Technology Transfer Agreements-Exempt from California Sales Tax. Can You Use One?

A recent California Court of Appeals decision could decrease sales tax on complex, software-operated systems, making them more affordable for customers in California. [1] As would be expected, hardware is subject to sales tax. However, a license for software that is created by the manufacturer for operating the hardware could be a Technology Transfer Agreement (TTA). TTAs are exempt from California sales tax.

There may be an opportunity for makers of these systems to create a software license which is a TTA. One mechanism is to “unbundle,” or segregate, software from the hardware. There are more factors to be considered than can be numerated here. The statute and regulations contain many details. A decision to claim a sales tax exemption should not be made without qualified assistance.

 The example below reviews a scenario in which the sales tax exemption was appropriate. If another scenario has key similarities, it could well be worth the effort to examine whether a sales tax exemption can be claimed.

Example

An agreement may be a TTA if the holder of a copyright assigns or licenses to another person the right to make and sell a product that is subject to a patent or copyright interest. Even a narrow copyright license is still a transfer, as long as the rights thus licensed are exclusive. Copyright protection extends to computer
programs. Inputting a software program from a storage medium into the computer’s memory entails the preparation of a copy.

In the case cited above, Nortel manufactured and sold switches including computer processors to Pacific Bell to processes telephone calls. A licensing agreement gave Pacific Bell the right to use Nortel’s software programs in the switches. Switch-specific programs (SSPs) operated the switch and enabled it to process telephone calls. Each SSP was created for a particular switch. Owing to their uniqueness, SSPs were not offered for general sale. The foundation for Nortel’s SSPs is a basic code library. Nortel takes portions of the basic code and merges it into parameters and instructions designed specifically for a given installation, resulting in an SSP. The newly created SSP operates the switch, enabling it to process telephone calls and operate features. Pacific Bell was allowed to copy the SSPs from media into its processors.

Licensing of this software was a TTA. The Court also found that certain prewritten programs were TTAs. These programs were contained on storage media external to the switch, and were loaded onto the switch computers. They were not embedded in the hardware at the time of manufacture. Here, a sales tax exemption was appropriate.

 We can review the legal, software, engineering, and marketing aspects of a scenario to identify opportunities to use a TTA.

 [1] Nortel Networks Inc. v. Board of Equalization, 191 Cal. App. 4th 1259 (2011); Review denied, 2011 Cal. LEXIS 4767 (Cal., Apr. 27, 2011)

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