Classification of Certain Transactions Involving Computer Programs

Federal RegisterNov 13, 1996

Ask Donna

What actually matters in this document.

Text

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-251520-96]

RIN 1545-AU70

Classification of Certain Transactions Involving Computer

Programs

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

-----------------------------------------------------------------------

SUMMARY: This document contains proposed regulations relating to the

tax treatment of certain transactions involving the transfer of

computer programs. The proposed regulations provide rules for

classifying such transactions as sales, licenses, leases, or the

provision of services or of know-how under certain provisions of the

Internal Revenue Code and tax treaties. This document also provides

notice of a public hearing on the proposed regulations.

DATES: Comments must be received by February 11, 1997. Requests to

speak (with outlines of oral comments) at a public hearing scheduled

for March 19, 1997, at 10 a.m. must be submitted by February 26, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-251520-96), room

5228, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. In the alternative, submissions may be hand

delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R

(REG-251520-96), Courier's Desk, Internal Revenue Service, 1111

Constitution Avenue NW., Washington, DC. Alternately, taxpayers may

submit comments electronically via the Internet by selecting the ``Tax

Regs'' option on the IRS Home Page, or by submitting comments directly

to the IRS Internet site at http:\\www.irs.ustreas. gov\prod\tax__regs\comments.html. The public hearing will be held in

the NYU Classroom, room 2615, Internal Revenue Building, 1111

Constitution Avenue NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, William H.

Morris, (202) 622-3880 or Carol P. Tello, (202) 622-3880; concerning

submissions and the hearing, Christina Vasquez, (202) 622-7180 (not

toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

These regulations are proposed to clarify the treatment under

certain provisions of the Internal Revenue Code (Code) and tax treaties

of income from transactions involving computer programs.

I. Introduction

Computer programs are generally protected by copyright law.

Typically the protection afforded by copyright law is a principal

source of the value of a computer program to the owner of the

program to the purchaser of a copy of the program is not the protection

afforded by copyright law, but the right to use or sell the copy. In

this regard, computer programs are similar to other copyrighted works

such as books, records, motion pictures, etc. For example, when a copy

of a book is purchased, the purchaser does not thereby also acquire any

distinguish between transactions in a copyright and in the subject of

the copyright.

In developing regulations addressing the treatment of computer

programs, the IRS and Treasury generally have been guided by the

following principles: (i) the rules should take into account the

special features of computer programs, such as the ability to deliver

copies electronically as well as physically, and to make perfect copies

at little or no cost, and (ii) wherever possible, transactions that are

functionally equivalent should be treated similarly. For example, a

transaction that involves the transfer for internal use only of fifty

copies of a computer program should generally be treated the same as a

transfer of one copy (for internal use) with the right to make forty-

nine other copies all for internal use. Similarly, if the right to use

a computer program is limited in time, the transaction should generally

be treated the same irrespective of whether, at the end of the period

of permitted use, a disk containing the computer program must be

returned, or the program automatically deactivates itself.

II. Copyright Law Principles

Distinguishing between transactions in a copyright and in the

subject of the copyright requires an examination of U.S. and foreign

Programs, 1991 (91/250/EEC); and the Berne Convention (Paris Text, July

24, 1971)). An overview of U.S. copyright law as it relates to computer

programs is set forth below. However, the IRS and the Treasury do not

purport in these regulations to interpret U.S. copyright law and these

proposed regulations should not be taken as an expression of the legal

or policy views of the U.S. Copyright Office.

The Copyright Act of 1976, as amended (17 U.S.C. 101 et seq.),

provides protection against infringement of the exclusive rights of the

owner of a copyright in original works of authorship, fixed in any

tangible medium of expression, including literary works. (17 U.S.C.

102.) The term literary works is defined to include: ``* * * numbers,

or other verbal or numerical symbols or indicia, regardless of the

nature of the material objects, such as books, periodicals,

manuscripts, phonorecords, film, tapes, disks, or cards, in which they

are embodied.'' (17 U.S.C. 101.) Thus, computer programs are literary

works for purposes of the Copyright Act.

The Copyright Act grants five exclusive rights to a copyright

owner. Of these, three are most relevant in the case of computer

programs: the right to reproduce copies of the copyrighted work (17

U.S.C. 106(1)); the right to prepare derivative works, which may

themselves be separately copyrighted, based upon the copyrighted work

(17 U.S.C. 103 and 106(2)); and the right to distribute copies of the

copyrighted work to the public by sale or other transfer of ownership,

or by rental, lease or lending (17 U.S.C. 106(3)). Additionally, in

certain circumstances, the right to publicly perform the copyrighted

work (17 U.S.C. 106(4)) and the right to publicly display the

copyrighted work may also be relevant (17 U.S.C. 106(5)).

Thus, under U.S. copyright law, the user of a computer program who

does not possess any of those five rights (or parts of them) has

obtained only rights to use the copyrighted article it possesses.

Generally, that user is treated

[[Page 58153]]

only as having received a copy of the copyrighted work. Under U.S.

any method now known or later developed, and from which the work can be

perceived, reproduced, or otherwise communicated, either directly or

with the aid of a machine or device (17 U.S.C. 101.). In these proposed

regulations a copy is also referred to as a ``copyrighted article.''

The distinction between copies and copyrights is made most clearly in

section 202 of the Copyright Act which provides:

Ownership of a copyright, or of any of the exclusive rights

under a copyright, is distinct from ownership of any material object

in which the work is embodied. Transfer of ownership of any material

object, including the copy or phonorecord in which the work is first

fixed, does not of itself convey any rights in the copyrighted work

embodied in the object; nor, in the absence of an agreement, does

transfer of ownership of a copyright or of any exclusive rights

under a copyright convey property rights in any material object.

Certain rights pass to the purchaser of a copy of a computer

program. The most important of these is the right to sell (but not,

without permission, to lease, rent, or lend) the copy to another

person. (17 U.S.C. 109.) Additionally, the owner of a copy of a

computer program has the right to make a copy of that copy as an

essential step in the utilization of the program (e.g., copying to the

memory of the computer) and may also make a copy for archival purposes.

(17 U.S.C. 117.) If, however, the owner of the copy sells that copy,

all copies made pursuant to the 17 U.S.C. 117 right must be destroyed.

III. The Proposed Regulations and Copyright Law Principles

Although the proposed regulations are guided by copyright law

principles in determining whether a copyright right or copyrighted

article has been transferred, the regulations depart in some cases from

a strict reliance on copyright law in order to take into account the

special nature of computer programs and to treat functionally

equivalent transactions in the same way. For example, the proposed

regulations do not treat the transfer of a right to copy as the

transfer of a copyright right, unless it is accompanied by the right to

distribute the copies to the public.

Thus, where a corporation obtains the right, under an agreement, to

make fifty copies of a program for use by its employees at one location

(a site license) the transaction is not, for all practical purposes,

any different from a transaction in which fifty individual disks are

purchased. Accordingly, the proposed regulations treat the transaction

as the transfer of a copyrighted article, rather than of a copyright

right, despite a copyright law requirement that the corporation receive

a ``license'' to make those fifty copies. Similarly, under the proposed

regulations, the transfer of a computer program in perpetuity for

internal use only on a single disk or set of disks in return for a one-

time payment, in a transaction styled as a license of copyright rights

(a so-called shrink wrap license), is treated as the sale of a

copyrighted article and not the transfer of a copyright right.

Therefore, such a transfer is classified solely as the sale of a

copyrighted article for the purposes of the proposed regulations.

IV. Explanation of Provisions

Section 1.861-18(a)(1) of the proposed regulations describes the

scope of the proposed regulations. These proposed regulations provide

rules for classifying transfers of computer programs for the purposes

of subchapter N of chapter 1 of the Internal Revenue Code, sections

367, 404A, 482, 551, 679, 1057, 1059A, chapter 3, chapter 5, sections

842 and 845 (to the extent involving a foreign person), and transfers

to foreign trusts not covered by section 679.

Section 1.861-18(a)(2) describes the categories of transactions

relating to computer programs. In particular, a transfer of a copyright

right may be either a sale or license of that right and a transfer of a

copyrighted article may be either a sale or lease of that copyrighted

article. Section 1.861-18(a)(3) defines the term computer program.

Section 1.861-18(b)(1) provides that a transaction involving the

transfer of a computer program will be classified as either the

transfer of a copyright right, the transfer of a copyrighted article,

the provision of services relating to the development of a computer

program, or the provision of know-how.

Section 1.861-18(b)(2) provides that a transaction involving

computer programs which consists of more than one of the categories in

paragraph (b)(1), is treated as separate transactions. Any resulting

transaction that is de minimis, however, taking into account all facts

and circumstances, will not be treated as a separate transaction.

Section 1.861-18(c)(1)(i) provides that the transfer of a computer

program will be classified as the transfer of a copyright right if the

transferee acquires one or more of the rights set forth in paragraph

(c)(2).

Section 1.861-18(c)(1)(ii) provides that if such rights are not

transferred and the transaction does not involve, or involves to only a

de minimis extent, the provision of services or know-how, then the

transaction will be classified solely as the transfer of a copyrighted

article.

Section 1.861-18(c)(2) identifies those rights that will be treated

as copyright rights for purposes of the proposed regulations. This list

differs from the list of rights set out in the Copyright Act to take

into account the special nature of computer programs. Specifically, the

for the purposes of the proposed regulations if it is accompanied by

the right to distribute such copies to the public. The copyright rights

that apply for purposes of this section are, in addition to the right

to copy and distribute to the public, the right to prepare derivative

computer programs, the right to make a public performance of the

computer program, and the right to publicly display the computer

program. The list of rights contained in Sec. 1.861-18(c)(2) rather

than those contained in the Copyright Act will apply for the purposes

of the proposed regulations.

Section 1.861-18(c)(3) defines a copyrighted article as a copy of a

computer program from which the work can be perceived, reproduced or

otherwise communicated.

Section 1.861-18(d) of the proposed regulations provides rules for

determining whether a transaction involving a newly-developed or

modified computer program will be treated as the provision of services

or another transaction described in paragraph (b)(1) of this section.

The determination is based on all facts and circumstances, including

how risk of loss is allocated and the intent of the parties as to

ownership of the copyright. See, e.g., Boulez v. Commissioner, 83 T.C.

584 (1984); Rev. Rul. 74-555 (1974-2 C.B. 202); Rev. Rul. 84-78 (1984-1

C.B. 173).

Section 1.861-18(e) provides rules for determining whether a

transfer of information related to a computer program will be

considered the provision of know-how. A provision of know-how will not

be considered to occur unless a party transfers information that (i)

relates to computer programming techniques, (ii) is not capable of

being copyrighted, and (iii) is protected by trade secret protection.

Under Sec. 1.861-18(f)(1), if a transfer involves copyright rights,

it will be further classified as either a sale or a license of

[[Page 58154]]

examining whether, taking into account all facts and circumstances, all

substantial rights, under the principles of sections 1222 and 1235,

have passed to the transferee.

Under Sec. 1.861-18(f)(2), if a transfer involves a copyrighted

article, it will be further classified as either a sale or a lease of a

copyrighted article. This classification will be made by examining

whether the benefits and burdens of ownership have passed to the

transferee. See, e.g., Grodt & McKay Realty, Inc. v. Commissioner, 77

T.C. 1221, 1237-38 (1981); Torres v. Commissioner, 88 T.C. 702, 720-27

(1987); Estate of Thomas v. Commissioner, 84 T.C. 412, 431-40 (1985).

Under Sec. 1.861-18(f)(3), the determination of the classification

of a transfer involving a copyright right or copyrighted article must

appropriately consider the special nature of computer programs in

transactions that take advantage of those characteristics. For example,

a transaction in which a person acquires a copyrighted article on disk

subject to a requirement that the disk be destroyed after a specified

period is generally the equivalent of a requirement that the disk be

returned after such period. Similarly, a transaction in which the

program deactivates itself after a specified period may also be treated

as the equivalent of returning the copy.

Section 1.861-18(g) of the proposed regulations provides certain

additional rules of operation. Section 1.861-18(g)(1) provides that

neither the form adopted by the parties to a transaction nor the

classification of a transaction under copyright law are determinative

for tax purposes. Therefore, as illustrated in Example 1, a transfer of

a computer program on a disk subject to a shrink-wrap license will

generally be a sale of a copyrighted article.

Section 1.861-18(g)(2) provides that the method of transferring the

computer program, for example by disk or electronically, shall not be

relevant in determining whether a copyright right or a copyrighted

article has been transferred.

The foregoing rules are illustrated by a number of examples

contained in Sec. 1.861-18(h).

Under Sec. 1.861-18(i), these regulations are proposed to apply to

all transactions occurring on or after the date that is 60 days after

the date the final regulations are published in the Federal Register.

No inference should be drawn from the proposed effective date

concerning the treatment of transactions involving computer programs

entered into before the regulations are applicable.

The application of these rules for purposes of the affected

Internal Revenue Code sections may result in a change in the method of

accounting for certain transactions involving computer programs by

certain taxpayers. If the final regulations are adopted, the IRS will

consider issuing an automatic change revenue procedure to address the

situation where the taxpayer is required to change its method of

accounting to comport with the new regulations.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in EO 12866. Therefore,

a regulatory assessment is not required. It also has been determined

that section 553(b) of the Administrative Procedure Act (5 U.S.C.

chapter 5) does not apply to these regulations, and because the

regulations do not impose a collection of information on small

entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not

apply. Pursuant to section 7805(f) of the Internal Revenue Code, this

notice of proposed rulemaking will be submitted to the Chief Counsel

for Advocacy of the Small Business Administration for comment on its

impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any comments that are submitted timely

(in the manner described in the ADDRESSES caption) to the IRS. All

comments will be available for public inspection and copying.

A public hearing has been scheduled for March 19, 1997, at 10 a.m.

in the NYU Classroom, room 2615, Internal Revenue Building, 1111

Constitution Avenue NW., Washington, DC. Because of access

restrictions, visitors will not be admitted beyond the Internal Revenue

Building lobby more than 15 minutes before the hearing starts.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

Persons that wish to present oral comments at the hearing must

submit comments by February 11, 1997 and submit an outline of the

topics to be discussed and the time to be devoted to each topic (in the

manner described in the ADDRESSES caption) by February 26, 1997.

A period of 10 minutes will be allotted to each person for making

comments.

An agenda showing the scheduling of the speakers will be prepared

after the deadline for receiving outlines has passed. Copies of the

agenda will be available free of charge at the hearing.

Drafting Information

The principal authors of these regulations are William H. Morris

and Carol P. Tello, of the Office of Associate Chief Counsel

(International), IRS. However, other personnel from the IRS and

Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in

part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.861-18 is added to read as follows:

Sec. 1.861-18 Classification of transactions involving computer

programs.

(a) General--(1) Scope. This section provides rules for classifying

transactions relating to computer programs for purposes of subchapter N

of chapter 1 of the Internal Revenue Code, sections 367, 404A, 482,

551, 679, 1057, 1059A, chapter 3, chapter 5, sections 842 and 845 (to

the extent involving a foreign person), and transfers to foreign trusts

not covered by section 679.

(2) Categories of transactions. This section generally requires

that such transactions be treated as being solely within one of four

categories (described in paragraph (b)(1) of this section) and provides

certain rules for categorizing such transactions. In the case of a

transfer of a copyright right, this section provides rules for

determining whether the transaction should be classified as either a

sale or exchange, or a license generating royalty income. In the case

of a transfer of a copyrighted article, this section provides rules for

determining whether the transaction should be classified as either a

sale or exchange, or a lease generating rental income.

(3) Computer program. For purposes of this section, a computer

program is a set of statements or instructions to be used directly or

indirectly in a computer in order to bring about a certain result. For

purposes of this paragraph (a)(3), a computer program includes any data

base or similar item if the data base or similar item is incidental to

the operation of the computer program.

[[Page 58155]]

(b) Categories of transactions--(1) General. Except as provided in

paragraph (b)(2) of this section, a transaction involving the transfer

of, or the provision of services or of know-how with respect to, a

computer program (collectively, a transfer of a computer program) is

treated as being solely one of the following--

(i) A transfer of a copyright right in the computer program;

(ii) A transfer of a copy of the computer program (a copyrighted

article);

(iii) The provision of services for the development or modification

of the computer program; or

(iv) The provision of know-how relating to computer programming

techniques.

(2) Transactions consisting of more than one category. Any

transaction involving computer programs which consists of more than one

of the transactions described in paragraph (b)(1) of this section shall

be treated as separate transactions, with the appropriate provisions of

this section being applied to each such transaction. However, any

transaction that is de minimis, taking into account the overall

transaction and the surrounding facts and circumstances, shall not be

treated as a separate transaction, but as part of another transaction.

article--(1) Classification--(i) Transfers treated as transfers of

transfer of a copyright right if, as a result of the transaction, a

person acquires any one or more of the rights described in paragraphs

(c)(2)(i) through (iv) of this section. For example, if a person

receives a disk containing a copy of a computer program which enables

it to exercise, in relation to that program, a non-de minimis right

described in paragraphs (c)(2)(i) through (iv) of this section (and the

transaction does not involve, or involves only a de minimis provision

of services as described in paragraph (d) of this section or of know-

how as described in paragraph (e) of this section), then, under

paragraph (b)(2) of this section, the transfer is classified solely as

a transfer of a copyright right.

(ii) Transfers treated solely as transfers of copyrighted articles.

If a person acquires a copy of a computer program but does not acquire

any of the rights described in paragraphs (c)(2)(i) through (iv) of

this section (and the transaction does not involve, or involves only a

de minimis provision of services as described in paragraph (d) of this

section or of know-how as described in paragraph (e) of this section),

the transfer of the copy of the computer program is classified solely

as a transfer of a copyrighted article.

(2) Copyright rights. The copyright rights referred to in paragraph

(c)(1) of this section are as follows--

(i) The right to make copies of the computer program for purposes

of distribution to the public by sale or other transfer of ownership,

or by rental, lease or lending;

(ii) The right to prepare derivative computer programs based upon

the copyrighted computer program;

(iii) The right to make a public performance of the computer

program; or

(iv) The right to publicly display the computer program.

(3) Copyrighted article. A copyrighted article is a copy of a

computer program from which the work can be perceived, reproduced or

otherwise communicated, either directly or with the aid of a machine or

device. The copy of the program may be fixed in the magnetic medium of

a floppy disk or in the main memory or hard drive of a computer.

(d) Provision of services. The determination of whether a

transaction involving a newly developed or modified computer program is

treated as either the provision of services or another transaction

described in paragraph (b)(1) of this section is based on all the facts

and circumstances of the transaction, including, as appropriate, the

intent of the parties (as evidenced by their agreement and conduct) as

to which party is to own the copyright rights in the computer program

and how the risks of loss are allocated between the parties.

(e) Provision of know-how. The provision of information with

respect to a computer program will not be treated as the provision of

know-how for the purposes of this section unless the information is--

(1) Information relating to computer programming techniques;

(2) Not capable itself of being copyrighted; and

(3) Subject to trade secret protection.

(f) Further classification of transfers involving copyright rights

and copyrighted articles--(1) Transfers of copyright rights. The

determination of whether a transfer of a copyright right is a sale or

exchange of property is made on the basis of whether, taking into

account all facts and circumstances, there has been a transfer of all

substantial rights in the copyright. A transaction that does not

constitute a sale or exchange because not all substantial rights have

been transferred will be classified as a license generating royalty

income. For this purpose, the principles of sections 1222 and 1235

shall apply.

(2) Transfers of copyrighted articles. The determination of whether

a transfer of a copyrighted article is a sale or exchange is made on

the basis of whether, taking into account all facts and circumstances,

the benefits and burdens of ownership have been transferred. A

transaction that does not constitute a sale or exchange because

insufficient benefits and burdens of ownership of the copyrighted

article have been transferred, such that a person other than the

transferee is properly treated as the owner of the copyrighted article,

will be classified as a lease generating rental income.

(3) Special circumstances of computer programs. In connection with

determinations under this paragraph (f), consideration must be given as

appropriate to the special characteristics of computer programs in

transactions that take advantage of these characteristics (such as the

ability to make perfect copies at minimal cost). For example, a

transaction in which a person acquires a copy of a computer program on

disk subject to a requirement that the disk be destroyed after a

specified period is generally the equivalent of a transaction subject

to a requirement that the disk be returned after such period.

Similarly, a transaction in which the program deactivates itself after

a specified period is generally the equivalent of returning the copy.

(g) Rules of operation--(1) Term applied to transaction by parties.

Neither the form adopted by the parties to a transaction, nor the

classification of the transaction under copyright law, shall be

determinative. Therefore, for example, if there is a transfer of a

computer program on a single disk for a one-time payment with

restrictions on transfer and reverse engineering, which the parties

characterize as a license (generally referred to as a shrink-wrap

license), application of the rules of paragraphs (c) and (f) of this

section may nevertheless result in the transaction being classified as

the sale of a copyrighted article.

(2) Means of transfer not to be taken into account. The rules of

this section shall be applied irrespective of the physical or

electronic medium used to effectuate a transfer of a computer program.

(h) Examples. The provisions of this section may be illustrated by

the following examples. All of the following examples assume that all

parties are unrelated to each other:

[[Page 58156]]

Example 1. (i) Facts. Corp A, a U.S. corporation, owns the

to disks. The disks are placed in boxes covered with a wrapper on

which is printed what is generally referred to as a shrink-wrap

license. The license is stated to be perpetual. Under the license no

reverse engineering of the computer program is permitted. The

transferee receives, first, the right to use the program on two of

its own computers (for example, a laptop and a desktop) provided

that only one copy is in use at any one time, and, second, the right

to make one copy of the program on each machine as an essential step

in the utilization of the program. The transferee is permitted by

the shrink-wrap license to sell the copy so long as it destroys any

other copies it has made and imposes the same terms and conditions

of the license on the purchaser of its copy. These disks are made

available for sale to the general public in Country Z. In return for

valuable consideration, P, a Country Z resident, receives one such

disk.

(ii) Analysis. (A) Under paragraph (g)(1) of this section, the

label license is not determinative. None of the copyright rights

described in paragraph (c)(2) of this section have been transferred

in this transaction. P has received a copy of the program, however,

and, therefore, under paragraph (c)(1)(ii) of this section, P has

acquired solely a copyrighted article.

(B) Taking into account all of the facts and circumstances, P is

properly treated as the owner of a copyrighted article. Therefore,

under paragraph (f)(2) of this section, there has been a sale of a

copyrighted article rather than the grant of a lease.

Example 2. (i) Facts. The facts are the same as those in Example

1, except that instead of selling disks, Corp A, the U.S.

corporation, decides to make Program X available, for a fee, on a

World Wide Web home page on the Internet. P, the Country Z resident,

in return for payment made to Corp A, downloads Program X (via

modem) onto the hard drive of his computer. As part of the

electronic communication, P signifies his assent to a license

agreement with terms identical to those in Example 1, except that in

this case P may make a back-up copy of the program on to a disk.

(ii) Analysis. (A) None of the copyright rights described in

paragraph (c)(2) of this section have passed to P. Although P did

not buy a physical copy of the disk with the program on it,

paragraph (g)(2) of this section provides that the means of

transferring the program is irrelevant. Therefore, P has acquired a

copyrighted article.

(B) As in Example 1, P is properly treated as the owner of a

copyrighted article. Therefore, under paragraph (f)(2) of this

section, there has been a sale of a copyrighted article rather than

the grant of a lease.

Example 3. (i) Facts. The facts are the same as those in Example

1, except that Corp A only allows P, the Country Z resident, to use

Program X for one week. At the end of that week, P must return the

disk with Program X on it to Corp A. P must also destroy any copies

made of Program X. If P wishes to use Program X for a further period

he must enter into a new agreement to use the program for an

additional charge.

(ii) Analysis. (A) Under paragraph (c)(2) of this section, P has

received no copyright rights. Because P has received a copy of the

program under paragraph (c)(1)(ii) of this section, he has,

therefore, received a copyrighted article.

(B) Taking into account all of the facts and circumstances, P is

not properly treated as the owner of a copyrighted article.

Therefore, under paragraph (f)(2) of this section, there has been a

lease of a copyrighted article rather than a sale. Taking into

account the special characteristics of computer programs as provided

in paragraph (f)(3) of this section, the result would be the same if

P were required to destroy the disk at the end of the one-week

period instead of returning it since Corp A can make additional

copies of the program at minimal cost.

Example 4. (i) Facts. The facts are the same as those in Example

2, where P, the Country Z resident, receives Program X from Corp A's

home page on the Internet, except that P may only use Program X for

a period of one week at the end of which an electronic lock is

activated and the program can no longer be accessed. Thereafter, if

P wishes to use Program X, it must return to the home page and pay

Corp A to send an electronic key to reactivate the program for

another week.

(ii) Analysis. (A) As in Example 3, under paragraph (c)(2) of

this section, P has not received any copyright rights. P has

received a copy of the program, and under paragraph (g)(2) of this

section, the means of transmission is irrelevant, P has, therefore,

under paragraph (c)(1)(ii) of this section, received a copyrighted

article.

(B) As in Example 3, P is not properly treated as the owner of a

copyrighted article. Therefore, under paragraph (f)(2) of this

section, there has been a lease of a copyrighted article rather than

a sale. While P does retain Program X on its computer at the end of

the one week period, as a legal matter P no longer has the right to

use the program (without further payment) and, indeed, cannot use

the program without the electronic key. Functionally, Program X is

no longer on the hard drive of P's computer. Instead, the hard drive

contains only a series of numbers which no longer perform the

function of Program X. Although in Example 3, P was required to

physically return the disk, taking into account the special

characteristics of computer programs as provided in paragraph (f)(3)

of this section, the result in this Example 4 is the same as in

Example 3.

Example 5. (i) Facts. Corp A, a U.S. corporation, transfers a

disk containing Program X to Corp B, a Country Z corporation, and

grants Corp B an exclusive license for the remaining term of the

Program X in the geographic area of Country Z, prepare derivative

works based upon Program X, make public performances of Program X,

and publicly display Program X. Corp B will pay Corp A a royalty of

$y a year for three years, which is the expected period during which

Program X will have commercially exploitable value.

(ii) Analysis. (A) Although Corp A has transferred a disk with a

copy of Program X on it to Corp B, under paragraph (c)(1)(i) of this

section because this transfer is accompanied by a copyright right

identified in paragraph (c)(2)(i) of this section, this transaction

is a transfer solely of copyright rights, not of copyrighted

articles. For purposes of paragraph (b)(2) of this section, the disk

containing a copy of Program X is a de minimis component of the

transaction.

(B) Applying the all substantial rights test under paragraph

(f)(1) of this section, Corp A will be treated as having sold

rights in Program X, has received the right to use them exclusively

within a geographic area, and has received the rights for the

remaining life of the copyright in Program X. Under paragraph (g)(1)

of this section, the fact that the agreement is labelled a license

is not controlling (nor is the fact that Corp A receives a sum

labelled a royalty). (This would also be the case if the copy of

Program X to be used for the purposes of reproduction were

transmitted electronically to Corp B, as a result of the application

of the rule of paragraph (g)(2) of this section.)

Example 6. (i) Facts. Corp A, a U.S. corporation, transfers a

disk containing Program X to Corp B, a Country Z corporation, and

grants Corp B the non exclusive right to reproduce and distribute

for sale to the public an unlimited number of disks at its factory

in Country Z in return for a payment related to the number of disks

copied and sold. The term of the agreement is two years, which is

less than the remaining life of the copyright.

(ii) Analysis. (A) As in Example 5, the transfer of the disk

containing the copy of the program does not constitute the transfer

of a copyrighted article under paragraph (c)(1) of this section

because Corp B has also acquired a copyright right under paragraph

(c)(2)(i) of this section. For purposes of paragraph (b)(2) of this

section, the disk containing Program X is a de minimis component of

the transaction.

(B) Taking into account all of the facts and circumstances,

there has been a license of Program X to Corp B, and the payments

made by Corp B are royalties. Under paragraph (f)(1) of this

section, there has not been a transfer of all substantial rights in

the copyright to Program X because Corp A has the right to enter

into other licenses with respect to the copyright of Program X,

including in Country Z (or even to sell that copyright, subject to

Corp B's interest). Corp B has acquired no right itself to license

the copyright rights in Program X. Finally, the term of the license

is for less than the remaining life of the copyright in Program X.

Example 7. (i) Facts. Corp C, a distributor in Country Z, enters

into an agreement with Corp A, a U.S. corporation, to purchase as

many copies of Program X on disk as it may from time-to-time

request. Corp C will then sell these disks to retailers. The disks

are shipped in boxes covered by shrink-wrap licenses (identical to

the license described in Example 1).

(ii) Analysis. (A) Corp C has not acquired any copyright rights

under paragraph (c)(2) of this section with respect to Program X. It

has acquired individual copies of Program X,

[[Page 58157]]

which it may sell to others. The use of the term license is not

dispositive under paragraph (g)(1) of this section. Under paragraph

(c)(1)(ii) of this section, Corp C has acquired copyrighted

articles.

(B) Taking into account all of the facts and circumstances, Corp

C is properly treated as the owner of copyrighted articles.

Therefore, under paragraph (f)(2) of this section, there has been a

sale of copyrighted articles.

Example 8. (i) Facts. Corp A, a U.S. corporation, transfers a

disk containing Program X to Corp D, a foreign corporation engaged

in the manufacture and sale of personal computers in Country Z. Corp

A grants Corp D the non-exclusive right to copy Program X onto the

hard drive of computers which it manufactures, and to distribute

those copies (on the hard drive) to the public. The term of the

agreement is two years, which is less than the remaining life of the

number of copies of Program X it loads on to computers.

(ii) Analysis. The analysis is the same as in Example 6. Under

paragraph (c)(2)(i) of this section, Corp D has acquired a copyright

right enabling it to exploit Program X by copying it on to the hard

drives of the computers that it manufactures and then sells. For

purposes of paragraph (b)(2) of this section, the disk containing

Program X is a de minimis component of the transaction. Taking into

account all of the facts and circumstances, Corp D has not, however,

acquired all substantial rights in the copyright to Program X (for

example, the term of the agreement is less than the remaining life

of the copyright). Under paragraph (f)(1) of this section, this

transaction is, therefore, a license of Program X to Corp D rather

than a sale and the payments made by Corp D are royalties.

Example 9. (i) Facts. The facts are the same as in Example 8,

except that Corp D, the Country Z corporation, receives physical

disks. The disks are shipped in boxes covered by shrink-wrap

licenses (identical to the licenses described in Example 1). Corp D

uses each individual disk only once to load a single copy of Program

X onto each separate computer. Corp D transfers the disk with the

computer when it is sold.

(ii) Analysis. (A) As in Example 7 (unlike Example 8) no

been transferred. Corp D acquires the disks without the right to

reproduce and distribute publicly further copies of Program X. This

is therefore the transfer of copyrighted articles under paragraph

(c)(1)(ii) of this section.

(B) Taking into account all of the facts and circumstances, Corp

D is properly treated as the owner of copyrighted articles.

Therefore, under paragraph (f)(2) of this section, the transaction

is classified as the sale of a copyrighted article.

Example 10. (i) Facts. Corp A, a U.S. corporation, transfers a

disk containing Program X to Corp E, a Country Z corporation, and

grants Corp E the right to load Program X onto 50 individual

workstations for use only by Corp E employees at one location in

return for a one-time per-user fee (generally referred to as a site

license). If additional workstations are subsequently introduced,

Program X may be loaded on to those machines for additional one-time

per-user fees. The license which grants the rights to operate

Program X on 50 workstations also prohibits Corp E from selling the

disk (or any of the 50 copies) or reverse engineering the program.

The term of the license is stated to be perpetual.

(ii) Analysis. (A) The grant of a right to copy, unaccompanied

by the right to distribute those copies to the public, is not the

transfer of a copyright right under paragraph (c)(2) of this

section. Therefore, under paragraph (c)(1)(ii) of this section, this

transaction is a transfer of copyrighted articles (50 copies of

Program X).

(B) Taking into account all of the facts and circumstances, P is

properly treated as the owner of a copyrighted article. Therefore,

under paragraph (f)(2) of this section, there has been a sale of

copyrighted articles rather than the grant of a lease.

Notwithstanding the restriction on sale, other factors such as, for

example, the risk of loss and the right to use the copies in

perpetuity outweigh, in this case, the restrictions placed on the

right of alienation.

Example 11. (i) Facts. The facts are the same as in Example 10,

except that Corp E, the Country Z corporation, acquires the right to

make Program X available to workstation users who are Corp E

employees by way of a local area network (LAN). The number of users

that can use Program X on the LAN at any one time is limited to 50.

Corp E pays a one-time fee for the right to have up to 50 employees

use the program at the same time.

(ii) Analysis. Under paragraph (g)(2) of this section the mode

of transmission is irrelevant. Therefore, as in Example 10, under

paragraph (c)(2) of this section, no copyright right has been

transferred and thus, under paragraph (c)(1)(ii) of this section,

this transaction will be classified as the transfer of a copyrighted

article. Under the benefits and burdens test of paragraph (f)(2) of

this section, this transaction is a sale of copyrighted articles.

Example 12. (i) Facts. The facts are the same as in Example 11,

except that Corp E pays a monthly fee to Corp A, the U.S.

corporation, calculated with reference to the permitted maximum

number of users (which can be changed) and the computing power of

Corp E's server. In return for this monthly fee, Corp C receives the

right to receive upgrades of Program X when they become available.

The agreement may be terminated by either party at the end of any

month. When the disk containing the upgrade is received, or if the

contract is terminated, Corp E must return the disk containing the

earlier version of Program X to Corp A, and delete (or otherwise

destroy) any copies made of the current version of Program X. The

agreement specifically provides that Corp E has not thereby been

granted an option to purchase Program X.

(ii) Analysis. (A) Corp E has received no copyright rights under

paragraph (c)(2) of this section. Under paragraph (d) of this

section, based on all the facts and circumstances of the

transaction, Corp A has not provided services to Corp E. Therefore,

under paragraph (c)(1)(ii) of this section, the transaction is a

transfer of a copyrighted article.

(B) Taking into account all facts and circumstances, under the

benefits and burdens test Corp E is not properly treated as the

owner of the copyrighted article. Corp E does not receive the right

to use Program X in perpetuity, but only for so long as it continues

to make payments. Corp E does not have the right to purchase Program

X on advantageous (or, indeed, any) terms once a certain amount of

money has been paid to Corp A or a certain period of time has

elapsed (which might indicate a sale). Once the agreement is

terminated, Corp E will no longer possess any copies of Program X,

current or superseded. Therefore under paragraph (f)(2) of this

section there has been a lease of a copyrighted article.

Example 13. (i) Facts. The facts are the same as in Example 12,

except that while Corp E must return copies of Program X as new

upgrades are received, if the agreement terminates, Corp E may keep

the latest version of Program X (although Corp E is still prohibited

from selling or otherwise transferring any copy of Program X).

(ii) Analysis. For the reasons stated in Example 10, the

transfer of the program will be treated as a sale of a copyrighted

article rather than as a lease.

Example 14. (i) Facts. Corp G, a Country Z corporation, enters

into a contract with Corp A, a U.S. corporation, for Corp A to

modify Program X so that it can be used at Corp G's facility in

Country Z. Under the contract, Corp G is to acquire one copy of the

program on a disk and the right to use the program on 5,000

workstations. The contract requires Corp A to rewrite elements of

Program X so that it will conform to Country Z accounting standards.

The services required to perform this task are de minimis taking

into account the facts and circumstances of this transaction. The

agreement between Corp A and Corp G is otherwise identical as to

rights and payment terms as the agreement described in Example 10.

(ii) Analysis. (A) As in Example 10, no copyright rights are

being transferred under paragraph (c)(2) of this section. Under

paragraph (b)(2) of this section, the services provided are de

minimis. This transaction will be classified, therefore, as a

transfer of copyrighted articles under paragraph (c)(1)(ii) of this

section.

(B) Taking into account all facts and circumstances, Corp G is

properly treated as the owner of copyrighted articles. Therefore,

under paragraph (f)(2) of this section, there has been the sale of a

copyrighted article rather than the grant of a lease.

Example 15. (i) Facts. Corp H, a Country Z corporation, enters

into a license agreement for a modified version of Program X only if

Corp A, a U.S. corporation, makes substantial modifications to the

program. Only the core idea of Program X will be used and a

considerable amount of labor will be expended in rewriting Program

X, which under applicable copyright law as a derivative work will be

a separate, new program. Corp A and Corp H agree that Corp A is

modifying Program X for Corp H and that, when modified Program X is

completed, the copyright in the modified program will belong to Corp

H. Corp H gives instructions

[[Page 58158]]

to Corp A programmers regarding program specifications. Corp H

agrees to pay Corp A a fixed monthly sum during development of the

program. If Corp H is dissatisfied with the development of the

program it may cancel the contract at the end of any month. In the

event of termination, Corp A will retain all payments, while any

procedures, techniques or copyrightable interests will be the

property of Corp H. All of the payments are labelled royalties.

There is no provision in the agreement for any continuing

relationship between Corp A and Corp H, such as the furnishing of

updates of the program, after completion of the modification work.

(ii) Analysis. Taking into account all of the facts and

circumstances, Corp A is treated as providing services to Corp H.

Under paragraph (d) of this section, Corp A is treated as providing

services to Corp H because Corp H bears all of the risks of loss

associated with the development of modified Program X and is the

owner of all copyright rights in modified Program X. Under paragraph

(g)(1) of this section, the fact that the agreement is labelled a

license is not controlling (nor is the fact that Corp A receives a

sum labelled a royalty).

Example 16. (i) Facts. Corp A, a U.S. corporation, and Corp I, a

Country Z corporation, agree that a development engineer employed by

Corp A will travel to Country Z to provide know-how relating to

certain techniques which are not generally known to computer

programmers which will enable Corp I to more efficiently create

computer programs. These techniques represent the product of

experience gained by Corp A from working on many computer

programming projects. Such information is not capable of being

copyrighted, but it is subject to trade secret protection.

(ii) Analysis. This transaction contains the elements of know-

how specified in paragraph (e) of this section. Therefore, this

transaction will be classified as the provision of know-how.

(i) Effective date. This section applies to transactions occurring

on or after the date that is sixty days after the date final

regulations are published in the Federal Register.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 96-29055 Filed 11-7-96; 3:11 pm]

BILLING CODE 4830-01-U

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.