference is to raw-data acquisition only, and assuming that
the costs of that raw-data would qualify for the COGS deduction, then CGG Veritas
still is not entitled to a tax refund. Plf’s Ex. 49, 4RR. (scenario 1).

                                         40
Veritas’s own documents referred to its processing of raw data as “data

transformation.” 5RR.35 (Def. Ex. 11). Montgomery testified at length to

the complexity of this transformational process, which is completed by

scientists with advanced degrees: booms and rumbles become 3D and 4D

images that will help an oil company know whether to expend huge sums

to drill a well on a particular area. Regardless, CGG Veritas has not

sufficiently distinguished the costs of producing its raw data from its

costs of its processed data,7 and so it cannot prove the exact amount of

any refund due based on its raw data alone.

      So long as the Comptroller’s interpretation of the Legislature’s

“tangible personal property” term is reasonable, doubts must be resolved

against CGG Veritas. CGG Veritas’s costs simply do not qualify for the

COGS deduction under § 171.1012(a)(1) or §171.1012(a)(3)(A)(ii).

III. CGG DOES NOT FURNISH LABOR OR MATERIALS TO A PROJECT
     FOR CONSTRUCTION OF REAL PROPERTY, SO ITS COSTS DO NOT
     QUALIFY FOR THE COGS DEDUCTION UNDER § 171.1012(I).

         This Court should also reverse the district court’s erroneous

conclusion that CGG Veritas’s business costs for report year 2008

7 Alternatively, if CGG Veritas’s use of the term “[data acquisition]” refers only to raw
data, then it does not qualify for any refund if only its data acquisition costs qualify
for the COGS deduction. Plf’s Ex. 49, 4RR.

                                           41
qualified for the COGS deduction under § 171.1012(i) of the Tax Code.

CR.266, 268, FOF 7, COL 1, 4, 7. Specifically, the Court misinterpreted

the law in concluding that CGG Veritas “furnishes labor and materials

to projects for the construction [or] improvement . . . of oil and gas wells

within the meaning of Tex. Tax Code § 171.1012(i).” CR.268, COL 1.

     Here, CGG Veritas’s business costs are ineligible for deduction

under this provision. As explained below, the text of § 171.1012 reveals

that the Legislature considers seismic-data services to be neither “labor”

nor “materials,” as those terms are used throughout that section. Also,

even if those services did constitute labor or materials, they are too far

removed from any real-property “project” to qualify for the COGS

deduction under § 171.1012(i).

     This Court’s analysis begins by reading § 171.1012 as a whole.

“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,” then the court must apply that

narrower meaning . TGS-NOPEC Geophysical, 340 S.W.3d at 439 (citing

In re Hall, 286 S.W.3d at 928–29.

                                    42
     Two subsections of § 171.1012 govern whether CGG Veritas’s

seismic-data services were incurred in “furnishing labor or materials to

a project for the construction . . . of real property” in 2008. The first is

§ 171.1012(i), which states in relevant part that:

     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. . . . 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 cost of
     goods sold.

TEX. TAX CODE § 171.1012(i) (emphasis added).

     The second is subsection § 171.1012 (c), which provides:

     (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;

           ....

           (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;
                                    43
            ....

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

Id. § 171.1012(c).

      The statutory framework reveals that these provisions work

together as follows: Section 171.1012(c) contains an expansive list of cost

categories—thirteen in all—that the actual owner of qualifying goods

may deduct as a cost-of-goods-sold. Id. § 171.1012(c)(1)-(13). Section

171.1012(i)’s deemed-ownership provision, by contrast, is not nearly so

broad. It applies only to an entity who “furnish[es] labor or materials” to

the construction or improvement of real property, and that provision only

allows that furnisher to deduct the costs of the “labor and materials” that

it furnished. Id. § 171.1012(i); see id. § 171.1012(c)(1) (listing “labor costs”

as a qualifying COGS deduction); § 171.1012(c)(2), (c)(3) (listing

“materials” costs as qualifying COGS deduction).

      The effect of this distinction is that an actual owner may deduct a

much broader category of costs than an entity relying on § 171.1012(i)’s

“labor or materials” deemed-ownership provision. Thus, an oil company—

whose production of oil into gasoline at a refinery would qualify the
                                      44
company for a COGS deduction—may deduct all thirteen categories of

costs in § 171.1012(c). But an entity relying on deemed ownership as a

furnisher of labor or materials is restricted to deducting only the costs of

its labor or materials.

     The district court’s agreement with this interpretation is evidenced

by its proper rejection of CGG Veritas’s argument that it was entitled to

a COGS deduction under § 171.1012(c)(10). CGG Veritas did not fully

explain its theory, but its argument suggests that it misinterpreted the

statute to make “geological and geophysical costs incurred to identify and

locate property that has the potential to produce minerals” deductible by

any entity that incurs those costs. This is not so. The statute provides

that only the owner of “goods” as defined in §171.1012(a) may deduct the

costs listed in § 171.1012(c). As explained in Part I, CGG Veritas’s

services and intangible property are not “goods.” Unless it meets the

criteria to be a deemed owner of its clients’ goods under §171.1012(i)—

and it cannot—then it has no path to a COGS deduction.

     A.    CGG Veritas Does Not Furnish “Labor” or “Materials.”

     CGG Veritas does not meet the statutory criteria to be a deemed

owner of its clients’ goods under §171.1012(i)’s provision for furnishers of

                                    45
labor and materials to a project for the construction, improvement, or

modification of real property. CGG Veritas is ineligible because the

Legislature does not consider its seismic-data services—which are the

“geological and geophysical costs” of locating producing property, id.

§ 171.1012(c)(10)8—to constitute either “labor” or “materials” for the

purposes of § 171.1012.

       Subsection (c) lists “geological and geophysical costs” of locating

producing property as a separate cost from either “labor costs,” “costs of

materials that are an integral part of specific property produced”; or

“costs of materials that are consumed in the ordinary course of

performing production activities.” TEX. TAX CODE § 171.1012(c)(10), (c)(1),

(c)(2), (c)(3).

       CGG Veritas’s business activities fall into the category of

“geological and geophysical costs” of locating producing property. The

Legislature’s decision to put “geological and geophysical costs” in an

entirely separate category from either labor or materials reveals that it

does not consider geological and geophysical costs to be either “labor” or

8CGG Veritas has argued that its services constitute the “geological and geophysical
costs” of locating potentially producing property under § 171.1012(c)(10). CR.8,
3RR.89-91.

                                        46
“materials.” Although this Court rejected a similar argument in Newpark

Resources, 422 S.W.3d 56, that case is distinguishable. The Court there

concluded that the transport and disposal of used drilling mud and other

waste material was “labor” because such activities fell within the term’s

common definition “the expenditure of physical or mental effort

especially when fatiguing, difficult, or compulsory.” Newpark Res., 422
S.W.3d at 56 (quoting WEBSTER’S THIRD NEW INTERNATIONAL DICTIONARY

1259, 2075 (Phillip Gove Ed. 2002)). Here, CGG Veritas’s work is

described as “sophisticated”—not fatiguing, difficult, or compulsory.

2RR.48. And while mud transporters must rely heavily on human effort,

CGG Veritas’s services rely heavily on a “sophisticated processing center

that has thousands of CPUs in it that are . . . applying proprietary,

patented, copyrighted algorithms.” Id. The definition simply does not fit.

     Nor do CGG Veritas’s projects constitute materials that are a part

of or consumed in the drilling process. CGG Veritas’s images provide a

roadmap, and a road map is neither part of the real property nor

consumed by it. 2.RR75.

     The statutory rules of construction fully support this interpretation

of the statute. This Court must presume that in enacting the statute, the

                                   47
Legislature intended the entire statute to be effective. See TEX. GOV’T

CODE § 311.021(2). Thus, the Court must give effect to all words of a

statute and avoid treating any statutory language as “mere surplusage.”

Hawkins v. Dallas Cnty. Hosp. Dist., 150 S.W.3d 535, 540 (Tex. App.—

Austin 2004, no pet.). Interpreting “geological and geophysical costs” of

locating producing property to be “labor” and “materials” costs would

render § 171.1012(c)(10) mere surplusage, since labor and materials are

already covered by § 171.1012(c)(1), (c)(2), and (c)(3).

      This distinction also prevents the terms “labor” and “materials”

from swallowing the remaining ten categories of costs—a result not

intended by the Legislature. Rather, the text reveals that while the

Legislature intended to allow an oil company to deduct its “geological and

geophysical costs” of locating producing property as a cost-of-goods-sold,

the Legislature did not intend for a geo-sciences company like CGG

Veritas to do the same because a geo-science company is not acquiring or

producing goods—it is creating intangible property.9 Subsection (c) of

section 171.1012 is limited to taxable entities that acquire or produce

9At the very least, it creates doubt as to whether the Court considered “geological
and geophysical costs” to qualify for the COGS deduction through deemed ownership,
and that doubt must be resolved in favor of finding no exemption.

                                        48
“goods,” and goods do not include services or intangible property. See Tex.

Tax Code §§ 171.1012(a)(3)(B), 171.1012(c). Otherwise, the Legislature

could have drafted § 171.1012(i) to allow an entity to become a deemed

owner of and deduct the costs of all of the items in § 171.1012(c)’s thirteen

categories simply by virtue of participating in real-property construction.

Instead, the Legislature limited both deemed-ownership and the

corresponding COGS deduction to only “labor” and “materials.”10

      There is no merit to any argument that CGG Veritas’s “geological

and geophysical costs” could be “labor” or “materials” for purposes of

§ 171.1012(i), but not for purposes of § 171.1012(c). This Court has

recognized that “[t]he presumption that a term used in different parts of

a statute has the same meaning is even stronger where the term is used

repeatedly in the same section.” Duvall v. Texas Dept. of Human Servs.,

82 S.W.3d 474, 480 (Tex. App.—Austin 2002, no pet.).

10There is no doubt in this case that CGG Veritas performs extremely sophisticated
and important work. However, it does not matter whether CGG Veritas’s geological
and geophysical services and products are “an integral, essential, and direct
component” of the oil and gas drilling process, CR.266, FOF 7, if they are not first and
foremost “labor” or “materials” for purposes of § 171.1012(i).

                                          49
     B.    CGG Veritas’s Services Are Too Far Removed from a
           “Project” for the Construction of Real Property to
           Qualify for the COGS Deduction under § 171.1012(i).

     Alternatively, assuming arguendo that CGG Veritas’s seismic-data

services are “labor” or “materials” for the purposes of § 171.1012(i), the

judgment must be reversed for a different reason: CGG Veritas’s services

are “too far removed from the construction, improvement, remodeling,

repair, or industrial maintenance of real property to qualify for the

[COGS] deduction under section 171.1012(i).” Newpark Res., 422 S.W.3d

at 57.

     Subsection 171.1012(i) creates a deemed ownership right only for

an entity “furnishing labor or materials to a project” for the “construction

. . . of real property.” Unlike § 171.1012(c)(10), which might allow an oil

company to recover its costs of seismic-data services incurred to locate

“potential[ly]” producing property regardless of whether a well is ever

drilled, § 171.1012(i) can be reasonably interpreted as tethering deemed

ownership of “labor” or “materials” to an actual “project,” not a potential

project.

     This poses another problem for CGG Veritas. Montgomery testified

that an oil or gas company employs CGG Veritas’s seismic-data services

                                    50
to determine whether to commence a drilling project at the location that

CGG Veritas surveys. The seismic data that CGG Veritas provides could

convince the client not to commence a drilling project, because the

endeavor would not be profitable. 2RR.130; 3RR.17 (Montgomery

testifying that “there are times when we do a survey and I don’t hear of

anything being found”).

     Even if a drilling project does commence, CGG Veritas produced no

evidence that it could possibly know whether its services will ultimately

benefit an actual drilling project at the time that its costs are incurred,

let alone whether those services will be of assistance in the same tax year

as when the costs were incurred. When CGG Veritas files its franchise

tax report each year, CGG Veritas would not know which of the costs

incurred during the year were for data, information, and interpretations

that will be used to commence a drilling project in that tax year or a later

year. Thus, CGG Veritas’s services thus are wholly unlike those of a

contractor who moves drilling mud toward or away from an existing

project site. Newpark Res., 422 S.W.3d at 56.

     This Court has already recognized that there is a point at which the

provision of labor or materials is “too far removed from the construction

                                    51
. . . of real property to qualify for the [COGS] deduction under section

171.1012(i).” Id. at 57. This Court should hold that this point has been

reached here: there is no drilling “project,” and may never be a drilling

“project” at the point that CGG Veritas incurs its costs in providing

seismic data products and services. CGG Veritas’s business costs

therefore do not qualify for the COGS deduction pursuant to § 171.1012(i)

of the Tax Code.

                                PRAYER

     For these reasons, State Defendants respectfully request that the

district court reverse the final judgment finding that COGS was entitled

to deduct approximately $568 million in costs and ordering the

Comptroller to issue a refund check. State Defendants also request that

the court render a take-nothing judgment in their favor. Alternatively, if

CGG Veritas has proven that it is entitled to a COGS deduction in a

lesser amount, State Defendants request that the Court remand to the

district court to calculate any refund owed.

                                   52
                        Respectfully submitted.

Dated: April 20, 2015
                         KEN PAXTON
                         Attorney General of Texas

                         CHARLES E. ROY
                         First Assistant Attorney General

                         JAMES E. DAVIS
                         Deputy Attorney General for Civil
                         Litigation

                         SCOTT A. KELLER
                         Solicitor General

                         _/s/ April L. Farris____________
                         APRIL L. FARRIS
                         Assistant Solicitor General
                         State Bar No. 24069702

                         OFFICE OF THE ATTORNEY GENERAL
                         P.O. Box 12548 (MC 059)
                         Austin, Texas 78711-2548
                         Tel.: (512) 936-2923
                         Fax: (512) 474-2697
                         april.farris@texasattorneygeneral.gov

                         COUNSEL FOR APPELLANTS

                          53
                       CERTIFICATE OF SERVICE

      I hereby certify that on April 20, 2015, a true and correct copy of

the foregoing document was served via File & ServeXpress to all counsel

of record.

      Amanda Taylor
      James F. Martens
      State Bar No. 13050720
      Lacy Leonard
      State Bar No. 24040561
      MARTENS TODD LEONARD & TAYLOR
      301 Congress Ave., Suite 1950
      Austin, Texas 78701
      Tel.: (512) 542-9898
      Fax: (512) 542-9899
      jmartens@textaxlaw.com
      lleonard@textaxlaw.com

                                  _/s/ April L. Farris________
                                  APRIL L. FARRIS

                     CERTIFICATE OF COMPLIANCE

      In compliance with Texas Rule of Appellate Procedure 9.4(i)(2), this

brief contains 10,333 words, excluding the portions of the brief exempted

by Rule 9.4(i)(1).

                                  _/s/ April L. Farris____________
                                  APRIL L. FARRIS
                                  Assistant Solicitor General

                                   54
APPENDIX
                            Appendix Table of Contents

Final Judgment, CGG Veritas Services v. Susan Combs,
     Cause No. D-1-GN-12-001316 (353rd D. Ct. Travis Cnty.
     Sept. 17, 2014) ........................................................................ A

Findings of Fact and Conclusions of Law, CGG Veritas
     Services v. Susan Combs, Cause No. D-1-GN-12-001316
     (353rd D. Ct. Travis Cnty. Oct. 13, 2014) .............................. B

TEX. GOV’T CODE § 311.021(2) .......................................................... C

TEX. GOV'T CODE §§ 403.203 et. seq. ................................................D

TEX. TAX CODE §§ 112.051 et. seq..................................................... E

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

TEX. TAX CODE § 171.1012 ...............................................................G
A
                        \;lterlocutory   None       DC           BK14262 PG9
Notice sent:

                                                CAUSE NO. D-1-GN-12-001316

           CGGVERITAS SERVICES (U.S.) INC.,                       §            IN THE DISTRICT COURT OF
                                                                  §
           Plaintiff~                                             §
                                                                  §
           v.                                                     §
                                                                  §
           SUSAN COMBS,       COMPTROLLER OF                      §                 TRAVIS COUNTY, TEXAS
           PUBLIC                                                 §
           ACCOUNTS OF THE STATE OF TEXAS;                        §
           AND GREG ABBOTT, ATTORNEY                              §
           GENERAL OF THE STATE OF TEXAS,                         §
                                                                  §
           Defendants.                                            §               353rd JUDICIAL DISTRICT

                                                      FINAL JUDGMENT

                      On February 18 and 19, 2014, the Court conducted phase one of a bifurcated bench trial

           of the above-entitled matter. The issue in phase one of the trial was the proper amount of

           Plaintiffs cost-of-goods-sold deduction in Report Year 2008. After considering the pleadings,

           briefings, authorities, statutes, evidence, and argument presented by the parties, the Court rules

           that the Plaintiff is entitled to claim a cost-of-goods-sold deduction in the amount of

           $567,600,223.

                      The issue in phase two of the bifurcated trial is the proper amount of Plaintiffs research

           and development credit in Report Year 2008. The parties have stipulated that the amount of the

           research and development carry forward credit available for Plaintiff to claim beginning with its

           2008 Texas Franchise Tax Report is $782,268.

                      The Court orders that Plaintiff's tax due for Report Year 2008 was $1,721,022.23. The

           Comptroller is ordered to issue an appropriate check, including appropriate statutory interest

               under TEX. TAX CODE § 112.060. This judgment shall not bar CGG from recovering additional

               CGGVeritas Services (U.S.) Inc. v. Combs, eta!.
               Final Judgment
               Page I of2

                                                                                                                   250
                                       DC           BK14262 PG1 0

franchise taxes arising from a final disposition of its apportionment claims presently pending at

the administrative level.

       The parties will bear their own attorney's fees and costs of court.

       This is a final, appealable order. All relief not expressly granted is denied.

APPROVED AS TO FORM:

Is! James F. Martens
James F. Martens                                      Charles K. Eldred
jmartens@textaxlaw .com                               Charles.Eldred@texasattorneygeneral.gov
Texas Bar No. 13050720                                Texas Bar No. 00793681
Lacy L. Leonard                                       Erika R. Sams
lleonard@textaxlaw .com                               Erika.Sams@texasattorneygeneral.gov
Texas Bar No. 24040561                                Texas Bar No. 24083 784
Danielle V. Ahlrich                                   Assistant Attorney General
dab lrich@textaxlaw .com                              Financial and Tax Litigation Division
Texas Bar No. 2405921 5                               P.O. Box 12548
Martens, Todd, Leonard & Taylor                       Austin, TX 78711-2548
301 Congress Ave., Ste. 1950                          (512) 463-8897- Telephone
Austin, TX 78701                                      (512) 457-4423 -Fax
(512) 542-9898- Telephone
(512) 542-9899- Fax

Attorneys for the Plaintiff                           Attorneys for the Defendants

CGGVeritas S'ervices (U.S.) Inc. v. Combs, et al.
Final Judgment
Page 2 of2

                                                                                                    251
B
                                                                                  Filed In The District Court
                                                                                   of Travis Countv. Texas
                                                                                         OCT 13 2014
                                 CAUSE NO. D-1-GN-12-001316                       At             I ~~rtkM.
                                                                                 Amalia Rodriguez-Mendoza, Clerk
CGGVERITAS SERVICES (U.S.) INC.,                    §          IN THE DISTRICT COURT OF
                                                    §
Plaintiff,                                          §
                                                    §
v.                                                  §
                                                    §
SUSAN COMBS,                                        §               TRAVIS COUNTY, TEXAS
COMPTROLLER OF PUBLIC                               §
ACCOUNTS OF THE STATE OF TEXAS;                     §
AND GREG ABBOTT, ATTORNEY                           §
GENERAL OF THE STATE OF TEXAS,                      §
                                                    §
Defendants.                                         §             353rd JUDICIAL DISTRICT

                   FINDINGS OF FACT AND CONCLUSIONS OF LAW

        Based on the pleadings, briefings, authorities, statutes, evidence, and argument presented

by the parties, the Court makes the following findings of fact and conclusions of law:

                                          Findings of Fact

1.      CGGVeritas Services (U.S.) Inc. ("CGG") satisfied all procedural prerequisites to file a
        protest suit under Texas Tax Code Chapter 112.

2.      CGG is a fully-integrated geo-sciences company that performs exploratory testing to
        produce seismic sound recordings and images that CGG sells on both a proprietary basis
        and licenses on a multi-client basis.

               •   See, e.g., Plaintiff's Ex. 7, 9, 10, 14, 17,· Testimony of Bob Montgomery

3.      CGG uses tools and devices that impact the Earth's surface and sub-surface to cause
        disturbances, the effect of which CGG captures as seismic sound recordings.

               •   See, e.g., Plaintiff's Ex. 22, 47,· Defendant's Ex. 3-12, 15; Testimony of Bob
                   Montgomery

4.      CGG processes the seismic sound recordings into visual images of the Earth's
        subsurface, using sophisticated computer programs and proprietary algorithms.

               •   See, e.g. , Plaintiff's Ex. 22, 47,· Defendant's Ex. 3-12, 15; Testimony of Bob
                   Montgomery

CGGVeritas Services (U S) Inc. v. Combs, et al.
Findings of Fact and Conclusions of Law
Page 1 of6

                                                                                                          265
5.     CGG's customers are generally oil and gas exploration and production companies.

                •   See, e.g. , Testimony of Bob Montgomery

6.     Customers purchase, license, and use CGG's seismic sound recordings and images to
       determine where to explore and drill for oil and gas.

                •   See, e.g. , Plaintiff's Ex. 7, 14; Testimony of Bob Montgomery

7.     CGG' s seismic services and products are an integral, essential, and direct component of
       the oil and gas drilling process.

                •   See, e.g., Plaintiff's Ex. 7, 14; Testimony of Bob Montgomery

8.     In performing seismic work, CGG furnishes labor, including the expenditure of employee
       effort to acquire seismic data and to create seismic surveys and images.

                •   See, e.g., Plaintiff's Ex. 7; Testimony of Bob Montgomery

9.     As a necessary part of the seismic labor furnished by CGG, CGG furnishes materials,
       such as dynamite, geophones, airguns, marine vessels, and vibroseis trucks.

                •   See, e.g., Plaintiff's Ex. 7, 9; Testimony of Bob Montgomery

10.     CGG creates and furnishes seismic sound recordings and images to customers for use in
        oil and gas drilling projects.

                •   See, e.g., Plaintiff's Ex. 7, 14; Testimony of Bob Montgomery

11.    CGG's non-proprietary seismic sound recordings and images are held for licensure to the
       public through its multi-client data library ("MCDL").

                •   See, e.g., Plaintiff's Ex. I 0, 17, 18; Testimony of Bob Montgom ery

12.     Multiple CGG customers have licensed the same product from CGG's multi-client data
        library.

                •   See, e.g. , Testimony of Bob Montgomery

CGGVeritas Services (U. S.) Inc. v. Combs, et al.
Findings of Fact and Conclusions of Law
Page 2 of6

                                                                                                  266
13.    At the time that costs are incurred to produce seismic sound recordings and images to be
       sold through CGG's multi-client data library, CGG intends or believes it reasonably
       likely that any medium in which its seismic product will be embodied will be mass-
       distributed by CGG for licensure to as many customers as possible in a form that is not
       substantially altered.

               •   See, e.g. , Plaintiff's Ex. 25; Testimony of Bob Montgomery

14.    For Franchise Tax Report Year 2008, CGG originally paid $1,251,645 .11, which was
       calculated using a cost-of-goods-sold deduction of$567,600,223 .

               •   See, e.g. , Plaintiff's Ex. 1; Testimony of Listya Diyah

15.    CGG's $567,600,223 cost-of-goods sold deduction, was comprised of:
         a. $674,062,370 of costs under Tex. Tax Code§ 171.1012(c); plus
         b. $17,281,917 of costs under Tex. Tax Code § 171.1 012(d); and
         c. $1,195,014 of costs under Tex. Tax Code§ 171.1012(e); less
         d. $124,939,078 for intra-group eliminations.

               •   See, e.g., Plaintiff's Ex. 19, 48; Testimony of Listya Diyah

16.    On September 24, 2010, the Comptroller issued a Notice that entirely disallowed CGG' s
       cost-of-goods-sold deduction and assessed $1 ,301 ,568 .86 in additional franchise tax due,
       plus $93 ,3 57.68 in interest.

               •   See, e.g., Plaintiff's Ex. 5; Testimony of Listya Diyah

17.    On April 17, 2012, after dismissal of an administrative suit prior to hearing, the
       Comptroller issued an updated Notice that assessed the same amount of additional
       franchise tax due, but increased the interest due to $179,850.42.

               •   See, e.g. , Plaintiff's Original Petition; Testimony of Listya Diyah

18.    On May 2, 2012, CGG timely paid the additional franchise tax assessment with all
       interest due as of that date (totaling $1 ,483,232 .96) under protest in compliance with the
       statute, and then filed this suit seeking a refund.

               •   See, e.g., Plaintiff's Original Petition Ex. 6; Testimony of Listya Diyah

19.    Any finding of fact that is more properly characterized as a conclusion of law shall be
       considered a conclusion of law.

CGGVeritas Services (U.S.) Inc. v. Combs, eta/.
Findings of Fact and Conclusions of Law
Page 3 of6

                                                                                                      267
                                        Conclusions of Law

1.     CGG furnishes labor and materials to projects for the construction, improvement,
       remodeling, repair, or industrial maintenance of oil and gas wells within the meaning of
       Tex. Tax Code§ 171.1012(i)

2.     CGG's seismic sound recordings and images qualify as "tangible personal property"
       under Tex. Tax Code § 171.1 012(a)(3)(A)(ii).

3.     Oil and gas wells constitute real property for purposes of Tex. Tax Code § 171.10 12(i).

4.     CGG is eligible for the cost-of-goods-sold deduction under the third sentence of Tex. Tax
       Code§ 171.1012(i).

5.     CGG's seismic sound recordings and images contained within its multi-client data library
       constitute "tangible personal property" under Tex. Tax Code§ 171.1012(3)(A)(ii).

6.     Through its multi-client data library, CGG licenses "goods" in the ordinary course of
       business within the meaning ofTex. Tax Code§ 171.1012(a)(l).

7.     CGG is eligible for the cost-of-goods-sold deduction under Tex. Tax Code §
       171.1012(a)(l), 171.1012(a)(3)(A)(ii), and 171.1012(i).

8.     Each ofthe costs that CGG included in its cost-of-goods-sold deduction were allowed by
       Tex. Tax Code§ 171.1012(c), (d) and (f).

9.     CGG is entitled to claim a cost-of-goods-sold deduction in the amount of $567,600,223
       for franchise tax Report Year 2008.

10.    The parties stipulated that the amount of the research and development ("R&D") carry-
       forward credit available for CGG to claim beginning with its 2008 Texas Franchise Tax
       Report is $782,268.

11.    Using the above-stated cost-of-goods-sold deduction and applying the above-stated R&D
       credit to CGG' s franchise tax calculation for Report Year 2008 based on its originally-
       used apportionment factor of 0.5166, CGG's franchise tax due for Report Year 2008 is
       $1,721,022.23   0

12.    The Court's judgment shall not bar CGG from recovering additional franchise taxes
       arising from a final disposition of its apportionment claims presently pending at the
       administrative level.

13.    Any conclusion of law that is more properly characterized as a finding of fact shall be
       considered a finding of fact.

CGGVeritas Services (US.) Inc. v. Combs, et al.
Findings of Fact and Conclusions of Law
Page 4 of6

                                                                                                   268
       SIGNED this        ( ~'1l\- day of October, 2014.

                                                  T                    TIM SULAK,
                                                  Judge Presiding
                                                  353rd District court
                                                  Travis County, Texas

CGGVeritas Services (U.S.) Inc. v. Combs, eta!.
Findings of Fact and Conclusions of Law
Page 5 of6

                                                                                    269
Is/ Amanda G. Tavlor
James F. Martens                                   Charles K. Eldred
jmartens@textaxlaw.com                             Charles .Eldred@texasattorneygeneral.gov
Texas Bar No. 13050720                             Texas Bar No. 00793681
Lacy L. Leonard                                    Erika R. Sams
lleonard@textaxlaw. com                            Erika. Sams@texasattorneygeneral. gov
Texas Bar No. 24040561                             Texas Bar No. 24083784
Amanda G. Taylor                                   Assistant Attorney General
ataylor@textaxlaw.com                              Financial and Tax Litigation Division
Texas Bar No. 24045921                             P.O. Box 12548
Danielle V. Ahlrich                                Austin, TX 78711-2548
dahlrich@textaxlaw.com                             (512) 463-8897- Telephone
Texas Bar No. 24059215                             (512) 457-4423- Fax
Martens, Todd, Leonard & Taylor
301 Congress Ave., Ste. 1950                       Attorneys for the Defendants
Austin, TX 78701
(512) 542-9898- Telephone
(512) 542-9899- Fax

Attorneys for the Plaintiff

CGGVeritas Services (U.S.) Inc. v. Combs, et al.
Findings of Fact and Conclusions of Law
Page 6 of6

                                                                                              270
C
V.T.C.A., Government Code § 311.021                                                       Page 1

                               Effective:[See Text Amendments]
Vernon's Texas Statutes and Codes Annotated Currentness
 Government Code (Refs & Annos)
   Title 3. Legislative Branch (Refs & Annos)
    Subtitle B. Legislation
          Chapter 311. Code Construction Act (Refs & Annos)
            Subchapter C. Construction of Statutes (Refs & Annos)
               § 311.021. Intention in Enactment of Statutes

In enacting a statute, it is presumed that:

 (1) compliance with the constitutions of this state and the United States is intended;

 (2) the entire statute is intended to be effective;

 (3) a just and reasonable result is intended;

 (4) a result feasible of execution is intended; and

 (5) public interest is favored over any private interest.

CREDIT(S)
Acts 1985, 69th Leg., ch. 479, § 1, eff. Sept. 1, 1985.

Current through the end of the 2013 Third Called Session of the 83rd Legislature
(C) 2015 Thomson Reuters. No Claim to Orig. US Gov. Works.
END OF DOCUMENT

                  © 2015 Thomson Reuters. No Claim to Orig. US Gov. Works.
D
V.T.C.A., Government Code § 403.203                                                       Page 1

                             Effective:[See Text Amendments]
Vernon's Texas Statutes and Codes Annotated Currentness
 Government Code (Refs & Annos)
   Title 4. Executive Branch (Refs & Annos)
    Subtitle A. Executive Officers (Refs & Annos)
          Chapter 403. Comptroller of Public Accounts
            Subchapter J. Suits by Persons Owing Taxes or Fees
               § 403.203. Protest Payment Suit After Payment Under Protest

(a) A person may bring suit against the state to recover an occupation, excise, gross receipts,
franchise, license, or privilege tax or fee covered by this subchapter and required to be paid to
the state if the person has first paid the tax under protest as required by Section 403.202.

(b) A suit under this section must be brought before the 91st day after the day the protest pay-
ment was made, or the suit is barred; provided that with respect to any tax or fee assessed an-
nually but that is required to be paid in installments, the protest required by Section 403.202
may be filed with the final annual return and suit for the recovery for any such installment
may be filed within 90 days after the final annual return is due.

(c) The state may bring a counterclaim in a suit brought under this section if the counterclaim
relates to taxes or fees imposed under the same statute and during the same period as the taxes
or fees that are the subject of the suit and if the counterclaim is filed not later than the 30th
day before the date set for trial on the merits of the suit. The state is not required to make an
assessment of the taxes or fees subject to the counterclaim under any other statute, and the
period of limitation applicable to an assessment of the taxes or fees does not apply to a coun-
terclaim brought under this subsection.

CREDIT(S)
Added by Acts 1989, 71st Leg., ch. 232, § 24, eff. Sept. 1, 1989. Amended by Acts 1993, 73rd
Leg., ch. 486, § 7.10, eff. Sept. 1, 1993.

Current through the end of the 2013 Third Called Session of the 83rd Legislature
(C) 2015 Thomson Reuters. No Claim to Orig. US Gov. Works.
END OF DOCUMENT

                 © 2015 Thomson Reuters. No Claim to Orig. US Gov. Works.
E
V.T.C.A., Tax Code § 112.051                                                               Page 1

                              Effective:[See Text Amendments]
Vernon's Texas Statutes and Codes Annotated Currentness
 Tax Code (Refs & Annos)
   Title 2. State Taxation (Refs & Annos)
    Subtitle B. Enforcement and Collection (Refs & Annos)
          Chapter 112. Taxpayers' Suits (Refs & Annos)
            Subchapter B. Suit After Protest Payment (Refs & Annos)
                § 112.051. Protest Payment Required

(a) If a person who is required to pay a tax or fee imposed by this title or collected by the
comptroller under any law, including a local tax collected by the comptroller, contends that
the tax or fee is unlawful or that the public official charged with the duty of collecting the tax
or fee may not legally demand or collect the tax or fee, the person shall pay the amount
claimed by the state, and if the person intends to bring suit under this subchapter, the person
must submit with the payment a protest.

(b) The protest must be in writing and must state fully and in detail each reason for recovering
the payment.

(c) The protest payment must be made within the period of time set out in Subdivision (3) of
Subsection (c) of Section 111.104 of this code for the filing of refund claims.

CREDIT(S)
Acts 1981, 67th Leg., p. 1512, ch. 389, § 1, eff. Jan. 1, 1982. Amended by Acts 1983, 68th
Leg., p. 460, ch. 94, § 6, eff. May 10, 1983; Acts 1989, 71st Leg., ch. 232, § 4, eff. Sept. 1,
1989.

Current through the end of the 2013 Third Called Session of the 83rd Legislature
(C) 2015 Thomson Reuters. No Claim to Orig. US Gov. Works.
END OF DOCUMENT

                 © 2015 Thomson Reuters. No Claim to Orig. US Gov. Works.
F
V.T.C.A., Tax Code § 171.101                                                              Page 1

                                   Effective: January 1, 2014
Vernon's Texas Statutes and Codes Annotated Currentness
 Tax Code (Refs & Annos)
   Title 2. State Taxation (Refs & Annos)
    Subtitle F. Franchise Tax (Refs & Annos)
          Chapter 171. Franchise Tax (Refs & Annos)
            Subchapter C. Determination of Taxable Margin; Allocation and Apportionment
                § 171.101. Determination of Taxable Margin

(a) The taxable margin of a taxable entity is computed by:

 (1) determining the taxable entity's margin, which is the lesser of:

   (A) the amount provided by this paragraph, which is the lesser of:

     (i) 70 percent of the taxable entity's total revenue from its entire business, as determined
     under Section 171.1011; or

     (ii) an amount equal to the taxable entity's total revenue from its entire business as de-
     termined under Section 171.1011 minus $1 million; or

   (B) an amount computed by determining the taxable entity's total revenue from its entire
   business under Section 171.1011 and subtracting the greater of:

     (i) $1 million; or

     (ii) an amount equal to the sum of:

       (a) at the election of the taxable entity, either:

         (1) cost of goods sold, as determined under Section 171.1012; or

         (2) compensation, as determined under Section 171.1013; and

                 © 2015 Thomson Reuters. No Claim to Orig. US Gov. Works.
V.T.C.A., Tax Code § 171.101                                                                 Page 2

       (b) any compensation, as determined under Section 171.1013, paid to an individual
       during the period the individual is serving on active duty as a member of the armed
       forces of the United States if the individual is a resident of this state at the time the in-
       dividual is ordered to active duty and the cost of training a replacement for the indi-
       vidual;

 (2) apportioning the taxable entity's margin to this state as provided by Section 171.106 to
 determine the taxable entity's apportioned margin; and

 (3) subtracting from the amount computed under Subdivision (2) any other allowable deduc-
 tions to determine the taxable entity's taxable margin.

(b) Notwithstanding Subsection (a)(1)(B)(ii)(a), a professional employer organization may
subtract only the greater of $1 million as provided by Subsection (a)(1)(B)(i) or compensation
as determined under Section 171.1013.

(c) In making a computation under this section, an amount that is zero or less is computed as a
zero.

(d) An election under Subsection (a)(1)(B)(ii) shall be made by the taxable entity on its annual
report and is effective only for that annual report. A taxable entity shall notify the comptroller
of its election not later than the due date of the annual report.

CREDIT(S)
Acts 1981, 67th Leg., p. 1697, ch. 389, § 1, eff. Jan. 1, 1982. Amended by Acts 1991, 72nd
Leg., ch. 901, § 53(b), eff. Aug. 26, 1991; Acts 1991, 72nd Leg., 1st C.S., ch. 5, § 8.05, eff.
Jan. 1, 1992; Acts 2006, 79th Leg., 3rd C.S., ch. 1, § 5, eff. Jan. 1, 2008; Acts 2007, 80th
Leg., ch. 1282, § 11, eff. Jan. 1, 2008; Acts 2013, 83rd Leg., ch. 117 (S.B. 1286), § 24, eff.
Sept. 1, 2013; Acts 2013, 83rd Leg., ch. 1232 (H.B. 500), § 6, eff. Jan. 1, 2014.

Current through the end of the 2013 Third Called Session of the 83rd Legislature
(C) 2015 Thomson Reuters. No Claim to Orig. US Gov. Works.
END OF DOCUMENT

                 © 2015 Thomson Reuters. No Claim to Orig. US Gov. Works.
G
V.T.C.A., Tax Code § 171.1012                                                             Page 1

                                    Effective: September 1, 2013
Vernon's Texas Statutes and Codes Annotated Currentness
 Tax Code (Refs & Annos)
   Title 2. State Taxation (Refs & Annos)
    Subtitle F. Franchise Tax (Refs & Annos)
          Chapter 171. Franchise Tax (Refs & Annos)
            Subchapter C. Determination of Taxable Margin; Allocation and Apportionment
                § 171.1012. Determination of Cost of Goods Sold

(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, ex-
  traction, 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 per-
      ceptible to the senses in any other manner;

      (ii) films, sound recordings, videotapes, live and prerecorded television and radio pro-
      grams, 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

                  © 2015 Thomson Reuters. No Claim to Orig. US Gov. Works.
V.T.C.A., Tax Code § 171.1012                                                              Page 2

     (ii) services.

(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, in-
cluding:

 (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 re-
 lated to the production of the goods, including all research or experimental expenditures de-
 scribed by Section 174, Internal Revenue Code;

 (10) geological and geophysical costs incurred to identify and locate property that has the

                    © 2015 Thomson Reuters. No Claim to Orig. US Gov. Works.
V.T.C.A., Tax Code § 171.1012                                                              Page 3

 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 tax-
 able entity as goods-in-kind in the ordinary course of production activities rather than being
 sold.

(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

                 © 2015 Thomson Reuters. No Claim to Orig. US Gov. Works.
V.T.C.A., Tax Code § 171.1012                                                            Page 4

 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 en-
tity'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;

 (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;

                 © 2015 Thomson Reuters. No Claim to Orig. US Gov. Works.
V.T.C.A., Tax Code § 171.1012                                                                 Page 5

 (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 pro-
cessing services, accounting services, personnel operations, and general financial planning
and financial management costs, that it can demonstrate are allocable to the acquisition or pro-
duction of goods, except that the amount subtracted may not exceed four percent of the tax-
able entity's total indirect or administrative 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 Subsec-
tion (e), or in accordance with Subsections (c), (d), and (f). If the taxable entity elects to capit-
alize costs, it must capitalize each cost allowed under this section that it capitalized on its fed-
eral 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 end-
ing 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 en-
tity 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.

                  © 2015 Thomson Reuters. No Claim to Orig. US Gov. Works.
V.T.C.A., Tax Code § 171.1012                                                               Page 6

(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 bur-
dens 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 con-
sidered 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 un-
der a contract with the federal government, including any subcontracts that support a contract
with the federal government, notwithstanding that the Federal Acquisition Regulation may re-
quire that title or risk of loss with respect to those goods be transferred to the federal govern-
ment 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 Subsec-
tion (c)(13).

(k) Notwithstanding any other provision of this section, if the taxable entity is a lending insti-
tution 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 Stand-
ard 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 pur-
poses of this subsection, an entity engaged in lending to unrelated parties solely for agricultur-
al 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 tan-
gible 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 un-
 der Section 152.026;

 (2) a heavy construction equipment rental or leasing company; and

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V.T.C.A., Tax Code § 171.1012                                                             Page 7

 (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, con-
densate, 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 re-
moval, 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 de-
scribed 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 ex-
penses directly related to the acquisition, production, or use of the property, including ex-
penses for the right to broadcast or use the property.

(p) to (s) [Blank].

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V.T.C.A., Tax Code § 171.1012                                                              Page 8

(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.

CREDIT(S)
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.

Current through the end of the 2013 Third Called Session of the 83rd Legislature
(C) 2015 Thomson Reuters. No Claim to Orig. US Gov. Works.
END OF DOCUMENT

                 © 2015 Thomson Reuters. No Claim to Orig. US Gov. Works.