Are rentals taxable when tax-paid software is loaded onto a tax-paid computer before the combined unit is leased?

Plain-English summary

The Tax Policy Division asked by absent July 14, 2011 email whether loading tax-paid prewritten software onto a tax-paid computer before leasing them together substantially changed their form. The internal Legal Department memo identifies this as Assignment 11-295 but does not identify the taxpayer or include any transaction record.

Counsel imposed five assumptions. The taxpayer separately bought hardware and prewritten software and paid its vendors California sales-tax reimbursement or use tax on both; charged nothing separately to install the leased software; gave customers possession of the original storage media so they could reinstall; used true leases without a nominal-price title option; and held or transferred no software patent or copyright interests that could create a technology transfer agreement.

Sections 6051, 6201, 6202 and 6401 supplied the sales/use-tax framework. Civil Code section 1656.1 and regulation 1700 allowed contractual reimbursement. Sections 6011 and 6012 included all sale-related amounts without cost, service or expense deduction unless a specific exclusion applied.

Sections 6006(g)(5), 6006.1, 6010(e)(5), 6010.1 and regulation 1660 required two conditions for rent to escape further tax: the lessor paid California acquisition tax, and the property was leased in substantially the same form. If either failed, the lessee owed use tax on rent and sections 6202–6204 required lessor collection/payment. Same form was a case-by-case comparison of acquired and leased property.

The memo cited live Annotations 330.3940, 330.4090, 330.4140 and 330.4190 for the principle that two tax-paid items could be rented as one unit if significant fabrication was unnecessary and the result was not substantially different from the components.

Here, software was merely loaded before the unit went to customers. Because customers received the same software on original media and could install or reinstall it, the taxpayer performed no significant fabrication under regulation 1502(f)(1)(D). Counsel presumed the lease amount reflected the hardware and media-borne software and that preloading added no significant value.

Under those assumptions, the computer and software were leased in substantially the same form as acquired. Because acquisition tax had already been paid, no further sales or use tax was due on the rental charges.

The memo describes annotations under regulation 5700 as staff guidance drawn from selected Legal Department opinions. Live Annotation 330.3950 publishes the tax-paid components, no installation charge, original-media facts and same-form conclusion, but omits the true-lease, intellectual-property and all-California-tax assumptions plus the cited precedent chain. No underlying purchases, media, installation, contract/license, charges, returns or later outcome appears.

Common questions

Did combining two tax-paid items automatically make the rentals taxable?

No. The memorandum says two tax-paid items can be leased as one unit without further tax when no significant fabrication produces a substantially different form.

Were the acquisition-tax facts proved?

No. Payment of California sales-tax reimbursement or use tax to both vendors was an express assumption.

Why did providing the original software media matter?

It supported the conclusion that loading the software was not a significant transformation; the lessee could install or reinstall the same software.

Did the taxpayer charge for installation?

Counsel assumed no separate charge. No invoice or lease appears.

Did the memo find that preloading added no value?

It presumed the lease amount reflected hardware and software-on-media value and concluded preloading did not add significant value under the assumed facts.

Would the result necessarily apply to customized software or a copyright license?

No. The opinion expressly assumed prewritten software, no patent or copyright transfer, and no technology transfer agreement.

Would a nominal-price purchase option produce the same answer?

Not under this memo. Counsel expressly assumed a true lease in which required payments did not let the customer obtain title through a nominal option.

What earlier annotations supported the two-component rule?

330.3940 (motor and boat), 330.4090 (restaurant equipment), 330.4140 (ski bindings) and 330.4190 (water-softener tank).

Was this an actual assessment or final taxpayer result?

No. It was internal advice on assumptions; no taxpayer record, return, audit or later outcome appears.

Citations and references

• Revenue and Taxation Code section 6051; Civil Code section 1656.1; regulation 1700 — sales tax and reimbursement
• Revenue and Taxation Code sections 6201, 6202 and 6401 — use-tax measure and consumer liability
• Revenue and Taxation Code sections 6011 and 6012 — inclusive gross-receipts/sales-price measure
• Revenue and Taxation Code sections 6006(g)(5), 6006.1, 6010(e)(5) and 6010.1; regulation 1660(b)(1)(E)/(c)(1)–(2) — continuing lease and same-form rules
• Revenue and Taxation Code sections 6202–6204 — lessee liability and lessor collection/payment
• Revenue and Taxation Code section 6006.3; regulation 1660(a)(1)–(2) — lease and true-lease definitions
• Regulation 1507 — technology transfer agreement assumption
• Annotations 330.3940, 330.4090, 330.4140 and 330.4190 — tax-paid components combined without significant fabrication
• Regulation 1502(f)(1)(D) — computer-program fabrication
• Regulation 5700 — nature of annotations
• Live Annotation 330.3950 — selected assumed facts and same-form result dated October 24, 2011
• Request, taxpayer and transaction/evidence, returns, tax payments and later outcome — absent

Source

• Annotated Legal Opinions collection: https://cdtfa.ca.gov/taxes-and-fees/annotations-menu.htm
• Annotation page: Annotation 330.3950
• Original supporting opinion: 330.3950 PDF

Original ruling text

State of California

Board of Equalization
Legal Department - MIC:82
Telephone: (916) 323-3092
Facsimile: (916) 323-3387

Memorandum

330.3950

To:

Susanne Buehler
Chief
Tax Policy Division (MIC:92)

Date: October 24, 2011

From:

Cary Huxsoll
Tax Counsel
Tax and Fee Programs Division (MIC:82)

Subject:

Legal Opinion Request – Leases of Computers with Prewritten Software Assignment No. 11-295

This is in response to your July 14, 2011, email in which you request information as to the application of the Sales and Use Tax Law to a lessor’s [Taxpayer] leases of computers and software. Specifically, you ask: Does the loading of prewritten software (tax paid at source) onto a computer (also tax paid at source) and leasing them as a single unit substantially change the form as acquired such that the taxpayer is precluded from applying the provision of Regulation 1660, subdivision (c)(2), “Property Leased in Form Acquired?” First, I assume that Taxpayer pays sales tax reimbursement or use tax to its vendors when it separately purchases the computer hardware and the prewritten software. Second, I assume that Taxpayer does not separately charge for the installation of the leased software onto the leased computer hardware. Third, I assume that Taxpayer also provides its customers possession of the originally purchased storage media containing the prewritten software (e.g., the original disks provided by the software vendor) so that the customer may re-install the leased software onto the leased computer hardware if necessary. Fourth, I assume that the lease transactions are contracts structured as leases and are, in fact, true leases (e.g., the customer could not obtain title to the leased property at the end of the lease term upon the completion of the required payments by exercising an option to purchase the leased property for a nominal amount). (See Reg. 1660, subd. (a)(2).) Finally, I assume that Taxpayer is not the holder of any patent or copyright interests associated with the prewritten software and that, accordingly, Taxpayer never assigns or licenses patent or copyright interests to the lessees (i.e., I assume that under no circumstances could the leases in question be reasonably characterized as technology transfer agreements). (See Reg. 1507 [discussing the application of tax to technology transfer agreements].)

Ms. Susanne Buehler

-2-

October 24, 2011
330.3950

DISCUSSION
As a starting point, California imposes a sales tax on a retailer’s gross receipts from the retail sale of tangible personal property in this state, unless the sale is specifically exempt from taxation by statute. (Rev. & Tax. Code, § 6051.) The sales tax is imposed on the retailer, who may collect reimbursement from the customer if the contract of sale so provides. (Civ. Code, § 1656.1; Reg. 1700.) When sales tax does not apply, such as when the sale takes place outside the state, use tax is imposed, measured by the sales price of property purchased from a retailer for storage, use, or other consumption in California. (Rev. & Tax. Code, §§ 6201, 6401.) The use tax is imposed on the person actually storing, using, or otherwise consuming the property. (Rev.
& Tax. Code, § 6202.) Taxable gross receipts or sales price includes all amounts received with respect to the sale, with no deduction for the cost of the materials, service, or expense of the retailer passed on to the purchaser, unless there is a specific statutory exclusion. (Rev. & Tax. Code, §§ 6011, 6012.) As relevant to your inquiry, a lease 1 of tangible personal property in California is a continuing sale and purchase subject to tax, unless the lessor leases the property in substantially the same form as acquired and has paid California sales tax reimbursement or has made a timely election to pay use tax measured by the purchase price of the property. (Rev. & Tax. Code, §§ 6006, subd. (g)(5), 6006.1, 6010, subd. (e)(5), 6010.1; Reg. 1660, subds. (b)(1)(E) & (c)(2).) When the lease is a continuing sale and purchase because either or both of the foregoing conditions are not satisfied, the lease is subject to use tax measured by rentals payable. (Reg. 1660, subd. (c)(1).) The lessee owes the tax and the lessor is required to collect it from the lessee and pay it to the Board. (Rev. & Tax. Code, §§ 6202, 6203, 6204; Reg. 1660, subd. (c)(1).) When a lease is not a continuing sale and purchase because both of the foregoing conditions have been satisfied, no sales or use tax is due with respect to the rentals charged. (Reg. 1660, subd. (c)(2).) Whether property is leased in substantially the same form as acquired is determined on a case-bycase basis. Property is “leased in substantially the same form as acquired” if the property is acquired by a lessor and then leased to the lessee without there being any substantial changes. (See Reg. 1660, subd. (c)(2).) The Board’s Legal Department has determined that no further tax is due when a lessor purchases two items tax paid and rents them as a single unit, so long as no significant fabrication labor is required to produce the single unit and the single unit is not leased in a substantially different form than the components. (See, e.g., Sales and Use Tax Annotation 2 (Annotation or Annot.) 330.3940 (8/31/66) [motor attached to boat without significant amount of fabrication labor], 330.4090 (9/5/68) [individual restaurant equipment items assembled into a working unit (a restaurant) prior to leasing], 330.4140 (1/12/68) [bindings attached to snow skis] & 330.4190 (7/7/70) [water softener tank installed to plumbing].)

1

Generally, the term “lease” implies that the possession of property, but not title to property, is passed to a customer for a consideration and includes rental, hire, and license. (Rev. & Tax. Code, § 6006.3; Reg. 1660, subd. (a)(1).) 2 Annotations are summaries of the conclusions reached in selected opinions of attorneys of the Board’s Legal Department and are intended to provide guidance regarding the interpretation of Board statutes and regulations as applied by staff to specific factual situations. (See Reg. 5700.)

Ms. Susanne Buehler

-3-

October 24, 2011
330.3950

Here, the transactions in question involve leases of tangible personal property, computer hardware loaded with prewritten canned software. Taxpayer has created a unit by merely loading the software onto the computer hardware prior to transferring the property to its customers. Indeed, since the lessee is receiving the same software on tangible media that was pre-loaded onto the computer, it could have easily installed or could reinstall the software onto the computer if necessary. Thus, as described, Taxpayer does not perform significant fabrication labor to the leased computer. (See Reg. 1502, subd. (f)(1)(D).) Moreover, presumably the lease amount reflects the value of the computer hardware and the software transferred on storage media, and in this case pre-loading the software onto the computer does not add significant value to the computer. Accordingly, the leased property does not constitute a unit leased in a substantially different form than the individual components. The property is thus rented in substantially the same form as acquired. That is, the general functional capabilities, characteristics, or form of the property has not been significantly changed following Taxpayer’s acquisition. Given these facts, no sales or use tax is due with respect to the amounts charged for such rentals. (Reg. 1660, subd. (c)(2).) I trust that this answers your questions. If you have any further questions, please contact me at (916) 323-3092. CCH/mcb cc:

Trista Gonzalez (MIC:44)
Jason Parker (MIC:44)