The Tax Court has held that processed seismic data was neither tangible personal property nor a sound recording. Therefore, it was not qualified production property for purposes of the pre-2018 domestic production activities deduction.
Background.
Prior to 2018, a taxpayer was allowed a deduction (the domestic production activities deduction or DPAD) based on a percentage of the taxpayer’s domestic production gross receipts (DPGR). (Sec. 199(a) of the Code before removed by the Tax Cut and Jobs Act, PL 115-97)
DPGR included the gross receipts of the taxpayer which were derived from any lease, rental, license, exchange, or other disposition of qualifying production property (QPP) which was manufactured, produced, grown, or extracted by the taxpayer in whole or in significant part within the United States. (Sec. 199(c)(4)(A)(i)(I))
Sec. 199(c)(5) defined QPP as tangible personal property, any computer software, and any sound recording described in Code Sec. 168(f)(4).
Tangible personal property is, generally, as any tangible property other than land, real property, computer software, sound recordings, qualified films, electricity, natural gas, or potable water. (Reg. §1.199-3(j)(2)(i))
In addition, Black’s Law Dictionary defines tangible personal property as that which is “corporeal,” capable of being “seen, weighed, measured, felt, touched, or in any other way perceived by the senses.”
Code Sec. 168(f)(4) defines sound recordings as “[a]ny works which result from the fixation of a series of musical, spoken, or other sounds, regardless of the nature of the material (such as discs, tapes, or other phono recordings) in which such sounds are embodied.”
The term “sound recordings” does not include the creation of copyrighted material in a form other than a sound recording, such as lyrics or music composition. (Reg. §1.199-3(j)(4)(ii))
Facts.
TGS-NOPEC Geophysical (TGS) engaged in the business of acquiring, processing, and licensing marine seismic data.
The acquisition of marine seismic data involves the recording and measurement of the travel time of seismic waves from a known energy source at or near the ocean’s surface to various depths in the earth’s subsurface.
Processing seismic data involves applying software programs based on geophysical principles to manipulate and convert the raw seismic data into a form that can be interpreted by petitioner’s clients.
During 2008, TGS earned revenue by licensing the processed seismic data to companies in the oil and gas industry.
TGS claimed on its 2008 tax return a DPAD of $2 million, on the basis of DPGR of $74 million from licensing the processed seismic data.
The IRS denied the deduction, saying that processed seismic data was not QPP.
TGS argued that the processed seismic data constituted QPP as either tangible personal property or as a sound recording.
TGS contended that the processed seismic data constituted tangible personal property because it was delivered to clients via one or more tangible media, such as computer hard drives, compact discs, computer tapes, or magnetic media tape.
Alternatively, TGS argued that the processed seismic data was a sound recording. TGS argued that the recording of the seismic waves constituted a recording of sound because the longitudinal mechanical waves that cause the pressure oscillations measured by the hydrophones which recorded the data during the seismic survey were, in fact, “sound.”
The IRS maintained that data, by its nature, was intangible, and the fact that it was delivered to petitioner’s clients on a tangible medium did not transform the data into a tangible item.
As for whether the data was a sound recording, the IRS argued that the recording of the seismic data was not a sound recording because sound was not recorded or fixed.
Seismic data not QPP.
The Court agreed with the IRS that the processed seismic data was not QPP as it was neither tangible personal property nor a sound recording.
The Court held that the item licensed by TGS was the processed seismic data. Data, as such, is inherently intangible.
Pointing to Reg. §1.199-3(j)(2)(i) and Black’s Law Dictionary definition of tangible personal property, the Court found that the data lacked corporeal form. The intangible nature of the data was not changed by TGS’s loading the information onto a CD or other tangible medium.
The Court said such a medium served only as a vehicle to transfer the data; it did not become an embodiment of the data itself. TGS’s clients were able to transfer the processed data from the tangible medium, copy the information, and share it within their organization.
As to whether the data was a sound recording, the Court held that the processed seismic data, in the form in which it was delivered to petitioner’s clients, was not sound; rather, it is a visual representation of the subsurface of the surveyed area, as derived through analysis and processing of the recorded seismic energy.
The Court said that, after reviewing Reg. §1.199-3(j)(4)(ii)), a visual representation of recorded seismic energy (whether or not such energy was considered sound) did not fall within the ambit of Code Sec. 168(f)(4).
To continue your research on QPP, see FTC 2d/FIN ¶L-4349.
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