Comptroller of the Treasury v. Equitable Trust Co.

• Decision Date: 11 August 1983
• Docket Number: No. 147,147
• Citation: 296 Md. 459,464 A.2d 248
• Parties: COMPTROLLER OF THE TREASURY v. EQUITABLE TRUST COMPANY.
• Court: Maryland Court of Appeals

Page 459

296 Md. 459

464 A.2d 248

COMPTROLLER OF THE TREASURY v. EQUITABLE TRUST COMPANY.

No. 147.

Court of Appeals of Maryland.

Aug. 11, 1983.

John K. Barry, Asst. Atty. Gen., Annapolis (Stephen H. Sachs, Atty. Gen., Baltimore, on brief), for appellant.

Paul E. Burke, Jr., Baltimore (McKenney, Thomsen & Burke, Baltimore, on brief), for appellee.

William W. Cahill, Jr., Robert W. Baker, Jr., Desmond D. Connall, Jr. and Weinberg & Green, Baltimore, on brief, amicus curiae brief of Data Processing Management Association.

Argued before MURPHY, C.J., and SMITH, ELDRIDGE, COLE, DAVIDSON, RODOWSKY and COUCH, JJ.

RODOWSKY, Judge.

This is a sales tax case. It involves computer programs in the business data processing field. At issue is how the computer program license transactions presented here are to be conceptualized under the statute which reaches sales of "any tangible personal property." Md.Code (1957, 1980 Repl.Vol.), Art. 81, § 324(f). Did the taxpayer, a computer user, acquire from the proprietors of canned, transactional computer programs

1. intangible personal property, namely, the right to use the programs, with copies of the programs transferred by the medium of magnetic tapes; or 2. intangible personal property, namely, "knowledge" or "information," which was transferred to the taxpayer by the temporary medium of magnetic tape; or

3. tangible personal property, namely, magnetic tapes which had been enhanced in value by the copies of the programs coded thereon?

Alternatives 1 and 2 result in no tax. An amicus, Data Processing Management Association, has raised the first alternative. The taxpayer, Equitable Trust Company (Equitable), emphasizes the second analysis. The Comptroller urges the third position, which we adopt.

As of September 16, 1974, Equitable entered into a written contract, delineated "License Agreement," with Auxton Computer Enterprises, Incorporated (AUXCO). AUXCO granted Equitable a nontransferable and nonexclusive right to use a program, the "AUXCO Project Management System," at a one-time price of $20,000. There was no termination date. Equitable covenanted not to publish or disclose to any third person any information concerning the program and not to copy the program tapes or documentation except for internal use. Paragraph 10 of the agreement in part provided that "[l]egal title to the System shall remain with AUXCO, and [Equitable] agrees that AUXCO may repossess the System" upon breach by Equitable of its obligations. This program was acquired for use by Equitable's systems and programming people in tracking project performance.

By a "License Agreement" of December 13, 1974 with PACE Applied Technology, Inc. (PACE), Equitable acquired the right to use two PACE programs in perpetuity. One was the "KOMAND Data Acquisition System" for the price of $10,800. The other was the "KOMAND Resource Billing System" for a price of $4,365. The agreement placed restrictions on Equitable's disclosing PACE's proprietary information. The PACE programs were described in testimony as an accounting system which would allow Equitable to know exactly how much its computer and peripheral equipment were used for running specific applications, such as the main deposit program or the time deposit program.

During an audit in 1975, the Comptroller assessed sales tax against Equitable based upon the prices paid pursuant to the foregoing agreements. That assessment was affirmed by a hearing officer in the Sales Tax Division whose decision was affirmed by the Maryland Tax Court. On appeal to the Baltimore City Court (now the Circuit Court for Baltimore City), the assessment was abated. That court concluded as a matter of law that the dominant purpose or essence of the transactions was the programs and that computer programs are intangible. The Comptroller appealed to the Court of Special Appeals. ¹ We issued the writ of certiorari on our own motion prior to consideration of the matter by the intermediate appellate court.

Before the legal contentions can be considered, some fundamentals should be stated. A computer is a machine. It does not think. It is designed to execute predetermined instructions. Ultimately a "program" is a set of such instructions. An "applicational program," as we shall use the term, is a set of instructions that will cause the machine to perform a specific task. An example from the banking field would be a program which listed certain information with respect to each installment loan account for which any payment was delinquent. Unless otherwise specified, "program" as used in this opinion will mean an applicational program. ²

Development of a program requires knowledge, time and effort. A program may be said to exist in different levels of language and in different physical forms. Theoretically, a program could exist in the mind of the programmer, but, as a practical matter, programs as obviously complex as those involved here must be recorded somewhere in some physical representation. In human readable form on paper, this representation might be in a procedure oriented language, e.g., COBOL or FORTRAN, in a symbolic language, or in machine language. "Machine language ... is a series of numbers, letters of the alphabet, or special characters that are used to represent bit [ (binary digit) ] patterns which can be recognized by the computer and cause specific operations to take place." W. Fuori, Introduction to the Computer, at 270 (2d ed. 1977). Symbolic language is "very closely related to machine language in that, in general, one symbolic instruction will translate into one-machine language instruction." Id. at 273. The representations might also be in machine readable form as a code on tape, disc or punched cards. The code might directly represent procedure oriented language or symbolic language which may be converted into machine instructions by operational programs called compliers or assemblers. The machine readable representation might also be in machine instructions, the binary code which the machine executes. See generally Gemignani, Product Liability and Software, 8 Rutgers J. Computers, Tech. & L. 173, 181-183 n. 27 (1981).

The programs involved here are stipulated to be existing, prepackaged programs of general application, called "canned" programs. The stipulation further states:

The programs assessed were not developed exclusively for use by Equitable but were developed to be sold to many different purchasers. None of the assessment for computer software relates to programs specially designed and developed exclusively for Equitable [, i.e., a custom program].

The advantage to a computer user of a canned program is that the user need not start from the beginning in developing the particular program. Reinventing the wheel is avoided. However, because the developer or proprietor is marketing a program for use by many different organizations of the same general type, and possibly for use on machines of various manufacture, there will ordinarily be a need for a particular user to make some adaptations in a canned program to meet the specifics of that user's situation. Equitable made some adaptations, but they are not described in evidence.

Each program received by Equitable was delivered to it on magnetic tape. This means that the proprietor of the program made a copy of it, directly or indirectly, from a master which was in some physical form. The physical form of the program copies, as delivered, was a coded series of magnetic impulses. Each code was readable by Equitable's computer and seems to have been in machine instructions. ³ Equitable loaded the program copy tape into computer memory and started the process of adaptation. At that point, Equitable had no further need for the particular copy delivered from the standpoint of instructing its computer. That copy, however, was retained by Equitable. ⁴

In order for a program to instruct computer execution, the magnetic tape copy of the program is loaded into memory. "In loading a program, nothing is taken from the storage media and nothing is added to the memory; rather, the user's computer reads the storage media and rearranges its memory to create a corresponding pattern of magnetic impulses." Note, Software and Sales Taxes: The Illusory Intangible, 63 B.U.L.Rev. 181, 189 (1983) (the B.U. Note) (Emphasis in original. Footnote omitted.). See also Note, Software Taxation: A Critical Reevaluation of the Notion of Intangibility, 1980 B.Y.U.L.Rev. 859, 871-72. The process of making changes to a program also takes place while the program is in memory. Equitable did not store the reproductions of the subject programs, or any adaptations thereof, in memory when they were not in use. They were stored peripherally. On any day when adaptations were made to a program, Equitable represents that it produced at least two tapes of the program, as changed. One was for storage on the computer premises, and the other was for storage off premises.

The Comptroller's position is that Equitable acquired tapes containing program copies. Magnetic tapes are tangible personal property. Acquisition of such tapes under the license agreements is a sale, because Art. 81, § 324(d) provides that "sale" means "any transaction whereby title or possession, or both, of tangible personal property is or is to be transferred by any means whatsoever for a consideration including rental, lease, or license to use ...."

Amicus says that the transaction is a license to use the program, and that such a license is a form of intangible property. Equitable contends that the predominant purpose or essence of the transaction governs classification of the sale as involving either tangible or intangible property. In the transfer of computer programs via magnetic tape, the purpose is to obtain the program, an intangible, and not the tangible tape. In taking this position, Equitable is supported by the overwhelming numerical majority of reported...