The California Department of Tax and Fee Administration (CDTFA) recently released a discussion paper and proposed regulations that would address the implementation of Senate Bill 122 (SB 122), which expands the state's sales and use tax base to include prewritten computer software regardless of delivery method. This expansion applies to transactions occurring on or after January 1, 2027, subject to specified exclusions and exemptions. (See Tax Alert 2026-1375.)

Among other matters, the proposed regulations would address sourcing, transition rules for existing contracts, multiple points of use (MPU) certificates, exclusions and exemptions, and the $5 million seller liability relief and purchaser use tax direct payment regime. The CDTFA discussed the proposed regulations at an interested parties meeting on September 10, 2026.

Key provisions and observations from interested party meeting

Proposed Regulation 1600 would confirm that qualifying infrastructure as a service (IaaS) and platform as a service (PaaS) offerings are examples of nontaxable digital infrastructure transactions, while software as a service (SaaS) transactions generally constitute taxable sales of prewritten software.

Other exclusions include:

• Sales of custom software
• Certain digital content
• Video games played for entertainment purposes
• Qualifying human effort services
• Products purchased solely for use outside California or in interstate or foreign commerce

Questions remain regarding how tax will apply to certain mixed and bundled offerings. At the interested parties meeting, attendees requested additional practical examples addressing these open questions.

For contracts spanning the January 1, 2027, effective date, taxability generally would depend on when the purchaser receives the right to access or use the software, rather than when the contract is executed or payment is made. Periodic subscriptions would be treated as continuing sales, with tax applying to subscription periods beginning on or after January 1, 2027. At the interested parties meeting, attendees requested additional practical examples clarifying the application of tax to periodic subscriptions and addressing renewals, amendments, additional licenses, and other contractual changes spanning the operative date.

For non-in-person sales of electronically transferred or remotely accessed software, Proposed Regulation 1600 generally would source the transaction using the purchaser's California "known address," with priority given to the billing address when multiple addresses are provided. This approach differs from the sourcing rules applied by other states and may create inconsistent and overlapping tax treatment. The CDTFA indicated that sellers generally would be allowed to determine sourcing on a transaction-by-transaction basis and, in the absence of evidence that would undermine good faith, would not be required to investigate their records for possible known California addresses of the purchaser when the only addresses disclosed by the purchaser during the consummation of the transaction are addresses outside California.

Proposed Regulation 1600.1 would shift responsibility for reporting tax exclusively to the purchaser, when a retailer's aggregate sales of electronically transferred or remotely accessed digital products to a single purchaser exceed $5 million during a calendar year.¹ When the $5 million threshold will be exceeded, the proposed regulation would require the purchaser to obtain a use tax direct pay permit so the purchaser can properly self-assess and pay the applicable use tax. The purchaser would also have to timely provide the retailer with a use tax direct payment exemption certificate for the transaction that will cause the purchaser to exceed the threshold.

Alternatively, the proposed regulation would allow the purchaser to request a waiver from the CDTFA, allowing the retailer to continue collecting and remitting the tax. The purchaser would submit the request before the purchase that would exceed the threshold and explain why the waiver would be mutually convenient for the CDTFA, retailer and purchaser. If approved, the purchaser would timely provide documentation confirming the waiver approval to the retailer, together with the anticipated places of first use, as well as the digital products expected to be used at each location.

The proposed regulation would prohibit a retailer from accepting a use tax direct pay permit certificate for digital products before the retailer-specific threshold is exceeded, even if the purchaser expects to exceed the threshold later in the year. At the interested parties meeting, attendees requested an early direct pay election, noting the proposed approach would create a significant administrative burden, since it would require purchasers and sellers to separately track the same threshold and change the tax treatment during the calendar year. In response, the CDTFA noted that, as an alternative to the $5 million purchaser use tax direct pay regime, purchasers could apply for the alternative use tax direct pay permit provided under Cal. Rev. and Tax. Code Section 7051.3(c), which is subject to a lower $500,000 threshold that is not retailer specific. However, this alternative use tax direct pay permit cannot be taken in good faith by a retailer when a transaction is subject to sales tax.

Proposed Regulation 1600.2 would allow purchasers to allocate digital products between California and non-California use, using any reasonable method that is applied consistently and uniformly, and is supported by the purchaser's books and records. User- and computer-based allocations would be presumed reasonable, while an allocation based on server location would not.

The proposed regulation would allow purchasers to issue an MPU certificate, but they would have to identify the California and non-California usage allocations and describe the allocation methodology used. Sellers would remain responsible for collecting and remitting tax on the California portion. This proposed MPU approach differs from the MPU approach commonly followed in other states, where the certificate generally shifts the allocation and tax payment responsibility to the purchaser without requiring specific allocation to be determined at the time of purchase. At the interested parties meeting, attendees requested that the CDTFA adopt a similar blanket MPU certificate approach, noting that purchasers may not know the allocation at the time of purchase and that sellers' systems may not support taxing the customer-specific California taxable allocations.

Implications

The proposed regulations would introduce significant compliance requirements for both sellers and purchasers, including new product classification and sourcing requirements, customer-specific MPU allocations, and retailer-by-retailer and customer-by-customer monitoring of the $5 million threshold. Businesses may need to review and modify contracts, tax engines, billing systems, procurement processes, and certificate procedures.

As the January 1, 2027, operative date approaches, sellers and purchasers of digital products may want to consider the following:

• Review existing and new contracts to determine when software access rights transfer, identify subscription periods extending beyond January 1, 2027, determine whether contract modifications could be made to reduce the effects of SB 122, and assess the parties' respective responsibilities under the new tax regime
• Review product and purchase classifications and evaluate whether billing, procurement, enterprise resource planning (or ERP), and tax engine systems can apply the appropriate tax treatment and sourcing rules, including the purchaser's known address hierarchy and the purchaser-specific MPU allocations
• Establish procedures to track qualifying digital product transactions toward the $5 million threshold, identify the threshold-triggering transaction, and coordinate the transition from retailer collection to purchaser self-assessment
• Evaluate the application procedures and timeliness requirements for obtaining a direct pay permit or requesting a waiver, as well as documentation requirements for issuing and accepting direct pay permits
• Revisit policies and controls for accepting, validating, and retaining exemption, direct pay permits, and MPU certificates
• Submitting comments to the CDTFA by September 24, 2026, particularly on the unresolved issues or administratively burdensome aspects of the proposed regulations.