On January 20, 2016, the California Supreme Court denied review in Lucent Technologies,¹ letting stand the appellate court's ruling that a software license granted to a purchaser in California, and transferred with tangible media as part of a technology transfer agreement, was exempt from sales and use tax as a matter of law. Implicitly, by denying certiorari, the Court upheld the California Appellate Court's (appellate court) findings in Lucent Technologies.

In Lucent Technologies, the appellate court stated that the intangible component of a taxpayer's sale of intangible property (e.g., a license) bundled with tangible personal property was not subject to California sales or use tax. In so doing, the appellate court stated that to find otherwise would lead to an "absurd result."

The appellate court also described the default rule to tax a single bundled sale of intangible and tangible personal property, when the two are inextricably intertwined. That is, when the tangible component is essential or physically useful to the intangible component, the entire transaction is (by default) subject to taxation. The appellate court specifically stated, however, that California's Technology Transfer Agreement (TTA) statutes set up a special rule and an exception to the default rule. The appellate court held so because of the TTA statutory language and because the statutes provide a method to determine the value of the intangible component not subject to tax. The appellate court found that, if a TTA exists, the amount paid for a license bundled and inextricably intertwined with tangible personal property is not subject to tax.

In reaching its conclusion in Lucent Technologies, the appellate court relied on Nortel,² in which it heldthat the purchase of an intangible software license that was used to operate telephone switching equipment was exempt from sales and use tax under the TTA statutes. In Lucent Technologies, the same appellate court held that the purchase of the software license at issue also was not subject to tax, despite being transferred with tangible personal property. It again held as it had in Nortel for a few reasons. First, the tangible media with which the software license was transferred was not essential to the use of the software. Second, the software was copyrighted and the software license enabled the licensee to copy the licensed software or make and sell products subject to the licensor's copyright interests. And third, the software embodied patented processes and the license enabled the licensee to make and sell products subject to the licensor's patent interests.

In reaching its decision and responding to the arguments by the California State Board of Equalization (Board), the appellate court specifically cited warnings given to the legislature during the proceedings by which the TTA statues were enacted. The legislature enacted the TTA statutes despite specific examples and warnings given by the Board and members of the legislature's own analysis bureau that the TTA statutes could exempt the value of patented interests transferred in the sale of integrated circuit boards, plastic injection machinery or any other tangible personal property that may be used to implement a patented process. According to the appellate court, the legislature codified the TTA statutes in spite of these warnings that any patent or copyright interests transferred with tangible personal property could be placed outside the bounds of California's sales and use tax laws. For more on the appellate court's ruling, see Tax Alert 2015-1934.

Implications

This decision in Lucent Technologies expressly affirms and expands on the findings in Nortel about the breadth and application of the TTA statutes. Upon a denial of review by the California Supreme Court, the appellate court's Lucent Technologies decision became binding. Lucent Technologies is the final statement of the law and the authoritative guidance on how to apply the TTA statutes in California. With this, the value of any copyright or patent interest is not subject to the sales or use tax if it is licensed to a person with the contractual right to: (1) copy the copyrighted work transferred, (2) make or sell a product subject to the interest, or (3) use patented processes embodied by the item transferred.

The Board has not stated whether it will petition for review by the United States Supreme Court and it seems questionable whether, even if appealed, there is a sufficient issue worthy of consideration by that Court. Currently, there are no California regulations fully codifying the conclusions reached in either the Nortel or Lucent Technologies decisions. Whether the Board and/or legislature intend to take additional actions, including modifying legislation, regarding future application of the TTA exemption is currently undetermined.

The Lucent Technologies decision reinforces the TTA statutes, the Nortel ruling and any claims for refund thereunder. In light of the California Supreme Court's denial of the Board's appeal of the Lucent Technologies decision, taxpayers should consider filing a TTA-based refund claim with the Board if they did not previously submit one.

———————————————

———————————————
ENDNOTES

¹ Lucent Technologies, Inc. et al v. State Board of Equalization,No. B257808 (Cal. Ct. App., Los Angeles County, Oct. 8, 2015), review denied, No. S230657 (Cal. S. Ct. Jan. 20, 2016).

² Nortel Networks Inc. v. State Board of Equalization, 191 Cal.App.4th 1259 (2011).