News and Insights

California BOE Considers Process to Redefine the Value of Software Discs and Drives for Sales Tax Purposes

Tax Development Mar 20, 2012

In an effort to limit a sales tax exemption for technology transfers and in spite of an adverse court decision, the staff of California Board of Equalization (“Department”) proposed a study or an interested-parties process to define the value of media (discs, drives, etc.) used to store and sell prewritten software.

In Nortel Networks Inc. v. Board of Equalization (“Nortel”), the Second District Court of Appeals (“Court”) held that prewritten software was exempt from sales and use tax under the California’s Technology Transfer Agreement exemption (“TTA exemption”). The TTA exemption limits the taxable sales price of prewritten software to the amount charged for or the value of tangible media (or storage device) on which software is transferred. If a value for the storage device cannot be determined, then tax is due on 200% of the cost of materials and labor to make the storage device.

To implement Nortel, the Department informed the members of the Board of Equalization (BOE) that auditors would be required to examine, in detail, taxpayer records to determine the value of the technology transfer agreements. In lieu of this approach, the Department attempted to perform a cost study by asking taxpayers to allow the Department to review their records. Taxpayers did not respond, and the Department has now proposed an interested-parties process to determine a standard percentage that would represent the value of the storage device.

Because the value of blank discs, drives, and other storage devices is easily determined, it appears that the Department intends to include development costs in its calculation of the amount subject to sales tax. In addition to ignoring the plain meaning of the statute, this method violates the Court’s holding in Nortel.

The BOE is scheduled to review the Department’s request for an interested-parties process at its March meeting.


Susan Traylor Bittick