Norwest Corp. & Subsidiaries v. Comm'r of Internal Revenue
| Decision Date | 30 April 1997 |
| Docket Number | No. 13908–92.,13908–92. |
| Citation | 108 T.C. 358,65 USLW 2776,108 T.C. No. 18 |
| Parties | NORWEST CORPORATION AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Mark Hager, Robert J. Jones, and Susan K. Matlow, for petitioner.
Robert M. Ratchford and Robert M. Fowler, for respondent.
Respondent determined the following deficiencies in petitioner's Federal income taxes:
+-----------------+
¦Year¦Deficiency ¦
+----+------------¦
¦1983¦$ 2,605,571 ¦
+----+------------¦
¦1984¦2,442,134 ¦
+----+------------¦
¦1985¦29,187 ¦
+----+------------¦
¦1986¦19,301,530 ¦
+-----------------+
Respondent also determined that the provision for increased interest under section 6621(c) applied for 1983, 1984, and 1986. Unless otherwise noted, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
After concessions by the parties and the continuation of other issues, the sole issue for decision is whether certain computer software expenditures made by petitioner during the years in issue qualify for the investment tax credit. Resolution of that issue depends on the characterization of the acquired software as either tangible or intangible property, as only investments in tangible property are eligible for the investment tax credit. We conclude that the acquired software is tangible personal property eligible for the investment tax credit.
Petitioner is a group of affiliated corporations (the Norwest affiliated group) that provides banking and other financial services. Petitioner files consolidated Federal income tax returns. At the time the petition was filed, petitioner's principal place of business was located in Minneapolis, Minnesota.
Petitioner extensively uses computers in processing data and in providing essential accounting and other business functions. During the years in issue, petitioner utilized three types of computer systems: (1) large-scale “mainframe” computers, which were used to process large amounts of data and transactions at a central location, (2) minicomputers, which were typically used to process self-contained single business applications, such as processing transactions from automated teller machines (ATMs) or controlling the work stations that tellers use to process transactions in a bank, and (3) personal computers (PCs), which were generally smaller stand-alone devices used for word-processing and spread-sheet applications.
Each of the above-described computer systems requires operating software (also called systems software) and applications software to enable the computer to function and perform specific tasks. Operating software is used to manage the operations of a computer; it schedules and controls jobs, keeps track of the placement and storage of information, manages traffic, and generally enables a computer to process a particular application. Applications software provides specific business functions like accounting, transaction processing, calculating interest, and producing customer statements. Petitioner purchased both operating and applications software during the years in issue.
Software enables a computer to function and perform specific tasks by providing instructions, or commands, to the computer system. The instructions are written in a programming language, or source code, understandable to humans, such as COBOL (Common Business Oriented Language) or FORTRAN (Formula and Translation code). The source code is written, line by line, by programmers in accordance with the overall design of the computer program and the specific tasks a computer is to perform.2 A completed computer program may contain hundreds of thousands of lines of source code and is eligible for copyright protection.
A compiler is used to convert source code into a machine-readable computer language, known as executable, or object, code. Executable code is composed of sequences of binary digits (zeros and ones). Each digit is called a “bit”, and eight-bit sequences are called “bytes”.3 A computer program can be written onto a magnetic disk or tape by encoding its particular executable code on the surface of the disk or tape.4 That magnetic recording allows the computer processor to read the executable code and to perform the specific tasks directed by the code.
Generally, the cost of a blank tape, similar to one upon which the computer programs acquired by petitioner were placed, was less than $25 during the years in issue. An encoded computer program can easily be transferred or copied onto additional blank tapes and disks, resulting in identical reproductions of the program. A computer program can also reside on media other than magnetic tapes and disks, such as punch cards and CD–ROMs (compact disk read-only memory).5 Moreover, computer programs can be received preinstalled on a computer's hard disk drive (internal storage device) and can be transferred from one computer to another via electronic transmission over telephone lines without the use of intervening tapes and disks. Although telephonic transmission was technologically possible during the years in issue, it was slow and unreliable and, therefore, was not a feasible method of transferring a large computer program. All of the software in issue was delivered to petitioner as computer programs encoded on magnetic tapes and disks. The software was purchased separately from computer hardware.
All of the software expenditures in issue were for software developed by third parties and sold to members of the Norwest affiliated group for use in their banking and financial services operations. The software was either of a type available to the general public or a specialized type of software used by financial institutions like petitioner. The software was sold subject to license agreements that entitled petitioner to use the software on a nonexclusive, nontransferable basis for an indefinite or perpetual term. Petitioner did not purchase any exclusive copyright rights or other intellectual property rights underlying any of the software in issue; petitioner did not purchase the right to reproduce such software outside the Norwest affiliated group.
All mainframe software purchased by petitioner during the years in issue consisted of computer programs encoded on magnetic tape (for large applications, on several reels of tape) and was either shipped or personally delivered by a service representative to petitioner's mainframe site. Each computer program was loaded (copied from the magnetic tape) onto the mainframe computer's own storage medium, known as a “disk pack”. The computer program would then be tested and modified, as necessary, over a period of several weeks or months. Modifications were made, for example, to change the layout of a screen, to add or revise reports, or to conform the title of a field to normal usage in petitioner's business operations.6 After the computer program was installed, petitioner retained the original tape or an exact copy in case a problem occurred that required the program to be reloaded onto the mainframe computer.7 Typically, one copy was kept on site for immediate access, and a second copy was kept off site as a second backup to the on-site copy in the event of a disaster.8
Petitioner typically entered into a maintenance and support agreement with the vendor (usually for an additional periodic fee) in conjunction with the purchase of mainframe or minicomputer software whereby the vendor agreed to correct errors in the computer program and to provide updated versions of the software as they became available. If a copy of software had been lost or destroyed (and a backup had not been made), a replacement copy would have been provided to petitioner by the vendor without charge.
Petitioner was entitled to only one running version of each copy of software purchased. Thus, if petitioner desired to load a copy of software onto a second computer (which it did), additional copies had to be purchased (sometimes at reduced rates) or a multiple-machine license was required.
OPINIONI. IntroductionA. Issue
Petitioner purchased during the years in issue operating and applications software for use in its banking and financial services businesses. The software was acquired subject to license agreements that entitled petitioner to use the software on a nonexclusive, nontransferable basis for an indefinite or perpetual term. Petitioner did not purchase any exclusive copyright rights or other intellectual property rights underlying any of the software in issue and was not permitted to reproduce the software outside the Norwest affiliated group. The sole issue for decision is whether petitioner's software expenditures qualify for the investment tax credit (ITC). Resolution of that issue depends on the characterization of the acquired software as either tangible or intangible property. We conclude that the acquired software is tangible personal property eligible for the investment tax credit.
B. Arguments of the Parties
Petitioner contends that the computer software it purchased during the years in issue constitutes tangible personal property eligible for the investment tax credit under section 38. Petitioner's position stems from its interpretation of the “intrinsic value” test first enunciated by the Court of Appeals for the Fifth Circuit (the Fifth Circuit) in Texas Instruments, Inc. v. United States, 551 F.2d 599 (5th Cir.1977). We adopted the intrinsic value test in Ronnen v. Commissioner, 90 T.C. 74, 1988 WL 2748 (1988), and held that the computer software in issue in that case was intangible property for purposes of the ITC. Petitioner argues that Ronnen and its progeny are distinguishable from the present case and finds support for its position that computer software is tangible personal...
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