Microsoft’s Remote Royalties Not Taxable Income in Wisconsin

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By Alex Ebert

Two states have now held that Microsoft’s software royalties from out-of-state manufacturers don’t count toward state income and franchise taxes when those computers are sold to in-state users.

The latest decision came last week when the Wisconsin Tax Appeals Commission sided with Microsoft in its appeal of a $2.88 million assessment by the Wisconsin Department of Revenue from the software giant’s state corporate franchise tax returns from June 2006 through June 2009. The commission held that just like royalties a business pays when it sells items licensed from a clothing brand, the licensing of Microsoft software to out-of-state manufacturers wasn’t “income-producing activity” in-state because Microsoft wasn’t directly engaged in the sale of the computers in Wisconsin ( Microsoft Corp. v. Wis. Dep’t of Revenue , Wis. Tax App. Comm’n, No. 13-I-042, 8/10/17 ).

The decision aligns with a 2012 California Court of Appeals decision that reached the same conclusion.

The two opinions indicate that millions of dollars in royalties that Microsoft or other computer companies collect from licensing software to manufacturers, called “original equipment manufacturers” or “OEMs,” don’t factor into apportionment for those states. While they appear to be the only two courts that have ruled on the issue, the holdings may set a strong example for other state revenue departments.

“Overreach”

Mark Nebergall, president of the Software Finance and Tax Executives Council, told Bloomberg BNA Aug. 16 that the Wisconsin Department of Revenue was “overreaching” when it sought to collect taxes on remote licensing deals. He said that both the California and Wisconsin tribunals were correct to side with Microsoft.

“Despite the fact that the software industry has been going on for 40 years, departments of revenue are still struggling with what to do,” Nebergall said. “You’ve got to wonder if the state was trying to double-dip.”

The Wisconsin Department of Revenue argued that it didn’t matter whether the licensing OEMs were outside the state because they sold the computers with Microsoft software to computer users in Wisconsin. The commission didn’t buy that argument.

“Although the sales of these computers assembled by the OEMs included a sublicense to allow the end-user to use the Microsoft software, the sale of the computers is simply not an activity directly engaged in by Microsoft,” the commission said in its ruling. The commission was only asked to consider Microsoft’s sales to out-of-state manufacturers, not the smaller Wisconsin-based manufacturers.

Consistent Ruling

Representatives from Microsoft declined to comment on the Wisconsin ruling. This is the second time in five years the software giant won on the issue.

California’s Franchise Tax Board attempted to tax software licensing agreements between Microsoft and out-of-state OEMs as far back as 1995. A trial court found the royalties “were taxable because they constituted receipts from the licensing of computer software production, which the court found to be tangible personal property.”

The appeals court overturned the ruling, finding that the sale was actually for intangible intellectual property rights to copy the software onto the OEM’s computer. The sale of this right to copy didn’t mean the state could tax Microsoft when a Californian later purchased the computer.

To contact the reporter on this story: Alex Ebert in Columbus, Ohio at aebert@bna.com

To contact the editor responsible for this story: Jennifer McLoughlin at jmcloughlin@bna.com

For More Information

Text of the ruling is at http://src.bna.com/rIQ.

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