BILL ANALYSIS �
AB 832
Page 1
Date of Hearing: May 9, 2011
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Henry T. Perea, Chair
AB 832 (Ammiano) - As Amended: March 31, 2011
Majority vote.
SUBJECT : Property tax: computer programs: storage media.
SUMMARY : Codifies a portion of the State Board of
Equalization's (BOE) regulations relating to property taxation
of "embedded" computer programs and imposes a higher evidentiary
standard on taxpayers seeking to prove that the "single price"
paid for the computer or equipment included charges for
nontaxable software programs or services. Specifically, this
bill :
1)Codifies subdivisions (d) and (e) of Property Tax Rule 152,
"Computer Programs Storage Media," issued by the BOE.
Specifically, it provides that:
a) The term "basic operational program" refers to a
"control program," as defined in Revenue and Taxation Code
(R&TC) Section 995.2, that is included in the sale or lease
price of the computer equipment.
b) States that a computer program is considered to be
included in the sale or lease price of the computer
equipment if either of the following is met:
i) The equipment and the program are sold or leased at
a single price.
ii) The purchase or lease documents set forth separate
prices for the equipment and the program, but the program
may not be accepted or rejected at the option of the
customer.
c) In valuing computer equipment that is sold or leased at
a single price not segregated between taxable property and
nontaxable programs, as defined in R&TC Section 995.2, the
county assessor, lacking evidence to the contrary, may
regard the total amount charged as indicative of the value
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of taxable tangible personal property.
2)Requires a person claiming that a "single price" sale or lease
includes charges for nontaxable programs and services to prove
by clear and convincing evidence, instead of the preponderance
of evidence, both of the following:
a) The existence of nontaxable programs and services.
b) The sales price, costs, or other information regarding
the nontaxable programs and services that will assist the
county assessor in making an informed judgment about the
proper value to be ascribed to taxable and nontaxable
components.
EXISTING LAW :
1)Provides that all property is taxable unless explicitly
exempted by the California Constitution or federal law and
limits the maximum amount of any ad valorem tax on real
property at 1% of full cash value.
2)Authorizes the Legislature to classify personal property for
differential taxation or exemption by a statute approved by a
2/3 vote of the membership of each house of the Legislature.
However, the tax rate is limited to the 1% rate otherwise
applicable to real property.
3)Provides that personal property used in a trade or business is
generally taxable and is valued each lien date at current fair
market value. Generally, the valuation of personal property
is based on the acquisition cost of the property, which is
used to estimate the reproduction cost new and the depreciated
reproduction cost of the property. The reproduction cost new
less depreciation value becomes the table value of the
property for the fiscal year.
4)Specifies that production computers - computer-operated
machinery and equipment or computers embedded in machinery -
are valued as other types of machinery and equipment specific
to an industry.
5)Provides that, generally, computer programs, i.e. software,
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are not taxable for purposes of property taxation. (R&TC
Section 995). However, storage media for computer programs
must be valued for property tax purposes as if there were no
computer programs on the media except basic operational or
"control" programs. Defines "basic operational programs" as
those programs that are fundamental and necessary to the
functioning of a computer. (R&TC Section 995.2). The
assessable value of storage media containing basic operational
programs includes the value of the storage media and the value
of the program embedded on it.
6)Exempts from property taxation application or processing
computer software, which is distinct from software that is
considered to be a basic operational program. (R&TC Section
995.2).
7)Provides that, in valuing computer equipment that is sold or
leased at a single price not segregated between taxable
property, i.e. equipment and basic operational programs, and
nontaxable programs, i.e. application computer software
programs, the assessor, lacking evidence to the contrary, may
regard the total amount charged as indicative of the taxable
tangible property. �Property Tax Rule 152(e)].
8)Requires taxpayers claiming that a single-price sale includes
charges for nontaxable programs and services to provide
information to the assessor to identify the nontaxable
property and services, and to supply sale prices, costs or
other information to enable the assessor to make an informed
judgment about the proper value to be ascribed to taxable and
nontaxable components of the sale. �Property Tax Rule
152(f)].
FISCAL EFFECT : The BOE staff estimates that this bill will have
no direct impact on General Fund revenue.
COMMENTS :
1)Author's Statement . The author states that, "Current law
requires the valuation and taxation of basic operational
software, but excludes the taxation of application software.
The administration and application of current law is
increasingly difficult for both the assessor and taxpayer
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because this law enacted in 1973 has not been updated to
consider the evolution of technology. Additionally, the Court
of Appeals decision in Cardinal Health v. County of Orange
overturned established local assessment practices and created
the potential for the majority of the value attributed to
modern equipment and machinery to be excluded from property
taxation. Unfortunately, the Cardinal Health case has
encouraged the business community to appeal all business
personal property containing software. While some appeals are
legitimate, the fair and equitable practices of assessing
business personal property should not be exploited by attempts
to expand a very limited exclusion in current law.
"AB 832 would provide uniformity and substantive direction to
assessors, assessment appeal boards, and taxpayers. This bill
is necessary to protect current revenue in California, not
generate new revenue. In 2010 California's property taxes
generated nearly $50 billion. K-12 education receives
approximately 52% of each property tax dollar generated.
Personal property tax accounted for approximately $3 billion
of that tax revenue. Based on recently received personal
property tax appeals, and the lack of definite direction, the
potential loss of revenue to California's local governments,
special districts and k-12 education could approximate $1.35
billion. California must have clarity in the assessment of
property to protect the taxpayer and the recipients of
property tax revenue.
"AB 832 establishes a clear and convincing standard so that
businesses have an exclusion when substantiated and are not
avoiding paying their fair share of taxes without
substantiating claims. This bill would provide uniformity and
substantive direction to assessors, assessment appeal boards,
and taxpayers."
2)Arguments in Support . The proponents of this bill state that
AB 832 "is a modest solution to assist assessors in accurately
valuing complex computer equipment." They argue that this
bill is needed to update existing law "to reflect the current
methodology for the assessment of software technology that did
not exist 37 years ago" and to provide "clarity to the
property tax code in response to a controversial and illogical
court decision" in Cardinal Health v. Orange County. The
proponents assert that the Legislature never intended "to
exempt from assessment a significant portion of the value of
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expensive, high technology machinery and equipment" because
most equipment, without the basic operational software, would
be totally useless and non-functioning. They state that AB
832 "makes clear that if a company claims an exemption �for
nontaxable portion of the computer equipment] they must
provide �by] a clear and convincing �evidence] independent
data to validate their claims." Finally, the proponents
caution that failure to enact this bill "will result in a
significant reduction in the assessed value of business
personal property and property tax revenues."
3)Arguments in Opposition . The opponents state that this bill
"would make it nearly impossible for taxpayers to establish
the existence of tax-exempt embedded software for personal
property tax purposes" because it will require taxpayers to
prove the existence and value of the embedded software by
"clear and convincing evidence," instead of the "preponderance
of the evidence," which is a general evidentiary standard
applicable in all property tax cases, except in very limited
circumstances. The opponents also believe that this bill is
unnecessary since BOE has already promulgated regulations "to
provide guidance to assessors and taxpayers with respect to
valuation of embedded software." They assert that the
"language of AB 832 is ambiguous," since it is not clear
whether the new "clear and convincing" standard "would apply
only in prescribing what must be shown to the assessor" or
would also apply in an appeals hearing. Finally, the
opponents state that this bill will "significantly increase
taxes on businesses throughout the state, placing yet another
burden on California's already struggling business community."
4)Computer Programs and Property Tax: Background . Prior to
1969, computer software was traditionally viewed as an
integral part of the computer hardware unit. However, since
IBM announced a separate pricing policy in 1969, there has
been much confusion surrounding the taxation of computer
software at the federal, state, and local levels. (Property
Taxation of Computer Software, J. Fairchild, 82 A.L.R. 3d
606). The courts are still struggling over the proper
classification of computer programs and services, seeking
analogies in other areas of law concerning intellectual
property.
Initially, computer hardware was viewed as taxable personal
property while computer software was viewed as intangible
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personal property exempt from property taxation. However, in
the early 1970s, the Orange County Assessor included the value
of the computers' programs when valuing computers for property
tax purposes. �Hahn v. International Business Machines
Corporation (1999) 73 Cal.App.4th 985, 989]. In 1972, the
California Legislature quickly responded by enacting law that
stated that computer programs are not taxable but a computer's
storage media for computer programs shall be valued as if
"there were no computer program on such media except basic
operational programs." (R&TC Section 995). The phrase
"except basic operational programs" was added only after the
Governor had returned the original bill to the Legislature, at
the urging of the County Supervisors Association of
California. �Hahn, 73 Cal.App.4th at p. 993, citing Assembly
Final History, A.B. No. 438 (1972 Regular Session); Letter
from County Supervisors Association to the Governor, May 10,
1972]. As explained by the court in Hahn, the intent of the
amendment was to clarify that "the Assessors could include in
the value of the computer hardware the basic computer programs
that were "bundled" in the price of the computer, thereby
preserving the existing tax base." (Ibid.)
That same year, the BOE adopted regulations, i.e. Property Tax
Rule 152, "to define and demonstrate by way of examples the
distinctions between taxable 'basic operational programs' and
other, nontaxable computer programs within the meaning of
Section 995." (Id. at p.990). In 1973, the Legislature
defined the term "basic operational program" as "fundamental
and necessary to the functioning of a computer." (R&TC
Section 995.2.). A basic operational program means a control
program that is included in the sale or lease price of the
computer equipment. The assessable value of the storage media
containing basic operational programs includes the value of
the storage media and the value of the program embedded on it.
As an example, the basic operational programs in personal
computers and mainframe computers are the basic input output
system (BIOS) and licensed internal code (LIC or microcode).
A year later, in 1974, Property Tax Rule 152 was amended, but
then remained unchanged until 1996, when BOE clarified that a
"basic operational program" is not subject to property tax
unless it is included in the sale or lease price of the
computer equipment, i.e. "bundled" or "embedded" in the
equipment. In other words, unbundled or non-embedded computer
programs may not be assessed as taxable property even if those
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programs qualify as "basic operational programs."
Until 2008, the assessors routinely assessed the computer
software that was embedded in the equipment and deemed
essential to the equipment's intended commercial operation.
The rationale for this assessment methodology was based on
Rule 152(e), which provides that, when the assessor values
computer equipment that is sold or leased at a single price
not segregated between taxable property and nontaxable
programs (i.e. when it is 'bundled' or 'embedded'), the
assessor may regard the total amount charged as indicative of
the value of the taxable property. In September of 2008,
however, the Court of Appeal in Cardinal Health 301, Inc. v.
County of Orange (2008) 167 Cal.App.4th 219, overturned the
established local assessment practices. In that case, the
court reiterated that "application" software, as distinct from
a basic operational program, is not valued for purposes of
property taxation and held that bundling by itself is not
dispositive of whether "application" software included in a
bundled programming package is taxable as "basic operational
programming" under R&TC Sections 995 and 995.2. Rather, it
stated that, when application software is bundled into the
sale or lease price of computer equipment, the burden is on
the taxpayer to segregate out the value of nontaxable
application software from the otherwise taxable value of the
computer. Thus, the court refused to adopt the assessors'
position that the fact of "embedding" or "bundling" of the
software in the equipment was dispositive in making the
otherwise nontaxable software taxable.
5)Is There a Problem ? In the last 40 years, software programs
have advanced in complexity and numbers to the extent that
they pervade virtually all aspects of our lives. As most
modern machinery and equipment are sold primarily with bundled
software, determining the extent to which the bundled software
is "application" and not "basic operation" is difficult, if
not impossible in some cases. The proponents of this bill
give an example of the airplane's embedded software necessary
to the aircraft's operation. If the value of that software is
excluded from assessment, for all practical purposes, the
value of the aircraft would be little more than that of metal
fuselage.
Until the Cardinal Health decision, there was significant
clarity and mutual agreement between assessors and industry
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regarding the methodology for valuing complex equipment and
machinery. Once the assessors' methodology for valuing
"embedded" software was declared invalid by the court in
Cardinal Health, a significant number of applications were
filed with the assessment appeals boards in various counties
challenging the valuation of software embedded in the
property. According to the assessors, the evidence provided
in some of those appeals has been a simple three- or four-page
spreadsheet prepared by the assessee or its agent, with no
supporting invoices or valid documentation, and in one
instance, the data provided appears to have been fabricated.
By necessity, it seems that a determination of whether the
embedded software is non-taxable must be based on the
information provided to the assessor by the taxpayer, since
there is no market data for the assessor to value many types
of computer equipment. Thus, unless the taxpayer submits
sufficient information for a proper valuation, an assessor is
not in the position to make that determination. Even then,
assessors have no uniform standard to determine what
constitutes "sufficient" information; what may be "sufficient"
to overcome the presumption of correctness in one county may
not be sufficient in another.
In sum, as the assessors face the increased workload of
administrative appeals, they have very little guidance as to
the type and amount of information that the assessee is
required to submit to overcome the presumption of correctness
otherwise afforded to the assessor's valuation. Property Tax
Rule 152(f) simply requires a person "claiming that a
single-price sale or lease includes charges for nontaxable
programs and services" to identify "the nontaxable property
and services" and to supply sales prices, costs, or other
information. The Legislature has not provided any direction
since 1972, when R&TC Sections 995 and 995.2 were enacted.
And the court in Cardinal Health did not address the issue of
whether the information provided to the assessor by Cardinal
Health, Inc. to value the embedded software in question was
valid or sufficient.
6)The Proposed Solution . AB 832 proposes to address the problem
by requiring a person claiming that a single-price sale or
lease includes charges for nontaxable programs and services to
prove, by clear and convincing evidence, the existence of
those programs and services, as well as the sales price,
costs, and other information in order to assist the county
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assessor in making an informed judgment regarding the proper
value of the nontaxable property. This bill is intended to
provide uniformity and substantive direction to assessors,
assessment appeals boards and taxpayers and to discourage
frivolous appeals.
7)The Burden of Proof in Property Tax Assessments. Existing law
defines "burden of proof" as "the obligation of a party to
establish by evidence a requisite degree of belief concerning
a fact in the mind of the trier of fact or the court."
�Evidence Code (EC) Section 115]. The party with the burden
of proof is required to establish the existence or
nonexistence of a fact by producing evidence that satisfies a
required standard. Generally, the evidentiary standard
applicable to assessment appeals hearings is the
"preponderance of the evidence." This standard applies in
most civil cases and, effectively, is satisfied if the
proposition is more likely to be true than not true (i.e.
there is greater than 50% chance that the proposition is
true). In contrast, the "clear and convincing evidence"
standard, which is a higher level of burden of persuasion, has
been held to require evidence "so clear as to leave no
substantial doubt in the mind of the trier of fact," and
"sufficiently strong to command the unhesitating assent of
every reasonable mind." �See Tannehill v. Finch (1986) 188
Cal.App.3d 224, 228; see also Lillian F. v. Superior Court
(1984) 160 Cal.App.3rd 314, 320]. The party with the burden
of proof must convince the trier of fact that it is
substantially more likely than not that the proposition is in
fact true.
An assessor is generally entitled to the presumption affecting
the burden of proof that he/she has properly performed his/her
duty to assess all properties fairly and on equal basis. �EC
Section 664; Hunt-Wesson Foods, Inc. v. County of Alameda
(1974) 41 Cal.App.3d 163, 180]. In other words, the taxpayer
has the burden of proving the property was improperly
assessed. �Texaco Producing v. County of Kern (1998) 66
Cal.App.4th 1029, 1046]. Thus, in a hearing before an
assessment appeals board, the taxpayer with the burden of
proof must present his/her evidence first. �California Code
Regulations, Title 18, Section 313(c)]. However, a county
assessor has a burden of proof in certain types of assessment
appeals hearings that involve (a) the value of owner-occupied
single-family dwellings, (b) penalty assessments, (c) escape
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assessments; (d) non-enrollment of a purchase price, and (e)
when the county assessor intends to report a higher assessed
value than the one on the assessment roll. In all of those
five types of assessment appeals hearings, the county assessor
must affirmatively establish, by a preponderance of evidence,
the correctness of his/her opinion of value or other
assessment action.
There is legal precedent, however, for the use of the stricter
"clear and convincing" standard in property tax law. For
example, if the assessor, in valuing possessory interests,
uses a term of possession other than the stated term of
possession in a contract, the "clear and convincing evidence"
standard applies. Similarly, the existence of a clerical
error in the determination of a base year value of property
must be proved by clear and convincing evidence if the
correction is made more than four years after the year of
enrollment. (R&TC Section 51.5). Other cases where the clear
and convincing evidence standard applies include presumptions
in R&TC Section 2512, relating to proof that an electronic
transmittal of a tax payment was made on a specific date and
time, and EC Section 662, providing that the owner of the
legal title is presumed to be the owner of the full beneficial
title.
8)Does the Solution Address the Problem? As noted in Cardinal
Health, BOE Property Tax Rule 152(e) creates a de facto
presumption that equipment sold with bundled software may be
assessed on the total sales price, unless the assessor has
"evidence to the contrary." It allows the taxpayer to
overcome this presumption by "identifying" what is nontaxable,
presumably, by a preponderance of the evidence. AB 832
codifies the presumption, but raises the evidentiary standard
from "preponderance of the evidence" to "clear and convincing
evidence." Usually, the clear and convincing evidence
standard applies only in cases involving civil fraud, punitive
damages, or other serious instances in which a very high
degree of certainty is required. Thus, a question arises as
to whether this higher evidentiary standard is appropriate in
this case and whether it moves the state any closer to an
important goal of establishing a uniform process of valuing
embedded software.
Arguably, a higher evidentiary standard is required because the
taxpayer challenging the assessor's valuation is the one who
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either possesses, or is in a better position to obtain from
the manufacturer, the necessary information about the embedded
software. Assessors, on the other hand, lack specialized
knowledge and information to determine the value of a
particular software program embedded in equipment and whether
it is essential to the equipment's commercial operation.
There are no uniform look-up tables for assessors to use as a
reference guide in such circumstances. It seems that
assessors are currently facing an almost insurmountable task
of trying to ascertain and rebut, if necessary, the
credibility of the evidence presented by assesses on appeal.
This bill attempts to balance the taxpayer's right to exclude
embedded software from taxation with the requirement to come
forward with sufficient and credible evidence.
It is unclear, however, what kind evidence would be deemed
"sufficient" to satisfy the "clear and convincing evidence"
standard. Presumably, under the preponderance of the evidence
standard, a taxpayer wishing to challenge the assessor's
valuation of computer equipment will satisfy the burden of
proof by simply providing an itemized list of prices assigned
by the manufacturer to various components of the equipment, if
one is available. It seems that, under the "clear and
convincing evidence" standard, the taxpayer would be required
to do something above and beyond simply providing an
itemization list. Would an independent appraisal of the
equipment be necessary and would it suffice? Is it fair to
ask the taxpayer to bear the additional costs of providing
evidence to satisfy the "clear and convincing evidence"
standard? How likely is it that a higher evidentiary standard
will ensure uniformity amongst various counties and local
assessment appeals boards?
It is important to note that this bill does not confront the
issue of whether embedded software should be subject to
property tax, even though it has not been addressed by the
Legislature in the last 40 years, since the era of punch cards
and large computer rooms, and seems to be ripe for
consideration. AB 832 does not seek to overturn the Cardinal
decision, which would require a 2/3 vote of the Legislature.
Instead, given the difficulty of garnering the support of a
2/3 vote of the Legislature, it simply tries to limit the
number of frivolous appeals by imposing a higher burden of
proof on taxpayers that decide to challenge the valuation of
property containing embedded software. While the solution
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offered by this bill is not perfect, absent some sort of
legislative action, the assessors and the assessment appeals
boards will continue to struggle with a significant number of
embedded software cases that potentially may lead to a
sizeable revenue loss for local governments.
9)BOE Comments . In the analysis of this bill, BOE staff notes
all of the following:
a) Mass appraisal . Existing law requires the annual
taxation of personal property used in a business or trade
at its current market value. The assessment of that
property is by necessity a mass appraisal system, which is
based on the acquisition cost. For example, the Vehicle
License Fee is imposed on the original total sales price of
the automobile, with no deduction or reduction of the sales
price for the value of the various computer programs that
operate the automobile.
b) State-assessed property . The provisions of Property Tax
Rule 152 and R&TC Sections 995 and 995.2 apply equally to
the valuation of property subject to assessment by the BOE,
which means that state and locally-assessed property will
be treated similarly under this bill.
c) Separate section for provisions related to application
software . While all three subdivisions of the proposed
R&TC Section 995.3 refer to "single price" sales, only
subdivision (a) is limited to basic operational computer
programs. BOE staff suggests to move subdivisions (b) and
(c) into a separate section of the R&TC, in order to
minimize confusion.
REGISTERED SUPPORT / OPPOSITION :
Support
California Assessors' Association
Lawrence Stone, the Santa Clara County Assessor
John R. Noguez, the Los Angeles County Assessor
Opposition
George Runner, Member of the State Board of Equalization
The California Taxpayer Association
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California Chamber of Commerce
Council on State Taxation
Silicon Valley Leadership Group
TechAmerica
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098