Was an unlimited source-code license taxable when acquired to reproduce, modify, and distribute a copyrighted driver program?

Plain-English summary

A company planned to hire a contractor to develop a product requiring modified communications-board driver software. The contractor would acquire an $18,000 unlimited license to the prewritten UNIX source code, modify it for OS/2, and deliver both the original and modified source. The company would sell a product built from the code together with the modified source.

The Board first noted that license fees for using a prewritten program were generally taxable. It then applied the reproduction-right exception. Assuming the contractor was merely the company's agent, the relevant transaction was the manufacturer's transfer to the company.

That payment was nontaxable if it granted the right to reproduce a federally copyrighted program so the company could publish and distribute it for consideration to third parties. Having the contractor modify the program for the company's application did not change that result under the stated facts.

What controlled the exception

• The program had to carry a federal copyright.
• The license had to grant reproduction and copying rights for publication and distribution to third parties.
• The contractor was assumed to act only as the buyer's agent.
• The exception was distinct from an ordinary taxable license to use prewritten software.

Citation

• California Sales and Use Tax Regulation 1502(f)(1) and (f)(1)(B) (as cited)
• Requester's June 2, 1992 letter about an unlimited source-code license and apparent Jan. 21, 1992 internal memorandum — facts and question supplied; request, attachments, complete memorandum, and entity identities beyond redaction not reproduced in the official PDF
• Planned product-development contract, $18,000 unlimited UNIX driver-source license, OS/2 modification, delivery of original and modified source, product sale, source distribution, manufacturer transfer, contractor agency, federal copyright, and reproduction/publication rights — facts and assumptions supplied; development contract, license, source code, manufacturer materials, agency agreement, copyright record, deliverables, product, invoices, payment records, returns, and tax computations not reproduced in the official PDF
• Official Annotation 295.0225's Company A/B development, manufacturer source-code acquisition, modification, delivery, assumed agency, reproduction/publication/distribution rights, federal copyright, and nontaxable license-or-royalty summary, dated Aug. 31, 1992 — annotation omits the June 2 request and internal-memorandum provenance, $18,000 price, UNIX/OS/2 details, F---/FBCS identity assumption, Regulation 1502 quotation, use-license contrast, source wording forms, missing records, and planned-only status and supplies no additional transaction record
• Possible later contract or license execution, source-code acquisition or modification, copyright verification, delivery, product sale or distribution, payment, return filing, audit, assessment, refund claim, appeal, or other agency action — not supplied in the official PDF

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: https://cdtfa.ca.gov/lawguides/vol2/suta/295-0000-all.html
• Original supporting opinion: https://cdtfa.ca.gov/lawguides/annotations/295-0225.pdf

Original ruling text

295.0225

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

WILLIAM M. BENNETT
First District, Kentfield

1020 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

August 31, 1992

MATTHEW K. FONG
Fourth District, Los Angeles
GRAY DAVIS
Controller, Sacramento

Ms. L--- F--Sr. Accountant
F--- B--- C--- S--XXXX --- Avenue
---, CA XXXXX

BURTON W. OLIVER
Executive Director

SY -- XX-XXXXXX
Dear Ms. F---:
This is in reply to your June 2, 1992 letter regarding the application of sales tax to a charge to F--- B--- C--- S--- (FBCS) for a software license. You included what appears to be a January 21, l992 F--- internal memorandum which provided the following facts: "We are planning to contract the development of a software product from A---, International. This product includes a communication board which requires driver software. The board's manufacturer does not offer a version of the driver software which will run under OS/2, as required for our product. A--- will purchase an unlimited source code license for the UNIX version of the driver software for F--- from the manufacturer, modify the driver source code to run under OS/2, and deliver the original and modified source to us at project completion. FBCS will sell the product built from code prepared by A--- along with the modified source. "The license will cost us $18,000...." You are apparently familiar with the application of tax to the various charges except for the charge for the unlimited source code license. Based on the facts you provided, it appears that the charge is a charge for the use of a prewritten program; that is, the UNIX version of the driver software. Sales and Use Tax Regulation 1502, Computers, Programs, and Data Processing, provides at subdivision (f)(l): "Prewritten programs may be transferred to the customer in the form of storage media or by listing the program instructions on coding sheets. In some cases they are usable as written; however, in other cases it is necessary that the program be

Ms. L--- F---

-2-

August 31, 1992
295.0225

modified, adapted, and tested to meet the customer's particular needs. Tax applies to the sale or lease of the storage media or coding sheets on which or into which such prewritten (canned) programs have been recorded, coded, or punched. "(A) Tax applies whether title to the storage media on which the program is recorded, coded, or punched passes to the customer, or the program is recorded, coded or punched on storage media furnished by the customer. The temporary transfer of possession of a program, for a consideration, for the purpose of direct use or to be recorded or punched by the customer, or by the lessor on the customer's premises, is a lease of tangible personal property. The tax applies unless the property is leased in substantially the same form as acquired by the lessor and the lessor has paid sales tax reimbursement or use tax with respect to the property. "(B) Tax applies to the entire amount charged to the customer. Where the consideration consists of license fees, all license fees, including site licensing and other end users fees, are includable in the measure of tax. Tax does not apply, however, to license fees or royalty payments that are made for the right to reproduce or copy a program to which a federal copyright attaches in order for the program to be published and distributed for a consideration to third parties, even if a tangible copy of the program is transferred concurrently with the granting of such right. Any storage media used to transmit the program is merely incidental." We assume that "F---" and FBCS are the same entity. We also assume from the facts you present that A--- merely acts as an agent on behalf of FBCS in acquiring the program from the manufacturer. In such case, the relevant transaction is the transfer of the program from the manufacturer to FBCS. Tax does not apply to the amount paid by FBCS to the manufacturer for the transfer of the program to FBCS if the transfer is to provide FBCS the right to reproduce and copy a program to which a federal copyright attaches in order for FBCS to publish and distribute the program regardless that FBCS has A--- modify the program to be compatible with FBCS's application. 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