By John P. Lyon
The California Supreme Court (“Court”) has issued an order refusing to overturn a lower court decision that affirmed the state’s sales tax exclusion applicable to technology transfer agreements (TTAs).
On Wednesday, January 20, 2016, the Court issued an order denying the State Board of Equalization’s (BOE’s) petition for review of a 2015 decision by the California Court of Appeals, Second District, in Lucent Technologies, Inc. v. State Board of Equalization. In the decision, the appellate court had rejected all of the BOE’s legal arguments and ordered it to pay the taxpayer’s estimated $2.5 million in attorneys’ fees for failing to pay the taxpayer “a tax refund to which it was indisputably entitled under controlling law.” The Supreme Court’s refusal to review that decision finalizes it and creates renewed pressure on the BOE to begin processing numerous TTA claims by other taxpayers that have been pending for several years.
The Lucent case presented virtually the same facts and most of the same legal arguments that the BOE lost previously in an earlier case, Nortel Networks, Inc. v. Board of Equalization, 191 Cal. App. 4th 1259, 119 Cal. Rptr. 3d 905 (2011). The BOE also appealed the Nortel decision, but the Supreme Court then also refused to intervene. When the Lucent case came before it four years after Nortel was decided, the appellate court chastised the BOE for wasting taxpayer dollars by relitigating decided law.
Both the Nortel and Lucent case involved manufacturers that sold tangible personal property (TPP) to communications companies and transferred to the companies a right to use software needed to operate the TPP. The BOE maintained that the software was taxable. The taxpayers, citing the state’s TTA statute, maintained that the software was exempt.
California’s sales tax law excludes TTAs from the definition of sales price and gross receipts. The law provides that when a TTA is transferred on a form of tangible personal property, such as a storage disk, tax is due on the amount charged for the tangible personal property, but no tax is due on the amount paid for the TTA.
Central to the BOE’s argument in the Lucent case was its claim that copying software to a disk or magnetic tape transformed the software from an intangible into a piece of tangible personal property and, thus, made it taxable. The appellate court said that approach puts too much emphasis on the manner in which software is delivered to the buyer. It noted that under prior case law, California courts have already held that the media used to transfer the software is not essential to its later use and, therefore, does not necessarily cause the transaction to be taxable. The court had also rejected the BOE’s attempts to limit the types of agreements that qualify as TTAs, as well as its arguments about how the taxable amount of the TPP should be determined. While the taxpayer said the taxable amount was the value of the blank disk, the BOE insisted that the value of the TPP included the research and development costs that went into the development of the software copied to the disks. The court called the BOE’s position “little more than a variation on an argument we have already rejected” and reiterated its holding that copying software to a disk “does not therefore transmogrify the software itself into tangible personal property.” It said that “the price of the blank disk is the price of the tangible personal property, and is what is to be taxed under the technology transfer statute.”