Computer and software industry players are tangling with the state Board of Equalization (BOE) on the governor’s revised budget which proposes trailer bill language to clarify that software delivered on media (such as on disc, diskettes, tape, or cartridge) is tangible physical property and thus will be subject to sales tax provisions. CalTax and computer industry players such as Qualcomm have opposed this language, asking that this complex issue be taken up in a policy committee and not treated in the budget process. The Assembly Budget Subcommittee #4 on State Administration disagreed at a May 22 hearing and approved the trailer bill language 3-2, but today, the Senate Budget Subcommittee #4 held the item over for further consideration.
The governor’s trailer bill language proposes to amend Section 6010.9(a) of the Revenue and Taxation Code to make clear that "Notwithstanding any other provision of this part, a computer program embodied or stored on storage media is tangible personal property."
As background, sales of software or other products like books or music that are delivered through the Internet are exempt by regulation and not subject to sales or use tax. Sales of software delivered on storage media, however, are considered tangible personal property and thus are taxable. Current law states that for an otherwise taxable transaction, the value of any technology transfer agreement (TTA) is not taxable. A TTA is an agreement under which a right to a patent or copyright is transferred to the buyer in a transaction. Recently, in a California Supreme Court case, Navistar vs. BOE, the Supreme Court found that software on tangible media is tangible personal property. In Nortel v. BOE, a California Appeals Court sided with the taxpayer’s contention that some transactions are TTAs. This court did not hold that software is intangible, but some in the computer industry have argued that all software, even prepackaged software, is intangible and thus not subject to tax.
According to the BOE representative at the Assembly subcommittee hearing yesterday: (1) the governor’s revise language clarifies existing law; (2) current law does not have an explicit statement that software delivered on media is tangible personal property but BOE argues it is implied by the current statute which has an exemption for custom software; (3) the revise language is consistent with recent court decisions; and (4) the language is consistent with practices by large retailers like Best Buy who do collect sales tax on pre-packaged software such as Microsoft Office. BOE argued that the May revise language should be approved to protect against potential loss of "hundreds of millions of dollars in tax revenues by the state and local governments." The Legislative Analyst’s Office had no issues with the May budget revise language.
CalTax’s representative lodged arguments that the revise language is unnecessary given pending litigation in a case involving Lucent, and noted that this is a very complex policy issue better suited to a policy committee process not a May revise budget process. She argued that the governor’s language may be seen as revoking the exemption for custom software due to the "notwithstanding" language. CalTax requested that its proposed amendments be accepted which protect TTAs, address site license taxation, and preserve TTAs for embedded software. Also speaking in support of the CalTax position were Qualcomm and Ryan Software.
In the hearing room discussion, it was revealed that BOE is engaging in some discussions with the industry about this language. The State BOE’s Chief Counsel Randy Farris noted that there is sharp disagreement as to the "foundational issue" of whether software is inherently intangible or not. He said the BOE’s position was the "once software is encoded onto storage media, that software becomes part of the tangible personal property because physical changes are being made in the storage media that are perceivable by the sense and instruments that humans use to perceive." At the Assembly hearing yesterday, a motion to hold open this language was defeated on a vote of 3-2, and the language was approved in a vote of 3-2.
Today, at a Senate Budget Subcommittee #4 on State Administration hearing, the language was held open for further industry discussions to take place, after a stronger showing by the industry.
