Was a separately billed source-code license taxable when an OEM needed it to distribute bundled products?

Plain-English summary

A software developer licensed object code to original-equipment manufacturers for incorporation into bundled products. It also supplied source code so the manufacturers could create and modify object-code versions for different environments and support the products they sold.

The letter agreed that the source-code charge was not taxable. The source code was incidental to the object-code transfer and necessary for the manufacturer to make and distribute its bundled product.

Billing the source code separately from the object code did not change the nontaxable status of the transfer under the described facts.

Citations and references

• California Sales and Use Tax Regulation 1502(f)(1)(B) (as cited)

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: https://cdtfa.ca.gov/lawguides/vol2/suta/120-0000-all.html
• Original supporting opinion: https://cdtfa.ca.gov/lawguides/annotations/120-0490.pdf

Original ruling text

120.0490

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

MEMBER
First District

450 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0001)
(916) 445-6450

BRAD SHERMAN
Second District, Los Angeles
ERNEST J. DRONENBURG, JR.
Third District, San Diego
MATTHEW K. FONG
Fourth District, Los Angeles
GRAY DAVIS
Controller, Sacramento

May 6, 1993

BURTON W. OLIVER
Executive Director

Ms. A--- DeA--Manager
E--- & Y--XX A--- Boulevard
--- ---, CA XXXXX

Dear Ms. DeA---:
This is in reply to your March 23, 1993 letter regarding the application of sales tax to charges for computer software programs under the following facts you described: "XYZ Company, our client, develops and licenses to original equipment manufacturers ('OEMS') 'Object' and 'Source' code of XYZ Company's internally developed software. The codes are transferred via diskettes to the OEMs. "Object code is a series of computer commands which enlists a desired outcome (the program). Source code is the 'blue print' of the Object code which provides a means for manipulating the Object code. "OBJECT CODE The Object code is sold to OEMs who in turn transfer the Object code in bundled products to distributors and end users.

Ms. A--- DeA---

-2-

May 6, 1993
120.0490

"Under the licensing agreement XYZ offers OEMs a non-exclusive, nontransferable, limited license to incorporate XYZ's Object code with other software in order to create a bundled product. Under the terms of the license agreement the OEM may reproduce, or have reproduced, and sub-license XYZ's Object code as incorporated in a bundled product. The Object code may only be incorporated in a bundled product sold by the OEM. OEMs are restricted from selling, licensing, or otherwise transferring XYZ's software as a stand alone product to any person or entity. "SOURCE CODE In addition to the Object code, XYZ grants OEMs a non-exclusive, nontransferable, limited license to XYZ's Source code. The Source code is used to create and modify Object code versions in various hardware and software environments. Use of XYZ's Source code allows OEMs to provide support to bundled products sold to end users. The Source code is used only by the OEMs to create the Object code in OEM's software sold in bundled products. "LICENSE FEES The OEMs pay license fees for the limited license rights to the Object and Source codes. Typically the arrangement calls for a per-unit object code fee and a onetime source code site license. Billing to OEM's, however, may be structured in the following ways: "Object Code Per unit sold by OEM Percentage of OEM's sales price (footnote omitted) Flat fee "Source Code Separate flat fee Lump sum (w/Object code) No fee (Source code not transferred)" Given this information, you asked whether the licensing of XYZ's Source code is incidental to the nontaxable licensing of the Object code pursuant to Sales and Use Tax Regulation 1502, subdivision (f)(1)(B) and, if so, whether XYZ's separate billing for the charge for the Object code and the Source code would affect the nontaxability of the charge. We agree with your conclusion that tax does not apply to the charge for the Source code under the facts you described. The transfer of the Source code is incidental to the transfer of the Object code and is necessary for the OEM to be able to manufacture and distribute the bundled product it creates and distributes. We do not believe that XYZ's separate billing for the Object code and the Source code affects the nontaxable status of the transfer.

Ms. A--- DeA---

-3-

May 6, 1993
120.0490

We hope this answers your questions; however, if you need further information, feel free to write again. Very truly yours,

Ronald L. Dick
Senior Tax Counsel
RLD:sr