Tax Savings

California Court Ruling and Software

In May, 2011, the Board of Equalization (BOE) authorized an amendment to make its current regulations consistent with a recent California Court of Appeal decision holding that sales tax does not apply to interests in patents and copyrights transferred with prewritten (or canned) software in a technology transfer agreement (TTA).

This recent Board amendment was a result of a January 18, 2011 decision by the California Court of Appeal for case Nortel Networks, Inc. v. State Board of Equalization,. The court ruled that the license of prewritten software by Nortel Networks, Inc. (“Nortel”) to Pacific Bell Telephone Company (“Pacific Bell”) — used to operate switching equipment sold by Nortel to Pacific Bell — was exempt from sales tax because it was in fact a TTA. As a result, Nortel was awarded a refund of over $29 million plus costs and interest.

Prior to the recent amendment, the BOE had adopted Regulation 1507, which defined a TTA. This regulation attempted to limit the scope of exempt TTA’s to exclude all prewritten software, including software that licensed or assigned a patent or copyright interest for the purpose of reproducing and/or selling other property subject to the patent or copyright. This exclusion was not consistent with existing Legislature and the Court of Appeals rejected this portion of the regulation, stating that the BOE exceeded its authority by adopting it.

What Does This Mean For You?

As a result of the recent ruling in favor of Nortel, the BOE may no longer be able to tax many prewritten software programs that are copyrighted, contain a patent process and enable the licensee to copy the software and to make and sell products.  They will instead have to examine the transfer of a prewritten software program on a case-by-case basis to determine if it in fact it is a TTA.

It is important that you are aware of these recent changes to avoid  overpaying State Taxes. There may  also be other software exemption issues, needing tax planning, savings, and refunds. Each case is unique and requires specific attention.