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Exhibiting Movies and Other Content Still Produces a Cost of Goods Sold Deduction

Tax Development Jan 09, 2017

Exhibiting Movies and Other Content Still Produces a Cost of Goods Sold Deduction for Texas Franchise Tax Purposes

On January 6, 2017, the Texas Third Court of Appeals (“Appellate Court”) withdrew its April 30, 2015 opinion and judgment in American Multi-Cinema, Inc. (“AMC”) v. Glenn Hegar, to substitute a revised version, which still concludes that 1) AMC’s exhibited movies constitute tangible personal property (TPP), not intangible property nor a service; and 2) the costs of producing the exhibited movies are not isolated to the screen and speakers but include the entire production area in the auditorium.

One of the allowed subtractions in computing franchise tax is the cost of goods sold (COGS). Tax Code § 171.1012(a)(1) defines “goods” as TPP sold in the ordinary course of business. Subsection (a)(3)(A)(i) defines TPP as “personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to the senses in any other manner.” In addition to the general definition of TPP, Tax Code § 171.1012(a)(3)(A)(ii) also provides that TPP includes “films, sound recordings, live and prerecorded TV, 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.” The Appellate Court determined that because this subsection was dispositive, it was not resolving whether the evidence also supports the trial court’s finding regarding Tax Code § 171.1012(a)(3)(A)(i).

Applying the standard that the court will uphold a trial court’s conclusion of law if the judgment can be sustained on any legal theory supported by the evidence, the Appellate Court, after discussing in detail the evidence presented, determined that the evidence was legally sufficient to support the trial court’s judgment that AMC’s exhibition of movies produces goods for sale in the ordinary course of business.

The Appellate Court was not persuaded by the Texas Comptroller’s (“Comptroller’s”) arguments that AMC’s customers were purchasing an intangible (license) or a service.  It relied on the plain and common meaning of those words: 1) Intangible – “property having no physical substance apparent to the senses: incorporeal property (as choses in action) often evidenced by documents (as stocks, bonds, notes, judgments, franchises) having no intrinsic value or by rights of action, easements, goodwill, trade secrets”; and 2) Service – “the performance of work commanded or paid for by another that does not produce a tangible commodity.” Citing “Newpark, 422 S.W.3d at 54 n.8 (defining ‘service’ according to common meaning in context of section 171.1012 and citing definition in Webster’s;  see also Webster’s at 2075 (defining ‘service,’ among other meanings, as ‘useful labor that does not produce a tangible commodity’), 458 (defining commodity as ‘economic good’)” [footnote omitted]. 

The Court was also not persuaded by the Comptroller’s “take-home” arguments that the customers did not leave with a copy of the film and found that the Comptroller’s proposed interpretation was at odds with a subsequent amendment to the statute. The amendment spelled out that COGS for a movie theater shall include “the acquisition, production, exhibition, or use of a film or motion picture.” Discussion regarding the amendment adding subsection (t) to the statute in 2013 had been included in a footnote in the withdrawn opinion but was promoted to the body text in the new opinion. 

In determining the costs that were allowed to be included in COGS, the Appellate Court found that because the definition of “production” in Tax Code § 171.1012(a)(2) is not ambiguous, the trial court erred in deferring to the Comptroller’s interpretation. Based on the evidence presented, the Appellate Court instead found that costs associated with the auditoriums were part of the direct costs of producing the product. The amount of refund was thus determined by the parties’ stipulations.

As with any COGS case, the facts and circumstances regarding the “good” and how it is produced are extremely unique. This makes the presentation of evidence a key factor in successfully resolving such cases.


Sandi Farquharson