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Software Licensed to Operate Switching Equipment Exempt from California Sales Tax


Software/Hi-Tech

Software licensed by a California taxpayer to a telephone company to operate switching equipment was deemed exempt from sales and use tax under statutes regarding technology transfer agreements (TTAs). The software was copyrighted, contained patented processes, and allowed the telephone company to copy the software and sell products that embody the patents and copyright. The taxpayer licensed the equipment to the telephone company, giving them the right to produce telephonic communications without infringing on the taxpayer’s patents. The Court of Appeal of California stated that the TTA statutes apply when patents or copyrights are transferred and that licensing agreements are exempt from sales and use tax if they qualify as TTAs. The licenses allowed the telephone company to reproduce the copyrighted material on its computers. As a result, the prewritten software qualified as a nontaxable TTA. The California State Board of Equalization (BOE) attempted to limit the scope of the TTA statute by excluding prewritten computer programs. This was determined to be an invalid exercise of its regulatory power. The TTA statutes apply to any agreement involving the sale or license of copyrighted materials or patented processes. They do not restrict agreements that transfer an interest in prewritten software. The BOE has announced that it will amend a regulation to make it consistent with the Court’s decision. The amendment clarifies that when the holder of a copyright or patent sells that intellectual property to another company in a TTA that includes the transfer of software, the amount charged for copyrights or patents is exempt from sales tax. Taxpayers that have licensed software in California should evaluate whether the software agreements qualify as TTAs and if tax was paid apply for a refund of the sales or use tax. The California State Board of Equalization has subsequently amended a regulation (Reg. 1507) to make it consistent with the court’s holding in this case. (Nortel Networks, Inc. v. State Board of Equalization, Court of Appeal of California, Second District, No. B213415, January 18, 2011; News Release 66-11-H, California State Board of Equalization, May 27, 2011; Reg. 1507, California State Board of Equalization, effective June 22, 2011)

(06/24/2011)
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