United States

Wisconsin: Receipts from Licensing Right to Install and Replicate Software Sourced Using the Income-producing Activity Test

Aug 28, 2017
From KPMG TaxWatch

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The Wisconsin Tax Appeals Commission recently held that, for the 2006-2009 tax years at issue, receipts from licensing the right to install and replicate proprietary software were receipts from licensing an intangible right. The taxpayer at issue, Microsoft, entered into licensing agreements with Original Equipment Manufacturers (OEMs) allowing the OEMs to install the taxpayer’s software on computers  that were subsequently resold to retailers or directly to end-users. Microsoft was paid royalties on a “per system” or “per copy” basis. The assembled computers included end-user license agreement (drafted by Microsoft for consistency) to allow an end-user to use the software. This agreement was between the end-user and the OEMs. Most of Microsoft’s OEMs were located outside of Wisconsin and the receipts from the few Wisconsin-based OEMs were not at issue in the case. On audit, the Department of Revenue took the position that the royalties from the OEMs should be sourced under the statutory provisions addressing gross receipts from the use of computer software. In the Department’s view, royalties related to the use of the software in Wisconsin by Wisconsin-based computer purchasers, should be sourced to the state. Because Microsoft could not know where the OEMs computer sales were made, the Department estimated Wisconsin sales by using a population proxy to try to accurately reflect the use of the software in Wisconsin. Microsoft, on the other hand, argued that the income-producing activity test applied to its receipts.

The Commission noted that the key question before it was whether the statutory provisions for sourcing gross receipts from the use of computer software applied to the receipts at issue. In the Commission’s view, they did not. The parties had already stipulated that the OEMs did not "use" the software, as anyone would understand the "use" of software (i.e., they were not using it to create documents or run spreadsheets). Although the Department argued that it did not matter which party “used” the software, the Commission noted that the royalties at issue were not a function of “use” by actual end-users; the payments were required regardless of whether any purchaser of the customer ever used the software. In sum, Microsoft's OEM customers purchased a bundle of rights which included the ability to copy and sublicense the software. In the Commission’s view, the royalties from the purchase of these intangible rights were properly sourced using the income-producing activity test. The Commission next addressed whether, under the income-producing activity test, the receipts should be sourced to Wisconsin. Although the Department appeared to try to argue that the income-producing activity was the sale of computers in Wisconsin, the Commission rejected this position because Microsoft did not sell the computers in question. The people that purchased the computers were not Microsoft’s customers. Although each computer sold included a sublicense to allow the customer to use the software, the sales activities in Wisconsin were not activities engaged in by Microsoft. Therefore, because all of Microsoft’s activities associated with the OEM transactions occurred outside Wisconsin, none of the royalty receipts from out-of-state OEMs were included in the sales factor numerator for the tax years at issue. For more information on Microsoft Corp. v. Wisconsin Department of Revenue, please contact Brad Wilhelmson at 312-665-2076.


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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.