SeeSALT Blog
The California Department of Tax and Fee Administration (CDTFA or Department) hosted its third workshop (Workshop III) on December 9, 2024, to discuss and receive input on technology transfer agreements (TTAs).
On January 22, 2025, the CTIA (formerly the Cellular Telecommunications and Internet Association) submitted comments. The California Taxpayers Association (CalTax) and the Silicon Valley Leadership Group (SVLG) also submitted their comments in a joint letter.
Workshop III
Background
Under California law, intangible property (IP) transferred as part of a TTA is not subject to tax. (Revenue and Taxation Code subdivisions (c)(10)(A)-(C) of Sections 6011 and 6012 and Regulation 1507.) Two Court of Appeals decisions in Nortel Networks Inc. v. State Board of Equalization, 191 Cal.App.4th 1259 (2011) and Lucent Technologies Inc. v. State Board of Equalization, 241 Cal.App.4th 19 (2015) held that software is IP even when transferred in a TTA via physical media, requiring amendments to Regulation 1507, Technology Transfer Agreements (Regulation 1507).
Over the initial two workshops, interested parties and the Department staff discussed various proposals regarding amendments to Regulation 1507. For an overview of Workshop II, see Pillsbury’s August 26, 2024 Client Alert entitled Technology Transfer Agreements: Latest Developments in California. Workshop III focused on three main proposals presented by Department staff: (1) an auditable “safe harbor” provision; (2) where intangible rights are not specifically bargained for as part of a transaction, a rebuttable presumption that the entire charge in the transaction represents the retail value of the tangible personal property (TPP) transferred; and (3) a rebuttable presumption with respect to embedded software.
CTIA Letter Comments [1]:
CTIA addressed the three main proposals contained in the Department’s Workshop III Paper:
1. Auditable Safe Harbor
The Department sought input on the following language:
For all transactions not subject to the rebuttable presumptions in subdivisions (1) and (2) of this regulation [note these would be the two rebuttable presumptions, discussed below], a taxpayer may elect to exclude from the gross receipts or sales price 20 percent of the total amount charged under a TTA as the amount charged for intangible personal property transferred with TPP in that TTA. If such election is made, a taxpayer must substantiate upon audit that a TTA exists and that the gross receipts or sales price attributable to the TPP transferred as part of the TTA does not exceed 80 percent of the total amount charged for the TTA under a method set forth in subdivisions (c)(10)(A)-(C) of Sections 6011 and 6012.
A precertification process for the 20 percent “safe harbor” was presented by Department staff which would involve submission of certain documentation and other information to be eligible to elect the 20 percent exclusion. However, in discussions it became clear that the precertification and election would be subject to review upon audit. Thus, this proposal was not a true safe harbor but more of a “sheltered harbor,” a term coined by Chief Counsel Chris Schutz. Use of the precertification process was envisioned by the Department as shifting the burden of proof from the taxpayer to the Department, with the Department possibly waiving penalties.
The Department’s proposed precertification process includes a statement made under penalty of perjury. In its letter, CTIA contended that there should be alternatives because the items the CDTFA requests taxpayers to swear to under the penalty of perjury are essentially legal conclusions. Rather, CTIA suggested as an alternative that a statement made to the best of the taxpayer’s knowledge and belief be required or where applicable, copies of relevant documents be provided such as: (1) copies of the TTA(s); (2) if the intangible personal property is patented, a copy of the patent(s); or (3) an internal cost information or valuation study.
In its letter, CTIA further noted: “A tremendous amount of work would likely be required to gather and provide the requested pre-certification documents described in the Third TTA Workshop Paper, especially for large-scale taxpayers. What is the point of expending the effort and incurring the expense to gather and provide these pre-certification documents if taxpayer can thereafter be audited just the same?” Accordingly, echoing many comments made at Workshop III, it was suggested that a true safe harbor option, about 10 percent, be included.
2. Rebuttable Presumption that for Non-Bargained-For Transactions the Price Charged for the Transaction is Equal to the Value of the Transferred TPP
In response to interested party written comments expressing concern that the presumption should not make a distinction based on whether the transaction is to a business or consumer, the Department noted that the language has been revised to focus on whether any copyright or patent interests were specifically negotiated as part of the sale. As such, the Department was no longer drawing a distinction with respect to whether the transaction is with a business or a consumer.
Under CDTFA’s proposal, the rebuttable presumption may be rebutted by providing:
- Documentation, contemporaneous with the sale, showing that any intangible copyright or patent interests were bargained-for as part of the transaction; and
- Documentation establishing that the value of the TPP as determined in Sections 6011/6012, subdivision (c)(10)(A)-(C), is less than the amount charged for the transaction.
In its letter, CTIA noted an inconsistency between the use of the above conjunctive requirement (“and”) which differed from an example in the Third TTA Workshop Paper (p. 9) where use of the term “also” indicated that either type of documentation was acceptable. It was suggested that “or” be substituted to cure the internal consistency.
3. Rebuttable Presumption Regarding the Transfer of TPP with Embedded Software
In response to interested party comments expressing concern that this presumption seeks to limit the scope of what constitutes a TTA, the Department noted in its Workshop III Paper that the presumption would assume that the transaction constitutes a TTA and would only relate to the value of the TPP transferred. In response to interested party concerns related to valuation, the Department noted that the current proposal excludes transactions in which the measure is established pursuant to subdivisions (b)(1)(A) or (b)(1)(B) of Regulation 1507 [2]. In addition, it was noted that there would not be any presumption as to the value of any intangible rights in embedded software, but rather be limited to the value of the TPP transferred.
In its letter, CTIA observed that the proposed Embedded Software Presumption is vague, confusing, and serves no meaningful purpose. Both the intent behind the presumption and the language used to describe it is unclear. CTIA went to say that the Third TTA Workshop Paper did not explain the reasons why CDTFA was excluding TTA transactions in which the measure of tax is established using the first and second methods provided by the TTA statutes and Regulation 1507, but not TTA transactions using the third method. CTIA sees no rational basis for the distinction.
CTIA further observed that the proposed Embedded Software Presumption does not provide ease of administration or certainty to retailers. Also, CTIA expressed concerns with the definition of Embedded Software.
CalTax and SVLG Joint Letter Comments
In their letter, CalTax and SVLG suggested a variety of proposed edits to the existing proposals in the Department’s Workshop III Paper (Discussion Paper), proposed numerous examples for its consideration and concluded:
The Discussion Paper includes a rebuttable presumption regarding the transfer of TPP with embedded software only. It would be very helpful for this paragraph to include specific language describing the characteristics of the TPP to which the presumption applies. For example, a specific statement that this rebuttable presumption applies to closed systems that cannot be accessed by purchasers and that are not updateable by the OEM.
Next Steps
The Department intends to move to the formal regulatory process with interested parties’ meetings in 2025 unless these recent submittals cause CDTFA to reconsider its position.
[1] CTIA suggested that it is premature to proceed from the Workshop Stage to the more formal Interested Parties Phase. Rather it recommended that the Department’s drafting staff meet with representatives of the taxpayer community for a joint drafting session(s).
[2] Regulation 1507(b) provides:
(1) Tax applies to amounts received for any tangible personal property transferred in a technology transfer agreement. Tax does not apply to amounts received for the assignment or licensing of a patent or copyright interest as part of a technology transfer agreement. The gross receipts or sales price attributable to any tangible personal property transferred as part of a technology transfer agreement shall be:
(A) The separately stated sale price for the tangible personal property, provided the separately stated price represents a reasonable fair market value of the tangible personal property;
(B) Where there is no such separately stated price, the separate price at which the tangible personal property or like (similar) tangible personal property was previously sold, leased, or offered for sale or lease, to an unrelated third party; or,
(C) If there is no such separately stated price and the tangible personal property, or like (similar) tangible personal property, has not been previously sold or leased, or offered for sale or lease to an unrelated third party, 200 percent of the combined cost of materials and labor used to produce the tangible personal property.