The New Proposed Rules for Computer Program Transactions

• Jurisdiction: United States,Federal
• Citation: Vol. 26 No. 5 Pg. 93
• Pages: 93
• Publication year: 1997

26 Colo.Law. 93 Colorado Lawyer 1997.

1997, May, Pg. 93. The New Proposed Rules for Computer Program Transactions

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93

Vol. 26, No. 5, Pg. 93

The Colorado Lawyer
May 1997
Vol. 26, No. 5 [Page 93]

Specialty Law Columns
Tax Tips
The New Proposed Rules for Computer Program Transactions
by Patrick A. Jackman

Column Ed.: James R. Walker of Rothgerber, Appel, Powers & Johnson LLP, Denver - (303) 623-9000

This column is prepared by the CBA Taxation Section to apprise members of the Bar of items of general interest concerning tax matters. This month's article was written by Patrick A. Jackman, Denver, an associate of Davis, Graham & Stubbs LLP, (303) 892-9400

The U.S. software industry is one of the most significant and growing parts of this country's economy. On a worldwide basis, the U.S. software industry exports more than $26 billion dollars worth of software annually.1 Notwithstanding the importance of this growing industry, the Internal Revenue Service ("IRS") previously had not developed any adequate guidance regarding transactions involving computer software.2

Finally, last fall, the IRS proposed regulations ("Proposed Regulations") relating to the tax treatment of certain transactions involving the transfer of computer programs.3 The Proposed Regulations classify such transactions into four categories: (1) the sale or license of a copyright right, (2) the sale or lease of a copyrighted article, (3) the provision of services, and (4) the provision of know-how. These categories appear to reasonably reflect the full set of possible computer program transactions

Background

Recent technological developments have caused the federal tax authorities to reexamine their classification of income arising from transactions in digitized information,4 such as computer programs, books, music, or images. In a recently issued discussion paper, the Treasury Department stated that the classification of income from transfers of digitized information (that is, as royalty, sale of goods, or services income) must be refined to take into account the ease of transmitting and reproducing digitized information.5

Previously, the type of income derived from transactions involving computer programs generally depended on whether the program was considered tangible or intangible property. If the program was tangible property, then the income generally was sale of goods income; on the other hand, programs treated as intangible property resulted in royalty income or, for certain customized programs, services income

Because software developers are able to control the transfer medium of computer programs (delivery on disk or electronically), computer software businesses can structure software transactions to achieve different tax results for functionally equivalent items. Consequently, the IRS acknowledged the limitations on using form to control tax consequences and has altered its approach so that classification depends on the type of intellectual property rights transferred.

Overview of Proposed Regulations

The Proposed Regulations do not seek to make determinations based on whether computer programs are "tangible" or "intangible" property. Instead, the Regulations rely on copyright law principles to classify transactions involving computer programs.6 However, in some instances, the Proposed Regulations do depart from a strict reliance on copyright law so as to take into account the special nature of computer programs and to treat functionally equivalent transactions consistently.7

Some...