California Updates Tax Regulations on Technology Transfer Agreements

The Department conducted three public workshops in 2024. For an overview of Workshops II and III, see Pillsbury’s August 26, 2024, and February 18, 2025, Client Alerts entitled Technology Transfer Agreements: Latest Developments in California and Technology Transfer Agreements: An Update on Latest Developments in California. The Department is now proceeding with an informal rulemaking (or interested parties) process to discuss draft regulatory language that the Department is considering in order to make the sales and use tax regulations consistent with Nortel^[1]and Lucent^[2]and to help retailers determine the value of tangible personal property (TPP) transferred under a TTA in the simplest way possible.

Proposed Amendments to Regulation 1502
The Department proposed amending the second sentence in subdivision (f)(1)(A) of Regulation 1502 to refer to storage media on which a program is recorded, coded, or punched rather than a program. As stated in their Discussion Paper:

The Department determined that, in accordance with Lucent, the provisions of subdivision (f)(1)(B) of Regulation 1502, which provide that tax applies to the entire amount charged to the customer for storage media or coding sheets on which or into which prewritten (canned) programs have been recorded, coded, or punched, must give way when software is transferred pursuant to a software TTA (as discussed further below). Therefore, the Department is proposing to add “Except as provided in Regulation 1507.1” (discussed below) to the beginning of subdivision (f)(1)(B) to limit subdivision (f)(1)(B) accordingly.

The Department determined that subdivision (f)(1)(D) of Regulation 1502 correctly provides that the sale or lease of a prewritten program is not a taxable transaction if the program is transferred by remote telecommunications from the seller’s place of business, to or through the purchaser’s computer. However, the transaction is not taxable because the prewritten program is being transferred electronically by remote telecommunication, and it’s not relevant that the prewritten program is being transferred from the seller’s place of business. Therefore, the Department is proposing to amend subdivision (f)(1)(D) to clarify that the prewritten program is being transferred electronically and delete the text about the software being transferred from the seller’s place of business to avoid confusion.^[3]

The Department also expressed concern that subdivision (f)(1)(D) of Regulation 1502 may be overly broad and inconsistent with the general rule in subdivision (f)(1). The Department’s principal concern was with the current regulation’s language where it indicates that the sale or lease of an electronically transferred program would be taxable if the purchaser obtains possession of any additional TPP in the transaction, rather than TPP on which the program is recorded, coded, or punched.

The Department was also concerned with subdivision (f)(1)(D) in that it indicates that the sale of a prewritten program by the load-and-leave method is taxable if the seller transfers title to or possession of additional storage media in the transaction, rather than storage media on which the program is recorded, coded, or punched. Therefore, the Department proposed amending subdivision (f)(1)(D) to refer to TPP and storage media “on which the program is recorded, coded, or punched” to make it consistent with subdivision (f)(1). They noted in their Discussion Paper:

The Department is also proposing to add a clarifying example to subdivision (f)(1)(D) to illustrate that if Company X sells a customer a computer and a license to electronically download and use a prewritten program, the sale of the license to electronically download and use the prewritten program is not taxable.^[4]

Proposed Amendments to Regulation 1507
The Department also addressed concerns with the first sentence in subdivision (b)(1) of Regulation 1502 as being overly broad because it provides that tax applies to amounts received for any TPP transferred in a TTA without regard to whether any exclusions or exemptions apply. Therefore, the Department proposed adding “unless otherwise exempt or excluded” to the end of the first sentence in subdivision (b)(1) to limit it accordingly.

During the workshops, the Department determined that subdivision (b)(1)(C) of Regulation 1507 was generally consistent with the provisions in subdivision (c)(10)(C) in the TTA statutes, which provide that under specified circumstances the retail fair market value of TPP transferred in a TTA shall be equal to 200 percent of the cost of materials and labor used to produce the TTP. However, interested parties indicated that it would simplify the process for retailers if they could calculate the combined cost of materials and labor used to produce TPP by adding the cost of direct materials and direct labor which must be attributed or allocated to the cost of producing the TPP under generally accepted accounting principles. The Department agreed with the interested parties’ suggestions and concluded that such approach should equal or reasonably approximate the combined cost of materials and labor used to produce the TPP under subdivision (b)(1)(C) of Regulation 1507. Therefore, the Department proposed reformatting the second and third sentences in subdivision (b)(1)(C) of Regulation 1507 as subdivisions (b)(1)(C)(i) and (b)(1)(C)(ii), respectively, and add new subdivision (b)(1)(C)(iii) to provide that:

For purposes of this subdivision, a taxpayer may calculate the combined cost of materials and labor used to produce TPP by adding the cost of direct materials and direct labor which must be attributed or allocated to the cost of producing the TPP under generally accepted accounting principles. For example, Company A makes a tangible product. Company A’s books and records, kept in accordance with generally accepted accounting principles, document that to produce the finished product in a form suitable for retail sale, Company A incurred $125 in direct material costs and $175 in direct labor costs. Company A may calculate the combined cost of material and labor used to produce the tangible product by adding the $125 cost of direct materials and $175 cost of direct labor ($300).^[5]

Proposed New Regulation 1507.1
The Department proposed adopting new Regulation 1507.1 because following the workshops, the Department concluded that it was necessary to further clarify the application of tax to software transactions and establish presumptions to help taxpayers and the Department determine first, whether there was a software TTA, and second, the value of hardware transferred under a software TTA.

Subdivision (a) provides that “software technology transfer agreement” or “software TTA” means a TTA as defined in Regulation 1507, Technology Transfer Agreements, that includes the transfer of copyright or patent interests in software transferred on TPP (e.g., a computer or storage media), as specified in Nortel and Lucent to ensure that new Regulation 1507.1 was consistent with Regulation 1507, Nortel and Lucent.

In the proposed regulation, the Department has included presumptions for bargained-for software and non-bargained-for software. See subdivision (d) of new Regulation 1507.1 (discussed below), rather than the presumptions for consumer and embedded software transactions discussed during the TTA workshops. Therefore, subdivision (a)(1) of new Regulation 1507.1 provides that “bargained-for software” means patented and/or copyrighted prewritten software transferred on TPP that the retailer separately or specifically agreed to sell or license intangible copyright or patent interests in for consideration. The Department also determined that:

It shall be rebuttably presumed that prewritten software is bargained-for software if the retailer provides an invoice, receipt, or other document to the purchaser, contemporaneous with the sale or license of the software, showing that the retailer separately or specifically agreed to sell or license intangible copyright or patent interests in the software for a consideration. The Department may rebut the presumption by establishing that the prewritten software was non-bargained-for software.^[6]

Subdivision (a)(4) of the new Regulation 1507.1 provides that “non-bargained-for software” means prewritten software transferred on TPP that the retailer did not separately or specifically agree to sell or license intangible copyright or patent interests in. Therefore, the Department determined:

It shall be rebuttably presumed that software transferred on TPP is non-bargained-for software, unless the retailer maintains a copy of an invoice, receipt, or other document provided to the purchaser, contemporaneous with the transaction, showing that the retailer separately or specifically agreed to sell or license intangible copyright or patent interests in the software.^[7]

Next Steps
Comments at the interested parties meeting, similar to those made at Workshop III, concerned the precertification process. Also, many expressed the need for examples to be added to the new regulation to provide guidance for taxpayers as well as for auditors. The Department appeared open to creating a small working group to develop some examples, but it is unlikely there will be another interested parties’ meeting. The deadline for interested parties to provide their written submissions to the Department regarding the Discussion Paper was extended to September 8, 2025. Written suggestions or comments, including any proposed regulatory language, can be forwarded to Aimee Olhiser, Chief, Tax Policy Bureau, Business Tax & Fee Division, by September 8, 2025.

^{[1]    Nortel Networks, Inc. v. State Bd of Equalization, 191 Cal. App. 4th 1295 (2011).}

^{[2]    Lucent Techs, Inc. v. State Bd of Equalization, 241 Cal. App. 4th 19 (2015).}

^{[3] Discussion Paper: Software Technology Transfer Agreements, CDTFA at p. 8.}

^{[4] Discussion Paper, at p. 9.}

^{[5] Discussion Paper, at p. 9.}

^{[6] Discussion Paper, at p. 10,}

^{[7] Discussion Paper, at p. 11.}