Benjamin Franklin would be relieved. Just when it seems that the taxman always wins, he doesn’t. In CGG Americas, Inc. v. Commissioner the U. S. Tax Court concluded that a taxpayer need not own underlying hydrocarbons in order to take a deduction for geological and geophysical expenses. Counterintuitive, you say? Read on.
CGGA “shoots seismic” for a living. Or, as the court put it more elegantly, conducts marine surveys in the Gulf of Mexico using geophysical techniques such as seismic reflection to detect the presence of oil and gas. The results are licensed on a nonexclusive basis to E&P customers.
CGGA took deductions for the expenses of conducting surveys and processing raw data, calling them geological and geophysical expenses under Tax Code Section 167(h). The deductions were rejected by the IRS, who issued tax deficiencies of $419,000 for the 2006 tax year and $2.8 million for 2007, and the parties ended up in the U. S. Tax Court.
The question: Deductibility
Were the expenses deductible? The IRS position was that the survey expenses were:
- Not geological and geophysical expenses of CGGA,
- Not incurred in connection with the development and exploration of oil and gas by CGGA,
- Could not be geological and geophysical expenses as expressed in Section 167(h) because CGGA didn’t own the hydrocarbons
The IRS also argued:
- according to the legislative history, Congress did not intend for the costs of surveys to be “geological and geophysical expenses” under Section 167(h).
- CGGA’s customers were the definitive developers of the oil and gas while CGGA only licensed the information it produced.
The Tax Court found:
- A taxpayer need not actually own the mineral interests to claim survey expenses. While targeting mineral interest owners may have been an intent of Congress (as the IRS pointed out) the Code itself does not limit the deduction to only those taxpayers owning the underlying mineral interests.
- The surveys were an essential component to the process of finding oil and gas deposits and CGGA was eligible to claim the deduction.
- Legislative intent as indicated by legislative history need not be considered in light of the plain and unambiguous language of the statute.
- The survey expenses were deductible under Section 167(h).
This was a bigger win for CGGA than just the two years. The parties stipulated that if the court determined that the survey expenses incurred in the 2006 and 2007 tax years qualified for Section 167(h) treatment, CGGA was entitled to an aggregate deduction for expenses incurred dating back to1998.