1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 450 N STREET 3 SACRAMENTO, CALIFORNIA 4 5 6 7 REPORTER'S TRANSCRIPT 8 AUGUST 21, 2012 9 10 BUSINESS TAXES COMMITTEE 11 12 13 14 15 16 17 18 19 20 21 Reported by: Juli Price Jackson 22 No. CSR 5214 23 24 25 26 27 28 1 1 2 P R E S E N T 3 4 For the Board Betty T. Yee of Equalization: Chair 5 Michelle Steel 6 Member 7 Jerome Horton Member 8 George Runner 9 Member 10 Marcy Jo Mandel Appearing for John 11 Chiang, State Controller 12 (per Government Code Section 7.9) 13 Joann Richmond 14 Chief, Board Proceedings Division 15 16 ---oOo--- 17 For the Staff: Susanne Buehler Chief, Tax Policy 18 Division, Sales and Use Tax Department 19 Bradley Heller 20 Tax Counsel IV Tax and Fee Division 21 Legal Department 22 Randy Ferris Chief Counsel 23 24 ---o0o--- 25 Speaker: Julian Decyk Attorney 26 Paul Hastings 27 ---o0o--- 28 2 1 450 N STREET 2 SACRAMENTO, CALIFORNIA 3 AUGUST 21, 2012 4 ---oOo--- 5 MR. HORTON: Good morning, Members. Let's call 6 the meeting of the Board of Equalization to order. 7 Ms. Richmond, what is our first item? 8 MS. RICHMOND: Good morning, Mr. Chairman and 9 Members. Our first item on today's agenda is the 10 Business Taxes Committee. Ms. Yee is the Chair of that 11 committee. 12 Ms. Yee. 13 MS. YEE: Thank you very much, Ms. Richmond. 14 Good morning, Members. 15 We'll convene the Business Taxes Committee. 16 There is one issue before the Committee and that is a 17 status update on the interested parties process that 18 relates to proposed amendments to Regulation 1507 19 relating to technology transfer agreements. 20 We have one speaker on this item, I believe. 21 I'm going to ask him to come forward, Mr. Julian Decyk 22 -- Decyk. 23 MR. DECYK: Decyk. 24 MS. YEE: Great, thank you. So, let me have 25 staff introduce the item while you're making your way up 26 here. 27 Good morning. 28 MS. BUEHLER: Good morning. I am Susanne 3 1 Buehler with the Sales and Use Tax Department. With me 2 today are Mr. Randy Ferris and Mr. Bradley Heller from 3 our Legal Department. 4 We have one agenda item for the Committee this 5 morning. This is a status update regarding the 6 interested parties process with respect to Regulation 7 1507, technology transfer agreements. 8 At the March 20th, 2012 Board meeting we 9 received your approval to begin the interested parties 10 process to discuss whether it is necessary to amend 11 Regulation 1507 to clarify when sales or purchases of 12 software on tangible storage property qualify as 13 technology transfer agreements and how tax applies to 14 software technology transfer agreements. 15 Due to the sensitivity of the issue, the Board 16 further directed staff to provide an update to the Board 17 after the first interested parties meeting. Since the 18 March 2012 Board meeting, staff distributed the initial 19 discussion paper on this issue and held the first 20 interested parties meeting on July 17th. 21 The meeting was well attended by members of the 22 software industry, taxpayers, representatives and 23 consultants and other interested parties. 24 At the time meeting there was a robust 25 discussion of differing views. Following the interested 26 parties meeting, staff received several written comments 27 which expressed overall disagreement with the staff's 28 analysis. 4 1 Staff also received a late submission, which 2 outlines a proposal to amend Regulation 1507 to allow 3 for the use of an optional percentage to determine the 4 measure of tax on transfers of software on tangible 5 storage media, as well as other considerations. 6 Therefore, the Business Taxes Committee 7 calendar has been revised to provide an opportunity for 8 all interested parties to review the proposal and submit 9 additional comments. The revised schedule will also 10 allow staff time to analyze the proposal, including its 11 effect on other regulations, such as Regulation 1502, 12 computers, programs and data processing and any 13 additional comments we might receive. The revised 14 schedule moves the Business Taxes Committee meeting for 15 this item from November 13th, 2012 to the January 2013 16 Board meeting dates. 17 We have speakers who would like to address the 18 Committee and we'd be happy to answer your questions 19 after their comments. 20 MS. YEE: Thank you, Ms. Buehler. We do have 21 one speaker on this item. 22 Mr. Decyk, do you want to introduce yourself 23 for the record and you have three minutes. 24 ---o0o--- 25 JULIAN DECYK 26 ---o0o--- 27 MR. DECYK: Yes, My name is Julian Decyk. I'm 28 an attorney at Paul Hastings. I was co-lead counsel 5 1 representing the NorCal Networks in Nortel case and I'm 2 currently co-lead counsel representing the taxpayers in 3 the Lucent cases. 4 MS. YEE: Proceed. 5 MR. DECYK: Shall I proceed? 6 MS. YEE: Please. 7 MR. DECYK: Thank you. You've asked for a 8 staff update on the interested parties process. I 9 thought you might also benefit from having an update 10 from at least some of the interested parties in the 11 interested parties process. 12 So far the interested parties process has been 13 premised on the initial discussion paper prepared by 14 Board staff. It's 14 pages. And in its final paragraph 15 it includes the following statement on the 16 pre-conditions for discussions about changes to 17 Regulation 1507. 18 And I quote, 19 "Staff also is open to recommending 20 amendments to Regulation 1507 to clarify the 21 application of tax to TTAs if the general 22 consensus of interested parties and staff can 23 agree that the amendments are clarifying and 24 consistent with all of the above-referenced 25 authorities." 26 Well, in this context, all the above-referenced 27 authorities means accepting the entire analysis provided 28 in the entire 14 pages of discussion up to that point. 6 1 Unfortunately, that starting point, especially 2 as a pre-condition for discussions, really is an error. 3 At its core, the initial discussion paper doesn't really 4 read as an analysis of the TTA statutes themselves, as 5 an authoritatively interpreted by the courts that have 6 actually considered and construed them. 7 Rather it reads much more as a presentation 8 model of taxation of computer software that's really 9 developed largely independently of the TTA statutes. 10 Now, I emphasize the legal problems with the 11 starting point in this process because it can easily 12 lead to legal problems at the conclusion of the process. 13 In particular, a starting point that doesn't properly 14 reflect the TTA statutes can easily lead to a regulatory 15 proposal that is in conflict with the statutes. And a 16 regulation that is in conflict with the statutes is 17 invalid. 18 I focused on the issue of the invalidity 19 because so far the courts have struck down two separate 20 regulations adopted by the Board interpreting the TTA 21 statutes. This is the Preston case and the Martell 22 case. And in both cases they did so precisely because 23 the regulations were in conflict with the statutes and, 24 so, were in excess of the power of the Board to adopt 25 and, so, invalid. 26 At the interested parties meeting in July, as 27 mentioned, there was a robust discussion and I would 28 point out that no one outside the Board staff agreed 7 1 with the analysis and the initial discussion paper. So, 2 there is a general consensus of interested parties, but 3 it's not that the -- the initial discussion paper is 4 correct. 5 So, the -- I think the interested parties 6 process has begun from the wrong starting point. And I 7 think it needs to be reset in order to have a successful 8 outcome, which would be a regulation that's valid. What 9 we don't need is another invalid regulation. 10 Thank you. 11 MS. YEE: Thank you very much. 12 Let me have staff respond to that, maybe, 13 Mr. Heller, if you could focus on what the courts, in 14 fact, did do relative to the regulations and the 15 particular proposal that's before the Committee right 16 now or the issues before the Committee right now. 17 MR. HELLER: I'm -- well, thank you, Ms. Yee. 18 Staff basically -- we've tried to set out all 19 the relevant authorities applicable to the -- that 20 explain how sales and use tax applies to tangible 21 personal property and intangibles when they're sold 22 together. 23 And, essentially, I think we do have a 24 disagreement between staff and some of the interested 25 parties. I think fundamentally about the nature of -- 26 of the computer programs when they're transferred on 27 tangible storage media. And we have a disagreement as 28 to whether or not the Nortel case actually decided 8 1 definitively whether or not a -- computer programs are 2 intangibles fundamentally or whether they are tangible 3 personal property that can be subject to tax. 4 And that issue itself is really -- has a lot of 5 effect on whether or not there's any apportionment 6 between the price paid for a computer program to 7 tangible personal property or whether it's all entirely 8 paid for an intangible. So, that's made it very 9 difficult to move forward in our discussions. 10 But, again, staff's really tried to lay out the 11 relevant authorities. And we have tried to, you know, 12 encourage the interested parties to meet with us to try 13 to see, you know, how we can clarify the authorities 14 that we do have and try to reach, you know, some kind of 15 agreement on what it is that we're trying to tax and how 16 to apply the technology transfer agreement statutes. 17 However, I would say in response, the Preston 18 case didn't involve a regulation, that just involved the 19 application of the technology transfer agreement 20 statute. So, that case didn't involve the invalidation 21 of a Board regulation. 22 We do recognize that one sentence in Regulation 23 1507 was held invalid in Nortel and staff's already 24 recommended and the Board has already amended the 25 regulation to delete that sentence. 26 So, we are earnestly working to try to figure 27 out how to -- how to tax a technology transfer agreement 28 involving a transfer of software on tangible storage 9 1 media, but we just have honest disagreements about how 2 Nortel applies and we still want to continue to discuss 3 it. And we're hoping we can make further progress. 4 And we don't think we started from a bad 5 standpoint in trying to say that we're clarifying the 6 existing authorities. We're really not necessarily 7 here to just, you know, come up with what suits us best 8 and it definitely is not a -- basically, a system of 9 taxation that's been developed by staff. We're really 10 just trying to work with all the relevant authorities, 11 including Supreme Court precedents. 12 MS. YEE: Yeah. Thank you, Mr. Heller. 13 I think what is particularly sensitive about 14 this particular interested parties process is that we 15 have a related case that is still pending litigation 16 fully. 17 And with respect to the Nortel decision and 18 their requirement of Regulation 1507, I mean, to me -- I 19 see a lot of back and forth between industry and the 20 Board for the next several months, you know, just to get 21 a handle on, you know, the kind of evidence that may, 22 you know, assist us in terms of how we value technology 23 transfer agreements. And I know it's sensitive because 24 some of the suggestions for records that we have thought 25 would be helpful in terms of what we can look at to 26 further our understanding of how to value technology 27 transfer agreements are sensitive information. We 28 certainly see that and want to treat that appropriately. 10 1 On the other hand, we also have heard from 2 others in the industry who believe that they have 3 relevant information to share with us that will begin to 4 further our understanding about how to value these 5 agreements. 6 And then I think -- and I think there's is till 7 another issue with respect to input that we're seeking 8 and that is whether a copyright license in software 9 constitutes a technology transfer agreement as well. 10 And that's TTA in the hands of a third party, generally 11 a retailer. 12 So -- but this is really, I think, a lot of 13 back and forth with respect to trying to get information 14 from industry. I know some in the industry have begun 15 to see the need to, you know, really engage in this 16 conversation because it's really looking at the kind of 17 evidence that's going to ultimately assist us in getting 18 a handle around valuation. 19 So, I know we've talked about the timeline 20 being extended and that's to really allow for that 21 dialogue to continue, essentially, yes. 22 Okay, questions or comments, Members? 23 Hearing none, any other thoughts? 24 All right then, thank you. Thank you for the 25 update on the timeline. And we will look forward to 26 further development in the Business Taxes Committee. 27 And with that, the Committee is adjourned. 28 Thank You. 11 1 MS. BUEHLER: Thank you. 2 ---o0o--- 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 12 1 REPORTER'S CERTIFICATE? 2 3 State of California ) 4 ) ss 5 County of Sacramento ) 6 7 I, JULI PRICE JACKSON, Hearing Reporter for the 8 California State Board of Equalization certify that on 9 AUGUST 21, 2012 I recorded verbatim, in shorthand, to 10 the best of my ability, the proceedings in the 11 above-entitled hearing; that I transcribed the shorthand 12 writing into typewriting; and that the preceding pages 1 13 through 12 constitute a complete and accurate 14 transcription of the shorthand writing. 15 16 Dated: September 19, 2012 17 18 19 ____________________________ 20 JULI PRICE JACKSON 21 Hearing Reporter 22 23 24 25 26 27 28 13