Taxpayers and state tax practitioners alike often scratch their heads at the fact that there is so much established guidance on the treatment of prewritten ("canned," or noncustom) software for sales-and-use-tax purposes but so little when it comes to state corporate income tax treatment. This item discusses the interplay between Public Law 86-272 (15 U.S.C. [section][section]381-384) and the federal treatment of computer software, as well as two states' approaches to the corporate income tax treatment of canned software, and how--despite similar characterization of software for sales tax purposes--these states arrive at disparate corporate income tax jurisdictional and apportionment results.
P.L. 86-272: Federal treatment of computer software
P.L. 86-272 provides that no state may impose a net income tax on a person engaged in interstate commerce if that person's business activities within the state are limited to solicitation of sales of tangible personal property (and certain activities ancillary to solicitation); its orders are approved outside the state; and shipment/delivery originates outside the state. This federal law limits state jurisdiction to tax even where the taxpayer has otherwise established constitutional nexus. As a federal statute, P.L. 86-272 should be interpreted in accordance with federal definitions and federal treatment of tangible personal property. However, P.L. 86-272 itself does not define tangible personal property, nor does it provide any suggestion of whether computer software is included within that term. In addition, there are no federal regulations interpreting P.L. 86-272.
Absent any specific P.L. 86-272 guidance, other federal laws must be looked at to help define tangible personal property, under the concept of in pari materia (i.e., the principle that statutes or regulations relating to the same subject or theme should be interpreted in light of each other). In the case of software, other federal law dealing with sourcing of taxable income from sources within the United States has been interpreted--via regulation--to treat the sale of canned computer software as a deemed sale of tangible property, regardless of whether the parties characterize the transaction as a lease or license, provided that none (or no more than a de minimis amount) of the following transfers of rights occur:
* 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;
* The right to prepare derivative computer programs based on the copyrighted computer program;
* The right to make a public performance of the computer program; or
* The right to publicly display the computer program (Regs. Secs. 1.861-18(c)(l) and (2)).
The use of the term "lease" or "license" in a computer software sale agreement is not dispositive as to whether it may be treated as the sale of a copyrighted article, under Regs. Sees. 1.861-18(g)(l) and 1.861-18(h), Example (7). For federal income tax purposes, a copyrighted article is sourced as a sale of tangible personal property (Regs. Sec. 1.861-18(c)(l)). In other words, the sale of a canned (off-the-shelf, noncustomized) computer program copied onto a CD-ROM and made available for sale to the general public or for resale is deemed to be the sale of a copyrighted article for federal income tax purposes and is treated as a sale of tangible personal property, provided no more than a de minimis transfer of the above-enumerated rights occurs (Regs. Sec. 1.861-18(h), Example (1)).
Federal law has not addressed whether canned computer software delivered via electronic (rather than tangible) media may also be considered the sale of tangible personal property. In the absence of federal guidance, state taxpayers performing a P.L. 86-272 analysis might look to available state-specific guidance for the treatment of canned computer software delivered electronically.
In a 1997 private letter ruling for a mail-order company that was selling canned software into the state (delivered via tangible medium), the Wisconsin Department of Revenue (DOR) concluded that the taxpayer's solicitation activities in the state were protected by RL. 86-272 (Wis. Dep't of Rev., Private Letter Ruling W9728006). In more recent years, however, the DOR has taken the position on audit and in response to corporate income tax nexus questionnaires that software--even if delivered via tangible medium--is an intangible, and solicitation within Wisconsin for sales of canned software or the licensing of canned software exceeds the protections of RL. 86-272 (Wis. Admin. Code [section][section]2.82(4)(a)(9) and (4)(a)(10); see also Private Letter Ruling W1335002, Wis. Dep't of Rev., Tax Bulletin No. 182 (Oct. 1,2013), Question 3).
As discussed above, the federal interpretation of canned computer software delivered via tangible medium as the sale of a copyrighted article should control in determining whether PL. 86-272 applies. Regarding canned computer software delivered electronically, Wisconsin should look to its available state-specific guidance. Wisconsin does not define tangible personal property or computer software within its corporate income tax law. For sales-and-use-tax purposes, Wisconsin defines tangible personal property as follows:
"Tangible personal property" means personal property that can be seen, weighed, measured, felt, or touched, or that is in any other manner perceptible to the senses, and includes electricity, gas, steam, water, and prewritten computer software, regardless of how it is delivered to the purchaser. [Wis. Stat. [section]77.51(20), emphasis added] Thus, based...