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The California State Board of Equalization (BOE) held an interested parties meeting on July 17, 2012, to discuss whether to amend its Regulation 1507 (Technology Transfer Agreements (TTA)) to clarify how the TTA statutes (Cal. Rev. and Tax Code §§ 6011(c)(10) and 6012(c)(10)) should apply to transfers of computer programs on tangible storage media. Under California law, the value of intangible property transferred under a TTA is excluded from the sales or purchase price under the Sales and Use Tax Law.

At the outset of the meeting, the BOE discussed the background of the TTA statutes and identified key issues for discussion. The background and key issues, as well as the comments from interested parties, are summarized below. Written comments will be accepted until August 1, and the BOE Business Taxes Committee will receive an update on the interested parties process at its meeting on August 21-23. A second interested parties meeting currently is scheduled for September 6.

  1. The Legal Department does not read Nortel v. State Bd. of Equalization as exempting all prewritten software. It believes Nortel is limited to its facts. Nortel held that the right to “use a process” subject to a patent, when combined with the transfer of tangible personal property, qualifies as a TTA even when the “process” is prewritten computer software.
  2. The TTA statutes only provide TTA treatment to agreements where the holder of the copyright or patent transfers a patent or copyright interest to third parties. Thus, the holder of the patent or copyright interest must be the transferor. Nonetheless, the BOE indicated that it would be open to considering whether the “holder” requirement has been met through a licensing entity in a group of entities.
  3. The Legal Department believes prewritten and canned computer programs transferred on TPP are TPP. Thus, software development costs should be included within the value of the taxable tangible personal property transferred under a TTA.
  4. The Nortel court did not invalidate the provision of Regulation 1507 that requires patented processes to be external to the tangible personal property, necessarily excluding embedded software from TTA treatment.
  5. If a TTA is created based on the transfer of a copyright interest, the copyright interest must provide the right to make and sell a product subject to the copyright interest for TTA treatment.
  6. The Nortel case did not address the measure of tax related to the TTA because the parties stipulated to the value of the tangible personal property. Thus, there was no guidance on which costs to include in determining the value of the tangible personal property based on the statutory test of 200% of the cost of labor and materials used to produce the tangible personal property.
  7. The BOE does not intend to change its position that software development costs are included in the value of the tangible personal property transferred under a TTA because that would be compromising its position in Lucent, which is at the superior court.

Continue Reading California BOE Holds Interested Parties Meeting on TTA Regulation

The California Supreme Court reversed the appellate court’s decision regarding the Franchise Tax Board’s (FTB) authority to conduct an audit to determine whether a taxpayer is entitled to an enterprise zone hiring credit. DiCon Fiberoptics, Inc. v. Franchise Tax Bd., Case No. S173860 (Apr. 26, 2012).

California’s Enterprise Zone Act (the Act) permits a taxpayer that employs a “qualified employee” in an enterprise zone to claim a tax credit for five years. To be a “qualified employee,” at least 90% of the employee’s services must “directly relate[ ] to the conduct of the taxpayer’s trade or business located in an enterprise zone,” and the employee must perform at least 50% of his or her services in the enterprise zone. Cal. Rev. & Tax. Code § 23622.7(b)(4)(A). In addition, the employee must fall within one of several categories that demonstrate the employee is disadvantaged or endures some form of employment barrier. Cal. Rev. & Tax. Code § 23622.7(b)(4)(A)(iv). To claim the credit, taxpayers are required under the Act to: (1) obtain from the local zone government authority a certification (or “voucher”) that provides the qualified employee meets the eligibility requirements; and (2) retain a copy of the certification and provide it upon request to the FTB. Cal. Rev. & Tax. Code § 23622.7(c).Continue Reading Franchise Tax Board’s Broad Audit Authority to Review Returns and Ascertain Correct Amount of Tax Underscored in Enterprise Zone Hiring Credit Decision by California Supreme Court

On May 30, 2012, California Assembly Bill (AB) 2323 (Perea) passed the Assembly floor by a vote of 47-19. AB 2323 would require the State Board of Equalization (BOE) to issue written decisions in cases involving amounts in controversy of $500,000 or more, excluding consent items. If enacted, the BOE could decide the type of…

Please join Sutherland’s State and Local Tax Team for a webinar to discuss recent developments regarding California’s sales and use tax treatment of sales of intangible property bundled with tangible property and sold subject to the seller’s patent or copyright interest.

California’s special tax provisions, known as technology transfer agreements (TTAs), have widespread application and have…

The Massachusetts Department of Revenue ruled that a California lubricant and cleaning products manufacturer was a manufacturing corporation, even though 70% of its production activities were outsourced to third parties. As a result, the Department permitted the company to use a single sales factor to apportion its taxable net income to Massachusetts. Mass. Ltr. Rul. 11-8: Qualification as a Manufacturing Corporation under G.L. c. 63, s. 38(I) (Dec. 16, 2011).

Under Massachusetts Law, a “manufacturing corporation” that has income from business activity that is taxable both in Massachusetts and outside the state is required to apportion its net income to Massachusetts using a single sales factor. There are two requirements to be a “manufacturing corporation.” First, the corporation must be engaged in manufacturing during the year, and second, the manufacturing activity must be substantial. A corporation’s manufacturing activities are substantial if the corporation meets one of the five statutorily enumerated tests. The first test is that the corporation derives 25% or more of its receipts for the taxable year from the sale of manufactured goods that it manufactures.Continue Reading Massachusetts Greases the Skids for Lubricant Manufacturer to Use Single Sales Factor

Understanding states’ various approaches to accountant-client privileges can make the difference in protecting communications from disclosure in litigation. In this edition of A Pinch of SALT, Sutherland SALT’s Pilar Mata and Melissa Smith examine the scope and breadth of accountant-client privileges that have been adopted by some states.

Read “Demystifying Accountant-Client Privileges in State…

A recently released California Chief Counsel Ruling authorized a corporate taxpayer to use its customers’ billing addresses as a proxy for the customers’ “commercial domicile” in calculating the taxpayer’s sales factor numerator. Chief Counsel Ruling 2011-01 (Aug. 23, 2011, rel. Dec. 28, 2011).

For sales factor purposes, California sources the sales of intangibles and services using costs of performance (COP) apportionment. The sales of intangibles and services are attributable to California if a greater proportion of the income-producing activity is performed in California than in any other state, based on COP. Before 2008, taxpayers could not include payments to agents and independent contractors as part of the taxpayer’s COP analysis. But beginning in 2008, California began to require taxpayers to take into account payments made to agents and independent contractors in calculating COP. As part of the analysis, the taxpayer must determine the location of the income-producing activity, and the regulations provide a comprehensive list of cascading rules to determine the appropriate location of the income-producing activity. See Cal. Code Regs. tit. 18, § 25136.Continue Reading We Know Where You Live: California’s Billing Address Sourcing