Software sales tax california

Before the Nortel ruling, most companies had been collecting California sales or use tax on all sales or licenses of prewritten computer software. However, under CA Rev. Code Sections c 10 D and c 10 D , sales tax does not apply to amounts charged for intangible personal property transferred in a technology transfer agreement.

Under CA Rev. Title 18, Section a 1 , which the BOE had issued to try to limit the scope of the technology transfer agreement provisions. As a result, the court said, Section a 1 cannot exclude prewritten software that is subject to a copyright or patent. As the law stands, canned software in whatever form may be exempt from taxation under either Nortel or the exemption for electronically delivered software.

However, given the decision in Nortel , the state may be reevaluating its position as it continually struggles to increase revenue. Therefore, taxpayers and preparers alike should be wary of the constantly changing climate. Editor Notes.

The editor would like to offer a special thanks to Christian J. Burgos, J. For additional information about these items, contact Mr. Cook at , ext. Business meal deductions after the TCJA. This article discusses the history of the deduction of business meal expenses and the new rules under the TCJA and the regulations and provides a framework for documenting and substantiating the deduction. This article discusses some procedural and administrative quirks that have emerged with the new tax legislative, regulatory, and procedural guidance related to COVID Toggle search Toggle navigation.

Sales tax applies to the sale of that property if located inside California at the time of sale, and use tax applies to the use of property purchased by Corporation A outside California which is first functionally used inside this state, or which is brought into California within 90 days after purchase unless the property is stored outside this state on half or more of the time during the six-month period immediately following its entry into this state. A customer has been using software, purchased from the taxpayer, for several years.

This customer paid sales tax reimbursement on the original software license when first purchased. The software is licensed to be used on only one computer system. The customer recently upgraded its computer hardware to new equipment. The taxpayer charged the customer a software license transfer fee to allow it to move the software to the new equipment.

The software license transfer fee charged to the customer to permit that customer to utilize the software on new computer equipment relates to the original sale of the software. Since the original sale was taxable, the additional fee is also taxable. A taxpayer, a software developer and publisher, sells software licenses and software maintenance agreements to its customer. Maintenance agreements are optional and are typically sold for a term of 12 months and renewed annually unless terminated by either party.

Currently, the software licenses and updates provided in the software maintenance agreements are delivered in tangible form. The taxpayer will have the capacity to deliver software and updates electronically in the near future. As a result, future software licenses and maintenance agreements may not include a transfer of tangible personal property.

Some customers have requested to terminate their existing maintenance agreements at the end of their month term and sign new agreements detailing that the updates be transmitted electronically. The new maintenance agreements will be regarded as the transfer of non-tangible personal property where the taxpayer and its customers actually terminate their previous agreements and enter into new and valid agreements requiring the transmission of updates in electronic transmission, and the taxpayer actually transfers the updates in electronic transmission to its customers.

On occasion, customers will purchase additional software licenses throughout the year. In order to have all of the software maintenance agreements expire at the same time, the taxpayer's practice has been to terminate the existing maintenance agreement granting credit for the unused portion and have the customer sign new month maintenance agreements for both the pre-existing and newly purchased license.

All would then have the same term. The new agreements require electronic software transmission. The sale of the initial maintenance agreement was a taxable sale. A customer's return of only a portion of a maintenance agreement does not qualify as "returned merchandise" pursuant to Regulation a. There is no provision that allows the taxpayer to claim a tax credit or deduction based on the customer's return of an unused portion of the maintenance agreement.

In connection with its sales of software electronically, the taxpayer may send documentation in tangible form to its customers. The CD-ROM does not contain any software such as a search engine in which to access particular information on the disk.

Under these facts, the taxpayer's transfer of software documentation and not the software itself to its customers in either CD-ROM or paper form is subject to tax where it makes a separate charge to its customers for such documentation. Where no charge is made, the taxpayer is the consumer of its documentation materials. Taxpayer licenses software and software maintenance agreements to its customers. Maintenance agreements are optional and are usually sold in month terms that renew annually unless terminated by either party.

Currently, the software updates provided in the maintenance agreements are delivered in tangible form. New customers or renewals may request updates be delivered electronically.

The current agreement provides software updates be provided in tangible form and, thus, are subject to tax. If new customers or renewals contract for updates to be delivered in tangible form, tax applies to charges for the entire 12 months of those contracts.

However, if new customers or renewals request the transmission of software updates solely by remote telecommunication, those new or renewal maintenance agreements will not be subject to tax provided the taxpayer delivers its software updates solely by remote telecommunications e.

Under a licensing agreement, a business provides software and maintenance of that software to a client. The maintenance is for providing updates and future releases of the software.

The contract for providing updates and future releases is a contract for the sale of tangible personal property. The charges for such a software maintenance contract are subject to sales tax regardless that the maintenance contract may be optional with the purchaser.

The issue of optional v. If the purchaser may, at its option, contract for consultation services for a separately stated price, these optional charges are nontaxable. If the purchaser does not have the option to purchase the consultation services in addition to the storage media, the charges are taxable as services that are part of the sale of the storage media. A company develops and publishes video games that are currently manufactured and distributed on floppy disks.

The company would supply to the licensees object code masters for the licensed games and mechanical art or film for all components necessary to complete the licensed products. The licensee pays the company licensor royalties equal to a percentage of net sales for the sale and distribution of the licensed products.

Royalties paid for the right to reproduce or copy a program to which a federal copyright attaches are not subject to tax provided the purpose is to publish and distribute the program to third parties for consideration. Charges for transfers of mechanical art and film in connection with such licensing agreements are subject to tax.

Rentals of video games to consumers are subject to tax pursuant to section g 7 and section e 7. A software products company markets a comprehensive mechanical computer aided engineering software system.

The program, which is licensed, is an application program that permits a computer to perform specific tasks. The engineering technology is transferred to the end user on magnetic tape. Additional software may be ordered by executing a supplemental Licensed Software Designation Agreement. The customer can obtain either an annual license or perpetual an extended term license.

When a customer obtains a perpetual license, they will frequently also obtain optional maintenance and support services. These services entitle the end user to receive services including:. Eight months later, the customer executes a new Agreement to expand to four simultaneous users. No additional tapes or manuals will be sent to the customer, but the customer is charged a fee for the addition of the two simultaneous users. After three months, the customer adds the solid modeling module that is embodied on the same magnetic media as the drafting module.

No additional tapes are sent to the customer. An additional manual is sent and a fee is charged for the additional module. No additional tapes or manuals are sent to the customer, but an annual license fee is charged. The customer claims that additional charges are nontaxable because no additional tangible personal property was transferred. The regulation provides that charges are nontaxable when the purchaser does not obtain possession of any tangible personal property.

Under the facts provided, possession of tangible personal property was transferred and a charge was made for the customer's increased use of the property. The fees in each of the described situations are subject to tax. A retailer of laser printers and related prewritten or "canned" software also offers a maintenance policy for the software.

The maintenance policy has two features, telephone consultation and updates or program enhancements. The updates are transferred on magnetic tape and are also "canned. The charge is billed lump sum and no allocation is made between the telephone consultation and the updates.

The company views the updates and program enhancements as incidental to the telephone consultation service.

Generally, telephone consultation is a service that does not by itself result in a tax liability. However, since the purchasers of the maintenance policies had to purchase the entire package, any person desiring the program updates had to pay for the telephone consultation as well. It follows that the telephone consultation was a "service that was part of the sale" of the program updates, and that the entire charge to the customer for the software maintenance policy is subject to tax.

A taxpayer's contract with its customers specifies that taxpayer would perform its software maintenance services, including transmission of program updates, by remote telecommunications means, i. In fact, the taxpayer would not contract with the customer unless the customer had a modem in order to receive software maintenance by telephone. Since the transfer of program updates is by remote telecommunications, there is no transfer of tangible personal property.

Therefore, charges for this software maintenance service is not subject to tax. A taxpayer entered into a contract to license its software programs on a rental basis. It also rented computer hardware on which it paid California sales tax reimbursement at the time of purchase as well as a third party software license on which it also paid sales tax reimbursement at time of purchase.

In addition, the taxpayer's monthly charge to the client included a charge for installation and upgrade work. The sale of the taxpayer's prewritten computer programs transferred to the customer in the form of storage media constitutes a sale of tangible personal property.

Tax applies to the entire amount charged for the prewritten programs, including all license fees. Regulation f 1. Labor charges for installation of prewritten programs are excluded from the measure of tax. Installation includes the actual installation of software and the testing of the prewritten programs on the purchaser's computer to ensure that the programs operate as required. This exclusion does not encompass any other services, such as converting a customer's data into a format suitable for use with the new software.

Conversion services are part of the sale of the prewritten program and charges attributable to such services are taxable. Since the taxpayer has timely paid "sales tax" on the hardware and the third party software and they are being leased in the same form as acquired taxpayer transferred physical possession of the storage media on which the original third party software was acquired , tax does not apply to the amount charged by the taxpayer for the lease of these items.

A software licensor L provides software to a computer equipment manufacturer M to be sublicensed to the end users of M's equipment. The agreement between L and M provides for a number of specified fees, some of which are taxable and some of which are not taxable. Nontaxable fees include: An initial participation fee and an annual nonrefundable renewal fee, both of which are paid to L by M for the right to participate in the sublicensing program; commissions paid to M by L for each sublicense M issues to an end user; royalties paid by M to L for each sublicense issued; fees for optional product support offered by L through M to M's sublicensees; fees paid by M to L for requested porting of program updates; and certification fees.

Taxable fees include: Charges to end users for the use of pre-existing programs, and technical support service fees which provide for updates paid by the end-user where the end-user has contracted directly with L or with M. A taxpayer sells software packages and software support agreements. Customers may choose one of the following support agreement options: full support or after-hours support.

Full support includes telephone hotline support as well as software upgrades released during the maintenance period. The taxpayer charges one price for this full support. There is no segregation of price between the hotline and the upgrades.

When an upgrade is released, the customers receive a software upgrade tape that they load onto their computer system.

The taxpayer's employee then dials into the customer's system via modem and performs the procedures to actually install the new upgrade. The other option, after-hours support, basically consists of telephone hotline support. The customers who choose this option are not entitled to any software upgrades. A customer initially purchasing a software package is required to purchase one of the maintenance options for the first year.

After the first year, the support agreement becomes optional. If a customer elects to discontinue the support, the customer cannot receive any future software upgrades unless all back support charges are paid. Since the customers are required to purchase one of the maintenance alternatives for the first year, whichever support contract the customer selects is mandatory. Thus, the taxpayer's charges for all first-year support agreements are taxable.

Even after the first year, all the taxpayer's charges for full support are taxable, even if that support is truly optional since the customer cannot purchase the software portion without also purchasing the services. The taxpayer may not deduct its charges for the services even if separately stated. After the first year, when the maintenance contracts are optional, the taxpayer's charges for its after hours support are not taxable if they consist entirely of telephone support.

When a customer who had discontinued support pays "back support charges" as a condition to obtaining a software upgrade, such charges are part of the sale of the upgrade and are subject to tax. A taxpayer is engaged in the business of providing computer services and software to school districts. It entered into a licensing agreement which included the following tasks:. The use of the software system will be made available to the school district through a telephone dial-up to the taxpayer's computer.

This is a nontaxable contract for service only and does not call for the transfer of tangible personal property. The school district's use of the program through a modem and the computer files prepared by the taxpayer also constitute nontaxable services. Charges for software technical assistance given on a noncontractual, per-call basis are not taxable provided there is no tangible personal property transferred to the customer.

A firm encodes its computer program on a master ROM BIUS chip, and transfers the chip together with the right to reproduce identical copies of the chip to its customer. For each chip copied the licensee pays a royalty. In certain situations, the firm also furnishes human readable source code.

The source code and other source materials allow the customer to modify the master chip's object code before reproducing the chip. The firm makes a one time flat fee for the license of the source code and restricts the licensee from selling, licensing, sublicensing, disclosing, or providing access to the source material. The exclusion from tax contained in Regulation f 1 B embraces both the source code version and the object code version.

The licensee who receives the source code and other source materials acquires the information incidental to the licensing transaction. As long as the licensee acquires the right to reproduce and distribute copies of the program in object code format, and does not acquire a site license for the object code, it makes no difference that the licensee does not have a similar right with respect to the source code. Independent Contractors. In determining whether a taxpayer is making taxable sales under Regulation f 2 or is merely furnishing "special employees" to its customers, the distinction between special employees and independent contractors must be drawn.

Of the factors entering into this distinction, the primary one is whether the person for which the work is being done has the legal right to control the manner and means of accomplishing the results desired. Other factors to be considered are:. The performance of keystroking services to enter data from source documents to magnetic computer disks for a customer is taxable fabrication labor unless the services are performed by "special employees" on the customer's premises.

The distinction is whether the taxpayer is engaged to produce a finished product, or to provide personnel who will work under the direction and control of the customer.

In this instance, the taxpayer's people were involved in handling the overflow of work normally done by the customer's staff and the customer's office manager assigned the tasks to be done. The supervisor provided by the taxpayer was only required when there were six or more temporary employees on a shift, and the contract specified that the work would be done "… as requested and directed by … the customer.

Charges for modem to modem stock quotations are not subject to tax where there is no transfer of any tangible personal property. If a seller contracts with its customer to provide a custom computer program to the customer's special order and then subcontracts with another person who creates the program to the special order of the seller's customer, sales tax would not apply to the seller's charge to the customer for the custom computer program.

A taxpayer obtains canned software from its lessor under a licensing agreement which that taxpayer will sublicense to its customer. The lease agreement requires a primary license charge plus annual license charges. Under the terms of the licensing agreement, if the annual license charge is not paid, the taxpayer must discontinue use of the product and return all copies to the lessor.

If the taxpayer transfers to its customer the actual software it obtains from the lessor and if the agreement requires that actual software be returned if the license fee is not paid, the transfer to the customer is a sublease under Regulation c 5. The sublease is subject to use tax measured by the subrental payments unless the taxpayer makes a timely election to pay its lessor use tax measured by the rentals payable under the prime lease.

See Annotation If, however, the taxpayer were to retain the original media which it receives from the lessor and make a copy for lease to its customer, the taxpayer would be using the software obtained from the lessor and not leasing it. As a result, the transfer to the taxpayer of the original media would be a taxable retail sale under section g 5 and the taxpayer's transfer of the copy to its customer would also be taxable because the software transferred to the customer would not be the same media that the lessor acquired from the taxpayer.

A manufacturer and retailer of printed circuit boards incorporates a title clause in the quotations given to its customers stating that title to all tools and computer programs, purchased or manufactured specifically for the contract which are used in the production or the testing of products, passes to the customer prior to the time the tools and computer programs are used by the seller. Under these facts, the seller transfers title to the tools and computer programs to its customer prior to use in the manufacturing process.

The seller may issue a resale certificate to its vendor to purchase the tools ex-tax. An agreed value between buyer and seller was reached as to the value of the traded in software.

When a retailer accepts a trade-in, the retailer must include in the measure of tax the amount agreed upon between the retailer and the buyer as the allowance for the merchandise traded in. If there is a trade-in and also a discount, the contract between the seller and the buyer must make it clear that the parties contract for both a trade-in allowance and for a discount.

If sales of computer programs include training services but the purchaser does not have the option to purchase the program without the services, then the consideration paid for the training is taxable as part of the sales of the computer software, whether such charge is separately stated or not.

On the other hand, when the purchaser may, at its option, contract for the services for a separately stated price in addition to the charges made for the tangible personal property, then a reasonable charge for the services is nontaxable. Charges for optional training is regarded as providing of a nontaxable service provided such training is not part of taxable consultation see Regulation f 1 C.

An artist prepares artwork and places it on the artist's removable computer storage media e. The artist takes the disk to the customer's location, inserts the disk into the customer's computer, and transfers the artwork from the artist's disk to the customer's computer.

The artist removes the disk and retains it, and does not otherwise provide any tangible personal property to the customer. The transfer is not a sale of tangible personal property provided the artist retains title to and possession of the disk at all times. For example, if, after inserting the disk and prior to its removal, the artist leaves the computer and the customer uses it, the artist would be regarded as making a taxable lease of the disk.

When an artist creates artwork on a client's computer and saves the artwork into the computer's memory, the artist's charge is nontaxable. In this situation, the artist does not transfer tangible personal property to the client.

The same result is not reached when the artist transfers the artwork to external storage diskettes or disks and transfers them to the client, whether the client or the artist furnishes the removable disk or diskettes. When the artist furnishes the disk or diskettes, the artist is making a sale of tangible personal property under subdivision a of section If the client furnishes either new or used disks or diskettes, the artist's charge for the work performed to create the artwork is a sale as defined in subdivision b of section The artist's charge for the sale, whether under subdivision a or b of section , is subject to tax.

Tax does not apply to the transfer of illustrations by computer modem and when seller does not provide its customer with any tangible personal property. A taxpayer prepares advertisement layouts and transfers the image of the advertisement by modem to its client, or the taxpayer posts the advertisement on the Internet. Sales tax does not apply to the taxpayer's charge because the taxpayer does not make a sale of tangible personal property when information is transferred by electronic means.

On the other hand, if the taxpayer provides the client with a hard copy of the advertising layout or transfers the layout to the client on a computer diskette, the charge is subject to sales tax. A firm is in the business of manufacturing and embossing credit cards for financial institutions. The information to be embossed is obtained from the financial institution on a data processing tape.

Occasionally the firm's equipment cannot read the financial institution's tape because it is incompatible with the firm's equipment. In order to make it compatible with its equipment, the firm transfers the information on the tape to four tapes.

In these cases, it makes a separate charge to the financial institution for "interim tape processing. This charge is not a charge for processing customer furnished information as described in Regulation d 5. The contract with the financial institution is a contract to produce credit cards.

The restructuring of the information is merely one step in the manufacturing process. The separately stated charge is part of the gross receipts from the manufacture of the credit cards.

Corporation A sold all of its assets, including software, to Corporation B. The programs were transferred by network wire. The programs were designed to be used by banks and were written for the purpose of selling to banks and other financial institutions.

For unknown reasons, the software was not marketed. The original master disks were retained by Corporation A, but were required under the contract to be stored in escrow. They were to be available to Corporation B for a period of five years to verify the accuracy of the wire transfer.

Corporation A was barred from using, making copies of, or permitting other persons access to the disks. At the end of the five-year period, Corporation A was required to erase the disks. The transaction is regarded as including the sale of the master disks since Corporation B obtained all of the rights of ownership except custody.

The transfer of the disks was, however, not taxable because Corporation B purchased the software to obtain the right to reproduce or copy a program to which a federal copyright attaches in order to publish and distribute it for consideration to third parties. That is, subdivision f 1 B is not limited to leases for copy and sale, but also to transfers of title for such purposes. It is immaterial that Corporation B may have later decided not to market the program.

Taxpayer is in the business of developing and selling software. All sales of its product includes documentation.

To learn more, see a full list of taxable and tax-exempt items in California. We value your feedback! Do you have a comment or correction concerning this page? Let us know in a single click. We read every comment! The CD-ROM does not contain any software such as a search engine in which to access particular information on the disk.

Under these facts, the taxpayer's transfer of software documentation and not the software itself to its customers in either CD-ROM or paper form is subject to tax where it makes a separate charge to its customers for such documentation. Where no charge is made, the taxpayer is the consumer of its documentation materials. Note: Regulation was amended so that beginning January 1, , 50 percent of the charge for optional software maintenance agreements is subject to tax.

Prior to that date, generally percent of the charge was subject to tax.