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A California Court of Appeals recently tackled the question of whether sales tax should be imposed upon a telecommunication company's license for software used to operate its telephone switch hardware. The court held that the software license was exempt from sales and use tax because the license constituted the transfer of patent and copyright interests.
Nortel Networks, Inc., the company whose practices were at issue, engaged in the manufacture and sale of telephone switching equipment switches to Pacific Bell Telephone Co. Nortel and Pacific entered into a licensing agreement whereby Pacific was permitted to utilize Nortel's software programs in the switches. The licensing software consisted of both prewritten and copyrighted switch-specific programs. The California Board of Equalization concluded that sales tax was applicable to the transactions between Pacific and Nortel and issued an assessment, of which Nortel appealed.
The California Legislature enacted the Technology Transfer Agreement ("TTA"), which is broadly defined to cover "any agreement under which a person who holds a patent or copyright interest assigns or licenses to another person the right to make and sell a product or to use a process that is subject to the patent or copyright interest." The provisions of the TTA exempt from taxation "the amount charged for intangible personal property transferred with tangible personal property in any technology transfer agreement."
On appeal, the Board argued that the TTA required a transfer of the right to make and sell a product and to use a process covered by a patent or copyright. However, the California Court of Appeals held Nortel's software license to be exempt from sales tax under the TTA because it was copyrighted, contained patented processes, and enabled Pacific to copy the software and make and sell products embodying the patents and copyrights.