Were patented-process royalties taxable when a licensee also had to lease the licensor's equipment to use the process?

Plain-English summary

A company licensed a patented contact-lens coating process and required each licensee to use coating equipment supplied under a separate lease. Royalties varied with the number of lens pairs coated each month.

Tax counsel concluded that both the equipment rental receipts and the process royalties were taxable. A licensee had to pay the royalties to use the equipment for its intended purpose, making the payments part of the consideration tied to tangible property.

The letter distinguished a process license standing alone. When an earlier question involved only royalties and no sale or lease of related equipment, the advice that sales tax did not apply was consistent because there was no transfer of tangible personal property.

Citations and references

• Thys v. Washington, 31 Wash. 2d 739, 199 P.2d 68 (as cited)
• Sept. 6, 1966 letter requesting a ruling on process-license fees for a patented contact-lens coating method used with separately leased nonpatented equipment — letter, patent, license and lease agreements, equipment description, invoices, and royalty records not reproduced in the official PDF
• Prior San Diego office advice to another unidentified firm that process-license fees alone were nontaxable when no related equipment transfer was presented — described through unidentified San Diego office information; request, advice, facts, correspondence, and office record not reproduced in the official PDF
• Board's stated consistent treatment of royalties under similar fact patterns — described but no ruling, memorandum, annotation, or other authority identified or reproduced beyond Thys
• Official Annotation 295.0480's patented-process license, required equipment lease, license-fee and royalty treatment, equipment rent, intended-use condition, and Sept. 21, 1966 date — annotation omits the Sept. 6 request, contact-lens and equipment facts, Thys, unidentified consistent treatment and San Diego advice, missing agreements and records, and later outcome and supplies no additional license or lease record
• Possible license or lease execution, equipment delivery or use, royalty calculation, rental or royalty payment, return filing, audit, assessment, refund claim, appeal, or other later 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/295-0480.pdf

Original ruling text

295.0480

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION
September 21, 1966
Gentlemen:
This is in reply to your letter of September 6, 1966, requesting a ruling as to the application of sales tax to certain process license fees. You state that ---, is a California corporation organized to license to others, for a fee, the use of a patented process for the coating of contact lenses. The license fees, or royalties, are based upon the number of pairs of lenses coated per month by the licensee. In connection with the use of this process, --- requires the licensee to use certain coating equipment owned and supplied by --- under a separate lease agreement. The equipment is a nonpatented design which was developed for the utilization of the coating process. It is your position that the license fees paid to --- are not in any way a part of the consideration for the equipment and are, therefore, not subject to sales tax. It appears, however, based upon the information you have supplied to us, that a licensee must pay the license fees in order to use the equipment for the purpose for which it was intended. In principle, we find very little to distinguish this case from Thys v. Washington, 31 Wn. 2d 739, 199 P.2d 68. The Washington court held that if, upon the sale of an article, further compensation is exacted for the right to use the article for the purpose for which it was intended, both amounts, the sale price and the royalties, are properly subject to sales tax. We conclude, therefore, that in addition to the equipment rental receipts, the process license fees charged by --- are subject to tax. We have consistently followed this approach in the application of sales tax to royalties under fact situations similar to that presented here. You mention in your letter that our San Diego office has advised another firm that t he license fees paid for the coating process would not be subject to tax. We believe that you are referring to the ---, which is owned by --- of the ---. Information received from the San Diego office indicates that the question presented, with regard to the --- Company, concerned only the license fees and no mention was made of a sale or lease of related equipment. The sales tax is applicable only to the sale, lease, etc., of tangible personal property. Since the question related solely to royalties payable for the use of a patented process and did not involve the transfer of tangible personal property, the advice given by our San Diego off ice was correct and is in no way inconsistent with the conclusion reached above. Very truly yours, Richard H. Ochsner Associate Tax Counsel cc:

San Jose -District Administrator San Diego -Supervising Tax Auditor (RH)