Lucent Techs., Inc. v. State Bd. of Equal.

• Decision Date: 08 October 2015
• Docket Number: B257808
• Citation: 193 Cal.Rptr.3d 323,241 Cal.App.4th 19
• Court: California Court of Appeals Court of Appeals
• Parties: LUCENT TECHNOLOGIES, INC., et al., Plaintiffs, Cross-defendants, and Respondents, v. STATE BOARD OF EQUALIZATION, Defendant, Cross-complainant, and Appellant.

241 Cal.App.4th 19

193 Cal.Rptr.3d 323

LUCENT TECHNOLOGIES, INC., et al., Plaintiffs, Cross-defendants, and Respondents,

v.STATE BOARD OF EQUALIZATION, Defendant, Cross-complainant, and Appellant.

B257808

Court of Appeal, Second District, Division 2, California.

Filed October 8, 2015

As Modified on Denial of Rehearing November 3, 2015

Rehearing Denied November 3, 2015

Review Denied January 20, 2016

Paul Hastings, Jeffrey G. Varga, Julian B. Decyk, Los Angeles, Paul W. Cane, Jr., San Francisco, Amy L. Lawrence, Los Angeles, for Plaintiffs, Cross-defendants, and Respondents.

Kamala D. Harris, Attorney General, Paul D. Gifford, Senior Assistant Attorney General, Diane S. Shaw, Stephen Lew, Supervising Deputy Attorneys General, and Ronald N. Ito, Deputy Attorney General, for Defendant, Cross-complainant, and Appellant.

OPINION

HOFFSTADT, J.

A manufacturer sells sophisticated telecommunications equipment to nine different telephone companies, who in turn use that equipment to provide telephone and Internet services to their customers. In the transactions between the manufacturer and telephone companies, the companies paid for (1) the equipment, (2) written instructions on how to use the equipment, (3) a copy of the computer software that makes the equipment work, and (4) the right to copy that software onto the equipment's hard drive and thereafter to use the software to operate the equipment. In Nortel Networks Inc. v. State Board of Equalization (2011) 191 Cal.App.4th 1259, 119 Cal.Rptr.3d 905 ( Nortel ), we held that an almost identical transaction satisfied the requirements of California's technology transfer agreement statutes ( Rev. & Tax. Code, §§ 6011, subd. (c)(10) & 6012, subd. (c)(10) )¹ and, as such, the manufacturer was responsible for paying sales taxes only on the tangible portions of the transaction (the equipment and instructions), but not the intangible portions (the software and rights to copy and use it). Notwithstanding Nortel, the Board of Equalization (Board) in this case persisted in assessing a sales tax of nearly $25 million on the intangible portions of nearly identical transactions. The manufacturer paid the taxes, and filed this action seeking a refund.

The Board's assessment of the sales tax was erroneous. In so concluding, we hold that (1) the manufacturer's decision to give the telephone companies copies of the software on magnetic tapes and compact discs (rather than over the Internet) does not turn the software itself or the rights to use it into "tangible personal property" subject to the sales tax, (2) a "technology transfer agreement" within the meaning of sections 6011, subdivision (c)(10)(D) and 6012, subdivision (c)(10)(D), which exempts from the sales tax the intangible portions of a transaction involving both tangible and intangible property, can exist when the only intangible right transferred is the right to copy software onto tangible equipment, and (3) a technology transfer agreement can exist as long as the grantee of copyright or patent rights under the agreement thereafter copies or incorporates a copy of the copyrighted work into its product or uses the patented process, and any of these acts is enough to render the resulting product or process "subject to" the copyright or patent interest.

Moreover, because the Board's trenchant opposition to the manufacturer's refund action in this case was all but foreclosed by Nortel and other binding decisional and statutory law, the Board's position was not "substantially justified" and the trial court did not abuse its discretion in awarding the manufacturer its "reasonable litigation costs."

We accordingly affirm.

FACTS AND PROCEDURAL BACKGROUND

I. Telephone Networks Generally

The telephone and data network in the United States is both terrestrial (land-based) and wireless, and is seamlessly interconnected through equipment called switches that are housed in so-called central offices scattered around the country. A single switch is comprised of "numerous computer processors, frames (sometimes called cabinets), shelves, drawers, circuit packs, cables, trunks and many other pieces of hardware." A switch serves two functions: (1) it routes incoming and outgoing calls or data streams toward their ultimate destination on the nation's network; and (2) it operates a panoply of features, ranging from call waiting, three-way calling and call forwarding to "caller ID" and voicemail. Because each switch is located in a unique place along the network, and because each can offer a different mix of features, "no two switches [are] alike."

Switches perform sophisticated and complex functions, and every switch is run by a computer. Each switch's computer runs two types of software: (1) software designed specifically for that switch (unimaginatively called "switch-specific software"); and (2) more generic software designed for use on any switch because it runs diagnostic tests and manages the availability of lines and trunks used to route calls and data between switches. Switch-specific software is drawn from a master, "basic code"; the switch-specific software for any given switch uses only those portions of the "basic code" necessary for the switch to know where it is on the network and to offer the features that its new owner has requested. (See Nortel, supra, 191 Cal.App.4th at pp. 1266–1267, 119 Cal.Rptr.3d 905.)

II. Underlying Transactions

Prior to 1996, AT&T Corporation (AT&T) manufactured switches. On February 1, 1996, AT&T spun off its network services division, which was responsible for manufacturing switches, into a separate company called Lucent Technologies, Inc. (Lucent). AT&T and Lucent (collectively, AT&T/Lucent) designed the software (both switch-specific and generic) that runs the switches they sell. That software is copyrighted because it is an original work of authorship that has been fixed onto tapes; the software also embodies, implements, and enables at least one of 18 different patents held by AT&T/Lucent.

Between January 1, 1995 and September 30, 2000, AT&T/Lucent entered into contracts with nine different telephone companies ² to (1) sell them one or more switches, (2) provide the instructions on how to install and run those switches, (3) develop and produce a copy of the software necessary to operate those switches, and (4) grant the companies the right to copy the software onto their switch's hard drive and thereafter to use the software (which necessarily results in the software being copied into the switch's operating memory). AT&T/Lucent gave the telephone companies the software by sending them magnetic tapes or compact discs containing the software. AT&T/Lucent's placement of the software onto the tapes or discs, like the addition of any data to such physical media, physically altered those media. The telephone companies paid AT&T/Lucent $303,264,716.51 for a copy of the software and for the licenses to copy and use that software on their switches.³

III. Tax Assessment

The Board assessed the sales tax on the full amount of the licensing fees paid under the contracts between AT&T/Lucent and its telephone company customers. At the then-current sales tax rate of 8.5 percent, this came to a sales tax liability of $25,777,500.90. As required by the state Constitution ( Cal. Const., art. XIII, § 32 ), AT&T/Lucent paid the sales tax and then sought a refund from the Board. The Board denied its application.

IV. Litigation

AT&T/Lucent sued the Board for a refund of the sales tax attributable to the software and licenses to copy and use that software. AT&T/Lucent filed two lawsuits—one covering the taxes paid between January 1, 1995 and January 31, 1996, before Lucent broke away from AT&T (Lucent I ), and a second covering the period between February 1, 1996, and September 30, 2000 (Lucent II ).⁴ In response to each complaint, the Board filed a cross-complaint seeking unpaid interest on the sales tax already paid—namely, $6,319,583.44 in the Lucent I cross-complaint and $12,321,890.58 in the Lucent II cross-complaint.

The parties filed cross-motions for summary judgment on AT&T/Lucent's tax refund claims, and the trial court issued a 15-page ruling granting AT&T/Lucent's motions. The court concluded that the contracts between AT&T/Lucent and the telephone companies were technology transfer agreements within the meaning of sections 6011, subdivision (c)(10) and 6012, subdivision (c)(10), such that AT&T/Lucent was obligated to pay sales taxes on the tangible portion of the sale (that is, for the switches, the instructions, and the 3,954 blank tapes and/or compact discs used to transmit the software), but not required to pay sales taxes on the intangible portion (that is, for the software and licenses). As a result, the court ordered the Board to refund the sales taxes paid on the software and licensing fees. With other adjustments, the court ordered a refund of $24,502,381.43. The parties subsequently stipulated that AT&T/Lucent owed $1,938,574 in unpaid interest out of the $6.3 million sought in the Board's Lucent I cross-complaint, but none of the $12.3 million in unpaid interest sought in the Lucent II cross-complaint.

AT&T/Lucent sought its court costs, and under section 7156, its "reasonable litigation costs," including attorney's fees. (Id., subd. (b)(1) .) The court awarded costs of $7,052.36, and after finding the Board's position in the litigation was not "substantially justified," awarded $2,625,469.87 in "reasonable litigation costs."

The court entered judgment, and the Board timely appeals.

DISCUSSION

I. Background Law on California's Sales Tax

The State of California imposes a sales tax upon sellers "[f]or the privilege of selling tangible personal property." (§ 6051; see Navistar Internat. Transportation Corp. v. State Board of Equalization (1994) 8 Cal.4th 868, 872, 35 Cal.Rptr.2d 651, 884 P.2d 108 ( Navistar ); see also Loeffler v. Target Corp. (2014) 58 Cal.4th 1081, 1104, 171 Cal.Rptr.3d 189, 324 P.3d 50 ( Loeffler ) ["...