LUCENT TECHNOLOGIES, INC., et al., Plaintiffs, Cross-defendants and Respondents, v. BOARD OF EQUALIZATION, Defendant, Cross-complainant and Appellant.
No. B257808
Court of Appeal, Second District, Division Two, California
Oct. 8, 2015
241 Cal.App.4th 19
Rehearing Denied November 3, 2015
Kamala D. Harris, Attorney General, Paul D. Gifford, Assistant Attorney General, Diane S. Shaw, Stephen Lew and Ronald N. Ito, Deputy Attorneys General, for Defendant, Cross-complainant and Appellant.
Paul Hastings, Jeffrey G. Varga, Julian B. Decyk, Paul W. Cane, Jr., and Amy L. Lawrence for Plaintiffs, Cross-defendants and Respondents.
HOFFSTADT, J.—A manufacturer sells sophisticated telecommunications equipment to nine different telephone companies, who in turn use that equipment to provide telephone and Internet services to their customers. In the transactions between the manufacturer and telephone companies, the companies paid for (1) the equipment, (2) written instructions on how to use the equipment, (3) a copy of the computer software that makes the equipment work, and (4) the right to copy that software onto the equipment‘s hard drive and thereafter to use the software to operate the equipment. In Nortel Networks Inc. v. Board of Equalization (2011) 191 Cal.App.4th 1259 [119 Cal.Rptr.3d 905] (Nortel), we held that an almost identical transaction satisfied the requirements of California‘s technology transfer agreement statutes (
The Board‘s assessment of the sales tax was erroneous. In so concluding, we hold that (1) the manufacturer‘s decision to give the telephone companies copies of the software on magnetic tapes and compact discs (rather than over the Internet) does not turn the software itself or the rights to use it into “tangible personal property” subject to the sales tax, (2) a “technology transfer agreement” within the meaning of
Moreover, because the Board‘s trenchant opposition to the manufacturer‘s refund action in this case was all but foreclosed by Nortel and other binding decisional and statutory law, the Board‘s position was not “substantially justified” and the trial court did not abuse its discretion in awarding the manufacturer its “reasonable litigation costs.”
We accordingly affirm.
FACTS AND PROCEDURAL BACKGROUND
I. Telephone Networks Generally
The telephone and data network in the United States is both terrestrial (land-based) and wireless, and is seamlessly interconnected through equipment called switches that are housed in so-called central offices scattered around the country. A single switch is comprised of “numerous computer processors, frames (sometimes called cabinets), shelves, drawers, circuit packs, cables, trunks and many other pieces of hardware.” A switch serves two functions: (1) it routes incoming and outgoing calls or data streams toward their ultimate destination on the nation‘s network, and (2) it operates a panoply of features, ranging from call waiting, three-way calling and call forwarding to “caller ID” and voicemail. Because each switch is located in a unique place along the network, and because each can offer a different mix of features, “no two switches [are] alike.”
II. Underlying Transactions
Prior to 1996, AT&T Corporation (AT&T) manufactured switches. On February 1, 1996, AT&T spun off its network services division, which was responsible for manufacturing switches, into a separate company called Lucent Technologies, Inc. (Lucent). AT&T and Lucent (collectively, AT&T/Lucent) designed the software (both switch-specific and generic) that runs the switches they sell. That software is copyrighted because it is an original work of authorship that has been fixed onto tapes; the software also embodies, implements, and enables at least one of 18 different patents held by AT&T/Lucent.
Between January 1, 1995, and September 30, 2000, AT&T/Lucent entered into contracts with nine different telephone companies2 to (1) sell them one or more switches, (2) provide the instructions on how to install and run those switches, (3) develop and produce a copy of the software necessary to operate those switches, and (4) grant the companies the right to copy the software onto their switch‘s hard drive and thereafter to use the software (which necessarily results in the software being copied into the switch‘s operating memory). AT&T/Lucent gave the telephone companies the software by sending them magnetic tapes or compact discs containing the software. AT&T/Lucent‘s placement of the software onto the tapes or discs, like the addition of any data to such physical media, physically altered those media. The telephone companies paid AT&T/Lucent $303,264,716.51 for a copy of the software and for the licenses to copy and use that software on their switches.3
The Board assessed the sales tax on the full amount of the licensing fees paid under the contracts between AT&T/Lucent and its telephone company customers. At the then-current sales tax rate of 8.5 percent, this came to a sales tax liability of $25,777,500.90. As required by the state Constitution (
IV. Litigation
AT&T/Lucent sued the Board for a refund of the sales tax attributable to the software and licenses to copy and use that software. AT&T/Lucent filed two lawsuits—one covering the taxes paid between January 1, 1995, and January 31, 1996, before Lucent broke away from AT&T (Lucent I), and a second covering the period between February 1, 1996, and September 30, 2000 (Lucent II).4 In response to each complaint, the Board filed a cross-complaint seeking unpaid interest on the sales tax already paid—namely, $6,319,583.44 in the Lucent I cross-complaint and $12,321,890.58 in the Lucent II cross-complaint.
The parties filed cross-motions for summary judgment on AT&T/Lucent‘s tax refund claims, and the trial court issued a 15-page ruling granting AT&T/Lucent‘s motions. The court concluded that the contracts between AT&T/Lucent and the telephone companies were technology transfer agreements within the meaning of
AT&T/Lucent sought its court costs, and under
DISCUSSION
I. Background Law on California‘s Sales Tax
The State of California imposes a sales tax upon sellers “[f]or the privilege of selling tangible personal property.” (
As relevant to this appeal, a “[s]ale“—the event that triggers the sales tax—includes “[a]ny transfer of title or possession, exchange, or barter, contractual or otherwise, in any manner or by any means whatsoever, of tangible personal property for a consideration” as well as “[a]ny lease of tangible personal property in any manner or by any means whatsoever” unless otherwise exempted by statute. (
However, transactions not involving tangible personal property, such as the sale of services or the sale of intangible personal property, are not subject to the sales tax. (See Overly Mfg. Co. v. State Board of Equalization (1961) 191
Whether a transaction involving both taxable and not-taxable components is subject to the sales tax turns on two considerations: (1) whether the taxable and not-taxable components are “inextricably intertwined” rather than “readily separable“; and, if they are inextricably intertwined, (2) whether the not-taxable component is a service or is intangible personal property. (Dell, Inc. v. Superior Court (2008) 159 Cal.App.4th 911, 924-925 [71 Cal.Rptr.3d 905] (Dell).) Where the transaction involves components that are “readily separable” and not “inextricably intertwined,” the sales tax is assessed against the component of the transaction involving tangible personal property and not assessed against the remaining, not-taxable component. (Dell, at p. 925.)
Determining how to apply the sales tax to a transaction where tangible personal property is inextricably intertwined with components not subject to the sales tax is, as our Supreme Court has noted, more “troublesome.” (Preston, supra, 25 Cal.4th at p. 208.) In this instance, the question of taxation hinges on the nature of the untaxable component. (Dell, supra, 159 Cal.App.4th at p. 924 [“California views sales of tangible property bundled with intangibles, rather than services, differently.“].) When the untaxable component is a service, a court is to determine whether the “true object” of the transaction is the sale of tangible personal property or instead the performance of a service. (
But this is only the default rule. In 1993, our Legislature enacted the technology transfer agreement statutes and thereby set up a special rule for technology transfer agreements by excluding them from the definition of “sales” and “gross receipts.” (See
II. Summary Judgment Ruling
Because AT&T/Lucent did not seek a refund of the sales tax assessed against the switches themselves and conceded the sales tax was properly assessed against the written instructions, the remaining question is whether the Board correctly assessed sales taxes on (1) the computer software sent to the telephone companies using tapes and compact discs, and (2) the licenses to copy and use that software on the switches.
The Board argues that the transfers of the software and licenses are wholly taxable, and that the trial court‘s summary judgment ruling to the contrary is erroneous for three reasons. First, the software is tangible personal property because the act of placing the software onto magnetic tapes and compact discs physically altered those media. Because those alterations can be (microscopically) seen and are otherwise “perceptible to the senses” (
We independently review the trial court‘s grant of summary judgment. (Salas v. Sierra Chemical Co. (2014) 59 Cal.4th 407, 415 [173 Cal.Rptr.3d 689, 327 P.3d 797].) Our task is to ascertain whether any “triable issue exists as to any material fact. . .” (ibid.), and we do so by independently reviewing the record, by viewing the evidence in the light most favorable to the Board (as the losing party below), and by resolving any evidentiary doubts and ambiguities against summary judgment (Elk Hills Power, LLC v. Board of Equalization (2013) 57 Cal.4th 593, 605-606 [160 Cal.Rptr.3d 387, 304 P.3d 105]). To the extent the summary judgment ruling turns on questions of statutory interpretation, we also review such questions independently. (Weinstein v. County of Los Angeles (2015) 237 Cal.App.4th 944, 965 [188 Cal.Rptr.3d 557].)
We will consider each of the Board‘s arguments separately.
A. Software as “tangible personal property”
The Board argues that the computer software in this case is tangible personal property, and offers the following syllogism in support of its position: (1) tangible personal property is property that “may be seen . . . or which is in any other manner perceptible to the senses” (
We reject this syllogism for two reasons. First and foremost, it is inconsistent with precedent. As detailed above, when tangible and intangible property is inextricably intertwined, whether the property is subject to the sales tax turns on whether the tangible property is “essential” or “physically useful” to the subsequent use of the intangible personal property. (Preston, supra, 25 Cal.4th at pp. 212, 211; see Navistar, supra, 8 Cal.4th at p. 878.) More to the point, the California courts have on multiple occasions held that the transmission of software using a tape or disc in conjunction with the grant of a license to copy or use that software does not yield a taxable transaction because the tape or disc is “merely . . . a convenient storage medium [used] to transfer [the] copyrighted content” and hence not in itself essential or physically useful to the later use of the intangible personal property. (Microsoft, supra, 212 Cal.App.4th at p. 92; accord, Nortel, supra, 191 Cal.App.4th at p. 1276 [noting that the buyer “made little use of the tangible
Second, the Board‘s construction of
The Board offers four further reasons in support of its position. First, it argues that two California cases—Navistar, supra, 8 Cal.4th 868 and Touche Ross, supra, 203 Cal.App.3d 1057—are consistent with its view that the sale of computer software on physical media is a transaction subject to the sales tax. However, both of these cases involved the sale of computer software “for its own sake” and not in conjunction with the concurrent sale of intellectual property rights. (Navistar, at pp. 877-878; see Touche Ross, at pp. 1060-1064.) Neither case had occasion to consider the issue before us now—namely, whether the transmission of software through a physical media as a means of effectuating the grant of a license to copy and use that software is subject to the sales tax. As noted above, courts assess taxability in this context using a different rule than they use to assess taxability in the context at issue in Navistar and Touche Ross.
Second, the Board argues that
Third, the Board argues that Louisiana courts treat software as tangible property subject to Louisiana‘s sales tax. (South Central Bell Telephone Co. v. Barthelemy (La. 1994) 643 So.2d 1240, 1244.) As explained above, California law is different. Indeed, Barthelemy itself distinguishes California law on this very point. (Ibid.) Where out-of-state authority is at odds with California law, it lacks even persuasive value. (Fairbanks v. Superior Court (2009) 46 Cal.4th 56, 63 [92 Cal.Rptr.3d 279, 205 P.3d 201].)
Lastly, the Board asks us to overturn the precedent that dictates a ruling against it. We are bound to follow the decisions of our Supreme Court (Auto Equity Sales, Inc. v. Superior Court (1962) 57 Cal.2d 450, 455 [20 Cal.Rptr. 321, 369 P.2d 937]), but do have some latitude to disregard the decisions of our sister Courts of Appeal (and even our own prior decisions [Roger Cleveland Golf Co., Inc. v. Krane & Smith, APC (2014) 225 Cal.App.4th 660, 677 [170 Cal.Rptr.3d 431], disapproved on other grounds in Lee v. Hanley (2015) 61 Cal.4th 1225 [191 Cal.Rptr.3d 536, 354 P.3d 334]]), although we only exercise that latitude when there is “good reason” to do so (Bourhis v. Lord (2013) 56 Cal.4th 320, 327 [153 Cal.Rptr.3d 510, 295 P.3d 895]). Courts are especially hesitant to overturn prior decisions where, as here, the issue is a statutory one that our Legislature has the power to alter. (Cf. Johnson v. Department of Justice (2015) 60 Cal.4th 871, 875 [183 Cal.Rptr.3d 96, 341 P.3d 1075].) Here, Nortel‘s analysis is largely governed by California Supreme Court precedent that binds us. Further, there is no good reason to revisit the remaining portions of Nortel because the interpretation the Board urges would, as noted above, lead to absurd results.
B. Applicability of the technology transfer agreement statutes
The Board alternatively contends that, even if AT&T/Lucent‘s computer software is not itself tangible personal property, the transactions between AT&T/Lucent and the telephone companies are still subject to the sales tax in their entirety because the contracts underlying them do not amount to technology transfer agreements and thus fall under the default “all-or-nothing” rule that, in the Board‘s view, subjects all of the property sold or leased under the contracts to the sales tax. The unspoken premise of the Board‘s argument is that the switches, documentation, software, and licenses are all inextricably intertwined, and thus not subject to the rule that independently assesses taxability for each “readily separable” component of a transaction. It is far from clear that this premise is valid. We need not decide the validity of the premise because, even if we assume these components are inextricably intertwined, the transaction is still not subject to the sales tax in its entirety because the contracts between AT&T/Lucent and the telephone companies meet the statutory definition of technology transfer agreements.
As noted above, a technology transfer agreement is an agreement that satisfies three elements: (1) a person holds a patent or copyright; (2) that person assigns or licenses to another the right to make and sell a product or to use a process; and (3) the resulting product or process is subject to the assignor‘s or licensor‘s patent or copyright interest. (
The first element is met because the undisputed evidence indicates that AT&T/Lucent‘s computer software was copyrighted and patented. (See Apple Computer, Inc. v. Formula Internat., Inc. (9th Cir. 1984) 725 F.2d 521, 523-525, overruled on other grounds in Flexible Lifeline Systems, Inc. v. Precision Lift, Inc. (9th Cir. 2011) 654 F.3d 989 [computer programs may be copyrighted].) The Board argues that AT&T/Lucent‘s evidence on this point was provided through the declarations of persons without personal knowledge, but these declarations specifically state to the contrary. The Board further argues that AT&T/Lucent never established which claim within each of its patents the software embodied and offered only conclusory declarations that the
The second and third elements are also met. AT&T/Lucent transferred a portion of its copyright interest in its software when it granted the telephone companies a license to “reproduce [its] copyrighted work.” (
Our prior decision in Nortel is exactly on point and came to the same conclusion. There, Nortel sold switches and licensed the software needed to operate them to a telephone company. The Board sought to assess the sales tax on the software that was transmitted to the telephone company using physical media. (Nortel, supra, 191 Cal.App.4th at pp. 1265-1267.) Indeed, as the trial court in this case observed, “One could almost substitute the names of the plaintiff and the monetary amounts, and the facts would be essentially the same.” Nortel came to the conclusion that the entire transaction constituted a technology transfer agreement, and that the portion of the
The Board nevertheless offers two reasons why we should reach a different result in this case. We consider each in turn.
1. Transfer of insufficient rights
The Board argues that a contract may qualify as a technology transfer agreement only if the manufacturer transfers “meaningful” copyright and patent rights, which the Board defines as “the right to mass-produce or sell downstream some patented or copyrighted item.” In the Board‘s view, it is not enough if the license grants merely the rights “any customer would need in order to make conventional use of the associated tangible personal property.”
We reject this argument for two reasons. First, it finds no support in the technology transfer agreement statutes, which refer simply to the assignment or licensing of “a patent or copyright interest.” (
The Board offers six arguments as to why we should nonetheless adopt its position. First, the Board argues that implying a requirement that the transfer of intellectual property rights be “meaningful” is necessary to assure that a technology transfer agreement—and the partial tax exemption that comes with it—is not based on a transfer of rights that is “completely lacking in substance.” This argument ignores that the technology transfer agreement statutes require a bona fide transfer of intellectual property rights. That the requisite transfer need not be as sweeping as the Board might prefer does not mean that any less sweeping transfer is a sham.
Second, the Board asserts that the technology transfer agreement statutes codified the decision in Petition of Intel Corporation (June 4, 1992)
Third, and along the same lines, the Board argues that several cases applying the technology transfer agreement statutes—namely, Preston, supra, 25 Cal.4th 197, Microsoft, supra, 212 Cal.App.4th 78, and Intel, supra, [1993-1995 Transfer Binder] Cal.Tax Rptr. (CCH) paragraph 402-675, page 27,873—involved the transfers of copyright and/or patent interests in anticipation of mass production of products using that intellectual property, and that we must interpret the statutes in light of the “lessons” these cases teach. But we are hesitant to engraft a limitation onto statutes that appears nowhere in their text and which the Legislature declined to adopt simply because a handful of cases later applying the statutes happened to arise in a particular factual setting. We are especially loathe to do so when other cases have also applied the statutes in a setting that the suggested limitation would foreclose. (Nortel, supra, 191 Cal.App.4th at pp. 1269-1278.)
Fourth, the Board cites one of its regulations to support its position. To be sure, the regulation provides that a sales tax is properly assessed against the storage media and all license fees attendant to the sale or lease of a prewritten (or “canned“) computer program unless the “license fees . . . are made for the right to reproduce or copy” a copyrighted program “in order for the program to be published and distributed for a consideration to third parties.” (
Lastly, the Board asks us to overrule Nortel. However, Nortel is not the only decision standing between the Board and the result it wants: The principle that the transfer of a single right can underlie a valid technology transfer agreement comes from the federal copyright statutes and our Supreme Court‘s decision in Preston, supra, 25 Cal.4th 197, authority we are not at liberty to disregard. Further, the Board gives us no good reason to depart from this authority, even if we could.
2. Failure to refute all possible copyright and patent defenses
The Board further contends that a product or process is “subject to” a copyright or patent—and that a contract transferring such rights may qualify as a technology transfer agreement—only if, without the license granted in the contract, the licensee would have infringed the copyright or patent. Put differently, the Board urges that the technology transfer agreement statutes are inapplicable unless and until the taxpayer makes “a prima facie showing that it was more likely than not that, absent the right-to-use licenses in the agreements, [its] customers would have infringed on [the taxpayer‘s] patent or copyright interests when using the acquired software.” Any lesser showing, the Board implies, would turn any contract into a technology transfer agreement merely because “the taxpayer says so.”
We decline to engraft such a requirement onto the technology transfer agreement statutes for several reasons. First and foremost, a defeat every possible copyright and patent defense requirement appears nowhere in the text of the statutes. Second, and as noted above, such a requirement is flatly inconsistent with our Supreme Court‘s holding that the licensee‘s product is “subject to” a copyright interest when that product “is a copy . . . or incorporates a copy of the” copyrighted work, and is “subject to” a patent
Third, the Board‘s interpretation would, for all intents and purposes, foreclose any use of the technology transfer agreement statutes. The Board suggests that AT&T/Lucent has not met the Board‘s proffered new standard because AT&T/Lucent did not refute the possible copyright defenses of implied license to make a single copy of computer programs (
We consequently conclude that the contracts between AT&T/Lucent and the telephone companies qualify as technology transfer agreements.
The Board finally asserts that, even if AT&T/Lucent‘s contracts are technology transfer agreements, the tangible personal property component of those agreements—the portion subject to the sales tax—was incorrectly calculated. As noted above, a taxpayer who transfers tangible personal property along with copyright or patent interests under a technology transfer agreement remains liable to pay the sales tax on the tangible personal property portion of the transfer. (
We are unpersuaded. The Board‘s argument is little more than a variation on an argument we have already rejected. As we conclude above, the fact that placing a computer program on storage media physically alters that media does not thereby transmogrify the software itself into tangible personal property; the media is tangible, the software is not. Thus, the price of blank media is the price of the tangible personal property, and it is what is to be taxed under the technology transfer agreement statutes.6
III. Reasonable Litigation Costs
The Board lastly argues that the trial court erred in requiring it to pay $2,625,469.87 in AT&T/Lucent‘s “reasonable litigation costs.”
The trial court did not abuse its discretion in finding that the Board‘s position was not “substantially justified.” A litigant‘s position is “substantially justified” if it is ” ‘justified to a degree that would satisfy a reasonable person, or “has a ‘reasonable basis both in law and fact.’ ” ’ ” (Agnew, supra, 134 Cal.App.4th at p. 909; see Wertin v. Franchise Tax Bd. (1998) 68 Cal.App.4th 961, 977 [80 Cal.Rptr.2d 644] (Wertin).)
In this case, each of the Board‘s primary arguments was foreclosed by existing precedent, much of which comes from our Supreme Court. The Board‘s arguments that placing computer software onto physical media turns the software itself into tangible personal property and that the taxable basis includes the software are irreconcilable with the rationales of Preston, supra, 25 Cal.4th at pages 211-212 and Navistar, supra, 8 Cal.4th at page 878, and with the specific holdings of Microsoft, supra, 212 Cal.App.4th at page 82 and Nortel, supra, 191 Cal.App.4th at pages 1275-1276. And the Board‘s argument that the technology transfer agreement statutes do not apply is inconsistent with federal copyright law, with Preston, at page 214, and with our factually and legally indistinguishable decision in Nortel.
The Board offers two arguments in response. First, the Board asserts that Nortel did not address any issue the Board raises in this case. The Board is wrong. To begin, Nortel explicitly decided whether an agreement factually identical to the agreements at issue here was a technology transfer agreement. To be sure, Nortel did not expressly confront the logically antecedent question of the tangibility of computer software. But Nortel‘s entire raison d‘etre—deciding the taxability of software transmitted using physical media under the technology transfer agreement statutes—would have been wholly academic if, as the Board contends, the software was itself tangible because the statutes do not apply to a transfer of wholly tangible personal property. (See People v. Herrera (2006) 136 Cal.App.4th 1191, 1198 [39 Cal.Rptr.3d 578] [courts do not decide “abstract or academic questions of law“].) In any event, Nortel‘s analysis was largely dictated by precedent from our Supreme Court and by federal copyright law, sources of law we are obligated to follow.
The Board‘s conduct in this litigation falls squarely within the heartland of
The trial court properly awarded AT&T/Lucent its reasonable litigation costs.
The judgment is affirmed. AT&T/Lucent is entitled to its costs on appeal.
Ashmann-Gerst, Acting P. J., and Chavez, J., concurred.
A petition for a rehearing was denied November 3, 2015, and the opinion was modified to read as printed above. Appellant‘s petition for review by the Supreme Court was denied January 20, 2016, S230657. Werdegar, J., did not participate therein.