California Bills Likely on Taxation of Software

By Laura Mahoney

California lawmakers are likely to introduce bills this year to clarify the reach of a 2015 court ruling on the measure of sales and use tax on software stored on tangible media, as the State Board of Equalization continues to struggle with its response.

The “innovation economy” should be paying its fair share of tax, Assembly Revenue and Taxation Committee Chairman Sebastian Ridley-Thomas (D) said at an informational hearing he convened on the topic Jan. 30. The question is how much, he said.

Legislation, as well as efforts to change SBOE regulations, will focus on whether the ruling in the Lucent case means tax applies only to to prepackaged software on storage media such as discs, more broadly to software preloaded onto computers, or even further to software embedded in products from coffee makers to cell phones and cars.

A lack of clarity about when tax applies is a a major concern for technology companies and Silicon Valley, SBOE Assistant Chief Counsel Robert Lambert said. If companies collect the tax improperly, they could be subject to class actions under state consumer protection laws, he said.

State Revenue Loss

State revenue losses would range from a low of $20 million a year under the narrowest interpretation to about $250 million if the tax exemption applies to preloaded software on computers, and probably billions of dollars if it also applies to software embedded in products, Jay Chamberlain, chief of the Department of Finance’s Revenue and Taxation Section, told the committee.

The ruling in Lucent Techs., Inc. v. State Bd. of Equalization and a similar ruling held that intangible, custom software that Lucent placed on telephone switches for customers was a nontaxable technology transfer agreement (TTA).

A TTA is defined in state law as a transaction in which tangible and intangible goods are sold and the seller holds a patent or copyright interest, the seller assigns or licenses the right to make and sell a product or to use a process to the buyer, and the right is subject to the patent or copyright interest the seller holds.

SBOE Staff Interpretation

The SBOE’s legal department believes the Lucent ruling means a tax exemption applies only to TTAs using external storage media convenient to the transfer of software, Lambert said.

For example, if software is on storage tapes that the buyer would discard after downloading the software, tax doesn’t apply to the tangible storage media. If the storage media is necessary for the usefulness of the software, tax should be measured on the value of the tangible storage media.

Lambert said he wasn’t speaking for the five-member elected board because the board hasn’t taken a position yet on the issue.

Some Broad Interpretations

Some attorneys and accountants are interpreting the ruling to mean it applies in the broadest sense to software embedded in products, Lambert said.

“That’s where the interest is because that’s the big money,” he said.

The SBOE began discussing options in 2016 to amend its regulations to reflect the court’s holding in Lucent, but has postponed holding more discussions with interested parties or releasing updated drafts of possible rule amendments scheduled for late 2016 and early 2017. Lambert said the board’s legal staff is still working to address comments it has received from interested parties so far.

In the meantime, the SBOE has begun acting on some of the 900 refund claims filed while the Lucent case was pending and plans to issue refunds to taxpayers with facts similar to the case.

To contact the reporter on this story: Laura Mahoney in Sacramento, Calif. at LMahoney@bna.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bna.com

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