The opinion
Filed 10/8/15
CERTIFIED FOR PUBLICATION
IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA
SECOND APPELLATE DISTRICT
DIVISION TWO
LUCENT TECHNOLOGIES, INC., et al., B257808
Plaintiffs, Cross-defendants, and (Los Angeles County
Respondents, Super. Ct. Nos. BC402036 and
BC448715)
v.
STATE BOARD OF EQUALIZATION,
Defendant, Cross-complainant, and
Appellant.
APPEAL from a judgment of the Superior Court of Los Angeles County.
Steven J. Kleifield, Judge. Affirmed.
Paul Hastings, Jeffrey G. Varga, Julian B. Decyk, Paul W. Cane, Jr.,
Amy L. Lawrence, for Plaintiffs, Cross-defendants, and Respondents.
Kamala D. Harris, Attorney General, Paul D. Gifford, Senior Assistant Attorney
General, Diane S. Shaw, Stephen Lew, Supervising Deputy Attorneys General, and
Ronald N. Ito, Deputy Attorney General, for Defendant, Cross-complainant, and
Appellant.
* * *
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.
State Board of Equalization (2011) 191 Cal.App.4th 1259 (Nortel), we held that an
almost identical transaction satisfied the requirements of California’s technology transfer
1
agreement statutes (Rev. & Tax. Code, §§ 6011, subd. (c)(10) & 6012, subd. (c)(10))
and, as such, the manufacturer was responsible for paying sales taxes only on the tangible
portions of the transaction (the equipment and instructions), but not the intangible
portions (the software and rights to copy and use it). Notwithstanding Nortel, the State
Board of Equalization (Board) in this case persisted in assessing a sales tax of nearly $25
million on the intangible portions of nearly identical transactions. The manufacturer paid
the taxes, and filed this action seeking a refund.
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 sections 6011,
subdivision (c)(10)(D) and 6012, subdivision (c)(10)(D), which exempts from the sales
tax the intangible portions of a transaction involving both tangible and intangible
property, can exist when the only intangible right transferred is the right to copy software
onto tangible equipment, and (3) a technology transfer agreement can exist as long as the
grantee of copyright or patent rights under the agreement thereafter copies or incorporates
1 All further statutory references are to the Revenue and Taxation Code unless
otherwise indicated.
2
a copy of the copyrighted work into its product or uses the patented process, and any of
these acts is enough to render the resulting product or process “subject to” the copyright
or patent interest.
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.”
Switches perform sophisticated and complex functions, and every switch is run by
a computer. Each switch’s computer runs two types of software: (1) software designed
specifically for that switch (unimaginatively called “switch-specific software”); and
(2) more generic software designed for use on any switch because it runs diagnostic tests
and manages the availability of lines and trunks used to route calls and data between
switches. Switch-specific software is drawn from a master, “basic code”; the switch-
specific software for any given switch uses only those portions of the “basic code”
necessary for the switch to know where it is on the network and to offer the features that
its new owner has requested. (See Nortel, supra, 191 Cal.App.4th at pp. 1266-1267.)
3
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
2
contracts with nine different telephone companies 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 the licenses to copy and use AT&T/Lucent’s
3
software on their switches.
2 Those companies are Pacific Bell, GTE Corporation, Advanced TelCom Group,
Inc., Allegiance Telecom, Alpine PCS, Inc., RCN Services, US TelePacific Corporation,
West Coast PCS, LLC, and Winstar Communications, Inc.
3 The contract price of the switches and the instructions are not part of the record.
4
III. Tax Assessment
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
$24,773,185.38. As required by the state Constitution (Cal. Const., art. XIII, § 32),
AT&T/Lucent paid the sales tax and then sought a refund from the Board. The Board
denied its application.
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
4
1, 1996 and September 30, 2000 (Lucent II). 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 sections
6011, subdivision (c)(10) and 6012, subdivision (c)(10), such that AT&T/Lucent was
obligated to pay sales taxes on the tangible portion of the sale (that is, for the switches,
the instructions, and the 3,954 blank tapes and/or compact discs used to transmit the
software), but not required to pay sales taxes on the intangible portion (that is, for the
software and licenses). As a result, the court ordered the Board to refund the sales taxes
paid on the licensing fees. With other adjustments, the court ordered a refund of
4 AT&T/Lucent initially sought additional relief in Lucent I, but later dismissed
those claims.
5
$24,502,381.43. The parties subsequently stipulated that AT&T/Lucent owed
$1,938,574 in unpaid interest out of the $6.3 million sought in the Board’s Lucent I cross-
complaint, but none of the $12.3 million in unpaid interest sought in the Lucent II cross-
complaint.
AT&T/Lucent sought its court costs, and under section 7156, its “reasonable
litigation costs,” including attorney’s fees. The court awarded costs of $7,052.36, and
after finding the Board’s position in the litigation was not “substantially justified,”
awarded $2,625,469.87 in “reasonable litigation costs.”
The court entered judgment, and the Board timely appeals.
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.” (§ 6051; Navistar Internat. Transportation Corp. v.
State Board of Equalization (1994) 8 Cal.4th 868, 872 (Navistar); see also Loeffler v.
Target Corp. (2014) 58 Cal.4th 1081, 1104 (Loeffler) [“the retailer is the taxpayer, not
the consumer”].) The tax is tied to a percentage of the seller’s “gross receipts.” (§ 6051;
see § 6012 [defining “gross receipts”].) The percentage at the time pertinent to the
transactions in this appeal was 8.5 percent.
As relevant to this appeal, a “sale”—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. (§ 6006, subds. (a) & (g), italics
added.) A “lease” includes a “license.” (§ 6006.3.) As the italicized text makes clear,
the sales tax attaches only to transactions involving “tangible personal property.”
“Tangible personal property” means “personal property which may be seen, weighed,
measured, felt, or touched, or which is in any other manner perceptible to the senses.”
(§ 6016.) If tangible personal property is transferred, the parties’ reasons for the transfer
do not matter; thus, the transfer of tangible personal property is subject to the sales tax
6
even if that property is being purchased more for its intellectual content than its physical
components. (Navistar, supra, 8 Cal.4th at p. 878; Simplicity Pattern Co. v. State Board
of Equalization (1980) 27 Cal.3d 900, 909, superseded by §§ 6011, subd. (c)(10) & 6012,
subd. (c)(10) (Simplicity Pattern).) This is why the purchase of a book “for its own
sake”—and not as part of a larger transaction transferring any copyright rights along with
the book—is still considered a sale of tangible personal property and thus subject to the
sales tax. (Navistar, at pp. 877-878 [sale of drawings and designs for industrial turbine
engines that are uncopyrighted trade secrets, without any transfer of intellectual property
rights, is a taxable sale].)
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 Cal.App.2d 20, 24 [“Sales tax
statutes do not impose a tax on services . . .”]; Preston v. State Board of Equalization
(2001) 25 Cal.4th 197, 208 (Preston) [“intangible personal property is not subject to sales
tax”].) The Revenue and Taxation Code does not define “intangible personal property”
(Navistar, supra, 8 Cal.4th at p. 875), but courts have “generally defined [it] as property
that is a ‘right’ rather than a physical object” (ibid.). “Intangible property includes a
license to use information under a copyright or patent.” (Nortel, supra, 191 Cal.App.4th
at p. 1269; Preston, at pp. 216-219.)
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. (See Dell, Inc. v. Superior Court (2008) 159 Cal.App.4th
911, 924-925 (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.)
7
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 pp. 924-925 [“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. (Cal. Code. Regs., tit. 18, § 1501; Preston, at p. 209; Navistar, supra, 8 Cal.4th
at p. 875.) This determination is dispositive: If the “true object” is the sale of tangible
personal property, the whole transaction is subject to the sales tax; if the “true object” is
the performance of a service, no portion—even the tangible storage media used to
perform the service—of the transaction is subject to the sales tax. (General Business Sys.
v. State Board of Equalization (1984) 162 Cal.App.3d 50, 55 [no sales tax to be assessed
on tangible storage media used to provide a service].) Indeed, section 6010.9 codified
this rule with respect to the service of creating “custom computer programs.” (§ 6010.9;
cf. Navistar, at pp. 880-883 [downstream sale of originally custom-made software is no
longer an exempted sale of a service]; Touche Ross & Co. v. State Board of Equalization
(1988) 203 Cal.App.3d 1057, 1064 (Touche Ross) [same].)
Where, as here, the untaxable component is intangible personal property, the
default rule is to determine whether the tangible portion of the transaction is “essential”
or “physically useful” to the purchaser’s subsequent use of the intangible personal
property portion of the transaction. (Preston, supra, 25 Cal.4th at pp. 211-212 [looking
to whether tangible personal property component is “essential”]; Navistar, supra, 8
Cal.4th at p. 878 [looking to whether the intangible property is “physically useful[] . . .
[to] the buyer’s manufacturing process”].) Under this rule, the “true object” of the
transaction is irrelevant. (Preston, at p. 211; Navistar, at p. 876.) Thus, when a seller
confers an intangible license to copy a copyrighted matter and gives the buyer a physical
copy of the copyrighted matter needed to make use of that license—as is the case with
8
film negatives, master audio recordings, or artwork to be used to make rubber stamps or
for integration into a printing plate for a book—the entire transaction is subject to the
sales tax. (See Preston, at pp. 211-212 [illustrations to be used to make rubber stamps
and book plates]; A&M Records, Inc. v. State Board of Equalization (1988) 204
Cal.App.3d 358, 364, 375-376, superseded by §§ 6011, subd. (c)(10) & 6012,
subd. (c)(10) [original master audio tapes]; Capitol Records v. State Board of
Equalization (1984) 158 Cal.App.3d 582, 596, superseded by §§ 6011, subd. (c)(10) &
6012, subd. (c)(10) [same]; Simplicity Pattern, supra, 27 Cal.3d at p. 912 [master audio
recordings].) Conversely, when a seller grants an intangible license to copy copyrighted
material or to use a patent and transfers the material using tangible media that is not
essential to the buyer’s use of the license or any further manufacturing process—as is the
case when software is transmitted via a disk that is “not essential” or otherwise physically
useful to the buyer’s subsequent use of that software—the entire transaction is not subject
to the sales tax. (Microsoft Corp. v. Franchise Tax Board (2012) 212 Cal.App.4th 78, 92
(Microsoft) [so holding].) This default rule is thus an all-or-nothing affair; depending on
the centrality of the tangible personal property to the subsequent use of the intangible
personal property, either the entire transaction is taxable or it is not.
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.”
(§§ 6011, subd. (c)(10), 6012, subd. (c)(10); Preston, supra, 25 Cal.4th at p. 212.) A
technology transfer agreement is “any agreement under which” (1) “a person who holds a
patent or copyright interest” (2) “assigns or licenses to another person the right to make
and sell a product or to use a process” (3) “that is subject to the patent or copyright
interest.” (§§ 6011, subd. (c)(10)(D), 6012, subd. (c)(10)(D).) Instead of sales tax
liability attaching to all or none of the transaction, a taxpayer who enters into a contract
that qualifies as a technology transfer agreement is required to sort the tangible personal
property from the intangible, and to pay sales tax on the tangible personal property that is
transferred but not on “the amount charged for [the] intangible personal property
9
transferred.” (§§ 6011, subd. (c)(10)(A) & 6012, subd. (c)(10)(A); Preston, at p. 212.)
The statutes provide three mechanisms—in declining order of preference—for
calculating the value of the tangible personal property: (1) the price stated in the
agreement itself (§§ 6011, subd. (c)(10)(A) & 6012, subd. (c)(10)(A)); (2) the price at
which “the tangible personal property or like tangible personal property has been
previously sold or leased, or offered for sale or lease, to third parties at a separate price”
(§§ 6011, subd. (c)(10)(B) & 6012, subd. (c)(10)(B)); or (3) 200 percent “of the cost of
materials and labor used to produce the tangible personal property” (§§ 6011,
subd. (c)(10)(C) & 6012, subd. (c)(10)(C)).
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” (§ 6016), the Board argues that the software itself became
tangible personal property and that the both the software and the licenses are subject to
the sales tax (ostensibly because the license to copy and use the software is, in the
5
Board’s view, incidental to the transfer of the software itself). Second, even if the
software and the licenses to copy and use it are not deemed to be “tangible personal
property,” the contracts between AT&T/Lucent and the telephone companies are not
5 We note that the Board’s attempt to assess the sales tax on the licenses themselves
is inconsistent with the position it took in Nortel, where it conceded that the licenses were
not taxable. (Nortel, supra, 191 Cal.App.4th at p. 1273.)
10
technology transfer agreements because (1) they did not transfer a sufficiently
“meaningful” cluster of intellectual property rights to the telephone companies, and
(2) AT&T/Lucent did not prove that, without the licenses, the telephone companies’ use
of the software would constitute copyright and/or patent infringement. Third, even if the
contracts qualify as technology transfer agreements, AT&T/Lucent did not sufficiently
establish the cost of developing the software, and thus the entire transaction should be
taxable.
We independently review the trial court’s grant of summary judgment. (Salas v.
Sierra Chemical Co. (2014) 59 Cal.4th 407, 415.) 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). 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.)
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” (§ 6016); (2) the act of placing data—in this case,
AT&T/Lucent’s software—on magnetic tapes and compact discs physically alters those
tapes and discs; ergo, (3) the software can be (microscopically) seen and perceived by the
senses, thereby rendering it tangible personal property.
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
11
personal property. (Preston, supra, 25 Cal.4th at pp. 211-212; 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 pp. 1275-1276 [noting that the buyer “made little use of the tangible
disk containing the program, which was simply copied onto its computers”].) Critically,
this is true even when—by definition—the use of the tape or disc to transmit the software
necessarily puts content on the tape or disc and thereby alters its physical structure. By
seeking to make the physical alteration of the storage media dispositive, the Board
ignores this precedent.
Second, the Board’s construction of section 6016 leads to an absurd result.
Although we must evaluate the taxability of a transaction by what the taxpayer actually
did rather than by what it could have done (Wallace Berrie & Co. v. State Board of
Equalization (1985) 40 Cal.3d 60, 70), in construing a statute we are to avoid an
interpretation that leads to absurd results (Riverside County Sheriff’s Dept. v. Stiglitz
(2014) 60 Cal.4th 624, 630). If we accepted the Board’s construction of section 6016,
AT&T/Lucent would be liable for nearly $25 million in sales tax because it decided to
transmit its software to the telephone companies using tapes and discs, but would have
been liable for no sales tax on the software if had instead transmitted the software
electronically (via email or through uploading it to a remote server on the Internet for
later download by the telephone companies) (Cal. Code Regs., tit. 18, § 1502, subd.
(f)(1)(D) [sale of canned computer program not subject to sales tax if “transferred by
remote telecommunications from the seller’s place of business”]). Ascribing such
tremendous consequences to the manner in which a software program is transmitted—
when that manner is wholly collateral to the subsequent use of the licenses regarding that
software and when that manner is so easily manipulated by the buyer and seller—is an
12
absurd result nowhere sanctioned by the language of, or policy underlying, California’s
sales tax law.
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; 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 sections 6010.9 and 6377.1, which create
exceptions to the sales tax for certain types of transactions involving computer software,
necessarily imply that all other transactions involving software are taxable; otherwise, the
Board reasons, these two sections would be superfluous. We agree that we should
generally avoid interpreting a statutory scheme in a way that renders any part of it
superfluous (City of Alhambra v. County of Los Angeles (2012) 55 Cal.4th 707, 724), but
the longstanding precedent we follow today does not render either section 6010.9 or
section 6377.1 superfluous. Section 6010.9 excepts from the sales tax the service of
creating a custom computer program, and section 6377.1 excepts from the sales tax the
sale of equipment (including the software necessary to operate that equipment) that is
purchased by entities using that equipment to stimulate economic development as part of
California’s enterprise zone program. (See Assem. Bill No. 93 (2013 Reg. Sess.) § 1.)
Neither provision arises in the context of a concurrent transfer of inextricably intertwined
intangible and tangible personal property, and consequently neither is rendered a nullity
by our ruling today.
13
Third, the Board argues that Louisiana courts treat software as tangible property
subject to Louisiana’s sales tax. (South Central Bell Tel. Co. v. Barthelemy (La. 1994)
643 So.2d 1240, 1244 (Barthelemy).) 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.)
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), 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. Crane & Smith (2014) 225 Cal.App.4th 660, 677, overruled
on other grounds by Lee v. Hanley (2015) 61 Cal.4th 1225]), although we only exercise
that latitude when there is “good reason” to do so (Bourhis v. Lord (2013) 56 Cal.4th 320,
327). 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.) 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.
For these reasons, we conclude that the transmission of AT&T/Lucent’s software
using physical media as part of a transaction granting a license to copy and use that
software did not transform that software into tangible personal property subject to the
sales tax.
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
14
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. (§§ 6011, subd. (c)(10)(D) & 6012, subd. (c)(10)(D).)
The first element is met because the undisputed evidence indicates that
AT&T/Lucent’s computer software was copyrighted and patented. (Accord, Apple
Computers, Inc. v. Formula International, Inc. (9th Cir. 1984) 725 F.2d 521, 523-525,
overruled on other grounds by Flexible Lifeline Sys., Inc. v. Precision Lift, Inc. (9th Cir.
2011) 654 F.3d 989 [computer programs may be copyrighted].) The Board argues that
the 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 and the Board has forfeited its challenge to the trial court’s decision to credit
these assertions of personal knowledge by not supporting its challenge on appeal with
legal authority (People v. Bryant, Smith & Wheeler (2014) 60 Cal.4th 335, 363-364).
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
software was copyright and patent-protected, yet these arguments are beside the point
because there is no dispute that the software was a copyrighted work or that the software
embodied some portion of AT&T/Lucent’s patents. Nothing in sections 6011 or 6012
requires any greater granularity of proof than was established here. (Accord, Preston,
15
supra, 25 Cal.4th at p. 214 [“The absence of the word ‘copyright’ in most of the
Agreements is irrelevant”].)
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.” (17 U.S.C. § 106(1); MAI Systems Corp. v. Peak
Computer, Inc. (9th Cir. 1993) 991 F.2d 511, 518, overruled on other grounds by eBay,
Inc. v. MercExchange, LLC (2006) 547 U.S. 388 [“loading copyrighted software into (a
computer’s random access memory or) RAM creates a ‘copy’ of that software in
violation of the Copyright Act”].) The transfer of a single copyright right is sufficient.
(Preston, supra, 25 Cal.4th at p. 214 [“Where the wording of the agreement clearly
transfers one of the rights or any subdivision of the rights specified in title 17 United
States Code section 106, a copyright transfer has occurred”], italics added;
17 U.S.C.S. § 201(d)(1) [allowing the rights attaching to a copyrighted work to be
transferred “in whole or in part”].) The resulting products—the telephone products the
telephone companies sold to their customers—were “subject to” this copyright interest.
“[A] product is ‘subject to’ a copyright interest [citations], if the product is a copy of the
protected expression or incorporates a copy of the protected expression.” (Preston, at
p. 215.) Without “incorporat[ing] a copy of” AT&T/Lucent’s software, the switches
could not route calls or data, or offer call waiting and other features, which are the very
products the telephone companies were selling. AT&T/Lucent also transferred a portion
of its patent rights when it granted the telephone companies licenses to use the processes
embodied in its software, and the companies’ resulting products—which, again, required
the use of that software—were consequently “subject to” those patents. That is because
“[t]he license of a patent interest . . . gives the licensee the right to make a product or use
a process.” (Id. at p. 216.)
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
16
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 transaction
dealing with the software and licenses to use it was not subject to the sales tax. (Id. at
pp. 1269-1278.)
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.” (§§ 6011, subd. (c)(10)(D) & 6012, subd. (c)(10)(D).)
The requirement that the transferred intellectual property interest be “meaningful” or
more than “conventional” appears nowhere in the text of the statute, and we are generally
bound by a statute’s plain text (People v. Gutierrez (2014) 58 Cal.4th 1354, 1369
(Gutierrez)), and “are not permitted to add words to a statute to accomplish a purpose . . .
not apparent from the face of the statute.” (Community Development Com. v. County of
Ventura (2007) 152 Cal.App.4th 1470, 1483.) Second, the argument is inconsistent with
federal copyright law, which provides that rights to a copyrighted work may be
transferred piecemeal (17 U.S.C.S. § 201(d)(1)), and with our Supreme Court’s
pronouncement that a technology transfer agreement may be based upon the transfer of a
single copyright right (Preston, supra, 25 Cal.4th at p. 214).
17
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) [1993-1995 Transfer Binder]
Cal. Tax Rptr. (CCH) paragraph 402-675, page 27,873 (Intel). Because Intel involved a
transfer of intellectual property rights in anticipation of a mass production of software,
the Board reasons, the statutes should be similarly limited. Although the technology
transfer agreement statutes surely sought to codify Intel (Preston, supra, 25 Cal.4th at
p. 216), the statutes the Legislature enacted reflect Intel’s central holding—namely, that
only the tangible portion of a concurrent transfer of tangible personal property and
intangible copyright and patent rights is subject to the sales tax—but the statutes are not
limited to Intel’s factual context. Indeed, the statutes’ legislative history indicates that
the Board warned the Legislature of how broadly the statutes could be construed, and the
Legislature enacted the statutes anyway. (Nortel, supra, 191 Cal.App.4th at p. 1269
[“The Legislature enacted the [technology transfer agreement] statutes over the Board’s
objections”].)
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) P 402-675, p. 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
18
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
consideration to third parties.” (Cal. Code Regs., tit. 18, § 1502, subds. (f)(1) &
(f)(1)(B).) But this regulation must give way to the technology transfer agreement
statutes in situations, as in this case, where they both may apply. (See Yamaha Corp. of
America v. State Board of Equalization (1998) 19 Cal.4th 1, 16 (conc. opn. of Mosk, J.)
[“‘“(N)o regulation adopted is valid or effective unless consistent and not in conflict with
the statute”’”], quoting Morris v. Williams (1967) 67 Cal.2d 733, 748, italics omitted.)
Fifth, the Board urges us to follow the general interpretive maxim that tax statutes
“‘must be construed liberally in favor of the taxing authority, and strictly against [a]
claimed exemption.’” (Dicon Fiberoptics, Inc. v. Franchise Tax Board (2012) 53 Cal.4th
1227, 1241, quoting Hospital Service of California v. City of Oakland (1972) 25
Cal.App.3d 402, 405.) An interpretive maxim is a helpful guide to use when a statute’s
language is ambiguous and the competing arguments on how to construe that statute are
in equipoise; maxims cannot be used to trump a statute’s plain text or to ignore binding
precedent. (See Butts v. Board of Trustees of California State University (2014) 225
Cal.App.4th 825, 838 [“If the plain language of a statute . . . is clear and
unambiguous, . . . there is no need to resort to the canons of construction or extrinsic aids
to interpretation”].)
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
19
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
when that product is made “us[ing]” the patented process. (Preston, supra, 25 Cal.4th at
pp. 215-216.) The requirements set forth in Preston are not a meaningless formality.
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 (17 U.S.C.S. § 117(a)); of implied oral license (Effects Assocs. v. Cohen (9th
Cir. 1990) 908 F.2d 555, 558); of equitable estoppel (Hadady Corp. v. Dean Witter
20
Reynolds, Inc. (C.D.Cal. 1990) 739 F.Supp. 1392, 1399-1400); of exhaustion (Morrissey
v. Proctor & Gamble Co. (1st Cir. 1967) 379 F.2d 675, 678-679); of the
uncopyrightability of ideas and processes (Lotus Dev. Corp. v. Borland International (1st
Cir. 1995) 49 F.3d 807, 815; 17 U.S.C. § 102(b)); and of fair use (17 U.S.C.S. § 117) and
the patent defenses of exhaustion (Quanta Computer, Inc. v. LG Electronics (2008) 553
U.S. 617, 638); of implied license (Zenith Electronics Corp. v. PDI Commun. Sys.
(Fed.Cir. 2008) 522 F.3d 1348, 1360); and of equitable estoppel (A.C. Aukerman Co. v.
R.L. Chaides Constr. Co. (Fed.Cir. 1992) 960 F.2d 1020, 1028, overruled on other
grounds by SCA Hygiene Prods. Aktiebolag v. First Quality Baby Prods., LLC (Fed.Cir.
2015) 2015 U.S.App. Lexis 16621). The Board has not adduced any evidence that these
defenses might be at issue in this case; if no evidentiary showing is required, as the
Board’s argument suggests, then the defenses a taxpayer would have to refute are limited
only by the Board’s ingenuity and imagination. This is a profoundly unsound result. It
would turn every taxpayer refund action involving the technology transfer agreement
statutes into a full-blown copyright and/or patent trial. Further, because it would obligate
the taxpayer—who by statute bears the burden of establishing its entitlement to a tax
exemption (§ 6091)—to refute every possible copyright and patent defense, the Board’s
interpretation would effectively nullify those statutes. This is a result we cannot
countenance. (Gutierrez, supra, 58 Cal.4th at p. 1369 [we interpret statutes “with a view
to promoting rather than defeating the[ir] general purpose”]; see also Soukup v. Law
Offices of Herbert Hafif (2006) 39 Cal.4th 260, 286 [declining to adopt an interpretation
of a statute because “it would require [a party] to identify and address every conceivable
statute that might have had some bearing . . . and then prove a negative”].)
We consequently conclude that the contracts between AT&T/Lucent and the
telephone companies qualify as technology transfer agreements.
C. Proof of value of tangible personal property
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
21
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. (§§ 6011, subd. (c)(10)(A) & 6012, subd. (c)(10)(A).)
That tangible personal property is to be valued in one of three ways: (1) by the price
stated in the technology transfer agreement itself; (2) by the price at which “the tangible
personal property or like tangible personal property has been previously sold or
leased . . . to third parties”; or (3) 200 percent of the cost of materials and labor used to
produce the tangible personal property. (§§ 6011, subd. (c)(10) & 6012, subd. (c)(10).)
The trial court held that AT&T/Lucent was liable to pay the sales tax on the retail value
of the switches, of the instructions, and of the blank tapes and compact discs used to
transmit its software; because only four of AT&T/Lucent’s contracts listed a price for the
blank media, the court looked primarily to the price that AT&T/Lucent had charged third
parties for blank media. The Board contends that this was wrong because blank media is
not “like” the tapes and discs that actually contained AT&T/Lucent’s software. What is
more, because AT&T/Lucent did not keep records of its research and development costs
for the software, AT&T/Lucent cannot avail itself of the final valuation method that looks
to 200 percent of development costs and must therefore be required to pay the sales tax
on the entire transaction.
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
6
property, and is what is to be taxed under the technology transfer agreement statutes.
6 In light of this conclusion, we have no occasion to reach the Board’s alternative
arguments that AT&T/Lucent’s failure to restructure its internal accounting procedures to
track the costs of developing software is a necessary prerequisite to invocation of the
technology transfer agreement statutes.
22
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.” Section 7156 empowers
a trial court to award the party who “substantially prevailed” in a tax proceeding,
including one involving the Board, all of its “reasonable litigation costs” if the Board’s
“position . . . was not substantially justified.” (§ 7156, subds. (a), (c)(2) & (f).) These
costs include expert witness fees, the cost of necessary studies, and reasonable attorney’s
fees. (Id., subd. (c)(1)(B).) On appeal, the Board does not dispute the amount of the
award, but contends that its position was substantially justified. This is a question we
review for an abuse of discretion. (Agnew v. State Board of Equalization (2005) 134
Cal.App.4th 899, 909 (Agnew).)
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; Wertin v.
Franchise Tax Board (1998) 68 Cal.App.4th 961, 977 (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
23
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’être—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 [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.
Second, the Board evokes a watered-down version of the argument it made to the
trial court—namely, that a government litigator should be entitled to more than “one-bite-
at-the-apple” and should not too quickly be “forced to adopt legal results that are
inconsistent with its own understanding of the law” because the government has a special
interest in ensuring “an accurate interpretation and application of the laws”
notwithstanding precedent to the contrary. For support, the Board cites Pierce v.
Underwood (1987) 487 U.S. 552, 569 (Pierce). However, Pierce upheld a trial court’s
finding that a government litigant’s position was not “substantially justified” under the
analogous Equal Access to Justice Act. (28 U.S.C.S. § 2412; Wertin, supra, 68
Cal.App.4th at pp. 977-978 [looking to the Equal Access to Justice Act in interpreting
section 7156].) Pierce did note that “the fact that one other court agreed or disagreed
with the Government does not establish whether its position was substantially justified.”
(Pierce, at p. 569.) But the Board’s position in this case, as noted above, was not
inconsistent with Nortel alone; it was also inconsistent with the whole cloth of California
Supreme Court precedent that informed Nortel as well as with federal copyright law.
The Board’s conduct in this litigation falls squarely within the heartland of section
7156, and the core purposes of the Taxpayer’s Bill of Rights of which it is the key part—
namely, to “deter[] state[] agents from asserting unreasonable and unfair claims and
defenses against private citizens” and thus to “preserve[] the balance between legitimate
24
revenue collection and ‘government oppression.’” (Garg v. People ex rel. State Board of
Equalization (1997) 53 Cal.App.4th 199, 208.) The position the Board took in this case
had been rejected by the Legislature that enacted the technology transfer agreement
statutes, rejected by several courts interpreting those statutes, and specifically rejected by
Nortel. Yet the Board continued to oppose AT&T/Lucent’s refund action, countersued
for more than $18 million (and ultimately agreed to accept less than $2 million),
propounded thousands of discovery requests, and generated a 20,000 page record on
appeal. The net result is that AT&T/Lucent incurred more than $2.5 million in litigation
costs to receive a tax refund to which it was indisputably entitled under controlling law.
It is certainly up to the Board to decide whether to take positions at odds with binding,
on-point authority, but section 7156 makes clear that the Board is not free to require
taxpayers to bear the cost of a litigation strategy aimed at taking a third, fourth, or fifth
bite at the apple.
The trial court properly awarded AT&T/Lucent its “reasonable litigation costs.”
DISPOSITION
The judgment is affirmed. AT&T/Lucent is entitled to its costs on appeal.
CERTIFIED FOR PUBLICATION.
_______________________, J.
HOFFSTADT
We concur:
____________________________, Acting P.J.
ASHMANN-GERST
____________________________, J.
CHAVEZ
25