Multistate Tax Alert: CA Court of Appeal Decided in Favor of Microsoft
Cost of performance sourcing for royalties for licensing right to replicate & install
On December 18, 2012, the California Court of Appeal for the First Appellate District (“Court of Appeal”) issued its decision in Microsoft Corp. v. Franchise Tax Board (“Microsoft”) reversing a lower court decision in favor of the Franchise Tax Board (“FTB”). In this case, Microsoft challenged the FTB’s sales factor treatment of royalties paid by original equipment manufacturers (“OEMs”) for licensing the right to replicate and install Microsoft’s software programs. The Court of Appeal concluded that, for Microsoft’s tax years ended June 30, 1995 and June 30, 1996, OEM royalties should be treated as sales other than sales of tangible personal property, and sourced to the State of Washington under California’s cost of performance rules. This decision provides guidance for taxpayers concerned with the proper sales factor treatment of receipts from licensing the right to replicate and install software.