Microsoft Corp. v. Franchise Tax Board
150 Cal. Rptr. 3d 770
Cal. Ct. App.2012Background
- Microsoft seeks a refund of California corporate franchise taxes for 1995 and 1996 based on royalties from OEM licenses and hardware sales.
- During the years, Microsoft and its subsidiaries operated as a unitary business; the SAP three-factor apportionment was used for tax liability.
- OEM licenses gave rights to install and replicate Microsoft software on OEM hardware, with royalties accruing per system or per copy.
- Trial court held the OEM licenses taxed as licensing tangible personal property; court found licenses properly taxed for California sales factor purposes.
- Court discusses tangibility tests, Preston/Nortel/Navi—regarding intangibles versus tangible property under franchise tax sourcing rules.
- Verdict reversed; remand to determine tax owed based solely on income from keyboard and mouse sales.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Are OEM licenses to replicate/install software tangible or intangible property? | Microsoft contends licenses are intangible rights to copy/install software. | FTB argues licenses license tangible product because disks/objects are involved. | Licenses are intangible property rights. |
| Should OEM license royalties be included in the California sales factor numerator? | Royalties arise from intangible rights; exclude from California numerator. | Licenses involve transfer of property; royalties included as California receipts. | Royalties improperly included; numerator must exclude intangible royalties. |
| What portion of income from bundled software (PowerPoint) is taxable in California? | PowerPoint portion de minimis; costs largely outside California; exclude. | All royalties should be taxed unless clearly exempt. | PowerPoint portion deemed de minimis and excluded. |
| How should keyboard/mouse hardware receipts affect tax calculation? | Hardware receipts should be included; estimate is about six percent of income. | Hardware receipts are included in the sales factor; need precise correlation. | Matter remanded to determine exact impact and apportionment. |
| What is the controlling framework for categorizing software licenses in unitary apportionment? | TTA-like reasoning supports intangible treatment; Preston guidance applicable. | Regulatory/regulatory guidance limited; argue tangible treatment is correct. | Federal-influenced, intangible characterization favored; remand for calculation. |
Key Cases Cited
- Microsoft Corp. v. Franchise Tax Bd., 39 Cal.4th 750 (Cal. 2006) (unitary apportionment framework; intangible vs tangible properties context)
- Navistar Internat. Transportation Corp. v. State Bd. of Equalization, 8 Cal.4th 868 (Cal. 1994) (sales tax; intangible vs tangible property distinction)
- Preston v. State Bd. of Equalization, 25 Cal.4th 197 (Cal. 2001) (technology transfer agreements; intangible rights)
- Nortel Networks Inc. v. Board of Equalization, 191 Cal.App.4th 1259 (Cal. App. 2011) (TTA guidance; intangible licensing considerations)
- Simplicity Pattern Co. v. State Bd. of Equalization, 27 Cal.3d 900 (Cal. 1980) (transfer of tangible property in manufacturing; intangible rights)
- A&M Records, Inc. v. State Bd. of Equalization, 204 Cal.App.3d 358 (Cal. App. 1988) (royalties from licensing master tapes; tangible property)
- Capitol Records, Inc. v. State Bd. of Equalization, 158 Cal.App.3d 582 (Cal. App. 1984) (royalties from licensing master recordings; tangible property)