On September 24, the Court of Appeal for the Second District heard oral argument in Lucent Technologies v. State Board of Equalization.1 The issue before the court was whether telephone switching software is exempt from sales tax under the statutory exemption for technology transfer agreements (“TTA”). The Revenue and Taxation Code provides that California sales tax does not apply to the amount charged for intangible personal property transferred in a TTA.2 A TTA is “any agreement under which a person who holds a patent or copyright interest assigns or licenses to another person the right to make and sell a product or to use a process that is subject to the patent or copyright interest.”3 The issue before the court in Lucent is nearly identical to the one addressed by the same court in Nortel Networks, Inc. v. State Board of Equalization.4 In that case, the Court of Appeal held that a license of prewritten software falls within California's sales tax exemption for transfers of intangible property pursuant to a TTA.
The State Board of Equalization (“SBE”) tried to distinguish Nortel by arguing that it never before raised the argument of “tangibility”—that when computer code is contained on a disk or other physical medium, it is not intangible property, but rather, is tangible personal property. The SBE also argued that although the TTA statute called for a transfer of intellectual property right, no “meaningful” rights were transferred here, just the “mere right to use” the property. The taxpayer, on the other hand, asserted that Lucent and Nortel were virtually indistinguishable and that the SBE’s attempt to limit the TTA exemption to transfers of “meaningful” intellectual property rights is not supported anywhere in the statute. Lucent also noted that the SBE warned the Legislature that it would broaden the exemption for software by enacting the TTA statutes, and the court asked SBE counsel about whether this fact supported the taxpayer’s read of the statute.
The court did not issue a tentative ruling signaling how it was going to rule, but any departure from the Nortel case would create an inconsistency within the same appellate district. That seems an unlikely result. Taxpayers who have software claims pending will still be left wondering how the SBE will implement the Lucent decision if it is favorable to the taxpayer. There has been no indication of any movement toward adoption of regulations, nor has there been any indication of any legislation regarding this tax exemption. There is no indication in the form of audit directives or other SBE guidance as to how taxpayers can resolve pending audits or claims. At this point, taxpayers should assume that to obtain their exemptions under the TTA statutes based on Nortel and Lucent, they will have to push the issue with the SBE and move forward toward litigation.
For more information on the Lucent and Nortel cases and the California sales tax exemption for intangible property pursuant to a TTA, contact the authors of this Alert or another member of the Reed Smith State Tax Group.
- California Court of Appeal No. B257808.
- Rev. & Tax. Code §§ 6011(c)(10)(D), 6012(c)(10)(D).
- 191 Cal. App. 4th 1259 (2011).
Client Alert 2015-170