In mid-May 2011, the California Supreme Court denied the State Board of Equalization’s petition for review of the Court of Appeal decision in Nortel Networks, Inc. v. State Board of Equalization (Case no. B21341, filed January 11, 2011). The Nortel case has broad implications for California’s taxation of software.
The amount charged for intangible personal property transferred with tangible personal property in any technology transfer agreement “TTA”) is exempt from tax. Nevertheless, the longstanding position of the State Board of Equalization (“BOE”) has been that all sales of prewritten software are subject to California’s sales tax. The BOE issued regulations that exclude prewritten software from the definition of a TTA. The underlying Court of Appeal decision determined that the BOE exceeded its authority when it issued its regulation.
The Court’s broad interpretation of the TTA statutes and invalidation of the BOE’s regulation excluding prewritten software from TTAs may create refund opportunities. Customers who have paid California sales or use tax on purchases or licenses of prewritten software (meaning, practically everyone in California) should work with vendors to file claims for refund. In the BOE’s own words, under the now-final Court of Appeal’s ruling, “sales of software programs, such as Windows 7 operating system, Microsoft Word, Quicken or TurboTax, will be subject to claims of exclusion from tax.”
Currently, hardware and software are often bundled in a single price. The hardware component remains taxable. In order to avoid taxation of the now tax-exempt software portion (whether for a refund or for future sales), an appraisal may be needed of the separate hardware and software components.