      TEXAS COURT OF APPEALS, THIRD DISTRICT, AT AUSTIN


                                      NO. 03-12-00515-CV



          Susan Combs, Comptroller of Public Accounts of the State of Texas; and
              Greg Abbott, Attorney General of the State of Texas, Appellants

                                                 v.

                               Newpark Resources, Inc., Appellee


     FROM THE DISTRICT COURT OF TRAVIS COUNTY, 250TH JUDICIAL DISTRICT
         NO. D-1-GN-11-002205, HONORABLE TIM SULAK, JUDGE PRESIDING



                                          OPINION


               In this suit to recover franchise taxes paid under protest, appellants Susan Combs,

Comptroller of Public Accounts for the State of Texas, and Greg Abbott, Attorney General of the

State of Texas (collectively, the Comptroller), appeal from the trial court’s final judgment in favor

of appellee Newpark Resources, Inc. On appeal, the Comptroller asserts that the trial court erred in

concluding that Newpark was entitled to a tax refund because (1) Newpark’s subsidiary, Newpark

Environmental Services, LLC (NES), did not qualify for a cost-of-goods-sold deduction and

(2) Newpark was not entitled to exclude from its total revenue NES’s payments to subcontractors.

See Tex. Tax Code §§ 171.1011(g)(3), 171.1012. We affirm the trial court’s judgment.
                                          BACKGROUND


Structure of the franchise tax

                Because this Court has not previously analyzed the most recent incarnation of

Texas’s franchise tax, we begin our discussion with a brief overview of the franchise tax. The

franchise tax is a tax on the value and privilege of doing business in Texas. See In re Nestle USA,

Inc., 387 S.W.3d 610, 612 (Tex. 2012 ) (orig. proceeding). The tax was enacted in 1893 but has

been significantly restructured several times. See id. at 612–13 (discussing history of franchise tax).

The current version of the franchise tax is codified in chapter 171 of the Tax Code, which was

adopted in 2006 as part of the legislature’s “effort to provide lasting property tax relief, establish a

stable and long-term source of funding for public schools, and meet the June 1, 2005 deadline

set in West Orange-Cove.” In re Allcat Claims Serv., L.P., 356 S.W.3d 455, 458–59 (Tex. 2011)

(orig. proceeding) (citing Neeley v. West Orange-Cove Consol. Indep. Sch. Dist., 176 S.W.3d 746,

753–54 (Tex. 2005) (concluding that previous school-funding scheme was unconstitutional)). “The

tax is still based primarily on revenue and only secondarily on capital, and now applies to every for-

profit entity doing business or chartered in Texas that is distinct from its owners.” In re Nestle USA,

387 S.W.3d at 614.

                As the supreme court explained, the current franchise tax is generally calculated

using the following formula:


                Total Revenue

                –       General Deduction: the greater of either the Cost of Goods
                        Sold, Compensation, or 30%

                                                   2
                 =      Margin

                 x      Percentage of gross receipts from Texas business

                 =      Taxable Margin

                 x      Tax Rate (0.5% for entities primarily engaged in wholesale
                        or retail trade, 1% for all others)

                 =      Franchise tax


Id.

                 The calculation of total revenue is governed by section 171.1011 of the Tax Code.

Generally, total revenue is “income reported to the federal IRS with various deductions, limitations,

and exceptions.” See id. at 615 (listing several exclusions from total revenue). The relevant revenue

exclusion in this case is set out in section 171.1011(g)(3) and requires a taxable entity to exclude

from total revenue all “flow-through funds that are mandated by contract to be distributed to”

subcontractors that “provide services, labor, or materials in connection with” various improvements

to real property.

                 After calculating total revenue, a taxable entity may take one of three general

deductions: cost of goods sold, compensation, or 30% of total revenue. The cost-of-goods-sold

deduction, which is the deduction Newpark elected to take in this case, is governed by section

171.1012 of the Tax Code. This provision allows a company to deduct “‘all direct costs of acquiring

or producing goods,’ some indirect costs like insurance, utilities, and quality control, and up to 4% of

other ‘indirect or administrative overhead costs.’” See id. (quoting Tex. Tax Code § 171.1011(a)(1),

(c)–(d), (f)).



                                                   3
                Newpark and its subsidiaries are “[a]ffiliated entities engaged in a unitary business.”

In re Nestle USA, Inc., 387 S.W.3d at 614; see also Tex. Tax Code § 171.1014. Therefore, Newpark

files a single tax report for the combined group. The group must elect to take the same general

deduction—meaning all members must take either a cost-of-goods-sold, compensation, or 30%

deduction. See Tex. Tax Code § 171.1014(d). With this background in mind, we turn to the specific

facts of this case.


Factual and procedural background

                Newpark describes itself as an “integrated oilfield services company,” providing

services to third-party “exploration and production companies” that are necessary for the drilling of

oil and gas wells. Newpark’s primary business activity—at least with respect to the disputed issues

in this case—involves the manufacture, sale, injection, and removal of “drilling mud.”1 Drilling mud

is a product that is injected into a well hole as it is being drilled to cool and lubricate the drill as well

as to facilitate the removal of rock, soil, and other “waste material” from the hole.

                Newpark, as the parent company, uses several subsidiaries for its various drilling-mud

operations. One subsidiary manufactures the industrial minerals that go into making drilling mud;

another subsidiary produces, sells, injects, and removes the drilling mud from the well; and

NES—the main subsidiary at issue in this appeal—removes the resulting nonhazardous waste

materials from the drilling site, transports the waste to NES’s underground disposal sites, and injects


        1
          Newpark also provides other services to drilling operations, including manufacturing and
renting “composite mats” and other “initial planning and drill-site-location and construction
services.” Although these other activities may be included in Newpark’s overall revenue and, by
extension, be subject to the franchise tax, they are generally not relevant to the issues in this appeal.

                                                     4
the waste into the sites for permanent disposal. NES hires subcontractors to operate the trucks and

barges that haul waste to the disposal sites.

               Newpark explained that its customers generally purchase Newpark’s services as an

“integrated service package” rather than separately from each subsidiary. Contracts are usually

between the customer and Newpark and its “subsidiaries and affiliated companies unless expressly

excluded by written agreement.” These contracts generally do not specify what subcontractors, if

any, Newpark or its subsidiaries will use to provide their services.

               The Comptroller conducted a “desk audit” of Newpark’s franchise-tax returns

for 2008 and 2009 and asked Newpark to explain its subsidiaries’ business activities. Newpark

explained NES’s business as outlined above, and based on that description, the Comptroller

determined that Newpark owed an additional $186,547.03 for 2008 and $205,698.98 for 2009, plus

penalties and interest. This adjustment was based on the Comptroller’s determination that NES’s

disposal of waste material was a service that did not qualify for a cost-of-goods-sold deduction.

Newpark paid the additional tax under protest and filed this underlying protest suit.

               In its suit, Newpark asserted that it was entitled to include NES’s expenses in

Newpark’s overall cost-of-goods-sold deduction. See id. § 171.1012. Alternatively, Newpark

argued that it was entitled to exclude a nearly equivalent amount from its total revenue based on

NES’s flow-through payments to subcontractors for hauling the waste.2 See id. § 171.1011(g)(3).


       2
          As the statute makes clear, if a taxable entity excludes flow-through payments to
subcontractors from its total revenue, it cannot claim those same payments in its cost-of-goods-sold
deduction. See Tex. Tax Code § 171.1011(i). The value of Newpark’s alleged exclusions and
deductions are not in dispute, and NES’s proposed cost-of-goods-sold deduction is slightly larger
than its proposed flow-through revenue exclusion.

                                                 5
Newpark also claimed additional cost-of-goods-sold deductions for its various indirect and

administrative overhead expenses that were not included in Newpark’s original tax return. See id.

§ 171.1012(f).

                 Following a bench trial, the trial court rendered a final judgment in Newpark’s

favor, concluding that Newpark was entitled to a refund of $472,872, plus statutory interest. The

Comptroller did not timely request, and the trial court did not issue, findings of fact and conclusions

of law. However, to reach the amount of Newpark’s refund, the trial court must have concluded that

Newpark was entitled to claim NES’s expenses—including its indirect and administrative overhead

expenses—in Newpark’s overall cost-of-goods-sold deduction. See supra n.2. This appeal followed.


                                     STANDARD OF REVIEW

                 The trial court, acting as factfinder, is the sole judge of credibility of the witnesses

and weight to be given to their testimony. McGalliard v. Kuhlmann, 722 S.W.2d 694, 696 (Tex.

1986). Where, as in this case, no findings of fact or conclusions of law are filed or requested, we

must infer that the trial court made all findings necessary to support its judgment. Holt Atherton

Indus., Inc. v. Heine, 835 S.W.2d 80, 83 (Tex. 1992). When the implied findings of fact are supported

by the evidence, we must affirm the trial court’s judgment on any theory of law applicable to the

case. See In re W.E.R., 669 S.W.2d 716, 717 (Tex. 1984); Carrollton-Farmers Branch Indep. Sch.

Dist. v. JDP, Inc., 168 S.W.3d 184, 188 (Tex. App.—Dallas 2005, no pet.).

                 The issues in this case primarily concern the proper construction of chapter 171 of

the Tax Code. See generally Tex. Tax Code §§ 171.1011–.1014. Statutory construction is a question

of law that we review de novo. See First Am. Title Ins. Co. v. Combs, 258 S.W.3d 627, 631 (Tex.

                                                    6
2008). When construing a statute, our primary objective is to ascertain and give effect to the

legislature’s intent. Id. at 631–32. In determining legislative intent, we first consider the plain

language of the statute. GMC v. Bray, 243 S.W.3d 678, 685 (Tex. App.—Austin 2007, no pet.).

When statutory text is clear, it is determinative of legislative intent, unless enforcing the plain

meaning of the statute’s words would produce an absurd result. Entergy Gulf States, Inc. v.

Summers, 282 S.W.3d 433, 437 (Tex. 2009). We consider the statute as a whole, reading each word

in context rather than in isolation, and unless a different definition is supplied by the legislature, we

assume the words chosen have their plain and ordinary meaning. See City of Rockwell v. Hughes,

246 S.W.3d 621, 625–26 (Tex. 2008). Our analysis is informed by the presumption that “the entire

statute is intended to be effective” and that “a just and reasonable result is intended.” See Tex. Gov’t

Code § 311.021(2), (3); Shook v. Walden, 304 S.W.3d 910, 917 (Tex. App.—Austin 2010, pet.

denied). Only when the statutory text is ambiguous “do we resort to rules of construction or extrinsic

aids.”3 Shook, 304 S.W.3d at 917 (internal quotations omitted); see also Combs v. Metropolitan Life

Ins. Co., 298 S.W.3d 793, 796–97 (Tex. App.—Austin 2009, pet. denied).


                                            DISCUSSION

                The Comptroller raises four issues on appeal, which we group into the following two

categories. First, the Comptroller asserts that NES provides only services, and therefore its expenses

do not qualify for a cost-of-goods-sold deduction. Second, the Comptroller argues that NES’s

payments to its subcontractors do not constitute “flow-through funds” that can be excluded from


        3
          The parties dispute whether the cost-of-goods-sold deduction is “an imposition of a tax
rather than an exemption,” which affects whether the tax is strictly construed in favor of or against
the taxpayer. See Upjohn Co. v. Rylander, 38 S.W.3d 600, 606 (Tex. App.—Austin 2000, pet.
denied). However, this rule of construction only applies if the statute is ambiguous. See id.

                                                   7
total revenue because Newpark’s contracts with its customers did not require Newpark or NES to

use those subcontractors.

                The parties concede that if Newpark can include NES’s expenses in its cost-of-goods-

sold deduction, then the trial court’s judgment in Newpark’s favor must be affirmed regardless of

whether Newpark can also exclude its flow-through payments from total revenue. See supra n.2.

Therefore, we will address the cost-of-goods-sold issue first because it may be dispositive in this

case.4 See Carrollton-Farmers Branch Indep. Sch. Dist., 168 S.W.3d at 188 (noting that appellate

court will affirm trial court’s determination of tax if correct on any legal theory presented); see also

Tex. R. App. P. 47.1 (requiring appellate courts to hand down opinions that are as short as possible

while addressing every issue necessary to disposition).

                In its first, third, and fourth issues on appeal, the Comptroller challenges the trial

court’s determination of Newpark’s overall cost-of-goods-sold deduction.5 Specifically, the



       4
            In addressing the cost-of-goods-sold-deduction issue first, we in no way suggest that the
Comptroller or taxable entities are free to determine a general deduction before determining total
revenue. However, in this case, the parties concede that if Newpark was entitled to take the cost-of-
goods-sold deduction, the trial court’s judgment must be affirmed. Therefore, although the cost-of-
goods-sold deduction is not a stand-alone theory for determining franchise tax, in this specific case,
it is a stand-alone theory for affirming the trial court’s judgment. See Tex. R. App. P. 47.1 (requiring
courts of appeals to hand down opinion that is as brief as practicable while addressing every issue
necessary for final disposition).
       5
           The Comptroller’s first, third, and fourth issues relate to whether NES’s direct expenses,
administrative-overhead costs, and pollution-control costs qualify for the cost-of-goods-sold
deduction. See Tex. Tax Code § 171.1012(c)(7), (f), (i). As the Comptroller concedes, if NES’s direct
expenses are deductible as a cost of goods sold, then NES may also deduct its administrative-overhead
and pollution-control costs. As part of its fourth issue, the Comptroller also asserts that there is no
evidence to substantiate how much Newpark spent on its pollution-control costs. Even assuming
that this argument was not waived as inadequately briefed, see Tex. R. App. P. 38.1(i), we conclude
that there is sufficient testimony and documentation in the record to support the trial court’s
valuation of NES’s pollution-control costs.

                                                   8
Comptroller argues that because NES provides only services, it does not sell any goods for which

it could claim a cost-of-goods-sold deduction. Therefore, according to the Comptroller, the trial

court erred in including NES’s expenses in Newpark’s overall cost-of-goods-sold deduction.

               As we will discuss, the resolution of this issue involves two separate questions.

First, in determining cost of goods sold, do we consider each member of a combined group’s

business in the context of the combined group’s business as a whole, rather than treating each

member as if it were a stand-alone company? Second, does NES “furnish[] labor or materials to a

project for the construction . . . of real property” such that it can include the cost of that labor or

material in its cost of goods sold? See Tex. Tax Code 171.1012(i). Under the facts of this case, we

answer yes to both questions, and therefore we affirm the trial court’s implied finding that Newpark

was entitled to include NES’s expenses in its cost-of-goods-sold deduction.


Do we consider NES’s expenses in the context of Newpark’s overall sales?

               In its brief, the Comptroller repeatedly emphasizes that NES does not sell any goods

in the ordinary course of its business, and therefore it cannot qualify for any cost-of-goods-sold

deduction. See id. § 171.1012(a)(1), (c)–(d) (defining “good” and listing several costs associated

with production and sale of goods that can be deducted). According to Newpark, this argument

underscores the fault in the Comptroller’s analysis, in that the Comptroller incorrectly views NES

as an isolated business rather than as a part of Newpark. The Comptroller’s analysis, according to

Newpark, is inconsistent with the plain language of the statute.6


       6
         It is not entirely clear whether the Comptroller actually asserts that NES’s activities
must be viewed in isolation. In its brief, the Comptroller states that “an entity which would not be

                                                  9
               We agree with Newpark that the plain language of the statute does not support

the Comptroller’s interpretation that section 171.1014(e)(1) requires each member’s business to

be viewed in isolation when determining the member’s eligibility to take a cost-of-goods-sold

deduction. Section 171.1014 generally governs when and how a combined group files a combined

report, and subsection (e) delineates how the combined group calculates its cost-of-goods-sold

deduction. This subsection states:


               For purposes of Section 171.101, a combined group that elects to
               subtract costs of goods sold shall determine the amount by:

               (1) determining the cost of goods sold for each of its members as
               provided by Section 171.1012 as if the member were an individual
               taxable entity;

               (2) adding the amounts of the cost of goods sold determined under
               Subdivision (1) together; and

               (3) subtracting from the amount determined under Subdivision (2)
               any cost of goods sold amounts paid from one member of the
               combined group to another member of the combined group, but only
               to the extent the corresponding item of total revenue was subtracted
               under Subsection (c)(3).


Id. § 171.1014(e) (emphasis added).



eligible for the Cost of Goods Sold deduction if it were an individual taxable entity must calculate
its Cost of Goods Sold deduction as zero.” This language could be read to support Newpark’s
argument that the Comptroller attempts to look at NES—and by extension all subsidiaries—as if it
were a stand-alone business, completely separate from its parent company. However, the Comptroller
also argues that the analysis would be the same even if NES were part of the subsidiary that
sold drilling mud because NES’s activities are still only services. Thus, it is unclear whether the
Comptroller actually attempts to analyze NES in isolation. Nevertheless, because resolution of
this issue is fundamental to our disposition of this case, we will address Newpark’s argument that,
when determining NES’s cost-of-goods-sold deduction, NES’s activities must be considered in the
context of Newpark’s overall business.

                                                10
               Subsection 171.1014(e) is an accounting mechanism that adds up each member’s

cost of goods sold while eliminating any “double counting” of intra-group sales or transfers. Given

that this provision is effectively a procedural tool, it would be inconsistent to treat subsection

171.1014(e)(1) as an additional substantive limitation that would require each member’s business

activity to be viewed in complete isolation from the combined group. Cf. Sergeant Enter., Inc. v.

Strayhorn, 112 S.W.3d 241, 249–50 (Tex. App.—Austin 2003, no pet.) (noting that procedural tax

tools generally do not affect vested rights of what can be taxed).

               This conclusion is directly supported by subsection 171.1014(d-1), which states that

“[a] member of a combined group may claim as costs of goods sold those costs that qualify under

Section 171.1012 if the goods for which the costs are incurred are owned by another member of the

combined group.” As this provision indicates, a member that does not sell any goods itself may

nevertheless deduct as cost of goods sold those expenses it incurs to sell goods owned by another

member of the combined group. It would be entirely inconsistent to treat individual members as

isolated entities under subsection (e)(1) but nevertheless allow them to deduct their costs for selling

goods that are owned by other members of the combined group.

               Finally, the overall structure of section 171.1014 supports the conclusion that when

determining the franchise tax of a combined group, we consider the group as whole, not each

member in isolation. See City of Rockwell, 246 S.W.3d at 625–26 (noting that courts consider

statute as a whole and read words in context, not in isolation). As subsection 171.1014(b) clearly

states, a “combined group is a single taxable entity for purposes of the application of the [franchise

tax].” Furthermore, subsection 171.1014(d) requires a combined group to choose to deduct either



                                                  11
cost of goods sold or compensation “for all its members,” thereby indicating that the franchise tax

is intended to apply to all members of a combined group as if they were a single taxpayer. See also

Tex. Tax Code §§ 171.1014(h) (requiring members of combined group to use same accounting

period for determining margin and apportionment), 171.1014(i) (making each member jointly and

severally liable for tax owed by 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. Compare id. § 171.1014(b), (d)–(d-1), with id.

§ 171.1014(e)(1). 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.

               Therefore, reading section 171.1014 as a whole, we agree with Newpark that each

member’s cost-of-goods-sold deduction must be determined by considering the member’s expenses

in the context of the combined group’s overall business. To the extent the Comptroller asserts

that section 171.1014(e)(1) requires us to look at NES in complete isolation, that interpretation is

inconsistent with the statute. Thus, under the plain language of section 171.1014, we determine NES’s

eligibility to take a cost-of-goods-sold deduction within the context of Newpark’s overall business.


Do NES’s expenses qualify as costs of goods sold under section 171.1012(i)?

               In its primary argument on appeal, the Comptroller asserts that Newpark cannot

include NES’s expenses in its cost-of-goods-sold deduction. Specifically, the Comptroller claims

                                                 12
that NES’s removal and disposal of waste material is a “service” within the meaning of section

171.1012, and therefore NES does not sell a good for which the cost-of-goods-sold deduction

could apply. See id. § 171.1012(a)(3)(B)(i) (excluding “services” from definition of tangible

personal property). In its response, Newpark asserts that NES furnishes labor to projects for the

construction and improvement of real property, and therefore Newpark is entitled to take a cost-of-

goods-sold deduction for these expenses under section 171.1012(i). We begin our analysis of this

issue with a brief overview of the cost-of-goods-sold deduction, focusing on those sections relevant

to this appeal.

                  For purposes of the cost-of-goods-sold deduction, a “good” is “real or tangible

property sold in the ordinary course of business of a taxable entity.” Id. § 171.1012(a)(1). “Tangible

personal property” is further defined as “personal property that can be seen, weighed, measured, felt,

or touched or that is perceptible to the senses in any other manner,” as well as various films, sound

recordings, and other forms of property not at issue in this case. Id. § 171.1012(a)(3)(A)(i)–(iii).

However, “services” are specifically excluded from the definition of tangible personal property. Id.

§ 171.1012(a)(3)(B)(i)–(ii).

                  A taxable entity that elects to take the cost-of-goods-sold deduction may deduct “all

direct costs of acquiring or producing the goods,” including labor, materials, handling, depreciation,

and other sunk costs related to production. Id. § 171.1012(c)–(d). A taxable entity may also deduct

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.” Id. § 171.1012(f). However, a taxable entity generally cannot include costs related to the

                                                   13
actual sale of goods—such as distribution, advertising, rehandling, or bidding expenses—in its

cost-of-goods-sold deduction. See id. § 171.1012(e).

                Finally, subsection 171.1012(i) creates a restriction—and potential expansion—of

which entities can take a cost-of-goods-sold deduction. It states, in relevant part:


                A taxable entity may make a subtraction under this section in relation
                to the cost of goods sold only if that entity owns the goods. . . .
                A taxable entity furnishing labor or materials to a project for
                the construction, improvement, remodeling, repair, or industrial
                maintenance . . . of real property is considered to be an owner of that
                labor or materials and may include the costs, as allowed by this
                section, in the computation of cost of goods sold.


Id. § 171.1012(i) (emphasis added). With this statutory framework in mind, we now consider the

facts of this case.

                Newpark concedes that NES’s disposal of waste does not qualify as either real or

tangible personal property, and thus NES itself does not sell a “good” within the meaning of the

franchise tax. See id. § 171.1012(a)(1). However, as discussed above, we do not consider NES in

isolation, but rather determine whether NES’s expenses qualify as a deductible cost of selling some

Newpark good. See id. § 171.1014(d-1). Within that context, Newpark asserts that NES’s expenses

are part of the overall labor and materials that Newpark furnishes to the drilling of oil and gas

wells, which the Comptroller does not dispute constitutes a project for the construction and

improvement of real property. See id. § 171.1012(i). Based on the record, it appears that NES’s

expenses do not fit into any of the specified costs that can be deducted under subsections (c), (d),




                                                  14
or (f).7 Therefore, if NES’s expenses qualify for a cost-of-goods-sold deduction, they must qualify

under section 171.1012(i).

               The Comptroller asserts that NES’s removal and disposal of drilling mud is purely

a service and does not constitute labor furnished to a project for the construction or improvement of

real property. The terms “labor” and “service” are not defined in chapter 171 or in the Tax Code.

Nevertheless, the Comptroller contends that the terms must have different meanings because

section 171.1011(g)(3) lists “services” and “labor” as separate activities that can be related to the

improvement of real property. See id. § 171.1011(g)(3) (noting that taxpayer may exclude flow-

through payments for “services, labor, or materials in connection with . . . design, construction,

remodeling . . . on real property”). This use of separate terms, according to the Comptroller,

indicates that the legislature understood services to mean something distinct from labor with respect

to the construction of real property.

               Although we agree that the separate listing of services and labor in section

171.1011(g)(3) indicates that they encompass different concepts, the fact that the terms are listed

separately does not mean they are mutually exclusive. See Matagorda Cnty. Appraisal Dist. v.

Coastal Liquids Partners, L.P., 165 S.W.3d 329, 334–35 (Tex. 2005) (noting that categories listed

separately in statute can still overlap). Furthermore, the fact that section 171.1011(g)(3) indicates

that labor and services have distinct meanings does not provide us with clear guidance as to what


       7
          The removal and disposal of waste from the drilling site is not an aspect of the acquisition
or production of drilling mud, nor is it a result of deterioration, spoliage, or other sunk cost
associated with the production of drilling mud. See Tex. Tax Code § 171.1012(c)–(d). In addition,
NES’s removal and disposal of waste does not constitute an indirect or administrative overhead
cost of producing a good. See id. § 171.1012(f).

                                                 15
that distinction is. Neither term is defined in the statute, and the ordinary definitions of labor and

services substantially overlap such that both definitions tend to refer to the words interchangeably.8

See City of Rockwell, 246 S.W.3d at 625–26 (noting that courts assume undefined terms have

ordinary meaning). Webster’s Dictionary does offer one arguably pertinent definition of services,

explaining it to mean “useful labor that does not produce a tangible commodity,” noting that

“railroads, telephone companies, and physicians perform services although they produce no goods.”

See Webster’s Third New International Dictionary 2075 (Phillip Gove Ed. 2002). However, even

assuming we could reconcile that definition with section 171.1011(g)(3)’s reference to “services . . .

in connection with the actual or proposed design, construction, . . . of real property,” the same

question still remains—does NES furnish “labor” to a project for the construction of real property?

In order to answer that question, we must determine section 171.1012(i)’s function.


Function of section 171.1012(i)

               The function of section 171.1012(i) must be determined within the context of the

section 171.1012 generally. See City of Rockwell, 246 S.W.3d at 625–26 (noting that courts consider

entire statute and put words in context). We will primarily consider the consequences of the various

proposed constructions, presuming that the legislature intended the entire statute to be effective and

to achieve “a just and reasonable result.” See Tex. Gov’t Code §§ 311.021(3), 311.023(5).




       8
          Webster’s defines “labor” as the “expenditure of physical or mental effort especially
when fatiguing, difficult, or compulsory,” while “service” is defined as “the performance of work
commanded or paid for by another.” See Webster’s Third New International Dictionary 1259, 2075
(Phillip Gove Ed. 2002). Thus, both labor and services are generally work done for another, with
labor potentially including an additional expenditure of either physical or mental effort.

                                                 16
               Generally, section 171.1012(i) operates as a broad limitation on which entities can

claim the cost-of-goods-sold deduction, restricting it to those that actually own the goods they sell.

See Tex. Tax Code § 171.1012(i). However, the section then provides a general exception to this

rule—stating that those that furnish labor or materials to certain projects related to real property are

“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.” See id. (emphasis added). It is not entirely clear

from the structure of this subsection what the legislature was trying to accomplish. Did it mean that,

in the context of improving real property, a party furnishing labor does not need to sell a separate

good to qualify for the cost-of-goods-sold deduction? If so, can those entities that furnish labor to

the improvement of real property deduct all expenses related to their supply of labor as a cost of

goods sold? Can multiple taxpayers qualify as furnishing the same labor, thereby allowing multiple

deductions for the same expense?

               The Comptroller asserts that “[t]he purpose of Section 171.1012(i) is to allow

construction companies and contractors . . . to act like they are the owner of those materials and

labor.” Otherwise, the Comptroller notes, “construction companies and contractors could not take

the Cost of Goods Sold deduction because they do not own the finished product.” Although this is

merely a litigation position and not a formal interpretation, it is generally consistent with Newpark’s

explanation of the statute and a common-sense understanding that many contractors and

subcontractors that improve or maintain real property do not actually own or sell the property. Given

that real property itself is a “good” within the meaning of section 171.1012, but that many of the

businesses that incur costs to improve or maintain real property never sell that good, the legislature

                                                  17
could have reasonably intended section 171.1012(i) to allow those same companies to deduct their

costs as if they were a cost of goods sold.

               Otherwise, section 171.1012(i)’s provision making the party that furnishes labor the

“owner” of that labor would be meaningless because, regardless of whether a contractor owned the

labor it supplied, the contractor could not deduct the cost of supplying that labor unless it also sold

the real property or some other tangible personal property in the ordinary course of its business. See

Tex. Tax Code § 171.1012(i); see also Tex. Gov’t Code § 311.021(2) (noting that courts presume

entire statute intended to be effective). Furthermore, it would make the classification of real

property as a good relatively ineffectual because a potentially large percentage of taxable entities

that incur costs to develop or maintain real property would never be able to deduct those costs as a

cost of goods sold. Therefore, we conclude that when viewed in the context of section 171.1012,

subsection (i) means that the party that supplies labor or materials to the construction, improvement,

remodeling, repair, or industrial maintenance of real property can deduct its labor or material

expenses as a cost of goods sold, assuming those expenses would qualify as the cost of selling real

property. See Tex. Tax Code § 171.1012(i) (permitting deduction of labor and materials costs “as

allowed by this section”). Having determined the function of section 171.1012(i), we can more

accurately determine what constitutes labor furnished for the improvement of real property.


Meaning of “labor” within the context of section 171.1012

                Given our conclusion that section 171.1012(i) is designed to allow the party that

furnishes labor for the improvement of real property to deduct that cost as if it sold the property,



                                                  18
there is no reason to believe that “labor” under subsection 171.1012(i) means anything different than

labor under section 171.1012 generally. See Sheshunoff v. Sheshunoff, 172 S.W.3d 686, 692 (Tex.

App.—Austin 2005, pet. denied) (noting that courts presume that same terms used in same connection

in different statutes have same meaning). Generally, a taxable entity may deduct “all direct costs of

acquiring or producing” goods, including “labor costs.” See Tex. Tax Code § 171.1012(c)(1).

               “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.”

Webster’s Third New International Dictionary 1259, 2075 (Phillip Gove Ed. 2002). None of the

surrounding statutory text indicates that labor has a more limited meaning than its common definition.

Cf. Railroad Comm’n of Tex. v. Texas Citizens for a Safe Future & Clean Water, 336 S.W.3d 619,

628 (Tex. 2011) (“[W]e have warned against expansively interpreting broad language where it is

immediately preceded by narrow and specific terms.”). Therefore, we presume that the legislature

intended to allow taxable entities to deduct a wide range of labor expenses.9 See Texas Dep’t Pub.

Safety v. Abbott, 310 S.W.3d 670, 675 (Tex. App.—Austin 2010, no pet.) (noting courts assume

broad statutory terms have broad meaning).




       9
          Because “labor” within the context of section 171.1012(i) can be given a clear and definite
meaning based solely on the plain language of the statute, we conclude that the statute is not
ambiguous. See Entergy Gulf States, Inc. v. Summers, 282 S.W.3d 433, 437 (Tex. 2008). Therefore,
we do not reach whether the cost-of-goods-sold deduction operates as an imposition of a tax rather
than a tax exemption. See Upjohn Co. v. Rylander, 38 S.W.3d 600, 606 (Tex. App.—Austin 2000,
pet. denied) (noting that these presumptions only considered when tax statute is ambiguous). Similarly,
we need not defer to the Comptroller’s interpretation of the statute. Id.

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                We look to the facts of this case to determine whether NES’s services, put in

the context of Newpark’s overall services, qualify as labor for the construction or improvement of

real property. It is undisputed that the drilling and construction of oil and gas wells qualifies as

construction or improvement to real property. Furthermore, it is undisputed that the injection and

removal of drilling mud qualifies as labor and materials that are furnished for the construction of oil

and gas wells. Therefore, the only question is whether NES’s subsequent transport and disposal of

the used drilling mud and other waste material is part of the labor involved in the drilling process.

                The Comptroller asserts that NES’s activities are akin to a garbage collector that

picks up trash cans on the street corner and transports the trash to the local landfill. These activities,

according to the Comptroller, are clearly a service and not labor supplied for the improvement of real

property. While the Comptroller’s hypothetical may be true as far as it goes, it seems that Newpark’s

activity in the record before us is more analogous to a demolition company that tears down a

preexisting structure and then removes the resulting debris so that new construction can begin. It

would be irrational to conclude that the demolition of the old structure is labor furnished for the

construction or improvement of real property but that the actual removal and disposal of the resulting

debris is a service that is not part of the construction process. After all, demolition without disposal

would be pointless in this situation.

                Similarly, it is difficult to view NES’s disposal of waste material as though it were not

an essential and direct component of the drilling process. Given that similar costs for scrap material

and pollution control devices are deductible as costs of producing tangible personal property, it

follows that such expenses should also be deductible for the improvement or maintenance of real

                                                   20
property. See Tex. Tax Code § 171.1012(c)(7)–(8), (d)(3). There was testimony at trial that the

waste material was an inescapable byproduct of drilling, that removal and disposal of this waste

material was essential to continue drilling, and that without this disposal the drilling process would

come to an immediate halt. Based on this testimony, the trial court could have reasonably concluded

that the removal and disposal of this waste material was labor furnished to a project for the

construction and improvement of real property.

               Admittedly, other cases may present a close issue as to when labor is too far removed

from the construction, improvement, remodeling, repair, or industrial maintenance of real property

to qualify for the cost-of-goods-sold deduction under section 171.1012(i). In this case, however, we

conclude that the record supports the trial court’s implied finding that NES furnishes labor to a

project for the construction or improvement of real property. Therefore, the trial court did not err

in including NES’s expenses within Newpark’s overall cost-of-goods-sold deduction. We overrule

the Comptroller’s first, third, and fourth appellate issues.


                                          CONCLUSION

               Having concluded that Newpark was entitled to include NES’s expenses in its overall

cost-of-goods-sold deduction, we need not determine whether Newpark could also exclude flow-

through payments to subcontractors from NES’s total revenue. See Carrollton-Farmers Branch

Indep. Sch. Dist., 168 S.W.3d at188 (noting that appellate courts affirm trial court’s determination

of tax if correct on any legal theory presented); see also Tex. R. App. P. 47.1. We affirm the

judgment of the trial court.



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                                            __________________________________________

                                            Scott K. Field, Justice

Before Chief Justice Jones, Justices Pemberton and Field
 Concurring Opinion by Chief Justice Jones

Affirmed

Filed: December 31, 2013




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