News and Insights

California’s Court of Appeals Affirms Lucent Technologies Decision

Tax Development Oct 09, 2015

A California Court of Appeals has affirmed the state’s sales tax exclusion applicable to technology transfer agreements (TTAs) and affirmed more than $2.5 million in attorney’s fees to the taxpayer due to the State Board of Equalization’s (BOE’s) failure to pay “a tax refund to which it was undisputedly entitled under controlling law.”

The decision in Lucent Technologies, Inc. v. State Board of Equalization wasissued by the California Court of Appeals, Second District, on October 8, 2015. In Lucent, the BOE was relitigating virtually the same facts and most of the same legal arguments that were rejected four years ago in Nortel Networks, Inc. v. Board of Equalization, 191 Cal. App. 4th 1259, 119 Cal. Rptr. 3d 905 (2011). This point was not lost on the Lucent court, which issued its decision just two weeks after hearing oral arguments in the case. In its decision, the court expressly refused to overturn Nortel andchastised the BOE for wasting taxpayer dollars relitigating decided law. It went on to reject every legal argument that the BOE made.

Like Nortel, the Lucent case involved a manufacturer’s sale of tangible personal property (TPP) to a communications company and its transfer to the company of a right to use software needed to operate the TPP. The BOE maintained that the software was taxable. The taxpayer, citing the state’s TTA statute and the decision in Nortel, maintained that the software was exempt.

California’s sales tax law excludes TTAs from the definition of sales price and gross receipts. The law provides that when a TTA is transferred on a form of tangible personal property, such as a storage disk, tax is due on the amount charged for the tangible personal property, but no tax is due on the amount paid for the TTA.

Central to the BOE’s argument was its claim that copying software to a disk or magnetic tape transformed the software from an intangible into a piece of tangible personal property and, thus, made it taxable. The court, however, said that approach puts too much emphasis on the manner in which software is delivered to the buyer. It noted that under prior case law, California courts have already held that the media used to transfer the software is not essential to its later use and, therefore, does not necessarily cause the transaction to be taxable.

The court also rejected the BOE’s arguments aimed at tightening the types of agreements that qualify as TTAs. Specifically, it asserted that a contract that transferred the mere right to use software did not qualify, that the TTA statute was limited to contracts in which the holder of the patent or copyright transferred “a meaningful right,” such as the right to mass produce or sell the patented or copyrighted item downstream. And it said that the licensee should be required to show that, but for the license, it would be infringing on the patent or copyright. The court dismissed these arguments, noting that these requirements are neither contained in the statute nor consistent with prior precedent.

Finally, the court addressed the BOE’s argument that Lucent had not correctly valued the TPP that was taxable in the transfer of the TTA (i.e., the storage media for the software). While the taxpayer said the taxable amount was the value of the blank disk, the BOE insisted that the value of the TPP included the research and development costs that went into the development of the software copied to the disks. The court called the BOE’s position “little more than a variation on an argument we have already rejected” and reiterated its holding that copying software to a disk “does not therefore transmogrify the software itself into tangible personal property.” It said that “the price of the blank disk is the price of the tangible personal property, and is what is to be taxed under the technology transfer statute.”

The BOE has the right to appeal the decision to the California Supreme Court; however, it is questionable if the Court would take the case because it refused to do so when the BOE appealed Nortel.


Richard V. Carlson 

John P. Lyon