Which technology-business assets were taxable when software was electronically transmitted but existing drawings and marketing materials were also transferred?

Plain-English summary

Buyer X planned to acquire assets used by permitted seller Y in a redacted technology business. The package included receivables, marketing and training materials, permits, technology and intellectual property, contracts, deposits, records, inventory, claims, goodwill, software, drawings, and related assets. Workstations and other tangible property were under separate negotiation in a transaction the letter called taxable.

The principal asset was technology reduced to practice in software source code. The letter treated prewritten programs transferred by remote telecommunications as nontaxable. Written documentation and manuals transferred with those programs were also nontaxable because there was no separate charge.

Marketing materials were taxable when transferred for the buyer's consumption, subject to a possible tax-paid-purchases-resold deduction to the extent tax had been paid and the seller made no taxable use. The letter did not separately classify every training, office, reference, or similar item listed in the same contract paragraph.

Drawings, designs, engineering and technical data, artwork, schematic drawings, and engineering drawings were taxable tangible property. The source says the parties contemplated an agreed price of about 180 percent of physical reproduction cost, and staff accepted the price to be agreed by buyer and seller as the tax measure. The live annotation instead prints 130 percent.

Draft asset package, item-by-item analysis, and source limits

Assistant Chief Counsel Gary J. Jugum wrote on October 19, 1990 to a redacted recipient in response to an October 11 letter. Buyer X was entering an agreement to acquire assets used by seller Y in the AA--- business; Y held a seller's permit. Section 1.1 of an Asset Purchase Agreement dated as of October 12 listed ten categories, but the request, complete agreement, schedules, and definitions are absent.

The categories were: pre-closing business receivables with recourse; marketing, training, office and reference materials; transferable franchises, licenses, permits, consents and certificates; a broad “Technology” category; listed contracts and separately listed excluded contracts; lease and rent deposits and prepaid expenses; books, customer and supplier lists, files and records; closing inventory; causes of action, judgments and claims; and goodwill.

“Technology” included inventions, trade secrets, formulae, process engineering, technical data, artwork, drawings, proprietary rights and knowledge, know-how, software and programming know-how, names, marks, logos, copyrights, patents, applications, registrations, and licenses. It included source code, object code, online files, documentation, testing materials and reports, plus seller software used in both the AA--- and BB--- businesses. It excluded named families of current and future seller hardware accelerators and buyer-developed technology not integral to the purchased business. The schedules that identified the actual assets are missing.

A separate agreement was under negotiation for X to purchase Y's workstations and other tangible property in a transaction the letter characterized as subject to California sales tax. The source prints that the main purchase price consisted of cash sales of common stock of X and royalty payments based on net sales; this page does not add punctuation or reinterpret that unclear phrase. At that stage, price was allocated between paragraphs (a) through (i) and goodwill, with more negotiation planned for specific assets.

Jugum referenced a same-day telephone discussion and said tax did not apply to paragraphs (a), (c), and (e) through (j): receivables; transferable permits; contracts; deposits and prepaids; records and lists; inventory; claims; and goodwill. The letter gives no separate legal explanation for each category and the phone record is absent.

The principal purchased asset was AA--- technology reduced to practice in software source code, with electronic transfer planned under absent Appendix B. Applying Regulation 1502(f)(1)(D), Jugum said remotely transmitted prewritten programs were not taxable and written documentation and manuals accompanying them were not taxable when separately uncharged.

The paragraph (b) analysis expressly calls the “marketing materials” consumed by the transferee and taxable. A tax-paid-purchases-resold deduction would be available to the extent acquisition tax had been paid, based on the represented fact that the transferor made no taxable use. The source does not separately say whether all training, office, reference, and similar items followed that result.

For paragraph (d), Jugum taxed drawings, designs, engineering and technical data, artwork, schematic drawings, and engineering drawings. He quoted Annotation 540.0240 for treating designs and drawings as tangible property taxed on reasonably allocated purchase price. The current live cross-reference also classifies customer lists, patents and goodwill as intangibles, subject to a patent/machinery condition, and carries 1966 and 1984 dates plus Am. 2001–3; those later live details were not part of the excerpt quoted in this 1990 letter.

The parties intended to agree on approximately 180 percent of physical reproduction cost for the taxable drawing group, and staff accepted their eventual agreed price as the measure. The live 395.1251 annotation prints 130 percent. No agreement, schedule, reproduction inventory, cost calculation, negotiation, or final allocation resolves that official-source conflict.

The parties planned to close as soon as possible and electronically transfer programs during October 20–21, 1990. Because of that timing, Jugum faxed the letter on October 19 and mailed the original. The PDF does not include the request, call record, executed agreement, schedules, Appendix B, software, media, manuals, marketing materials, drawings, design or engineering data, excluded technology, workstations agreement, transfer records, price or consideration detail, allocation, reproduction costs, acquisition-tax support, resale deduction, return, audit, assessment, Board adoption, appeal, or later outcome. It does not show that the proposed closing occurred.

The live 395.1251 annotation preserves only drawings and blueprints, seller-permit status, a business sale, agreed reproduction-cost pricing, and taxable result. It omits every party and date except the opinion date, draft-agreement posture, all ten asset categories, separate taxable equipment agreement, printed consideration phrase, telephone discussion, nontaxable categories, electronically transmitted programs, manuals, marketing materials, tax-paid-purchases-resold deduction, Regulation 1502, Annotation 540.0240, planned transfer weekend, facsimile, missing records, and outcome gap. It also conflicts with the source's 180-percent figure by printing 130 percent.

What this means for you

Buyers and sellers of technology businesses

Do not treat a mixed technology acquisition as entirely intangible. This letter separated remotely transmitted programs from consumed marketing materials, drawings, design data, and separately purchased equipment.

Accountants and tax professionals

Identify each asset category and delivery method, document no-charge bundled manuals, test any resale deduction, and separately allocate consideration to taxable tangible assets using supportable terms.

Common questions

Q: Was the electronically transmitted software taxable?
A: No, under the historical rule applied in the letter.

Q: What about software manuals and documentation?
A: They were not taxed when transferred with the software without a separate charge.

Q: Which technology assets were taxable?
A: The letter expressly taxed consumed marketing materials plus drawings, designs, engineering and technical data, artwork, schematic drawings, and engineering drawings.

Q: Was the drawings allocation 130 or 180 percent of reproduction cost?
A: The live annotation says 130 percent, but the complete source letter says approximately 180 percent. The agreement and calculation are absent, so this page preserves the conflict.

Q: Which listed categories did the letter call nontaxable?

A: Receivables; transferable permits; contracts; deposits and prepaids; books, customer and supplier lists and records; inventory; claims; and goodwill. The letter cites a phone discussion but gives no category-by-category rationale.

Q: Did the letter classify every item in paragraph (b)?

A: It expressly analyzes “marketing materials.” It does not separately state the result for each training, office, reference, or similar item in that paragraph.

Q: What did the parties plan to transfer separately?

A: Workstations and other tangible property under another agreement that the letter characterized as taxable.

Q: Did the transaction close on the planned weekend?

A: The source says electronic transfer was planned for October 20–21, 1990, but supplies no executed agreement, transfer record, return, audit, or outcome.

Citations and references

• California Sales and Use Tax Regulation 1502(f)(1)(D)
• California Sales and Use Tax Annotation 540.0240 — quoted in part for designs and drawings; current live entry includes additional intangible and patent conditions
• October 11, 1990 request and October 19 telephone discussion — identified but not included
• October 12, 1990 Asset Purchase Agreement, Schedules 1.1(c)–(f), and Appendix B — quoted or identified but not included
• Separate workstation and tangible-property agreement — described as under negotiation but not included
• Software, transmission, documentation, marketing, drawing, design, engineering, equipment, price, allocation, reproduction-cost, deduction, tax, administrative, and outcome records — described or implicated but not included

Verbatim support

From the official October 19, 1990 Gary J. Jugum letter:

Sales tax does not apply where prewritten programs are transferred by remote telecommunications. Tax does not apply to written documentation and manuals transferred in conjunction with the transfer of the programs, since no separate charge is made for the transfer of these items.

The marketing materials described in paragraph (b) will be consumed by the transferee for sales and use tax purposes. Accordingly, sales tax applies on the sale of these items.

Sales tax applies to the sale of drawings, designs, engineering and technical data, artwork, schematic drawings and engineering drawings, as described in paragraph (d).

We understand that the parties intend to agree that the price with respect to these items will be approximately 180 percent of the cost of physical reproduction of these items.

From the official live annotation:

If the agreement provides that the drawings and blueprints will be sold for 130% of reproduction cost, tax applies to the amounts as agreed to by the parties.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.1251
• Original supporting opinion: 395.1251 PDF

Original ruling text

395.1251

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION
1020 N STREET, SACRAMENTO, CALIFORNIA
(P.O. BOX 942879, SACRAMENTO, CALIFORNIA 94279-0001)
(916) 445-3723

October 19, 1990

Dear Mr. ---:
This is in response to your letter of October 11, 1990.
We understand that X is entering into an agreement to purchase the assets used by Y in the AA --business. Y has a seller’s permit. Section 1.1 of the Asset Purchase Agreement, dated as of October 12, 1990, provides for the purchase of the following assets: (a) All notes and accounts receivable of the Business as of the Time of Closing in connection with sales arising out of the Business prior to the Time of Closing (“Accounts Receivable”) with recourse to the seller. (b) Marketing materials, training materials, office and reference materials and similar items associated with the Business; (c) All franchises, licenses, permits consents and certificates of any regulatory, administrative or other governmental agency or body issued to or held by Seller necessary or incidental to the conduct of the Business (the “Permits”), (to the extent the same are transferable), a description of all such franchises, licenses, permits, consents and certificates being included in Schedule 1.1(c). (d) All inventions, trade secrets, formulae, process ingineering, technical data, art works, schematic drawings, secret processes, engineering drawings, proprietary rights, proprietary knowledge, know-how, computer software and programming know-how (including source code, object code, on-line files, documentation, testing materials, reports, etc.), names, symbols, service marks, logos, copyrights, and patents and all applications therefore, registrations thereof and licenses in respect thereof necessary to or used in the conduct of the Business, including without limitation, all rights in and to the names “XY” and further including, without

Mr. ---

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October 19, 1990
395.1251

limitation those items listed but not extensively or revealingly described on Schedule 1.1.(d) (the “Technology”). Without limiting the generality of the foregoing, Technology shall include all software owned or licensed by Seller and used in both its AA -business and its BB -- business (the “BB Software”). Notwithstanding the foregoing, the Technology shall not include: (i) the current and future hardware accelerator families of the Seller, including without limitation, the B family, C family, D and E family, F family and G family, and (ii) products of technologies developed by X that are not integral to the Business (collectively, the “Excluded Technology”). (e) The contracts, agreements, contract rights, license agreements, purchase and sales orders, quotations and other executory commitments of Seller, entered into in connection with the conduct of the Business (the “Contracts”) listed on Schedule 1.1(e) (the “Contracts”). All other contracts, agreements, contract rights, license agreements, purchase and sales orders, quotations and other executory commitments of Seller entered into in connection with the Business (the “Excluded Contracts”) are listed on Schedule 1.1(e) as well under the heading “Excluded Contracts.” (f) All lease and rent deposits and prepaid expenses relating to the Business, as described in Schedule 1.1(f). (g) All books of account, customer and supplier lists including addresses, files, papers and records relating to the Business. (h) All inventory relating to the Business, as is in existence at the Time of Closing (the “Inventory”). (i) All causes of action, judgments and claims or demands of whatever kind or description arising out of or relating to the Business. (j)

All goodwill, if any, associated with the Business.

A separate agreement is under negotiation whereby X will properly purchase workstations and other tangible personal property used by Y in a transaction subject to California sales tax. The purchase price for the assets consists of cash sales of common stock of X and royalty payments based on net sales. At this juncture, the Asset Purchase Agreement provides for allocation of the purchase price between (1) the specific assets, identified in paragraphs (a) through

Mr. ---

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October 19, 1990
395.1251

(i), and (2) goodwill. It is our understanding that the parties will further negotiate a selling price with respect to certain specific assets, described below. The principal asset being acquired under the Asset Purchase Agreement is the AA -technology reduced to practice in software source code. It is contemplated that this software will be transferred by electronic transmission in accordance with the program described in Appendix B of the Agreement. As we discussed by telephone on October 19, 1990, sales tax does not apply to items in paragraphs (a), (c), (e), (f), (g), (h), (i) and (j). The marketing materials described in paragraph (b) will be consumed by the transferee for sales and use tax purposes. Accordingly, sales tax applies on the sale of these items. Tax-paid purchases resold deduction would be available to the extent tax may have been paid upon the acquisition of these items, because we understand that no taxable use was made of these items by the transferor. With respect to assets listed in paragraph (d), our analysis is as follows. Sales tax does not apply where prewritten programs are transferred by remote telecommunications. Tax does not apply to written documentation and manuals transferred in conjunction with the transfer of the programs, since no separate charge is made for the transfer of these items. Regulation 1502(f)(1)(D). Sales tax applies to the sale of drawings, designs, engineering and technical data, artwork, schematic drawings and engineering drawings, as described in paragraph (d). Business Taxes Law Guide Annotation 540.0240 provides, in relevant part, as follows: “Designs, drawings, customer lists, patents and goodwill of an outof-state corporation were purchased by an in-state purchaser. Since the designs and drawings are tangible personal property, they are subject to use tax measured by the portion of the purchase price reasonably attributed thereto….” We understand that the parties intend to agree that the price with respect to these items will be approximately 180 percent of the cost of physical reproduction of these items. We are in agreement that the measure of tax is properly the price which will be agreed to by seller and buyer. We understand that the parties intend to close this transaction as soon as possible and that the parties desire to make the electronic transfer of the programs during the weekend of October 20-21, 1990. Accordingly, we are providing you with a facsimile transmission of this letter, and we are mailing the original today. Very truly yours,

Mr. ---

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Gary J. Jugum
Assistant Chief Counsel

GJJ:sr
Transmitted by facsimile October 19, 1990

October 19, 1990
395.1251