On January 30, 2017, the California Legislature Assembly Committee on Revenue and Taxation held an informational hearing on “Life after Lucent: Administering California’s Technology Transfer Agreement Law.” The California State Board of Equalization (SBE) and the Board’s staff are currently wrestling with the meaning of the Technology Transfer Act (TTA) provisions in sections 6011 and 6012 of the Revenue and Taxation Code in connection with implementation of the California Court of Appeal decision in Lucent Technologies v. Board of Equalization, 241 Cal. App. 4th 19 (2015). The January 30 hearing demonstrates that the Legislature is now apparently interested in this issue.
The hearing attempted to present a measured view of the Lucent TTA issues and future developments. It is unclear at this point what action the Legislature may take on this topic, but the committee’s chair stated he anticipated this hearing to be the first of many on the broad subject of tax and technology. The committee showed interest in how other states are addressing these issues and if perhaps the “true object” test, which applies to transactions involving both tangible personal property (TPP) and services, may be utilized in transactions involving both TPP and intangible property rights.
An economist from the Legislative Analyst’s Office provided testimony on the background of California’s sales and use tax law and the events leading up to and through the Lucent decision in 2015. (His written report is available at http://www.lao.ca.gov/Publications/Detail/3541)
Robert Lambert, assistant chief counsel of the SBE’s Litigation Division, also testified. He made clear that his remarks were offered by the Board’s staff and not on behalf of the Board itself, and that the Board staff’s most pressing issue moving forward after Lucent was the sales/use tax treatment of pre-installed/embedded software. Mr. Lambert testified that the Board’s staff believes such transactions are taxable under “physical usefulness” principles and that if storage media is necessary for the usefulness of the software after it is sold, unlike a discarded disc or cartridge, then the software plus its storage media together should be taxable as tangible personal property. These comments reflect what the Court of Appeal in Lucent referred to as “the default rule” where the untaxable component is intangible personal property, and it must be determined “whether the tangible portion of the transaction is ‘essential’ or ‘physically useful’ to the purchaser’s subsequent use of the intangible personal property portion of the transaction.” Mr. Lambert also said that he did not know what the Board would ultimately decide to do with these issues. Questions raised by committee members demonstrated that some members were grappling with why the SBE thought it could tax intangible property in any context. Mr. Lambert additionally expressed concerns over potential class actions pursuant to consumer protection laws if tax is collected on a broad basis.
Jeffrey Varga, the attorney who represented the taxpayers in Lucent (as well as in the earlier Nortel case) and the California Taxpayers Association also presented testimony. Both witnesses said that Lucent was not a revolutionary decision, that it simply applied California tax law principles correctly, and that the TTA statutes establish a bright line test on how to determine the value of TPP in transactions involving intangible property rights.
The final witness to testify was Jay Chamberlain, chief of the Revenue and Taxation Section for the Department of Finance. Mr. Chamberlain reported projected annual fiscal impact numbers for various scenarios on taxing software, with the tax exemption of embedded software likely being the most costly.
No further legislative committee hearings have been scheduled at this time. However, the Board’s Business Tax Committee held an interested parties meeting on June 30, 2016, on the implementation of Lucent and possible amendments to the Board’s Regulation 1507 (Technology Transfer Agreements). That committee intends to issue another discussion paper on the Lucent issues, and hold another interested parties meeting, in the near future. However, no dates are currently set for either event.