Tgs–nopec Geophysical Co. D/B/A Tgs–nopec Corp.. v. Combs

Decision Date27 May 2011
Docket NumberNo. 08–1056.,08–1056.
Citation54 Tex. Sup. Ct. J. 1023,340 S.W.3d 432
PartiesTGS–NOPEC GEOPHYSICAL COMPANY d/b/a TGS–NOPEC Corporation, Petitioner,v.Susan COMBS, Successor–in–Interest to Carole Keeton Strayhorn, Comptroller of Public Accounts, and Greg Abbott, Attorney General of Texas, Respondents.
CourtTexas Supreme Court


James Thomas McBride, Jackson Walker LLP, Houston, for TGS-Nopec Geophysical Company.William E. Storie, Office of the Attorney General of Texas–Taxation, Christine Monzingo, Office of the Attorney General of Texas, Kevin D. Van Oort, Asst. Atty. General Taxation Div., Attorney General Greg W. Abbott, Attorney General of Texas, Clarence Andrew Weber, Kelly Hart & Hallman LLP, David S. Morales, Office of the Attorney General of Texas, Austin, for Susan Combs.Gerard A. Desrochers, Houston, for Amicus Curiae International Association of Geophysical Contractors.Thomas R. Phillips, Renn G. Neilson, Baker Bots L.L.P., Austin, for Amicus Curiae Westerngeco LLC.Justice MEDINA delivered the opinion of the Court.

This appeal arises from a franchise tax dispute involving the apportionment of receipts from the licensing of geophysical and seismic data to customers in Texas. The taxpayer complains that the Comptroller has mischaracterized these receipts as Texas business and thereby has erroneously increased its franchise tax burden. At issue is whether these receipts should be categorized as receipts from the use of a license or as receipts from the sale of an intangible asset. If the receipts are from the use of a license, then the Comptroller has correctly assessed the tax. If the receipts are from the sale of an intangible, then the Comptroller has erred in assessing additional taxes because receipts from the sales of intangibles are Texas receipts only if the legal domicile of the payor is Texas.

The lower courts concluded that the Comptroller had appropriately characterized the revenue as receipts from the use of a license in Texas and therefore correctly assessed the additional taxes. 268 S.W.3d 637 (Tex.App.-Austin 2008). We disagree and reverse and remand to the trial court for further proceedings.

I. Background

The taxpayer is TGS–NOPEC Geophysical Company (TGS), a Delaware Corporation with its principal place of business in Houston, Texas. It gathers, interprets, and markets seismic and geophysical data regarding subsurface terrains worldwide with sophisticated seismic equipment and software technology. TGS collects and stores this data in a master library and licenses various parts of the library to customers who use the licensed data to evaluate oil and gas formations for drilling operations. TGS requires its customers to enter into a master license agreement, which governs the parties' rights and obligations. The master license agreement describes TGS's seismic data as proprietary information and as valuable and highly confidential trade secrets. The master license agreement also states that TGS retains title to the seismic data and that it only licenses the limited use of the information to its customers.

When a customer wants to access data for a particular location, TGS and the customer enter into a specific license agreement under the master license agreement. TGS generally charges its customers a flat fee to access data under these specific license agreements and does not receive any additional payments, such as royalties. TGS delivers the data to its customers in tangible media forms such as magnetic tapes, printed materials, or film. Each piece of data provided by TGS includes the following notice:

These data are owned by and are trade secrets of [TGS]. The use of these data is restricted to companies holding a valid use license from [TGS] and is subject to the strict confidentiality requirements of that license. The data may not be disclosed or transferred except as expressly authorized by the license. Unauthorized disclosure, use, reproduction, reprocessing or transfer of this data by or to a third party is strictly prohibited.

The licensing agreements are nonexclusive, and TGS may license the same data to multiple customers. Its customers receive unlimited access to the data under the specific license purchased, but they cannot disseminate the information to third parties, nor is the license transferrable.

The Comptroller audited TGS in 2004 for the 19972000 and 20012003 tax years and concluded that TGS owed additional franchise taxes, penalties, and interest. The audit deficiency arose from the Comptroller's determination that, for apportionment purposes, a significant amount of TGS's receipts should have been characterized as Texas receipts rather than non-Texas receipts. This caused a larger percentage of TGS's earned surplus and taxable capital to be subject to the franchise tax. The contested gross receipts are revenue that TGS received from licensing its seismic data to customers in Texas. TGS characterized these receipts as revenue from the sale of intangibles. TGS reported some of these receipts as coming from “other business done in the state,” but the bulk of these receipts were reported as falling outside the category of business done in Texas. Receipts from the sale of intangibles are Texas receipts only if the payor is located in Texas. 34 Tex. Admin. Code § 3.549(e)(30)(B). The payor's location is deemed to be its legal domicile. 1 34 Tex. Admin. Code § 3.549(b)(7).

For many years, the Comptroller characterized TGS's licensing of its geophysical information as the sale of an intangible and allocated the revenue TGS derived therefrom to the customer's legal domicile. See Tex. Tax Code § 171.103(a)(6). The Comptroller's 2004 audit, however, characterized this revenue as receipts from the use of a license. This determination is significant because receipts from the use of a license are allocated to Texas if the license is used in Texas, whereas receipts from the sale of an intangible sold and used in Texas are not allocated to Texas, if the payor's domicile is elsewhere. Tex. Tax Code § 171.103(a)(4); see also 34 Tex. Admin. Code § 3.549(e)(30)(A)(iii) (providing that revenue an owner of a license receives is included in Texas receipts to the extent the license is used in Texas). The Comptroller's audit also concluded that most of TGS's licenses were used in Texas, which increased its Texas receipts and franchise taxes. After the audit, TGS owed $1,394,748.11 in additional franchise taxes and $333,741.60 in penalties and interest.

TGS paid the additional taxes, penalties, and interest under protest and timely filed this suit. See Tex. Tax Code § 112.052(a) (requiring taxpayer to pay contested taxes as a predicate to filing suit). TGS and the Comptroller filed cross motions for summary judgment in the trial court, which granted both motions in part. The trial court granted the Comptroller's motion with regard to the assessment of the additional tax liability and TGS's motion with regard to penalties and interest, ordering the Comptroller to refund the assessed penalties and interest. The court of appeals affirmed the trial court's judgment, 268 S.W.3d 637 (Tex.App.-Austin 2008), and TGS appealed to this Court, complaining that it did not owe the additional franchise taxes assessed by the Comptroller and affirmed by the lower courts.

II. Analysis

The dispute here is over how the receipts TGS generates from licensing its data should be allocated. TGS asserts that the revenue it earns as the owner and licensor of seismic data should be characterized as receipts derived from the sale of an intangible asset and, as such, allocated to the state of the payor's domicile. Tex. Tax Code § 171.103(a)(6). The Comptroller, on the other hand, argues that this revenue is derived from the use of a license because TGS employs license agreements to complete its sales in Texas. Receipts from the use of a license are allocated to the state in which the license is used. Id. § 171.103(a)(4).

The court of appeals agreed with the Comptroller, holding that [t]he gross receipts earned by TGS are derived from TGS' use of a license within the meaning of the statutes.” 268 S.W.3d at 646. The court thus interpreted the statutory phrase “use of a license” to apply to the use of a license as a transfer mechanism. See id. at 645 (holding that “the payments received by TGS for licensing its customers to use proprietary seismic data are gross receipts from the use of a license”). The question then is whether the act of licensing an intangible asset is the “use of a license” within the meaning of the franchise tax statute. To answer that question, we begin with the purpose and operation of the Texas franchise tax statute. See Tex. Tax Code ch. 171.

A. The Texas Franchise Tax

The franchise tax is a tax on the privilege of doing business in Texas. Bullock v. National Bancshares Corp., 584 S.W.2d 268, 270 (Tex.1979), cert. denied, 444 U.S. 1016, 100 S.Ct. 667, 62 L.Ed.2d 645 (1980). It is imposed on each taxable entity that does business in this state or that is chartered or organized here. Tex. Tax Code § 171.001(a); see also id. § 171.002 (defining taxable entity). Before 2008, the franchise tax was imposed on an entity's capital or earned surplus. See Act of May 30, 1997, 75th Leg., R. S., ch. 1185, §§ 5–6, 1997 Tex. Gen. Laws 4569, 4569–70. The tax code, however, presently imposes franchise tax on an entity's “taxable margin.” Tex. Tax.Code §§ 171.002, .101; see Act of May 2, 2006, 79th Leg., 3rd C.S., ch.1, § 2, 2006 Tex. Gen. Laws 1, 6 (amending Tex. Tax Code § 171.002). Because all of a company's capital, earned surplus, or 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 capital, earned surplus, or taxable margin (depending on the applicable version of the code) by a fraction, the numerator of which consists of receipts...

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