California Rules That License of Software Pursuant to a Technology Transfer Agreement Is Not Taxable
In California, software licenses delivered to a customer on a tangible medium may be exempt from sales/use tax if the software license is included as part of a technology transfer agreement, as demonstrated in a recent case.
When considering the applicability of sales/use tax to licenses of prewritten (or canned) software, the following are typically true statements: (1) if the software is transferred to the customer via a tangible medium (e.g., disk, flash drive, etc.), then the license is taxable, and (2) if the software is delivered to the customer electronically or via load and leave, then the license will be taxable in some states.  However, in California, software licenses delivered to a customer on a tangible medium may be exempt if the software license is included as part of a technology transfer agreement (TTA).  On Oct. 8, 2015, the California Court of Appeals issued a decision that explains the application of the TTA rules. 
In that case, Lucent engaged in transactions with telephone companies, whereby Lucent sold and the telephone companies paid for (1) switching equipment, (2) instructions on how to install and run the switches, (3) a copy of the software necessary to run the switches (which was provided via magnetic tapes or compact disks) and (4) the right to copy the software onto the switch’s hard drive and to thereafter use the software to operate the switches. Lucent received an assessment for sales tax on the licenses, paid the tax and then filed a claim for refund, which was denied.
The state argued that the fact that the software licenses were provided in tangible form means that the intellectual property rights transferred should be taxable. However, the Court explained that the California legislature enacted a special rule for software or intangibles transferred pursuant to TTAs. A TTA is any agreement under which (1) a person who holds a patent or copyright interest (2) assigns or licenses to another person the right to make and sell a product or to use a process (3) that is subject to the patent or copyright interest. The Court then concluded, despite arguments by the state to the contrary, that the agreements satisfied the TTA rule, and thus sales tax was not due on the licenses (tax was still due and was originally paid on the tangible equipment and manuals). To determine the price of the tangible property, the statute provides three possible methods, in declining order of preference: (1) the price stated in the agreement; (2) the price that such property or similar property has been sold to third parties or (3) 200 percent of the cost of the materials and labor used to produce the property.
The California State Board of Equalization, as a result of the prior case (Nortel – see footnote three below), issued a News Release making clear that these cases do not impact the way that sales tax applies to “off-the-shelf” canned software because the typical retailer does not hold any patent or copyright interest in the software.  Taxpayers that paid sales/use tax on purchases of non-custom software from the retailer that held the patent or copyright may be eligible for refunds, and our SALT team is able to assist you to review your situation and pursue a refund if available. 
It is not uncommon for states to have unique rules that may exempt or subject to tax transactions that most (or all) other states would treat differently. Being aware of these rules can help you minimize your tax liabilities or potential exposures. The SALT team at HA&W is experienced with these issues, and we constantly strive to keep our clients advised of important issues and developments in SALT in order to help them address their specific tax situations. We will continue to monitor these and other significant SALT developments and include any updates in future issues of the HA&W SALT Newsletter.
Contact Jeff Glickman, partner-in-charge of HA&W’s SALT practice, at email@example.com for more information.
 The load and leave method of software delivery typically involves the software vendor bringing the software on a disk or other tangible medium to the customer’s business location, loading the software onto the customer’s equipment and not leaving the tangible medium containing the software (or any tangible instruction manuals) with the customer.
 Cal. Rev. & Tax Code §6011; Cal. Code Regs. §1507.
 Lucent Tech. Inc. v. State Bd. of Equalization, No. B257808 (Cal. Ct. App. Oct. 8, 2015). There was a previous case with almost identical facts that also ruled in favor of the taxpayer – Nortel Networks, Inc. v. State Bd. of Equalization, 191 Cal.App.4th 1259 (2011).
 California SBE News Release No. 66-11-H (5/27/2011)
 For more information on TTAs, click here.
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