The proposed amendments and new regulation address the need to clarify and update California’s sales and use tax regulations as they apply to software transactions, particularly those involving Technology Transfer Agreements (TTAs). Previous court decisions (Nortel and Lucent) established that when software is transferred on tangible personal property (TPP) under a TTA, only the value of the physical media - not the software license or intangible rights - is subject to tax. However, existing regulations applicable to TTAs were inconsistent and unclear, leading to confusion for businesses and tax authorities.
The proposed amendments and new regulation aim to define key terms (such as “bargained - for software”), establish clear presumptions for when software is or isn’t covered by a TTA, and provide simplified methods (including a safe harbor) for determining the taxable value of TPP in software transactions. According to the California taxing agency, the changes are intended to ensure that tax is applied consistently and fairly, reduce disputes, and align regulatory language with legal precedents. Undertaking a taxability analysis requires recognizing the distinction between custom and prewritten software, the method of software delivery, and the contractual terms governing software rights, as these factors may impact the sales tax treatment of software when sold with related hardware in California.
Key takeaway
The proper taxation of products sold with software embedded or included in hardware or other tangible property, continues to be unsettled in California. Both Taxpayers and the California Department of Tax and Fee Administration continue to assess the proper interpretation of California statutes and case law when applied to evolving technologies. As a result, taxpayers selling such products should exercise diligence in reviewing the state of the law and its potential application to their businesses.
Reference
Proposed Amendments to Regulations 1502 and 1507 and New Regulation 1507.1
[View source.]
