Court Opinion

ID: 4070443
Source: CourtListenerOpinion
Date Created: 2016-09-30 01:16:29.036931+00
Date Added: 2024-06-11T14:26:47.616409
License: Public Domain

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

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

                                  v.

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

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

                      APPELLEE’S BRIEF

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

                 ORAL ARGUMENT REQUESTED
                                TABLE OF CONTENTS

TABLE OF CONTENTS .....................................................................................i

INDEX OF AUTHORITIES .............................................................................. v

RECORD ABBREVIATIONS ........................................................................... ix

REQUEST FOR ORAL ARGUMENT................................................................ x

RESPONSIVE ISSUES PRESENTED .............................................................. xi

STATEMENT OF FACTS .................................................................................. 1

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

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

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

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

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

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

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

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

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

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

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

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

SUMMARY OF THE ARGUMENT ................................................................. 19

STANDARDS OF REVIEW .............................................................................22

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

      B.      The Statute Does Not Require Parsing of Costs. ...............65

V.    NO DEFERENCE IS OWED TO THE COMPTROLLER’S POSITIONS. ........ 68

                                           iii
PRAYER ..........................................................................................................70

CERTIFICATE OF COMPLIANCE ................................................................. 71

CERTIFICATE OF SERVICE .......................................................................... 72

APPENDIX:

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

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

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

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

                                                        iv
                            INDEX OF AUTHORITIES

CASES

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

STATUTES & RULES

34 Tex. Admin. Code § 3.588 ...................................................... 29, 31, 51, 52

Tex. Gov’t Code § 311.005 ............................................................................ 38

Tex. Gov’t Code § 311.012............................................................................. 47

Tex. Gov’t Code Ch. 2001 ............................................................................ 42

Tex. R. App. P. 9.4 ........................................................................................ 71

Tex. R. App. P. 9.5........................................................................................ 72

Tex. R. App. P. 38.1 .................................................................................. x, 44

Tex. R. App. P. 39.1 ........................................................................................ x

Tex. R. App. P. 43.4 ..................................................................................... 70

Tex. R. Civ. P. 139 ........................................................................................ 70

Tex. Tax Code § 112.052 ................................................................................15

Tex. Tax Code § 112.060 ...............................................................................15

Tex. Tax Code § 121.151 ................................................................................. 17

Tex. Tax Code § 151.0031 ............................................................................. 52

Tex. Tax Code § 151.009 ........................................................................ 54, 55

                                                      vii
Tex. Tax Code § 171.051 ............................................................................... 69

Tex. Tax Code § 171.088............................................................................... 69

Tex. Tax Code § 171.103 ...............................................................17, 51, 54, 56

Tex. Tax Code § 171.1012 ...................................................................... passim

Tex. Tax Code § 171.1013 .............................................................................. 26

Tex. Tax Code § 171.1014 ............................................................. 11, 27, 37, 66

OTHER AUTHORITIES

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

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

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

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

                                                   viii
                   RECORD ABBREVIATIONS

     Appellee uses the following abbreviated references to the record:

Abbreviation            Reference
CR                      Clerk’s Record (1 volume)

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

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

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

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

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

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

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

                                     ix
                REQUEST FOR ORAL ARGUMENT

      Appellee CGG Veritas Services (U.S.), Inc. respectfully requests that

this Court grant oral argument to aid in the Court’s decisional process.

Although this Court has previously analyzed portions of Texas Tax Code

Section 171.1012 (i.e., the cost of goods sold (COGS) provision at issue here),

CGG agrees with the Comptroller that this case presents additional issues of

first impression beyond the Court’s prior holdings. Oral argument will assist

the Court in understanding the statutory framework and reasonable

interpretation of these provisions. Tex. R. App. P. 38.1(e), 39.1.

                                       x
                 RESPONSIVE ISSUES PRESENTED

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

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

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

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

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

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

                                       xi
                      STATEMENT OF FACTS

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

     Appellee CGGVeritas Services (U.S.), Inc. (“CGG”) is “a fully-integrated

geoseismic company.” (2.RR.73; CR.266 at FOF.2). CGG’s customers are

“E&P companies”: companies that explore for and produce oil and gas.

(2.RR.73-74; 5.RR.D.Ex.35, p.10; CR.266 at FOF.5). “CGG designs, acquires,

processes, [and] occasionally interprets seismic data” in a manner that “aids

in the construction of [its customers’] oil and gas wells.” (2.RR.74, 144;

4.RR.P.Ex.7, §§ 1, 4.1; 5.RR.D.Ex.3-12, 15; CR.265-66 at FOF.2-10).

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

     CGG produces seismic images by collecting “sound waves” and then

“writ[ing] them out to some form of media.” (2.RR.76; CR.265 at FOF.3). A

large crew of workers using powerful materials and equipment, which “make

a physical impact on the property,” are required to create the sound waves.

(2.RR.106, 111; 3.RR.9; 4.RR.P.Ex.22; 4.RR.P.Ex.47). CGG’s materials and

equipment include dynamite, large vibroseis trucks that shake the ground,

marine “airguns” that “make a large bang in the water,” and GPS satellites.

(2.RR.76, 80-88, 134-35).

                                      1
     To shoot seismic on land, the dynamite is often placed 100-200 feet

below the surface, with tens or hundreds of thousands of “shot hole”

placements, by a crew of 75-100 people. (2.RR.82-83, 106; 3.RR.8-9). The

vibroseis trucks weigh between 60,000 to 90,000 pounds, and there are

normally five or six of them in the field. (2.RR.85, 106). The vibration

created by these trucks leaves a four-inch indentation to the earth below.

(2.RR.86, 106). For marine settings, CGG uses “as many as 50 airguns in an

array” and a vessel “about 300 feet long.” (2.RR.87). For example:

      Land,
     Dynamite

                                                            Land,
                                                          Vibroseis

                                     2
        Marine

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

      CGG furnishes a variety of other materials in connection with the use

of its large equipment. For example, in one of its customer’s projects, CGG

was required to supply the following materials:

(4.RR.P.Ex.9, p.12).

                                         3
      CGG’s labor generate sound waves that “illuminate the subsurface of

the earth,” and allow CGG to “produce a three-dimensional image . . . to see

below the surface.” (2.RR.76, 81; 3.RR.7-8; 5.RR.D.Ex.15; 5.RR.D.Ex.36,

p.9-11; CR.265 at FOF.2, 4). The “seismic data in its raw form is written out

onto some sort of media, like magnetic tapes or USB drives.” (2.RR.81;

3.RR.7).

      This is an “extremely specialized” process.        (2.RR.88; 3.RR.21-22;

CR.265 at FOF.4). CGG does “[s]ome minor processing on site” at the

intended drilling location but then turns the raw sound recordings into

seismic images using “high-powered algorithms” at its processing center.

(2.RR.89, 133; 3.RR.7; 5.RR.D.Ex.36, p.14). This requires complex hardware

and software, and “a lot of highly-trained and experienced people.”

(2.RR.90, 112-13; 3.RR.10; 4.RR.P.Ex.14, p.18). Generating seismic images

is “a lot of science and somewhat of an art.” (2.RR.141). As one CGG

employee described it by simplified analogy: “the raw data is like a black and

white [photograph]. . . . I colorize it and I touch it up. And I print it out in a

form that you can use.” (5.RR.D.Ex.36, p.26). Generally, “[t]he ultimate

output is a high resolution digital image of the subsurface of the earth.”

(2.RR.92). For example:

                                        4
(4.RR.P.Ex.47, p.14) (in color, as admitted at trial).

       The time spent by CGG’s workers to acquire seismic date and produce

seismic images ranges from several months to several years. (2.RR.91, 137-

39). This process is very expensive. The “average” cost is “tens of millions of

dollars” and it can be as high as “hundreds of millions of dollars.” (3.RR.24-

25).

       B.   Seismic Data is Essential to Drilling Projects.

       The geo-seismic work performed by CGG “constitutes an integral part”

of its customers’ oil and gas production business. (2.RR.102; CR.266 at

FOF.6-7, 10). The contracts between CGG and its E&P customers expressly

recognize that CGG’s work is performed for “the benefit of the [customer]”;

that “[t]he work performed by [CGG] . . . is part of [the customer’s] trade,

                                        5
business, or occupation”; and “[a]s such, [CGG’s] work constitutes an

integral part of the [customer’s] business necessary to generate [customer’s]

goods, products, and services.” (4.RR.P.Ex.7, §§ 1, 4.1).      CGG’s work is

“important to the entire drilling project.”      (2.RR.130).     All of CGG’s

customers intend to use the seismic data to construct productive oil and gas

wells. (3.RR.26-27). None of CGG’s customers pay for the acquisition and

production of seismic data simply to ignore it and drill regardless of the

information they see on the seismic images. (2.RR.130).

     The purpose of the geophysical work performed by CGG is to locate oil

and gas for drilling and production. (2.RR.101; CR.266 at FOF.6-7, 10).

CGG’s seismic data provides a “roadmap” or a “blueprint for the project,”

which its customers use “as a guide [for] where to drill the wells, [and] how

deep to drill the wells.” (2.RR.75-76, 130). By demonstrating the “porosity,

permeability, rock type, . . . [and] depth” of the earth’s subsurface, CGG’s

seismic images allow petroleum companies “to identify fairly clearly

potential places to drill.” (2.RR.94-96).     The data can also show “geo-

hazards,” like an “overpressurized zone[] . . . that would be dangerous to the

drilling operations.”   (2.RR.130).   In these instances, the data helps a

customer determine that it should drill elsewhere. (2.RR.130).

                                      6
     The subsurface of the earth is complex and non-uniform. There may

be salt domes and other structures under the surface that would prevent one

from reaching the oil and gas reservoirs if they were to just drill straight

down without the use of a seismic data map. (2.RR.78-80, 93). “[Y]ou have

to have a high-resolution image to be able to do that.” (2.RR.80). The

seismic map (especially in 4-D format) can identify mineral resources that

were otherwise compartmentalized and bypassed with prior methods.

(2.RR.116-17; 3.RR.24; 4.RR.P.Ex.14, § 1.5).

     C.    Sales to Proprietary Customers.

     CGG performs its work for both “proprietary” and “non-proprietary”

customers. (2.RR.117; CR.265 at FOF.2). A proprietary customer is typically

an E&P company that pays CGG to develop and sell it seismic images of an

area designated by the customer for the customer’s exclusive ownership and

use. (2.RR.117). Proprietary customers acquire all rights to the seismic data

(both raw data and processed images). (2.RR.117, 134). This information is

confidential and provides a valuable edge over competitors. (2.RR.117).

     CGG enters a Master Agreement for Geophysical Services with its

proprietary customers. (2.RR.101, 108-09; 4.RR.P.Ex.7; 4.RR.P.Ex.12). The

contract states the basic scope of work and describes the labor and materials

                                      7
to be furnished to the project, as illustrated above. (2.RR.105, 109, 111; see,

e.g., 4.RR.P.Ex.7, p.1, 9, Schedules; 4.RR.P.Ex.9, p.12, 15-18).

      CGG gets involved “early on” in the customer’s drilling project.

(2.RR.75). By this point, the typical customer has identified a prospective

drilling area based on “a lot of geologic work” and has “establish[ed] a lease

position” that will allow them to drill there. (2.RR.75, 96). The customers

specify the area where they want CGG to shoot seismic, the scope of CGG’s

work, and the necessary timeline. (2.RR.97). In some cases, a customer may

already own the raw data and provide it to CGG for processing. (2.RR.98,

141-42; 5.RR.D.Ex.36, p.12).

      Because CGG’s seismic data is critical to the success of an oil and gas

project, CGG must deliver its products timely and keep the customer

informed. (2.RR.128; 3.RR.22-23). CGG provides frequent updates, and the

customers often have on-site representatives. (2.RR.128-29; 3.RR.25). CGG

may provide intermediate seismic images to help the customer make prompt

decisions about when and where to drill. (2.RR.140; 3.RR.26).

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

      The non-proprietary division of CGG’s business is called the “multi-

client data library” (MCDL). (2.RR.118; CR.266 at FOF.11). When a drilling

area is “hot” with several E&P companies interested, CGG may choose to

                                       8
fund the up-front cost of acquiring the data and producing the seismic

images. (2.RR.118, 121; 4.RR.P.Ex.18).     Sometimes, customers approach

CGG requesting that it produce MCDL images for a certain area, and they

help fund the project. (3.RR.19; 5.RR.D.Ex.36, p.12). Either way, to ensure

the endeavor is profitable, CGG will generally not begin MCDL work unless it

has a requisite minimum of “pre-commitments” from customers who want

to use the images. (See 5.RR.D.Ex.13, p.23-24).

     CGG then puts those products “on the shelf” and “try[s] to sell them to

as many people as possible.”         (2.RR.118-19; 3.RR.20; 4.RR.P.Ex.18;

5.RR.D.Ex.35, p.8, 12-13). The data available for any particular area can be

delivered in several different mediums or “derivatives,” ranging from the raw

sound recordings to a fully-processed image. (2.RR.118-19, 122; 3.RR.13-14;

4.RR.P.Ex.17; 5.RR.D.Ex.36, p.20).

     The labor and materials necessary to acquire, process, and sell seismic

data is the same for the MCDL products as it is for the proprietary

customers. (5.RR.D.Ex.36, p.12-13, 17). The only difference is that, with

proprietary customers, CGG sells the exclusive rights to the data to one

customer, while with MCDL customers, CGG sells a non-exclusive license to

use the data to as many customers as possible. (5.RR.D.Ex.35, p.13, 16-17).

                                      9
      CGG enters a “Master Geophysical Data-Use License Agreement” with

MCDL customers.         (2.RR.122, 124, 126; 4.RR.P.Ex.10; 4.RR.P.Ex.17;

5.RR.D.Ex.35, p.17). The customer purchases a “license to use” the seismic

data product. (2.RR.123, 125, 134; 5.RR.D.Ex.35, p.11, 17). CGG maintains

ownership of the underlying seismic data.     (2.RR.123-24; 5.RR.D.Ex.36,

p.13, 17, 19).   The Agreement specifies what the customer can do with the

data and places restrictions on the customer’s ability to share the

information. (2.RR.125, 143; 5.RR.D.Ex.35, p.17; 5.RR.D.Ex.36, p.28-29).

Supplements to the Agreement describe the medium of the data being

licensed. (2.RR.126-28; 5.RR.D.Ex.35, p.17-18).

      CGG’s goal is to sell its MCDL data “to as many people as [it] can,”

regardless of the medium. (2.RR.119, 125; 3.RR.13; CR.267 at COL.13). Of

the 11,854 oil and gas companies registered with the Texas Railroad

Commission, CGG intends to sell its MCDL products to “[a]ll of them.”

(2.RR.120; 4.RR.P.Ex.25). As of trial, CGG had actively worked with more

than half (over 6,000) of those companies. (2.RR.120). It has licensed the

same seismic image for a single area to as many as 114 companies. (3.RR.17;

CR.266 at FOF.12).

                                     10
II.   PROCEDURAL HISTORY.

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

      CGG timely filed its 2008 Texas Franchise Tax Report paying

approximately $1.3 million in taxes. (3.RR.33; 4.RR.P.Ex.1; CR.267 at

FOF.14). CGG calculated its taxable margin by first determining its revenue

and then deducting its allowable costs of goods sold (“COGS”) from that

amount. (3.RR.37-39); see infra, Argument I.

      CGG is a “combined group” that is required to calculate its franchise

taxes in accordance with Texas Tax Code Section 171.1014. (3.RR.34-37, 39).

As such, CGG must “file[] a single tax report . . . elect[ing] to take the same

general deduction [for] all members” of its integrated company. See Combs

v. Newpark, 422 S.W.3d 46, 48 (Tex. App.—Austin 2013, no pet.). 1 Upon

calculating the COGS amounts attributable to each of CGG’s members and

summing them together, CGG’s total COGS amount for report year 2008 was

$567,600,223       (hereafter,    “$567     million”).    (3.RR.41;    4.RR.P.Ex.1;

4.RR.P.Ex.19; CR.267 at FOF.15).2

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

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

                                          11
     CGG’s tax department determined that it was eligible for the COGS

deduction based on frequent communication with the project managers and

personal knowledge about the nature of CGG’s business, including the facts

underlying the revenues and expenses reported in CGG’s general ledger.

(3.RR.40; 4.RR.P.Ex.21). They used this information to capture CGG’s costs,

and included in the COGS calculation only the costs eligible for deduction

under the statute. (3.RR.40-41, 48-52, 54-56; 4.RR.P.Ex.19; 4.RR.P.Ex.48;

5.RR.D.Ex.35, p.15); see Tex. Tax Code § 171.1012(c), (d), (e); infra,

Argument IV. CGG’s federal and state tax director, Ms. Listya Diyah—who

holds master’s degrees in both tax and finance, and has decades of corporate

experience in these areas (3.RR.29-32)—personally reviewed the source

documents and the calculations, and believes all of the numbers are

accurate. (3.RR.42-43, 53).

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

     After CGG filed its tax report, it received a letter stating that the

Comptroller was reviewing whether CGG qualified for the COGS deduction.

(3.RR.44-45; 4.RR.P.Ex.2). The letter expressly stated that “[t]his review is

not an audit” but it directed CGG to “complete the enclosed form” and return

it within 15 days. (4.RR.P.Ex.2; see also 3.RR.81). The one-page form

                                     12
requested only two pieces of information: (1) a description of the entity’s

activities, and (2) a list of items included in the COGS calculation.

(4.RR.P.Ex.3). CGG timely responded with this information. (3.RR.46-47;

4.RR.P.Ex.3). CGG anticipated that the Comptroller would then initiate a

formal audit but it did not receive any further communications in that

regard. (3.RR.47-48).

     Instead, CGG received a letter stating that the Comptroller had

completed his review of CGG’s 2008 franchise tax report, and “determined

that [CGG] did not qualify for the [COGS] deduction.”                (3.RR.48;

4.RR.P.Ex.5; CR.267 at FOF.16). The Comptroller included a bill assessing

CGG an additional $1,301,568 (hereafter, “$1.3 million”) in tax plus interest.

(3.RR.48, 54; 4.RR.P.Ex.5).

     Mr. Gary Dullum, an auditor for the Comptroller, was responsible for

reviewing CGG’s information, making the decision to deny its COGS

deduction, and assessing CGG an additional $1.3 million in taxes. (3.RR.64,

78-79, 82-83; 4.RR.P.Ex.4-5). He did so as part of the Comptroller’s larger

“Cost of Goods Sold Project,” which targeted taxpayers statewide whom the

Comptroller believed to be “service providers” or “something other than . . .

manufacturing or retail or wholesale” providers. (3.RR.80, 91-92).

                                      13
     In making his decision about CGG’s 2008 taxes, Dullum never spoke

to CGG’s named representative, tax director Stephen Marshall. (3.RR.82;

4.RR.P.Ex.4, p.D0064). Dullum never visited CGG’s facilities nor otherwise

examined the nature of CGG’s business (beyond the two pages of

information provided by CGG in response to the Comptroller’s form and a

“tour” of CGG’s website).       (3.RR.83; see 4.RR.P.Ex.3; 4.RR.P.Ex.4,

p.D0066). His notes reflect that he was not even aware of the work CGG

performed for its proprietary customers. (4.RR.P.Ex.4, p.D0065). Dullum

spent a total of 3 hours conducting a “limited” review before deciding to

assess CGG an additional $1.3 million in taxes. (3.RR.83; 4.RR.P.Ex.4,

p.D0062, 65).

     Dullum’s incorrect conclusion was based on his misunderstandings

that CGG is merely a “service provider” and that Section 171.1012(i) requires

a taxpayer to “affect a physical change” to real property to qualify for the

COGS deduction—a litigating position taken at trial but now publically

abandoned by the Comptroller. (3.RR.80, 84-85, 88-89, 141; 4.RR.P.Ex.4,

p.D0066; 4.RR.P.Ex.46, p.31); infra, Argument III.A.1.d.

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

     CGG paid $1,483,233 under protest covering the $1.3 million in

additional taxes plus interest accrued through the date of payment.

                                     14
(4.RR.P.Ex.6; CR.267 at FOF.17-18). CGG filed a protest letter with this

payment explaining, inter alia, why it qualified for the COGS deduction in

the full amount of $567 million. (4.RR.P.Ex.6). CGG thereafter filed suit

asserting these same grounds and seeking a full refund with interest.

(3.RR.54; CR.4-10, 265 at FOF.1); see also Tex. Tax Code §§ 112.052,

112.060. This claim was tried to the bench before the Honorable Tim Sulak

in Travis County.

      Although CGG maintains that it qualifies to deduct the full COGS

amount and is entitled to a full refund on this basis, at trial it proved five

alternative calculations based on its various business activities. (3.RR.52-55;

4.RR.P.Ex. 49). CGG also provided a break-down of all of the costs included

in its COGS deduction by each category allowed for deduction under

Sections 171.1012(c), (d), and (f). (3.RR.40-41, 48-52, 54-56; 4.RR.P.Ex.19;

4.RR.P.Ex.48).

      At trial, the Comptroller challenged only whether CGG qualified for the

COGS deduction under Section 171.1012(i). It preserved no argument about

whether the specific costs included in CGG’s COGS calculation are allowed

for deduction under subsections (c), (d), and (f). (See 2.RR.16; 3.RR.58-63,

91-98; CR.41-66); infra, Argument IV.A. The Comptroller rested without

presenting any evidence. (3.RR.161). The court “rule[d] in favor of [CGG]

                                      15
for the full amount of the refund sought” and requested that CGG prepare an

appropriate order. (CR.217).

     D.    The Comptroller’s Counterclaim Was Separately Resolved.

     The Comptroller counter-claimed that the amount of “research and

development (R&D) credit” claimed by CGG for report year was too high.

(CR.25-32). That claim was bifurcated and, following the COGS bench trial,

it was resolved by a joint stipulation.      (CR.35, 188-89).    The parties

stipulated that “the amount of the R&D carry-forward credit available for

[CGG] to claim beginning with its 2008 Texas Franchise Tax Report is

$782,268.” (CR.188-89).

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

     Following resolution of the only two claims in this lawsuit, both parties

agreed that it was appropriate for the court to sign a final judgment that the

Comptroller owes CGG a tax refund for report year 2008. (CR.194, 200,

202-03). However, the parties disagreed about how to calculate that refund

in light of separately-pending administrative claims regarding the

“apportionment factor” to be used in calculating CGG’s 2008 taxes. (CR.203-

                                      16
07, 228-230); see Tex. Tax Code § 121.151 (requiring that CGG initiate these

claims at the administrative level).3

      If CGG prevails on its separate apportionment claims, it will further

decrease the “tax due” amount shown on line 30 of its 2008 franchise tax

report. (CR.206-07, 220). This, in turn, will impact how much of the R&D

credit CGG applies to its 2008 taxes versus carries forward for application to

future years because the credit is capped at 50% of the tax due amount for

any given year. (CR.207, 220, 225; 1.Supp.RR.19). In combination, this

could result in an additional refund owed to CGG of approximately $1

million. (CR.206; 1.Supp.RR.9, 11).

      CGG was concerned that, if the judgment calculated a “final refund”

amount, the Comptroller would later argue CGG was barred by res judicata

or collateral estoppel from collecting any further refund for report year

2008. (1.Supp.RR.8-9). The Comptroller agreed it would not do so, and

agreed that CGG would be entitled to seek an additional refund if it prevails

on the apportionment claims. (1.Supp.RR.26-30).

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

                                            17
      F.    The Trial Court Entered a Final Judgment and Made Findings
            and Conclusions in Favor of CGG.

      The trial court entered a final judgment (1) concluding that CGG “is

entitled to claim a [COGS] deduction in the amount of $567,600,223” for

report year 2008; (2) incorporating the parties’ stipulation on the R&D

credit amount; and ordering that (3) CGG’s tax due4 was $1,721,022.23; (4)

the Comptroller shall issue an appropriate refund check with interest; and

(5) CGG shall not be barred from seeking an additional refund upon final

disposition of its apportionment claims. (CR.250-51).

      The trial court also issued findings of fact (FOF) and conclusions of law

(COL) in support of the judgment.          (CR.265-270).     These findings and

conclusions confirm that CGG qualifies for the COGS deduction under

Section 171.1012(i), and that all of the costs included in its COGS calculation

were allowed by Sections 171.1012(c), (d), and (f). (CR.265-270).

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

                                         18
                   SUMMARY OF THE ARGUMENT

      The trial court correctly determined that CGG is entitled to claim a

$567 million cost of goods sold (COGS) deduction in calculating its 2008

franchise taxes.    Under the plain language of Texas Tax Code Section

171.1012, CGG qualifies to claim the COGS deduction because it is the actual

and/or deemed owner of goods (per subsection (i)), and CGG incurred costs

within the categories allowed for deduction (per subsections (c), (d), and (f)).

The Comptroller, who raises only a couple of legal sufficiency complaints,

has not demonstrated a complete absence of evidence to support any of the

trial court’s findings. The Comptroller also has not proven that any of the

court’s conclusions (which are fully supported by the underlying facts) are

legally wrong. The judgment should be affirmed.

      The Comptroller’s analysis, which begins by looking at the specific

costs deducted, is convoluted. The threshold question is taxpayer eligibility.

Once it is determined that a taxpayer qualifies as either an actual or deemed

owner of goods to calculate its “margin” using the COGS deduction, then the

taxpayer calculates the amount of its deduction by summing together all of

the costs allowed by Section 171.1012.

      To qualify as a “deemed owner,” a taxpayer need not actually own or

sell “goods” as defined by Section 171.1012(a).        Thus, the meaning of

                                         19
“tangible personal property” is irrelevant to this analysis. Instead, a taxpayer

who “furnishes labor or materials” to projects for the construction or

improvement of real property is “considered to be the owner of that labor or

materials,” which provides an alternative way to qualify for the COGS

deduction. CGG satisfies this test under the analysis set forth in Combs v.

Newpark, 422 S.W.3d 46, 49 (Tex. App.—Austin 2013, no pet.). In regard

to both its proprietary and MCDL customers, CGG exerts physical and

mental effort to acquire and produce seismic data, which is a critically

important part of oil and gas drilling/production projects. The Comptroller’s

contrary arguments (1) improperly conflate qualifying “activities” with

allowable “costs,” and (2) construe Newpark in an overly-narrow manner

based on the same principals underlying the Comptroller’s previously-

rejected theory that a taxpayer must “effect a physical change” to the

property.

      To qualify as an “actual owner,” the taxpayer must actually own goods

based on traditional incidents of ownership. It is undisputed that CGG owns

the seismic data that it sells through the multi-client data library (MCDL).

This data, although otherwise considered “intangible” for sales tax and

apportionment purposes, is specially treated as “tangible personal property”

exclusively for purposes of the COGS deduction.          Thus, it satisfies the

                                      20
definition of “goods” under Section 171.1012(a)(3)(A)(ii). The Comptroller’s

argument is fundamentally flawed because it fails to appreciate the

difference in treatment of this unique type of intellectual property for

purposes of the COGS deduction, and his interpretation of the relevant

definition is overly narrow.

      Because CGG qualifies under subsection (i) as an actual and/or

deemed owner, CGG is entitled to deduct all of its incurred costs allowed by

the categories listed in subsections (c), (d), and (f). For report year 2008,

this amount totaled $567 million, which was calculated for CGG’s entire

business as a combined group pursuant to the analysis set forth by this Court

in Newpark, 422 S.W.3d at 52. At trial, the Comptroller challenged only

whether CGG qualified for the COGS deduction and preserved no complaint

about the specific costs to be included in the calculation. In any event, CGG’s

calculation is legally correct and supported by sufficient evidence.

      Section 171.1012 is not ambiguous. Newpark, 422 S.W.3d at 56 n.9

Hence, there is no need to defer to the Comptroller’s contrary litigating

position nor to add words or requirements into the statute that our

Legislature did not intend.      Moreover, the COGS deduction should be

construed strictly against the Comptroller because it is akin to an “exclusion”

rather than an “exemption” from tax.

                                       21
                      STANDARDS OF REVIEW

I.    STATUTORY CONSTRUCTION.

      “The issues in this case primarily concern the proper construction of

chapter 171 of the Tax Code.”       Newpark, 422 S.W.3d at 49.      Statutory

construction is a question of law reviewed de novo.         Id. The primary

objective is to ascertain and give effect to the legislature’s intent by first

considering the statute’s plain language.        Id. Courts should reject any

attempt to read words or requirements into the statute that were not

intended by our Legislature. See Zimmer US, Inc. v. Combs, 368 S.W.3d
579, 587 (Tex. App.—Austin 2012, no pet.). “Undefined terms in a statute

are typically given their ordinary meaning, but if a different or more precise

definition is apparent from the term’s use in the context of the statute, we

apply that meaning.” Greater Houston P’ship v. Paxton, No. 13-0745, 2015
WL 3978138, *5 (Tex. June 26, 2015) (quoting TGS–NOPEC Geophysical

Co. v. Combs, 340 S.W.3d 432, 439 (Tex. 2011)).

      If the statutory text is unambiguous, then “it is determinative of

legislative intent, unless enforcing the plain meaning of the statute’s words

would produce an absurd result.” Newpark, 422 S.W.3d at 49. “Only when

the statutory text is ambiguous ‘do we resort to rules of construction or

extrinsic aids.’” Id. (internal citations omitted).

                                        22
      Finally, “statutory determinations in tax disputes should reflect the

economic realities of the transactions in issue.” Combs v. Roark Amusement

& Vending, L.P., 422 S.W.3d 632, 637 (Tex. 2013). “And ‘[t]axing statutes

are construed strictly against the taxing authority and liberally for the

taxpayer.” Am. Multi-Cinema, Inc. v. Hegar, No. 03-14-00397-CV, --S.W.3d

--, 2015 WL 1967877, *3 (Tex. App.—Austin Apr. 30, 2015, no. pet. h.) .

II.   FINDINGS OF FACT AND CONCLUSIONS OF LAW.

      The trial court entered findings of fact and conclusions of law in

support of the judgment.         (CR.265-270).       The Comptroller specifically

challenges:    FOF.12-13 (Appellants’ Brief, p.37-38: arguing findings are

irrelevant and supported by no evidence); COL.1, 2, 4, 5, 7 (id. p.29, 36, 42:

arguing conclusions are legally incorrect).5

      “[F]indings of fact [are reviewed] for legal and factual sufficiency of the

evidence by the same standard applied to a jury verdict.”                Am. Multi-

Cinema, 2015 WL 1967877, at *4. “When a party attacks the legal sufficiency

of an adverse finding on an issue on which it did not have the burden of

proof, it must demonstrate on appeal that no evidence supports the adverse

finding.” Graham Cent. Station, Inc. v. Pena, 442 S.W.3d 261, 263 (Tex.

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

                                          23
2014). The court must credit favorable evidence if a reasonable fact-finder

could, and disregard contrary evidence unless a reasonable fact-finder could

not. Id. “The trial court, acting as factfinder, is the sole judge of credibility of

the witnesses and weight to be given to their testimony.” Newpark, 422
S.W.3d at 49.

      “[C]onclusions of law [are reviewed] de novo to determine their

correctness.” Am. Multi-Cinema, 2015 WL 1967877, at *4. But even an

erroneous conclusion will not support reversal if the trial court rendered the

proper judgment. Id.; see also Vinson v. Brown, 80 S.W.3d 221, 230 (Tex.

App.—Austin 2002, no pet.).

      Unchallenged fact findings are “binding on the appellate court unless

the contrary is established as a matter of law, or if there is no evidence to

support the finding.” McGalliard v. Kuhlmann, 722 S.W.2d 694, 696 (Tex.

1986).   The court must disregard all contrary evidence and, if there is any

remaining evidence in support of the finding, it must be upheld; and if that

finding is sufficient to support the judgment, it should be affirmed. Id.; see

also DPRS 15th St., Inc. v. Texas Skyline, Ltd., No. 03-11-00101-CV, 2014
WL 4058796, *5-6 (Tex. App.—Austin Aug. 13, 2014, no pet.); Murray v.

Grayum, No. 03-10-00165-CV, 2011 WL 2533796, *5 (Tex. App.—Austin

June 24, 2011, pet. denied).

                                        24
                               ARGUMENT

      The trial court properly determined that CGG qualifies for the COGS

deduction as an actual or deemed owner of goods, and that CGG is entitled to

deduct $567 million in COGS as a result. By allowing CGG to deduct its costs

and arrive at a tax on net profits, the judgment comports with the overall

goal of the franchise tax: to tax a business’s margin.

      This Court should reject the Comptroller’s arguments because they

arise from a misunderstanding of how Section 171.1012 operates, ignore

ample evidence in the record to support the trial court’s conclusions, and ask

this Court to read requirements into the statutory text not intended by our

Legislature. The final judgment appropriately interprets and applies Section

171.1012 to CGG’s business. It should be affirmed in full.

I.    FRANCHISE (MARGIN) TAX CALCULATION.

      The franchise tax is a tax on the privilege of doing business in Texas.

TGS-NOPEC, 340 S.W.3d 437. As amended in 2006, the tax is specifically

designed to be imposed on a business’s margin, not on its revenue, net

worth, or earned surplus. Id.; see also In re Nestle USA, Inc., 387 S.W.3d
610, 614, 622 (Tex. 2012). Margin is akin to net profits. See Tex. Tax Code

§ 171.101. To effectuate this purpose, the statute provides that every method

                                       25
of calculating one’s franchise tax shall benefit from specified reductions to

the taxpayer’s total revenue, as discussed below. (See 2.RR.41; 3.RR.68).6

      “[T]he first step for all taxable entities and all methods of computing

taxable margin is to calculate the taxpayer’s ‘total revenue.’” Titan Transp.,

LP v. Combs, 433 S.W.3d 625, 628 (Tex. App.—Austin 2014, pet. denied);

Tex. Tax Code § 171.1011 (a)-(d). Taxpayers determine total revenue by

subtracting statutory exclusions from the gross income reported on federal

income tax returns. Id. §§ 171.1011(e)-(g)(11), (k), (m)-(n), (q)-(r), (u)-(x).

      “After calculating total revenue, taxpayers may then employ the

method of determining taxable margin that produces the lowest franchise-

tax obligation.” Titan, 433 S.W.3d at 628; Tex. Tax Code § 171.101 (a). For

report year 2008, the code offered three calculations using a specific

deduction from revenue plus additional credits: (1) the cost of goods sold

(COGS) deduction under Section 171.1012; (2) the compensation deduction

under Section 171.1013; and (3) the 70% ceiling/30% default deduction

under Section 171.101 (a)(1)(A). Titan, 433 S.W.3d at 628-29; Newpark, 422
S.W.3d at 47-48. 7

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

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

                                           26
      The total tax due is calculated as follows (with corresponding

references to the 2008 franchise tax report, see 4.RR.P.Ex.1):

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

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

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

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

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

In re Nestle, 387 S.W.3d at 614-616; Titan, 433 S.W.3d at 627-28. Because

there is always some deduction from revenue, the resulting tax is one

imposed on an entity’s margin, not its revenue.                  See Tex. Tax Code

§ 171.1014(d).

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

                                           27
II.   THE COGS DEDUCTION, SECTION 171.1012.

      The only relevant calculation method in this suit is the COGS

deduction. The Comptroller’s analysis of Section 171.1012 is improperly

inverted. The Comptroller argues that the Court should first determine

whether CGG has any allowable costs to deduct as costs of goods sold

(COGS) and then determine whether CGG qualifies for the deduction. See

Appellants’ Brief, p.21, 25.

      “That defies the logic of the statute.”    (3.RR.155).   The threshold

inquiry is whether the taxpayer qualifies under Section 171.1012(i) to claim

the COGS deduction. Once the taxpayer crosses that threshold test, the

taxpayer is entitled to calculate its COGS deduction by including all the costs

it incurred that are classified as allowable costs under subsections (c), (d),

and (f).

      A.    Does the Taxpayer Qualify for the COGS Deduction?

      Section 171.1012(i) begins by stating that “A taxable entity may make a

subtraction under this section in relation to the cost of goods sold [i.e.

qualify to claim the COGS deduction] only if that entity owns the goods.”

Tex. Tax Code § 171.1012(i). A taxpayer can satisfy this test by being either

an “actual” or “deemed” owner of goods. Id. As discussed in more detail

below, these two terms mean:

                                      28
                   Actual owner: a taxpayer who is the “owner of goods . . .
                    based on all of the facts and circumstances, including the
                    various benefits and burdens of ownership vested with the
                    taxable entity.” Id. § 171.1012(i), second sentence; see also
                    34 Tex. Admin. Code § 3.588(c)(8) (same).

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

      The Comptroller devotes much of his argument to whether CGG’s

seismic data satisfies the meaning of “goods,” as defined for purposes of

COGS to include certain types of “tangible personal property.” See Tex. Tax.

Code § 171.1012(a)(1), (3).       These terms are relevant only to whether a

taxpayer is an “actual owner.” The Comptroller’s argument about “tangible”

property ignores the statute’s alternate provision entitling a taxpayer to

qualify as a “deemed owner.”            CGG first addresses the deemed owner

provision, and then turns to the actual owner provision along with the

proper interpretation of goods or “tangible personal property” for purposes

of the COGS deduction.

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

                                           29
       B.    What Costs are Allowed for the COGS Deduction?

       Once a taxpayer crosses the threshold qualification for the COGS

deduction (as either an actual or deemed owner of goods), the statute directs

the taxpayer to calculate the dollar amount of its deduction by adding all of

the costs it incurred under the categories allowed by subsections (c), (d), and

(f).   See Tex. Tax Code § 171.1012(i), first sentence (actual and deemed

owners “may make a subtraction [of costs allowed] under this section”);

third sentence (confirming deemed owners may “include the costs, as

allowed by this section, in the computation of [COGS]”) (emphasis added);

id. §§ 171.1012(c), (d), (f). Infra, Argument IV.

       The costs allowed “by or under this section” include “all direct costs of

acquiring or producing the goods,” and “up to 4% of its indirect or

administrative overhead costs—such as legal, security, and accounting

services—provided that it can demonstrate those costs ‘are allocable to the

acquisition or production of goods.’” Newpark, 422 S.W.3d at 53.

III.   CGG QUALIFIES FOR THE COGS DEDUCTION.

       CGG qualifies for the COGS deduction as a “deemed owner” based on

its proprietary and/or MCDL business activities. If this Court agrees, then

the judgment should be affirmed regardless of whether CGG’s seismic

images satisfy the definition of “goods” under Section 171.1012(a)(3)(A)(ii).

                                       30
However, even if CGG were not a “deemed owner,” CGG would qualify as an

“actual owner of goods” based on its MCDL business activity. This provides

an alternative basis for affirming the final judgment in full.

      A.    CGG Qualifies as a “Deemed Owner.”

      Under the third sentence of Section 171.1012(i), a taxpayer qualifies as

a “deemed owner” if it “furnish[es] labor or materials to a project for the

construction, improvement, remodeling, repair, or industrial maintenance . .

. of real property.” Tex. Tax Code § 171.1012(i). A taxpayer engaged in such

activity “is considered to be an owner of that labor or materials and may

include the costs, as allowed by this section, in the computation of cost of

goods sold.” Id.; see also 34 Tex. Admin. Code § 3.588(c)(8)(A)-(B) (same).

      The Comptroller agrees with the concept of “deemed ownership” but

disputes whether CGG’s activities qualify. Appellants’ Brief, p.5, 44-45, 50.9

As discussed below, CGG satisfies both elements of the deemed-owner test

because (1) it furnishes labor or materials (2) in a manner that is sufficiently-

connected to a real-property improvement project.

      The deemed owner provision applies when a taxpayer does not actually

own and sell “goods” as defined by subsection (a). The “labor or materials”

furnished by the taxpayer is substituted in lieu of “ownership of goods.” In

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

                                        31
Newpark, this Court recognized that the third sentence of subsection (i)

would be rendered “meaningless” if the taxpayer had to actually own or sell

goods to qualify for the COGS deduction as a deemed owner. Id. at 55.

     As an initial matter, the Comptroller did not challenge Findings of Fact

8 and 9, which specifically state that CGG “furnishes labor” and “furnishes

materials.” (CR.266). Nor did the Comptroller challenge Findings 2-4,

which provide additional detail about the nature of CGG’s work, nor

Findings 5-7 and 10, which confirm that CGG’s labor and materials are

furnished for the purpose of oil and gas exploration and production.

(CR.265-66). Relatedly, the Comptroller does not challenge Conclusion of

Law 3, stating that “[o]il and gas wells constitute real property for purposes

of [Section] 171.1012(i).” (CR.268). The unchallenged findings are binding

on the Court because there is evidence in the record to support them, as

described below. The judgment should be affirmed because Conclusions of

Law 1 and 4 (concluding that CGG is eligible for the COGS deduction as a

deemed owner) stand on the basis of these findings. Supra, Standard of

Review II.

             1.   CGG furnishes labor and materials.

     The first element to qualify as a deemed owner is that the taxpayer

“furnish labor or materials.” Tex. Tax Code § 171.1012(i). A taxpayer is not

                                      32
required to furnish both labor and materials to qualify as a deemed owner;

either will suffice. Id. However, CGG furnishes both, and the judgment can

be affirmed on either ground standing alone.

                   a.    Labor.

      Section 171.1012 does not define “labor.” This Court addressed the

meaning of that term in Newpark, 422 S.W.3d at 56, which likewise involved

a taxpayer’s activities related to the production of oil and gas. “‘Labor’ is a

broad term that encompasses a wide range of activities, including

‘expenditure of physical or mental effort especially when fatiguing, difficult,

or compulsory.’” Newpark, 422 S.W.3d at 56 (quoting Webster’s Third New

International Dictionary 1259, 2075 (Phillip Gove Ed. 2002)).         Because

nothing in the statutory text indicates that “labor” for purposes of the COGS

deduction has “a more limited meaning than its common definition,” this

Court “presume[d] that the legislature intended to allow taxable entities to

deduct a wide range of labor expenses.” Id. Under this definition, the post-

drilling “transport and disposal of [] used drilling mud and other waste

material” qualified as “labor.” Id. at 55, 57.

      Just as in Newpark, CGG’s acquisition and production of seismic data

and images satisfies the meaning of “labor” under Section 171.1012(i). As

detailed in Statement of Facts I.A, CGG employs large crews to create sound

                                        33
waves using specialized materials and equipment. CGG’s workers travel to

and spend a considerable amount of time at the physical locations where

their customers intend to construct wells for the production of oil and gas.

The work required to acquire seismic data on these project sites is intense

and requires specialized skills, such as drilling holes, blasting large swaths of

dynamite, driving thousands of geophones into the earth, shaking the earth

with a series of 60,000 to 90,000 pound vibrating trucks, and/or shooting

an array of large airguns into the sea and through the ocean floor to create

seismic sound waves. The second step of producing or processing seismic

data likewise requires a hefty expenditure of effort, albeit more mental than

physical. Here, highly-trained workers apply complicated algorithms and

geophysical concepts, using specialized hardware and software.          In total,

this requires several months to several years of work.

      CGG’s activities constitute the “expenditure of physical or mental

effort.” The efforts regarding both the acquisition of data and production of

seismic images are difficult, fatiguing, and require specialized skills. Thus,

CGG’s activities satisfy the meaning of “labor” under Section 171.1012(i).

                  b.    Materials.

      The meaning of “materials” is not defined by Section 171.1012, was not

at issue in Newpark, and has not otherwise been addressed by any appellate

                                       34
court in the context of the COGS provision. As with “labor,” nothing in the

statutory text indicates an intention for the term “materials” to have any

narrower of a meaning than its common definition. See Tex. Tax Code

§ 171.1012(i). The common meaning of “material” is “elements, constituents,

or substances of which something is composed or can be made.” Merriam-

Webster’s Collegiate Dictionary 765 (11th ed. 2012).      The definition also

includes, “something (as data) that may be worked into a more finished

form.” Id.

      CGG furnishes materials in the form of dynamite, geophones, airguns,

cables, trucks, batteries, and other miscellaneous parts used to create sound

waves for the acquisition of seismic data, as well as the ultimate seismic data

or images provided for use in the exploration and production of oil and gas.

Supra, Statement of Facts I.A. These items satisfy the common meaning of

materials as used in Section 171.1012(i).

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

      The Comptroller attempts to categorically dismiss the labor and

materials furnished by CGG with a contrived argument that CGG’s activity

cannot be “labor or materials” because subsection (c) contains separate

provisions for “geological and geophysical costs” versus “labor” and

                                      35
“material” costs. Appellants’ Brief, p.45-49. This argument fails for multiple

reasons.

     Section 171.1012(c) provides in relevant part:

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

           (1)   labor costs;

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

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

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

Tex. Tax Code § 171.1012(c).

     As an initial matter, the Comptroller claims—without any citation to

the record—that the trial court “reject[ed]” CGG’s “argument that it was

entitled to a COGS deduction under § 171.1012(c)(10).”       Id., p.45.   This

represents a factual misunderstanding of what happened at trial, and it

relates to the Comptroller’s legal misunderstanding of how Section 171.1012

operates. Infra, Arguments II, IV. CGG did not argue that it “qualifies” for

the COGS deduction on the basis of subsection (c)(10). Rather, it claimed

that having qualified for the deduction as an actual or deemed owner under

                                      36
subsection (i), it is entitled to deduct all of its incurred costs as allowed by

subsections (c), (d), and (f), including the costs specified under (c)(10).

(2.RR.41-43; 3.RR.103, 155-56; CR.84).

      The record conclusively demonstrates that the trial court accepted

CGG’s argument that it was entitled to deduct the costs it incurred under

subsection (c)(10) and all other subcategories of CGG’s proven costs. CGG’s

tax director (Listya Diyah) testified about the costs incurred by CGG under

subsection (c)(10), and two exhibits provide a breakdown of these costs.

(3.RR.55-56; 4.RR.P.Ex.19, 48). This was sufficient evidence for the trial

court to find that CGG’s calculation included approximately $674 million10 in

subsection (c) costs (the total shown on CGG’s exhibits, including the full

amount of its (c)(10) costs), and to conclude that “[e]ach of the costs that

CGG included in its [COGS] deduction were allowed by [subsections] (c), (d),

and (f),” and that “CGG is entitled to claim [the total amount of its COGS

deduction] for Report Year 2008.” (CR.267-68 at FOF.15, COL.8-9). The

trial court could not have made these determinations if it “rejected” CGG’s

ability to include the (c)(10) costs in its COGS deduction. Moreover, Finding

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

                                           37
15 is binding on this Court because the Comptroller has not raised a

sufficiency challenge to it, and it is supported by the record.

      The Comptroller’s categorical argument also misinterprets the

statutory text by conflating a description of activities with the costs incurred

to perform certain activities.    See Appellants’ Brief, p.46. Subsection (i)

refers to the activities required for a taxpayer to qualify as a deemed owner of

goods: furnish labor or materials. Tex. Tax Code § 171.1012(i). As discussed

above, the statute does not limit the meaning of “labor” or “materials”

beyond their broad, common definitions. Subsection (c) describes thirteen

categories of direct costs that may be deducted by a taxpayer who qualifies

under subsection (i). Id. § 171.1012(c).

      Notably, this list is written in inclusive rather than exclusive terms.

“‘Includes’ and ‘including’ are terms of enlargement and not of limitation or

exclusive enumeration, and use of the terms does not create a presumption

that components not expressed are excluded.” Sneed v. Webre, No. 12-0045,

2015 WL 3451653, *14 (Tex. May 29, 2015) (citing Tex. Gov’t Code

§ 311.005(13)). The list begins by identifying broad categories, such as the

descriptions of general labor and material costs in (c)(1)-(3), and then

delineates more industry-specific costs such as those in (c)(10). That does

not mean a taxpayer who deducts costs under (c)(10) is prohibited from also

                                       38
deducting costs under (c)(1)-(3). Instead, all categories are “included” as

examples of the types of direct costs allowed for deduction by qualifying

taxpayers. Subsection (c)(10) is not rendered meaningless by this

interpretation.

      This broad allowance of deductible costs does not limit the meaning of

the underlying activities. Just because a taxpayer incurs costs “to identify

and locate property that has the potential to produce minerals” does not

prohibit a conclusion that the taxpayer has also “furnished labor and

materials.” It would be illogical to conclude that a taxpayer who performs

“geological and geophysical” work never “furnishes labor or materials” as

part of that work. Stated another way, the activity of performing “geological

and geophysical work” is not mutually exclusive of “furnishing labor or

materials,” and vice-versa.

      To the contrary, the statute’s express allowance of deductions for

oilfield related costs, such as intangible drilling costs and geological and

geophysical costs informs the court of the types of activities contemplated as

those eligible for COGS.      Under the Comptroller’s analysis, oil and gas

drilling contractors would not be eligible to claim COGS for the reason that

their costs include, by and large, intangible drilling costs, which the statute

expressly allows under subsection (c)(7).

                                      39
                  d.     The Comptroller’s argument that CGG’s work is a
                         “service” that is not “fatiguing, difficult, or
                         compulsory” enough to constitute “labor” is an
                         improper recast of its previously-rejected “physical
                         change” theory.

      The Comptroller next argues that CGG’s work does not constitute

“labor” because it is a “service” that is “sophisticated—not fatiguing, difficult,

or compulsory.” Appellants’ Brief, p.47. This argument misreads Newpark,

ignores evidence in the record, and is merely a repackaged version of the

Comptroller’s prior “physical change” argument, which has been twice

rejected by this Court and publically-abandoned by the Comptroller.

      As here, the Comptroller argued in Newpark that NES’s transport and

disposal of used drilling waste were “clearly a service and not labor supplied

for the improvement of real property.” 422 S.W.3d at 56-57. This Court

rejected the argument, holding that that the meanings of “service” and

“labor” are not “mutually exclusive,” and “the[ir] ordinary definitions . . .

substantially overlap such that both definitions tend to refer to the words

interchangeably.” Id. at 54. Notably too, certain “service” costs are expressly

allowed for deduction under subsection (f), showing the Legislature’s intent

that aspects of “service” can be provided as part of “furnishing labor or

materials.” Tex. Tax Code § 171.1012(f); (3.RR.73, acknowledged by auditor

Dullum). Hence, although an activity may have attributes of “service,” that

                                       40
does not holistically prevent it from constituting “labor.” CGG’s activity

qualifies as labor just as NES’s did.

      Moreover, Newpark does not hold that a taxpayer’s activities are

absolutely required to be “fatiguing, difficult, or compulsory” to satisfy the

meaning of “labor.” Newpark holds that it will be “especially” clear that a

taxpayer’s efforts qualify as labor where any one of those (or presumably

similar) characteristics are present. 422 S.W.3d at 56. Newpark also holds

that “mental” effort can satisfy the definition of labor—it does not have to be

physical effort.   Id.   Granted, at some point, activities become “too far

removed” from a real-property construction project to qualify under Section

171.1012(i).   Infra, Argument III.A.2.      Nevertheless, Newpark does not

create a bright-line test that efforts must be “physical,” nor that they must be

“fatiguing, difficult, or compulsory” to qualify. In any event, the record

demonstrates that CGG’s activities satisfy the definition as described in

Newpark. Supra, Argument III.A.1.

      At trial, the Comptroller’s auditor, Gary Dullum, testified that the only

reason he denied CGG the COGS deduction was because he considered CGG

a “service provider” rather than the actual driller/producer of minerals.

(3.RR.84-85). Dullum’s misunderstanding apparently arose from the

Comptroller’s training that, to qualify for the COGS deduction as a “deemed

                                        41
owner” of goods under Section 171.1012(i), a taxpayer must “physically work

[on] and effect a change” to real property. (3.RR.88-89).

       The Comptroller’s corporate representative, Sarah Pai, confirmed it

was the agency’s “litigation position and . . . policy . . . that an entity must

physically work on and effect a change to real property in order to be entitled

to take the [COGS] deduction available under 171.1012(i).” (4.RR.P.Ex.46,

p.31). She also confirmed that the only reason the Comptroller concluded

CGG does not qualify as a deemed owner under Section 171.1012(i) is

“because [CGG is] not physically working on the property and making a

change.” (Id., p.46). She acknowledged that CGG is “physically present on

the property and they’re working,” but claimed the “element they fail is that

work does not effect a physical change.” (Id., p.174; see also 2.RR.64; CR.61-

62).

       After trial, the Comptroller publically-abandoned its “physical change”

argument in recognition of the fact that this Court has repeatedly rejected it.

In a June 2014 memorandum, the Comptroller’s office stated:

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

                                         42
                   [W]e are expanding the interpretation of what is
             considered to be furnishing labor or materials to a
             [real property project] . . . and will no longer require
             an entity to actually physically touch the property or
             make a change to the property to qualify for the COGS
             deduction. . . .

Texas Comptroller of Public Accounts, Memorandum from Tax Policy

Division, 201406920L (June 10, 2014) (STAR document available at

http://cpastar2.cpa.state.tx.us/index.html) (emphasis added). This “change

has immediate effect and a taxable entity may file an amended franchise tax

report for years that are open within the statute of limitations.” Id. Thus,

the change has retroactive application and must be applied to CGG in this

case.

        Despite this announcement, the Comptroller’s Brief returns to the

same theory and underlying principles of the “physical change” argument,

and simply recasts them as CGG’s activities being too “sophisticated” and

“service” oriented, and not physically demanding (“fatiguing, difficult, or

compulsory”) enough to be considered “labor.” See Appellants’ Brief, p. 25-

26, 28-32, 47. Ultimately, this is the same argument, and it fails for the same

reason: None of these requirements are contained within the plain statutory

text requiring the taxpayer to “furnish labor or materials.” If the Legislature

wished to limit the provision to entities actually performing construction or

                                       43
other physical labor or affecting a physical change onsite, it would have left

out the words “or materials” and “to a project,” which expand the scope of

the provision.

      Moreover, Section 171.1012(i) explicitly applies to entities furnishing

labor or materials to a project for the industrial maintenance of real

property, which is outside the scope of normal activity for a “construction

company” and often would not result in any physical change to the property.

Auditor Dullum admitted this. (3.RR.75).

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

      Beyond the Comptroller’s attempt to categorically dismiss CGG’s

“furnishing of labor or materials,” his only argument for why CGG does not

furnish materials is confined to two sentences without supporting legal or

factual analysis. Appellants’ Brief, p.47. The Comptroller argues that CGG’s

seismic data is not “consumed” in the drilling process. Id. To any extent this

argument has been adequately briefed for preservation under Texas Rule of

Appellate Procedure 38.1(i), it fails.

      The Comptroller overlooks many of the other materials furnished by

CGG beyond its seismic data, and the Comptroller utilizes an overly-narrow

definition of “materials.” Supra, Argument III.A.1.b. The Comptroller relies

on Section 171.1012(c)(3), which allows deductions for the “cost of materials

                                         44
consumed in the ordinary course of performing production activities.” To

any extent this cost category describes one type of material that could be

furnished under subsection (i), it does not do so exclusively. The meaning of

“materials furnished” is broader than the specific categories of material costs

that can be deducted. Moreover, our supreme court has held that

“consumption” of materials is not required to establish that they were

“furnished” for purposes of a materialman’s lien. Houston Fire & Cas. Ins.

Co. v. Hales, 279 S.W.2d 389, 392 (Tex. Civ. App.—Eastland 1955, writ ref’d

n.r.e.) (citing W. L. MacAtee & Sons v. House, 153 S.W.2d 460 (Comm’n of

App. adopted by Sup.Ct.)).

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

      To qualify for the COGS deduction as a deemed owner, the labor or

materials furnished by the taxpayer must be “to a project for the

construction, improvement, [etc.] of real property.”          Tex. Tax Code

§ 171.1012(i). “It is undisputed that the drilling and construction of oil and

gas wells qualifies as construction or improvement to real property.”

Newpark, 422 S.W.3d at 55; (see also 4.RR.P.Ex.46, p.115). Thus, the only

question is whether CGG’s activities are sufficiently connected to projects for

the drilling and construction of oil and gas wells.

                                       45
      In Newpark, this Court did not create a bright-line test. Instead, it

held that satisfaction of this standard must be on a case-by-case basis. Id. at

56-57. There, the Court held that NES’s waste-disposal activity qualified

based on three considerations. One, “it is difficult to view [the activity] as

though it were not an essential and direct component of the drilling process.”

Id. at 56. Two, the Legislature indicated that such activity should qualify by

allowing deduction of “similar costs for scrap material and pollution control

devices.” Id.   And three, the evidence demonstrated that drilling activity

could not continue without the waste removal and disposal activities

provided by NES. Id.

      CGG’s activity is likewise sufficiently connected to oil and gas drilling

projects. In light of the uncontroverted testimony of Bob Montgomery and

the contractual agreements stating that CGG’s acquisition and production of

seismic data is an integral part of the customer’s drilling business, and

considering the millions of dollars E&P companies are willing to pay for this

critical work, it is difficult to view CGG’s activity as though it were not an

essential and direct component of the drilling process. Supra, Statement of

Facts I.B.

      Second, the Legislature indicated that such activity should qualify by

specifically allowing deduction of “geological and geophysical costs incurred

                                      46
to locate property that has potential to produce minerals.” See Tex. Tax

Code § 171.1012(c)(10).    Contrary to the Comptroller’s argument, this

category of costs expands upon rather than limits the type of labor and

materials that should qualify under subsection (i).      Supra, Arguments

III.A.1.c, IV.B.

      Third, the record demonstrates that drilling activity could not

commence—or at least not do so successfully or in a manner that efficiently

locates all producible mineral reserves—without the seismic data “blueprint”

furnished by CGG. Supra, Statement of Facts I.B. These considerations

sufficiently support the trial court’s conclusion that CGG furnishes labor or

materials to a real-property construction or improvement project.

      The Comptroller argues that CGG’s activities are “too far removed”

because its customer’s drilling projects are only “potential” not “actual.”

Appellants’ Brief, p.50-52. This argument reads words into the statute and

ignores important evidence in the record. Nothing in the statute specifies

the status of when a project “officially” begins, nor does the statute

definitively require that the labor or materials be furnished to only one

project rather than several. See Tex. Gov’t Code § 311.012(b) (In construing

statutes, “[t]he singular includes the plural and the plural includes the

singular.”).

                                     47
     Before CGG begins working with a proprietary customer, the customer

has already done a substantial amount of “macro geology” to identify the

general location they want to drill and have established lease rights on that

location to enable drilling once the minerals are located by CGG’s seismic

data. Supra, Statement of Facts I.C. Moreover, the customer is far enough

into the project to specify the parameters of work for CGG, and they remain

actively involved with CGG throughout the timeline of its work.           Id.

Sometimes a customer has gone so far as to obtain initial seismic data for

CGG to process. This is sufficient evidence from which the trial court could

conclude that CGG furnishes labor and materials “to a project.”

     In regard to CGG’s MCDL customers, CGG does not begin the process

of acquiring and producing seismic data in any location unless it is “hot”

with interest by several E&P companies to drill there. Supra, Statement of

Facts I.D.   It would be far too costly of CGG to do otherwise.         (See

5.RR.D.Ex.14, p.23-24: stating CGG’s policy of generally requiring a certain

number of “pre-commitments” from customers before beginning the

acquisition of MCDL data). Thus, at a minimum, the MCDL data is acquired

and produced “for a project” that is reasonably anticipated to occur.

Sometimes, customers approach CGG to shoot a specific area, akin to a

proprietary customer but with a trade-off of less cost for non-exclusive

                                     48
rights. (3.RR.19; 5.RR.D.Ex.36, p.12). Moreover, by the time customers are

able to buy licenses “off the shelf,” they are presumably doing so for projects

that are underway.

      The Comptroller’s arguments that CGG’s seismic data does not qualify

because it may indicate where not to drill, or because the drilling may not

ultimately be successful, or because drilling may not occur in the same tax

year, are all red herrings. Determining where to drill and not to drill are

equally essential components of the project. Just because a customer may

review the seismic map and decide to not drill in location A, but to instead

drill in location B, or to avoid a dangerous blowout and not drill at all, does

not mean CGG failed to furnish labor or materials “to a project.”

Furthermore, nothing in the statute requires that a taxpayer maintain books

and records that would somehow trace and parse its costs by the dates and

ultimate successes of the customers’ drilling projects. Such an argument

ignores the economic realities of business in direct contravention to the

Texas Supreme Court’s holding in Combs v. Roark Amusement & Vending,

L.P., 422 S.W.3d 632, 637 (Tex. 2013).

      In Newpark the Comptroller vehemently argued NES’s activities were

nothing more than that of a “garbage collector,” which was clearly a service

and not the furnishing of labor or materials to a project for the construction

                                      49
or improvement of real property. 422 S.W.3d at 55-57.        Now, the

Comptroller argues the opposite, contending that NES’s transporters “must

rely heavily on human effort,” and that “mov[ing] drilling mud toward or

away from an existing project site” is a qualifying activity. Appellants’ Brief,

p.47, 51. Just as the Comptroller maintained an unreasonable argument for

years against Newpark, the Comptroller does so here against CGG. CGG

qualifies as a deemed owner for the COGS deduction just as NES/Newpark

did, and the Comptroller’s attempts to distinguish that case are unavailing.

      B.    CGG Qualifies as an “Actual Owner.”

      Alternatively, CGG qualifies for the COGS deduction as an actual

owner of goods (i.e., an owner “based on all of the facts and circumstances,

including the various benefits and burdens of ownership vested with the

taxable entity”). See Tex. Tax Code § 171.1012(i), second sentence. Through

its MCDL, CGG sells goods in the ordinary course of business.

            1.    CGG owns and sells seismic data.

      There is no dispute that CGG owns the seismic data it licenses through

its MCDL. (2.RR.123-24; 5.RR.D.Ex.36, p.13, 17, 19). The Comptroller also

does not dispute that CGG’s licensing of seismic data constitutes a “sale.”

See TGS-NOPEC Geophysical Co. v. Combs, 340 S.W.3d 432, 442 (Tex.

2011) (because the revenues from licensing seismic data derive from

                                       50
conveyance and use of the underlying data, whereas the license itself is not a

“revenue-producing asset,” the transaction constitutes a “limited sale” of

property)12; see also Avis v. First Nat. Bank of Wichita Falls, 174 S.W.2d
255, 258 (Tex. 1943) (“This Court has definitely declared that an oil and gas

lease is the same as a sale of real estate.”).

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

      The only dispute regarding CGG’s qualification as an “actual owner” is

whether the products sold by CGG satisfy the relevant definition of “goods.”

See Appellants’ Brief, p. 25-41. CGG qualifies because the seismic data that

it intends to license for mass distribution without substantial alteration

through its MCDL satisfies a unique definition of “goods” applicable only to

the COGS deduction. See id. § 171.1012(a)(3)(A)(ii).

      “Goods” are defined to mean “real or tangible personal property sold in

the ordinary course of business of a taxable entity.”                Tex. Tax. Code

§ 171.1012(a)(1); see also 34 Tex. Admin. Code § 3.588(b)(3) (same). The

legislature has defined three categories of property that shall be treated as

“tangible personal property” exclusively for purposes of the COGS deduction:

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

                                           51
            (a)   In this Section: . . .

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

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

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

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

Tex. Tax Code § 171.1012(a)(3)(A)(i)-(iii); see also 34 Tex. Admin. Code

§ 3.588(b)(10)(A) (same).      By using the language “In this Section”, the

statute confined this specialized definition of ‘[t]angible personal property’

to Section 171.1012. In doing so, it excluded all other forms of (i) intangible

property and (ii) services as being outside the definition of “goods” for

purposes of the COGS deduction. Tex. Tax Code § 171.1012(a)(3)(B); see also

34 Tex. Admin. Code § 3.588(b)(10)(B) (same).

                                           52
      The first category covers property that is traditionally thought of as

“tangible”: items that “can be seen, weighed, measured, felt,” etc. Tex. Tax.

Code § 171.1012(a)(3)(A)(i). Neither party argues that CGG’s seismic data

satisfies the first category.13

      The second two categories cover property that is, in reality,

“intangible” (i.e., not of physical form). Id. § 171.1012(a)(3)(A)(ii)-(iii).

Nevertheless, for the particular tax purpose of allowing a COGS deduction,

our Legislature has chosen to specially define or treat these specific types of

intangible property as “tangible personal property” (TPP). (See 3.RR.106).

It is a legal fiction employed to serve a special purpose—the allowance of a

deduction for high-cost industries important to the State that do not

otherwise produce traditionally “tangible” products. As such, categories (ii)

and (iii) constitute “artificial TPP” solely for purposes of the COGS

deduction. See TGS-NOPEC, 340 S.W.3d at 443 & n.11 (noting that Texas

legislature and other state legislatures are able to and have chosen to identify

certain types of intangible property for specialized tax treatment).

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

                                        53
                  a.    TPP for COGS is different than TPP for sales tax or
                        apportionment.

      It is important to understand the distinctions between TPP as defined

for purposes of (1) the COGS deduction versus (2) the Texas sales and use tax

and (3) the franchise tax code’s apportionment provision, which also employ

the term “tangible personal property.”        See Tex. Tax Code § 151.009,

§ 171.103.   The Comptroller overlooks these distinctions and improperly

conflates authorities interpreting the relevant statutes.

      This matters for two reasons. First, the authorities relied on by the

Comptroller to characterize CGG’s seismic data as “intangible” are based on

sales tax or apportionment principles and, thus, do not control for purposes

of the COGS deduction. See Appellants’ Brief, p.32-34. Second, the Court

should be aware of the implications of characterizing property as “tangible”

or “intangible” under these various statutes. Generally speaking, sales of

“tangible” personal property are subject to sales tax, and revenues from such

sales are apportioned by the location of use for franchise tax purposes, while

sales of “intangible” property are not subject to sales tax, and their revenues

are apportioned by the location of payor. See TGS-NOPEC Geophysical Co,

v. Combs, 340 S.W.3d 432 (Tex. 2011).             Because CGG has pending

administrative claims regarding its apportionment factor, the Court’s

discussion and holdings here should be limited to the treatment of CGG’s

                                       54
seismic data for purposes of the COGS deduction and not inadvertently

result in an advisory opinion about its treatment for apportionment

purposes.

      The definitions of “goods” and “tangible personal property” in Section

171.1012(a) are expressly limited to application “in this section.” Comptroller

representative Sarah Pai agreed that “in this section” as used in Section

171.1012(a) refers exclusively to the COGS provision and not to the franchise

tax code generally. (4.RR.P.Ex.46, p.120-21). She unequivocally agreed that

the phrase “in this section” “confine[s] the[] definitions [provided under

Section 171.1012(a)] to Section 171.1012 and [they] don’t extend into the

apportionment rule.” (Id., p.128). On this basis, Pai further agreed that “if

an item qualifies . . . as tangible personal property under (ii) of Section

171.1012[(a)(3)(A)], it is still correct to apportion that as an intangible, the

sale of an intangible because the words ‘in this section’ confine the scope of

those definitions to that Section 171.1012.” (Id., p.128-29).

      For purposes of sales tax, TPP is defined as “property that can be seen,

weighed, measured, [etc.]” and “includes a computer program and a

telephone prepaid calling card.”      Tex. Tax Code § 151.009.       Thus, the

definition overlaps with categories (i) and (iii) of TPP under the COGS

                                       55
definition but notably leaves out category (ii), regarding the intellectual

property at issue here.

      The apportionment provision does not define TPP. See Tex. Tax Code

§ 171.103. However, the legislative history indicates a parallel treatment of

TPP for purposes of sales tax and apportionment, distinct from the

treatment of TPP for COGS purposes.         The apportionment rules have

remained largely unchanged since their amendment in 1997—a date when

the Texas sales tax existed but vastly pre-dating the 2006 enactment of the

current franchise tax.     Because apportionment does not impact the

calculation of one’s tax base, no major changes were made to that provision

when the Legislature adopted the margin/franchise tax.

      Considering that (1) the COGS provision did not even exist until a

decade after the current apportionment provision was enacted, (2) no

relevant change was made to apportionment upon adoption of the COGS

provision, and (3) the legislature expressly limited the definition of TPP for

purposes of COGS—it is not logical to conclude that the legislature intended

for the meaning of TPP for apportionment purposes to be the same as for

COGS purposes. Rather, it is more logical to interpret the meaning of TPP in

the apportionment and sales tax rules consistently, with the important

                                      56
distinction for COGS purposes being the intellectual property described by

Section 171.1012(a)(3)(A)(ii).

      Under this analysis, CGG agrees that for purposes of sales tax and

apportionment—which do not include “sound recordings, film, . . . and other

similar property” in their definitions of TPP—its seismic data should be

treated as “intangible” property.    See TGS-NOPEC, 340 S.W.3d at 444.

However, that does not prevent the seismic data from qualifying as a “good”

for purposes of the COGS deduction because the Legislature chose to treat

this specific type of otherwise intangible property as a form of “artificial

TPP” exclusively for this purpose, and CGG’s seismic data satisfies the

applicable definition.

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

      Section 171.1012(a)(3)(A)(ii) treats “films, sound recordings, . . . and

other similar property” (i.e., intellectual property that is otherwise

intangible) as an artificial form of TPP for purposes of the COGS deduction.

CGG’s seismic data satisfies each element of the (A)(ii) definition because:

(1) seismic data is the type of intellectual property described therein; and (2)

at the time CGG incurs the costs to produce the data, CGG intends to mass

distribute it (3) in a form that is substantially unaltered, regardless of the

                                       57
means or methods of distribution or the medium in which it is distributed.

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

      First, CGG’s seismic data falls within the statute’s broad definition of

intellectual property. The Legislature provided an expansive list, drafted in

non-exclusive terms, of the types of property that qualifies, described by

both type and characteristic: “films, sound recordings, videotapes, live and

prerecorded television and radio programs, books, and other similar

property embodying words, ideas, concepts, images, or sound.”             CGG’s

seismic data is “similar” to the described types of visual and sound

recordings, which convey unique information that could not be organically

duplicated by another creator.

      The Comptroller claims that CGG’s seismic data “is nothing like the

items listed” because it lacks “esthetic, narrative, musical, or artistic value.”

Appellants’ Brief, p.40. This aligns with the Comptroller’s trial argument

that the property had to be “creative” and could not be “scientific” to qualify

under Section 171.1012(a)(3)(A)(ii). (3.RR.120; 4.RR.P.Ex.46, p.149, 158).

Nothing in the statute expressly or impliedly limits the definition in the

manner sought by the Comptroller.           And, as the Comptroller’s counsel

acknowledged regarding this theory, “I can’t prove it.          I don’t have a

precedent for you.” (3.RR.154). Moreover, this argument would disqualify

                                       58
producers of documentaries from claiming the COGS deduction. Nothing in

the language of the statute supports such a narrow reading.

      Second, the record demonstrates that CGG intends to mass distribute

the seismic images at the time it incurs the costs to produce them. CGG does

not even consider undertaking the expense of funding the production of

seismic images for purposes of the MCDL unless there is substantial interest

by E&P companies for the geological information of a particular location.

(2.RR.118, 121; 4.RR.P.Ex.18; 5.RR.D.Ex.14, p.16: “In developing our multi-

client data library, we carefully select survey opportunities in order to

maximize our return on investment.”). The entire purpose of CGG incurring

these costs is to sell the data to “as many people as possible,” including all

12,000 of the Texas companies registered in the oil and gas drilling industry.

(2.RR.118-20,    125;   3.RR.13,   17,        20;   4.RR.P.Ex.18;   4.RR.P.Ex.25;

5.RR.D.Ex.35, p.8, 12-13, 16-17). Comptroller representative Pai admitted

that the “mass distribution” requirement is satisfied by a taxpayer’s intent to

mass distribute, not its ability to actually do so: She agreed a taxpayer would

qualify if it “intended to sell to as many people as possible [but] no one

bought it.” (4.RR.P.Ex.46, p.157). On this record, the Comptroller cannot

satisfy his burden of demonstrating that there is “no evidence” to support

                                         59
Findings of Fact 12-13, especially when the evidence is viewed in favor of the

judgment. See City of Keller v. Wilson, 168 S.W.3d 802, 807 (Tex. 2005).

      The Comptroller defines “mass” as “a large number of individuals,” yet

claims CGG’s intent to license its MCDL products to all 12,000 industry

members is not enough. To the extent this argument is based on a belief that

a taxpayer must intend to distribute its product to masses “of the general

public” rather than a specific industry, this argument fails. Nothing in the

statute provides such a limitation, and it is easy to understand how it would

not be true for many types of niche musical or artistic products that the

Comptroller admits qualify under Section 171.1012(a)(3)(A)(ii).14

      The Comptroller’s remaining two “mass distribution” complaints are

red herrings. Appellants’ Brief, p.38. First, just as discussed in regard to

why CGG’s activities are sufficiently connected to drilling projects, the

statute does not require a taxpayer to maintain accounting records and parse

its costs based on the timing or success of a project. This argument should

be rejected because it ignores the economic realities of CGG’s business.

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

                                          60
Supra, Argument III.A.2. Second, the Comptroller’s claim that “[o]ne would

not expect data . . . regard[ed] as a ‘trade secret’ to be mass distributed”

misses the point.15 CGG’s MCDL products are sold on a non-exclusive basis

to whomever will pay for them. Just because the purchaser is prohibited

from re-distributing those products (as is the purchaser of a copy of any

movie, song, or image described by this section) does not show a lack of

intent for the owner/seller of the product to mass-distribute it for profit.

      Third, CGG intends to distribute the data in a form that is substantially

unaltered. Here, it is critical to understand the difference between altering

the underlying data versus providing that data by various means or on

various mediums. The underlying data (originally captured as sound waves

from the earth’s surface) never changes.            Only its format changes.        By

applying algorithms and other techniques to interpret the underlying data,

CGG is able to make that same data (originally captured as a sound

recording) appear in the medium of a high-resolution image.

      This is no different than taking the underlying text of a Shakespeare

play, originally written with ink and paper, and reprinting it for sale as a

hardback book, and then as a digital version, or performing it as a play, or

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

                                           61
making it into a movie.     The underlying content of Shakespeare’s work

remains substantially unaltered regardless of the medium or means of

distribution, and he (or his heirs or assignees) remain the owners of that

underlying intellectual property.

      The statute expressly provides that a product will qualify as artificial

TPP under Section 171.1012(a)(3)(A)(ii) “without regard to the means or

methods of distribution or the medium in which the property is embodied,”

and that the distribution can be intended in “any medium in which the

property is embodied.”      Comptroller representative Pai confirmed the

purpose of the statute is to allow the taxpayer to distribute the product

“through as many means as are - - are profitable to the distributer.”

(4.RR.P.Ex.46, p.67; see also p.138-139 (agreeing that this was a reasonable

interpretation as shown by 4.RR.P.Ex.34)).

      Based on the foregoing, the record sufficiently supports the conclusion

that the seismic data products sold through CGG’s MCDL are “goods” or

“artificial TPP” within the definition of Section 171.1012(a)(3)(A)(ii). As

such, the Legislature has placed these products outside of the definition of

“intangible property” for purposes of the COGS deduction.

                                      62
IV.   ALL OF CGG’S COSTS ARE ALLOWED FOR THE COGS DEDUCTION.

      Once a taxpayer qualifies as an actual or deemed owner of goods under

Section 171.1012(i), it is instructed to calculate its total costs of goods sold as

allowed “by this section,” including all of the direct and indirect costs

allowed for deduction under subsections (c), (d), and (f). That is exactly the

computation CGG performed to arrive at its COGS deduction of $567

million. The trial court correctly concluded that CGG was entitled to claim

the COGS deduction in this full amount. (CR.250-51, 268 at COL.8-9).

      For the first time on appeal, the Comptroller seeks to parse these costs

between CGG’s lines of business (proprietary and MCDL), its activities

(acquisition and processing), and/or the assorted categories of allowable

costs under subsections (c), (d), and (f).        Recognizing that it failed to

preserve these arguments at trial, the Comptroller seeks a remand for a

second bite at the apple to parse the amount of CGG’s deduction. Not only

has this argument been waived, it is also legally incorrect and inconsistent

with recent policy announced by the Comptroller.

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

      CGG provided evidence that classified all of the costs included in its

COGS deduction into each of the categories allowed under Texas Tax Code

                                        63
Sections 171.1012(c), (d), and (f). (3.RR.40-41, 48-52, 54-56; 4.RR.P.Ex.19,

48).   The Comptroller limited its opposition to a holistic challenge of

whether CGG qualified for the COGS deduction under Section 171.1012(i).

The Comptroller preserved no argument that, assuming CGG qualifies, the

specific costs included in its COGS calculation are not allowed for deduction

(in whole or in part) under Section 171.1012(c), (d), or (f). (See 2.RR.16

(Comptroller’s counsel conceded that he was “not even fighting [CGG] on [its

costs], except as to whether they’re eligible for [the COGS deduction of]

them.”); 3.RR.58-63, 91-98 (Comptroller’s counsel asked no questions of

relevant witnesses to challenge the allowance of specific costs under

subsections (c), (d), or (f)); 3.RR.98; 4.RR.P.Ex.3, p.P000128 (Comptroller’s

auditor agreed that he “did not challenge any of the categories or the

amounts that are reflected on [CGG’s COGS calculation spreadsheet]”);

CR.41-66 (Comptroller’s trial brief raises no challenge to allowance of

specific costs under subsections (c), (d), or (f))).

       Thus, the Comptroller has waived any challenge to which of CGG’s

costs should be included in the calculation. The only question before this

Court is the threshold issue of whether CGG qualified for the COGS

deduction. Assuming that the Court agrees that CGG qualifies as an actual

or deemed owner under Section 171.1012(i), then it should affirm the

                                        64
judgment in full allowing CGG the full amount of its COGS deduction. There

is no legitimate basis for a remand in this circumstance.

      B.    The Statute Does Not Require Parsing of Costs.

      The Comptroller agrees that taxpayers who qualify for the COGS

deduction as “actual owners” may deduct any of the costs allowed by (c), (d),

and (f). Appellants’ Brief, p. 44-45. However the Comptroller argues that

taxpayers who qualify as “deemed owners” should be treated differently

under the same provision. Id., p.19, 43-49 (arguing that deemed owners are

entitled to deduct only their “labor and material costs” and not the

remainder of costs allowed by subsections (c), (d), and (f)). This contravenes

the plain language of the statute and ignores the Comptroller’s own

admissions at trial.

      Regarding both “actual” and “deemed” owners, Section 171.1012(i)

plainly states that the taxpayer may subtract the costs as provided “by” or

“under” “this section.” Tex. Tax Code § 171.1012(i), first and third sentences.

The reference to “this section” must mean the entirety of Section 171.1012

because the Legislature did not say “subsection,” which it knew how to do if

that is what had been intended. See generally Tex. Tax Code § 171.1012

(containing 12 separate references to “subsections”).

                                      65
      The Comptroller’s auditor, Gary Dullum, agreed that “as allowed by

this section” means all of the costs under (c), (d), and (f). (3.RR.72-73). The

Comptroller’s prior letter rulings also support this interpretation.

(4.RR.P.Ex.28, ¶ 4: explaining that the taxpayer is entitled to deduct all costs

allowed by 171.1012(c), (d), and (f), not just labor and material costs;

4.RR.P.Ex.32: in regard to a deemed owner, explaining that “Section

171.1012(c), (d), and (f) lists the types of costs included in the COGS

deduction for all types of businesses.”).

      Additionally, nothing in the statute requires parsing of costs between

business lines or activities. Instead, the taxpayer simply must qualify by

some portion of its business activity to elect the COGS deduction under

subsection (i), and then it may calculate all of the costs allowed by

subsections (c), (d), and (e). This is equally true for single businesses as it is

for integrated companies like CGG and Newpark, which report their taxes on

a combined group basis, making a single election for the calculation method

used. As this Court explained:

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

                                        66
            costs that qualify under Section 171.1012 if the goods for
            which the costs are incurred are owned by another
            member of the combined group.” As this provision
            indicates, a member that does not sell any goods itself
            may nevertheless deduct as cost of goods sold those
            expenses it incurs to sell goods owned by another
            member of the combined group. . . .

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

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

      Finally, the Comptroller’s position that the includable costs are limited

to only those associated with particular business activities is belied by his

recent public pronouncement that businesses incurring research costs may

deduct them as COGS even if the taxpayer doesn’t produce any of the goods

it sells.   See Texas Comptroller of Public Accounts, Letter Ruling

201504069L      (April   23,    2015)    (STAR     document     available    at

http://aixtcp.cpa.state.tx.us/opendocs/open32/201504069l.html).

                                        67
V.    NO DEFERENCE IS OWED TO THE COMPTROLLER’S POSITIONS.

      As a default argument throughout his brief, the Comptroller contends

that this Court must defer to his positions either because the Comptroller is

charged with enforcement of the tax code or because the COGS deduction is

an “exemption” rather than an “exclusion.” Both arguments lack merit.

      “[A] precondition to deference to an agency’s interpretation of a statute

is ambiguity.” Am. Multi-Cinema, Inc. v. Hegar, No. 03-14-00397-CV, --

S.W.3d --, 2015 WL 1967877, *3-4 (Tex. App.—Austin Apr. 30, 2015, no. pet.

h.) (citing Combs v. Roark Amusement & Vending, L.P., 422 S.W.3d 632,

635 (Tex. 2013) (describing agency-deference doctrine)). Section 171.1012 is

not ambiguous, so no deference is owed to the Comptroller’s positions.

Newpark, 422 S.W.3d at 56 n.9.

      In any event, such deference is not required where the agency’s

interpretation “is plainly erroneous or inconsistent” with the controlling

statute. Combs v. Roark Amusement & Vending, L.P., 422 S.W.3d 632, 635

& n.10 (Tex. 2013); USA Waste Servs., Inc. v. Strayhorn, 150 S.W.3d 491,

494 (Tex. App.—Austin 2004, pet. denied). Consequently, this Court need

not defer to the Comptroller’s flawed interpretations of Section 171.1012.

      Finally, the Comptroller incorrectly asserts that this Court should

interpret the COGS deduction as an exemption from tax and, on that basis

                                      68
hold CGG to stricter rules of construction and a higher burden of proof. The

COGS deduction is not an exemption. It is a method used to arrive at

“margin,” the tax base adopted by the legislature, which is akin to an

“exclusion.” “Exemptions,” on the other hand, make special reductions to

that base after it is calculated (allowing a taxpayer to avoid paying the tax

completely). These are specifically identified and treated separately in the

code. See Tex. Tax Code §§ 171.051-.088. Because the same concerns of

equality and uniformity do not arise with exclusions and deductions as they

do with exemptions, the stricter rules applicable to exemptions should not be

imposed on taxpayers claiming exclusions or deductions. Instead, this Court

should construe the COGS deduction strictly against the Comptroller and

liberally in favor of CGG, and require CGG to prove its entitlement by a

preponderance of the evidence. See Am. Multi-Cinema, 2015 WL 1967877,

at *3; Roark Amusement & Vending, L.P. v. Combs, 2011 WL 255535 (Tex.

App.—Austin Jan. 26, 2011), aff’d by 422 S.W.3d 632 (Tex. 2013).

     In urging otherwise, the Comptroller relies on an overly-broad

interpretation of Upjohn Co. v. Rylander, 38 S.W.3d 600, 606 (Tex. App.—

Austin 2000, pet. denied). Upjohn involved the former “earned surplus tax,”

which is fundamentally different than the current “margin tax.”          The

taxpayer in Upjohn sought a special deduction, imposed after the calculation

                                     69
of the tax base, which would have allowed it to avoid tax for food and health

care supplies. Id. at 605. This was properly treated as an exemption. To the

contrary, the COGS deduction, as a component of the tax-base calculation for

all taxpayers, should be treated as an “exclusion.”

                                    PRAYER

      Based on the foregoing, Appellee CGG Veritas Services (U.S.), Inc.

respectfully prays that this Court overrule each of the Comptroller’s issues

and affirm the judgment in full.16 CGG further prays that this Court tax all

costs against Appellees, in this Court and the court below, and award CGG

any such other relief at law or equity to which it may be justly entitled. Tex.

R. App. P. 43.4; Tex. R. Civ. P. 139.

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

                                         70
                            Respectfully submitted,

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

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

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

                CERTIFICATE OF COMPLIANCE

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

                                           /s/ Amanda G. Taylor
                                          Amanda Taylor

                                     71
                    CERTIFICATE OF SERVICE

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

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

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

                                            /s/ Amanda G. Taylor
                                           Amanda Taylor

                                      72
APPX.1 (P.Ex.4)
APPX.1 (P.Ex.4)
APPX.1 (P.Ex.4)
APPX.1 (P.Ex.4)
APPX.1 (P.Ex.4)
APPX.1 (P.Ex.4)
APPX.1 (P.Ex.4)
APPX.2 (P.Ex.5)
APPX.2 (P.Ex.5)
APPX.2 (P.Ex.5)
APPX.2 (P.Ex.5)
APPX.2 (P.Ex.5)
APPX.2 (P.Ex.5)
APPX.3 (P.Ex.19)
APPX.3 (P.Ex.19)
APPX.3 (P.Ex.19)
APPX.3 (P.Ex.19)
APPX.3 (P.Ex.19)
APPX.4 (P.Ex.48)
§ 171.1012. Determination of Cost of Goods Sold, TX TAX § 171.1012

  	

		
    
		
      
		
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(a) In this section:

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

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

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

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

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

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

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

        (i) intangible property; or

        (ii) services.

                © 2015 Thomson Reuters. No claim to original U.S. Government Works.                                          1
§ 171.1012. Determination of Cost of Goods Sold, TX TAX § 171.1012

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

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

  (1) labor costs;

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

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

  (4) handling costs, including costs attributable to processing, assembling, repackaging, and inbound transportation costs;

  (5) storage costs, including the costs of carrying, storing, or warehousing property, subject to Subsection (e);

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

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

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

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

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

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

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

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

               © 2015 Thomson Reuters. No claim to original U.S. Government Works.                                                2
§ 171.1012. Determination of Cost of Goods Sold, TX TAX § 171.1012

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

  (1) deterioration of the goods;

  (2) obsolescence of the goods;

  (3) spoilage and abandonment, including the costs of rework labor, reclamation, and scrap;

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

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

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

  (7) the cost of insurance on the produced goods;

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

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

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

(e) The cost of goods sold does not include the following costs in relation to the taxable entity's goods:

  (1) the cost of renting or leasing equipment, facilities, or real property that is not used for the production of the goods;

  (2) selling costs, including employee expenses related to sales;

  (3) distribution costs, including outbound transportation costs;

  (4) advertising costs;

               © 2015 Thomson Reuters. No claim to original U.S. Government Works.                                               3
§ 171.1012. Determination of Cost of Goods Sold, TX TAX § 171.1012

  (5) idle facility expense;

  (6) rehandling costs;

  (7) bidding costs, which are the costs incurred in the solicitation of contracts ultimately awarded to the taxable entity;

  (8) unsuccessful bidding costs, which are the costs incurred in the solicitation of contracts not awarded to the taxable entity;

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

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

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

  (12) officers' compensation;

  (13) costs of operation of a facility that is:

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

     (B) managed or operated primarily to house members of the armed forces of the United States; and

  (14) any compensation paid to an undocumented worker used for the production of goods. As used in this subdivision:

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

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

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

                © 2015 Thomson Reuters. No claim to original U.S. Government Works.                                            4
§ 171.1012. Determination of Cost of Goods Sold, TX TAX § 171.1012

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

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

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

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

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

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

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

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

                © 2015 Thomson Reuters. No claim to original U.S. Government Works.                                                  5
§ 171.1012. Determination of Cost of Goods Sold, TX TAX § 171.1012

  (2) a heavy construction equipment rental or leasing company; and

  (3) a railcar rolling stock rental or leasing company.

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

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

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

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

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

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

(p) to (s) [Blank].

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

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

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

Notes of Decisions (1)

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

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

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

    Editor's and Revisor's Notes (8)

    HISTORICAL AND STATUTORY NOTES

    2015 Main Volume

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

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

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

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

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

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

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

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

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

  	

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

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

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

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

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

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

  (6) other business done in this state.

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

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

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

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

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

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

Notes of Decisions (49)

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

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

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

    Editor's and Revisor's Notes (36)

    HISTORICAL AND STATUTORY NOTES

    2015 Main Volume

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

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

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

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

    “(2) each service performed in this state;

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

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

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

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

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

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

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

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

    “(2) 171.103(5);”

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

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

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

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

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

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

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

    Prior Laws:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

  	

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

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

Notes of Decisions (9)

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

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

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

    Editor's and Revisor's Notes (6)

    HISTORICAL AND STATUTORY NOTES

    2015 Main Volume

    Prior Laws:

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

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

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

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

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

    V.A.T.S. Tax.-Gen. art. 20.01, § (P).

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

         Texas Comptroller of Public Accounts    STAR System

                 201406920L

                 DATE:        June 10, 2014

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

                 FROM:        Teresa Bostick, Tax Policy Division

                 SUBJECT: Policy change based on TITAN and NEWPARK

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

3 of 3                                                                                                    7/20/2015 3:36 PM
201504069L [Tax Type: Franchise] [Document Type: Letter/Memo]                 http://aixtcp.cpa.state.tx.us/opendocs/open32/201504069l.html

         Texas Comptroller of Public Accounts    STAR System

                 201504069L

                 Date:        April 23, 2015

                 To:          Denise Stewart, Director, Audit Division

                 From:        Teresa Bostick, Director, Tax Policy Division

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

                 Issue

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

                 Relevant Authorities

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

                 Discussion

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

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

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

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

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201504069L [Tax Type: Franchise] [Document Type: Letter/Memo]               http://aixtcp.cpa.state.tx.us/opendocs/open32/201504069l.html

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

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

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

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

2 of 2                                                                                                                7/20/2015 3:37 PM
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      "ho •rlcs lo bring two unn1orrkd individuals to(lclhcr In an at·                      t he sources. nature, proponleo<, an d 11reparat lon o f dru gs b : a trea tise
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r \' "made u:.u. or rish In n seasoned wini; sa u ce                                        (1$73) 1 : the science or numbers and their operations, intcrrdottlon~.
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