In a significant rebuff of the California State Board of Equalization (BOE), the California Second District Court of Appeal held that a manufacturer’s sale of software on tangible media was exempt from sales tax under the technology transfer agreement (TTA) statutes. Lucent Technologies, Inc. v. State Bd. of Equalization, No. B257808, 2015 WL 5862533, (Cal. Ct. App. Oct. 8, 2015). The court also upheld a $2.6 million attorneys’ fees award to the taxpayer after concluding that the BOE’s position was not “substantially justified.” The court also provided a useful framework for analyzing all bundled transactions, not just those involving TTAs.


California law provides a special rule for sales of software pursuant to a TTA that taxes the tangible component of the transaction (e.g., storage media) but exempts the intangible software component for sales and use tax purposes. See Cal. Rev. & Tax. Code §§ 6011(c)(10) & 6012 (c)(10). A TTA is any agreement under which a person who holds a patent or copyright interest assigns or licenses to another person the right to make and sell a product or to use a process that is subject to the patent or copyright interest.

The facts and legal issues in Lucent were “almost identical” to the court’s 2011 decision in Nortel Networks, Inc. v. State Bd. of Equalization, 191 Cal. App. 4th 1259 (2011). As in Nortel, the taxpayer sold equipment with embedded software to telecommunications companies that allowed the companies to provide phone and Internet services. The taxpayer’s agreements with customers provided that it would: (1) sell the equipment, (2) provide instructions on how to install and run the equipment, (3) develop and produce a copy of the software necessary to operate the equipment, and (4) grant the right to copy the software from storage media onto hard drives and thereafter to use the software. Despite the court’s holding inNortel, the BOE assessed sales tax on more than $300 million paid to Lucent for software licensing fees.

Software as “Tangible Personal Property”

The BOE first argued that, despite the TTA provisions, the software was taxable as tangible personal property because the software was recorded in physical form that could be microscopically seen on the magnetic tapes and compact discs and thus was perceptible to the senses. The court rejected this argument as not only directly contradicting Nortel but also as being inconsistent with other cases holding that “the transmission of software using a tape or disc in conjunction with the grant of a license to copy or use that software does not yield a taxable transaction because the tape or disc is ‘merely ... a convenient storage medium [used] to transfer [the] copyrighted content.’”1 The court also concluded that the BOE’s position would create an “absurd result” by taxing software transferred using a tangible medium while not taxing software transferred electronically. The court thus concluded that the transmission of the software using physical media did not transform the software into taxable tangible personal property.

Sutherland Observation: The court’s opinion includes a clearly expressed, succinct restatement of California law regarding the application of sales tax to bundled transactions. According to the court, the “true object” test is used to determine whether a transaction involving both services and tangible personal property is taxable. The taxability of transactions involving both intangible and tangible personal property depends on whether the tangible portion of the transaction is “essential” or “physically useful” to the purchaser’s subsequent use of the intangible property.

Applicability of the TTA Statutes

The court also rejected the BOE’s arguments that the agreements did not satisfy the statutory requirements of a TTA. Lucent sufficiently proved that the software was a copyrighted work through declarations stating as much, and “[n]othing in [the TTA statutes] requires any greater granularity of proof.” Lucent transferred copyright interests under the agreements when it granted its customers the right to reproduce and use the copyrighted work. The court rejected the BOE’s attempt to narrow the TTA provisions by requiring the assignment of a more “meaningful right” beyond just the conventional use of the patent or copyright interest. To qualify as a TTA, there need only be: (1) a single copyright interest transferred, such as the right to make a single copy of the software, or (2) a single patent interest transferred, such as the right to use a patented process embodied in the software.

Finally, the resulting telephone products and services were “subject to” the copyright interests because the copyright interests were incorporated into the equipment, which allowed the telecommunications companies to provide phone services that were ultimately sold to consumers. The court rejected the BOE’s argument that the taxpayer must prove that the customer would have infringed on a copyright or patent absent the agreement. The product or process is “subject to” the patent or copyright interest as long as it incorporates the patent or copyright interest.

Sutherland Observation: The Lucent decision broadly reaffirmed that the threshold for an agreement to qualify as a TTA is low. The court rebuked the BOE’s attempt to impose additional requirements on the taxpayer, both from a substantive perspective and with respect to the level and nature of proof the taxpayer must provide. Considering the minimal requirements for a TTA, taxpayers should consider circumstances involving sales of software – outside of telecommunications switch software – that could qualify for exemption under the TTA statutes.

Proof of Value of Tangible Personal Property

Only the tangible personal property component of a transaction is taxable under the TTA statutes, and the TTA statutes expressly provide a tiered valuation methodology for how the taxable value is determined.2 Despite the statutes’ text, the BOE contended that the taxable portion included the entire value of the software and not just the nominal value of the blank storage media. The court rejected this argument as merely a variation of the previously rejected position that software becomes part of the tangible property upon which it is stored. The court concluded that the taxable portion of the transactions was equal to the value of the blank media.

Sutherland Observation: Where the price of the software is separately stated in the agreement or invoicing between the parties, the court held that the taxable portion of the transaction is the value of the blank storage media. Where the price of the software is not separately stated from hardware or other equipment on which the software is embedded, it becomes necessary to assign a value to the software. Many taxpayers have used “cost segregation” studies and other methods to support their assignment of value to the tangible and intangible components of a TTA.

Attorneys’ Fees

In addition to ruling for the taxpayer on the merits, the court also upheld the award of $2.6 million in attorney’s fees to the taxpayer for having to pursue a refund through litigation that was “factually and legally indistinguishable” from Nortel. The court summarized its rationale for doing so as follows:

The Board conduct in this litigation falls squarely within the heartland of . . . the Taxpayer’s Bill of Rights . . . – namely, to “deter[ ] state[ ] agents from asserting unreasonable and unfair claims and defenses against private citizens” and thus to “preserve[ ] the balance between legitimate revenue collection and ‘government oppression.’” . . . The position the Board took in this case had been rejected by the Legislature that enacted the technology transfer agreement statutes, rejected by several courts interpreting those statutes, and specifically rejected by Nortel. Yet the Board continued to oppose AT&T/Lucent’s refund action, countersued for more than $18 million (and ultimately agreed to accept less than $2 million), propounded thousands of discovery requests, and generated a 20,000 page record on appeal. The net result is that AT&T/Lucent incurred more than $2.5 million in litigation costs to receive a tax refund to which it was indisputably entitled under controlling law. It is certainly up to the Board to decide whether to take positions at odds with binding, on-point authority, but section 7156 makes clear that the Board is not free to require taxpayers to bear the cost of a litigation strategy aimed at taking a third, fourth, or fifth bite at the apple.


The court’s opinion was an unmitigated win for the taxpayer and ultimately other taxpayers with pending and forthcoming refund claims involving the application of California’s TTA statutes. Taxpayers’ TTA-related refund claims, which have generally been held in abeyance pending the outcome in Lucent, may now potentially start moving forward. Taxpayers may want to also consider whether theLucent decision creates an opportunity for additional refunds for software other than just telecommunications software.

Sutherland Observation: The BOE can petition the California Supreme Court to accept review of the case and generally has 40 days from the date of the Court of Appeal’s opinion to do so. The appeal is discretionary rather than as-of-right, however. Although it is difficult to predict what the state’s highest court would do, it is noteworthy that the California Supreme Court declined review of the Nortel case just four years ago. Companies with outstanding refund claims should consider whether and how to approach the BOE regarding refund claims during the pendency of the appeal.