Alert
How California’s Proposed TTA Changes Impact Software Taxation
The California Department of Tax and Fee Administration (CDTFA) recently hosted an interested parties meeting regarding Technology Transfer Agreements (TTA), a continuation of a three-decade California sales tax saga.
This meeting gave participants an opportunity to discuss proposed language for a new TTA regulation as well as modifications to existing software and TTA regulations. Since 2024, the CDTFA has engaged with stakeholders through an informal rulemaking process which will hopefully result in long-needed guidance on applying TTA statutes.
Expand your knowledge of TTAs and explore highlights of the proposed regulation with the following insights.
TTA Background
California’s general rule is that software transferred as part of tangible personal property (TPP) is subject to sales tax. However, software that meets the statutory definition of a TTA is exempt.
The definition provides that a TTA is any agreement under which a person who holds a patent or copyright interest assigns or licenses to another person the right to make and sell a product or to use a process that’s subject to the patent or copyright interest.
Generally, this means that software that’s embedded in or used to operate TPP could be a TTA and would reduce the sales or use tax due on the TPP sold.
The TTA concept is unique to California, as this issue is avoided in many other states via broader exemptions for software, manufacturing equipment, telecommunications equipment, or other business inputs. While the statutory definition isn’t new, it has proven challenging for taxpayers to take nontaxable positions on TTAs, as evidenced by a series of court cases in the 1990s through 2010s.
The CDTFA’s proposed regulations show promise to finally reconcile the statutory guidance and court decisions to support the concept that TTAs are nontaxable and provide practical guidance for taxpayers, practitioners, and auditors.
Highlights From Proposed Regulations
The proposed regulation introduces new terms for determining what software can qualify for TTA treatment: bargained-for and non-bargained-for software.
The primary distinction in the proposed definitions is that bargained-for software requires a separate or specific agreement, which may be evidenced by a separate line item for the software, by the seller to sell or license their intangible interest in the software for consideration.
The existence of contemporaneous documentation of the separate or specific agreement to sell software, such as a contract or invoice, creates a rebuttable presumption that the software is bargained for.
While bargained-for and non-bargained for software are new terms, the elements that distinguish bargained for software are consistent with the pre-existing statutory definition of a TTA. This language underscores the importance of separately identifying software components, on invoices, purchase orders or through other such documentation prior to or at the time of sale to demonstrate that the software component is bargained-for and specifically address the software interests being transferred under the TTA.
Once a sale qualifies for TTA treatment the value of the exempt imbedded software must be determined. To provide a level of certainty for taxpayers, the proposed regulation creates pre-approval processes where taxpayers can pre-certify the ratio of the taxable and non-taxable elements of the TTA transaction.
The CDTFA’s inclusion of a precertification process and specific examples are positive developments in response to requests from stakeholders at prior interested party meetings.
Stakeholders can continue to provide comments to the CDTFA until September 8, 2025.
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To learn more about how California’s proposed TTA regulations can impact your business, contact your firm professional.