RODOWSKY, J., delivered the opinion of the Court.
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
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
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.
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.
The programs involved here are stipulated to be existing, prepackaged programs of general application, called "canned" programs. The stipulation further states:
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
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 cases applying tax statutes restricted to tangible personal property.
This Court has dealt with the taxation of programs once before. Computer software was involved in Greyhound Computer v. St. Dep't, 271 Md. 674, 320 A.2d 52 (1974), an ad valorem tax case. The property consisted of a computer, clearly tangible, and associated software, all of which had been acquired at a single price — a "bundled" transaction. Included in the software were programs, educational services and systems engineering services. The assessment had utilized the cost of the bundled transaction, without any allocation. We remanded for allocation between tangible and intangible property. What Greyhound teaches with respect to tangibility of programs is a subject on which unanimity is lacking among other courts and commentators. Later in this opinion we shall return to Greyhound for a more detailed analysis.
The starting point for our legal inquiry is the effect of the license agreements. There is no evidence that the subject programs are patented, or are part of any patent, even if we assume that programs can be patented. Nor is there any evidence of copyright.
But while neither "license agreement" purports to transfer absolute legal title to anything, not even to the specific magnetic tapes used to deliver the program copies, Equitable has the right to use the specific tapes. This is a sale of the tapes under Art. 81, § 324 (d).
Equitable's principal argument is that this Court should conceptually sever the program copy contained on the magnetic tape from the tangible tape itself. The argument is that the transaction should be viewed as operating on two levels, one the transfer of intangible knowledge or information and the other the delivery of a tangible tape. To have a scalpel for this legal surgery, it would be necessary for us to adopt as part of Maryland sales tax law a principle that the buyer's predominant purpose for a transaction controls the classification of the acquisition as either tangible or intangible.
Quotron Systems v. Comptroller, 287 Md. 178, 411 A.2d 439 (1980) recognized a predominant purpose test as one of several factors in determining use tax applicability to the type of transaction presented there. That taxpayer undertook concurrently to render two types of interrelated
The rule of Quotron has been implicitly applied in the case at bar on an aspect which is not disputed by Equitable. In addition to providing program copies on tape, each proprietor agreed to furnish certain installation services. AUXCO also contracted to furnish a limited amount of training within the fixed contract price. Equitable does not argue, however, that these services predominate.
We have no doubt that the dominant purpose of the subject transactions was to obtain a copy of the programs. But there are problems in adopting a dominant purpose test in order conceptually to sever information or data from the physical medium employed to deliver a copy of the information, and next to declare that the information predominates, so as thereby to classify the transaction as a sale of intangible property. One factor used in determining the dominant purpose is the admittedly insignificant value of a blank magnetic tape when compared to the price paid for a program copy on tape. But § 324 (i) defines "price" to mean
While Equitable points out that the question of price is not reached unless it is first determined that property sold is tangible, the legislative policy embraced in the definition of price runs contrary to the conceptual severing of the insignificant blank tape from the valuable program copy superimposed thereon as magnetic impulses.
A second concern is the precedent established for apparently comparable transactions. If the dominant purpose is to obtain knowledge, information or data which thereby results in severing the dominant purpose object from the physical medium of transfer, the analogy to books, motion picture films, video display discs, phonorecords and music tapes immediately comes to mind. In sales of the latter,
The earliest decision, which set the tone for the later cases, is District of Columbia v. Universal Computer Associates, Inc., 465 F.2d 615 (D.C. Cir.1972). It involved a property tax on hardware which was assessed based on the cost of a bundled IBM data processing installation. Two programs were included, one the usual standard program and the other a custom tax program. Both programs were on punched cards. The court stated the legal issue to be "whether the two sets of punched cards (the software) represent tangible personal property ... or whether they represent intangible values which are not subject to tax." Id. at 617. The custom program was said to be basically a service. However, the canned program was said to represent "an investment of IBM in an intellectual property, which it licenses users like Universal to employ in the computers IBM sells." Id. at 618. Another factor of significance to the court was that
Here the court is talking about memory in the computer. What rests in a programmed memory is not "knowledge" in any true sense of the word, but machine instructions. Further, the taxability of a sale of a canned program copy should not turn on whether the buyer stores the program in memory. A tax system cannot be administered dependent upon whether or not, at the time of the transaction, the buyer's intent is to store the program continuously in memory. Nor should taxability turn on the capacity of memory of the buyer's machine; otherwise, program copies bought for large storage machines would not be taxed, but those for small storage machines would be taxed.
The District of Columbia Circuit also concluded that both programs were to be likened to cartoon mats which had been involved in Washington Times-Herald v. District of Columbia, 213 F.2d 23 (D.C. Cir.1954). Cartoon mats are the medium by which a cartoonist's drawings are transferred for reproduction in newspapers. Washington Times-Herald held that the sale of one time use of the mats was a sale of professional and personal services, because the price was paid for the work of the artist and not for the mats which had inconsequential value. Professor Jerome R. Hellerstein in his article, The Scope of the Taxable Sale Under Sales and Use Tax Acts: Sales As Distinguished From Services, 11 Tax L. Rev. 261, 275 (1956) has criticized the holding in Washington Times-Herald, saying that "[t]his rationale and holding undercut much established sales tax law." (Footnote omitted.)
An assessment of sales tax on the transfer of custom and canned, applicational programs, and of two operational programs, was abated in Commerce Union Bank v. Tidwell, 538 S.W.2d 405
The tax collector argued the phonorecord analogy in Commerce Union Bank. In distinguishing, the Tennessee court said that the buyer has no viable method of bringing the particular music into his living room other than by the record, whereas the above-described alternative methods are available for acquiring programs. Secondly the court stated flatly that the tape containing the program copy "is not retained in the possession of the user." Id. at 408. This latter point is contrary to Equitable's representation of the facts in the instant matter. More importantly, intangibility should not be determined by the extent of use. After all, a book that is read only once is and remains tangible personal property. The court also said that the phonorecord is complete and ready for use at the time of purchase, while a program copy on tape "must be translated into a language understood by the computer." Id. We are at a loss to understand this distinction. A computer user purchases a canned program copy on tape because it is considered to be sufficiently compatible with the user's machine to be read by it and, either directly or after having been compiled, executed by it.
The Arizona intermediate appellate court, in a 1977 decision, simply referred to computer software, including programs, as intangible property in a property tax case. Allocation was directed as to the assessment of a hardware manufacturer whose inventory had been valued from list prices for bundled installations. Honeywell Information Systems, Inc. v. Maricopa County, 118 Ariz. 171, 575 P.2d 801 (1977). The court made no analysis of the intangibility issue.
The authorities relied upon by Equitable also include cases that involve contracts with keypunch operations rather than software purchases. In Bullock v. Statistical Tabulating Corp., 549 S.W.2d 166 (Tex. 1977), a sales tax case, customers brought copies of their business records to the taxpayer whose employees typed out on keypunch machines the data reflected on those copies to produce machine readable cards for use with the customers' computers. The taxpayer supplied the cards. It was held that "the true object of this transaction is not the data processing card... but the purchase of coded or processed data, an
When the purchase of canned programs on tape was presented to the Court of Civil Appeals of Texas in 1979, it held that no sales tax was due, based on Statistical Tabulating Corp., supra. The transaction was viewed as being "the purchase of the computer process, an intangible."
Canned programs were held not to be subject to the Illinois use tax in First National Bank of Springfield v. Department of Revenue, 85 Ill.2d 84, 421 N.E.2d 175 (1981). In response to analogies argued by the tax collector the court said:
We can take judicial notice, based on modern human experience, that the technology exists for producing a copy of a movie film on disc, of a phonograph record on tape, and of a book on microfiche. We have previously discussed how the program copy is not separated from the tape, when it is used in the computer. See B.U. Note, supra, at 188-89. To remove the program copy from the magnetic tape requires that it be overwritten, or obliterated in a magnetic field, in the way in which one dictating on tape makes corrections or wipes the tape clean.
A case departing from the analytical mold of the preceding authorities is Maccabees Mutual Life Insurance Company v. State, Department of Treasury, 122 Mich.App. 660, 332 N.W.2d 561 (1983) (per curiam). It is a use tax case involving tradenamed programs acquired from software proprietors. Consequently, adaptations had been made for the taxpayer's particular installation. The tangibility issue was presented on summary judgment with a concession by the tax collector that the programs, as adapted, were customized. It was held:
Here the parties have stipulated that the programs are "canned," by which they mean a program other than one originally developed exclusively for the buyer. While the record shows that adaptations were made to the programs acquired by Equitable, Equitable does not contend that services rendered to Equitable by the proprietors were of sufficient magnitude to classify either subject transaction as a purchase of services under the rule of Quotron, supra.
The tangible-intangible debate with respect to computer software can arise in contexts other than that of state and local sales, use and property taxes. The problem arises under the federal income tax as to eligibility for investment credit and accelerated depreciation. When the hardware manufacturers' segment of the industry unbundled their installation contracts and began separately to state prices for software, it was necessary for the Internal Revenue Service to adopt a position. Basically, bundled software is treated as part of the hardware, while unbundled software is treated as an intangible. See Rev. Proc. 69-21, 1969-2 C.B. 303; Rev. Rul. 71-177, 1971-1 C.B. 5; Bigelow, The Computer And The Tax Collector, 30 Emory L.J. 357, 362, 365 (1981).
Software, as embodied in tapes and documentation, has been held to be subject to the writ of replevin, over the objection that improved programs developed for the defendant's existing hardware were simply "a body of intangibles, that is, concepts or ideas...." F & M Schaefer Corp. v. Electronic Data Systems Corp., 430 F.Supp. 988, 992 (S.D.N.Y. 1977), aff'd mem., 614 F.2d 1286 (2d Cir.1979). Cf. Institutional Management Corp. v. Translation Systems, Inc., 456 F.Supp. 661 (D. Md. 1978) (documentation of program replevied, without discussion of tangibility issue).
The severability argument is not a new one in sales tax cases. It has been rejected in a line of cases where those who rent motion picture films from producers have argued that the intellectual property or the right to use the copy transmitted for commercial exhibition should be severed from the tangible copy of the film. See, e.g., Boswell v. Paramount Television Sales, Inc., 291 Ala. 490, 282 So.2d 892 (1973); Columbia Pictures Industries, Inc. v. Tax Commissioner, 176 Conn. 604, 410 A.2d 457 (1979); Florida Association of Broadcasters v. Kirk, 264 So.2d 437 (Fla. Dist. Ct. App. 1972); United Artists Corp. v. Taylor, 273 N.Y. 334, 7 N.E.2d 254 (1937); Crescent Amusement Co. v. Carson, 187 Tenn. 112, 213 S.W.2d 27 (1948). In the latter case the court reasoned that
The movie film cases have been applied to reject the severability argument in the leasing of video tapes for television broadcasting. See Turner Communications Corp. v. Chilivis, 239 Ga. 91, 236 S.E.2d 251 (1977). A transfer of film negatives and master recordings used for making audio-visual aids for the training of medical personnel was held subject to sales tax, despite the purchaser's argument that its primary interest was not in the physical objects but in the right to exploit the intellectual products they embodied. Simplicity Pattern Company, Inc. v. State Board of Equalization, 27 Cal.3d 900, 615 P.2d 555 (1980). That result, however, was aided by the fact that a statute, enacted
Artistic designs were purchased in transactions held to be subject to sales tax in Columbus Coated Fabrics Division v. Porterfield, 30 Ohio St.2d 307, 285 N.E.2d 50 (1972). For use in decorative, vinyl coated wallcoverings that it manufactured, the taxpayer purchased designs, presented on paper or woven fabric, from independent artists and from design studios that were sources for designs in the clothing industry. Even though the purchased designs were the products of artists' talent and skill, and their value was determined by the quality and merit of the design and not by the inconsequential cost of the conveying medium, the court stated that "it is the product of the service, not the service itself, that the taxpayer is interested in." Id. at 310, 285 N.E.2d at 53.
On the other hand, at least two courts have held that a sales tax imposed on transfers of tangible personal property does not apply to mailing lists acquired for one time use and delivered on magnetic tape. See Spencer Gifts, Inc. v. Director, Division of Taxation, 182 N.J.Super. 179, 440 A.2d 104 (N.J. Tax Ct. 1981) (real object of the transaction involves intangible personal property); Mertz v. State Tax Commission, 89 A.D.2d 396, 398, 456 N.Y.S.2d 501, 503 (1982) (information was the essence of the transaction and tape was the medium of transmission).
At the administrative level, taxing authorities in at least 36 states, as of 1981, reportedly imposed a sales tax on software transfers. See White and Venecek, Taxpayer Beware! The Current State of Computer Software Taxation, 60 Taxes 373 (1982). According to the Wayne Note, supra, at 1531-36, as of 1977, 24 states taxed the sale of both canned and customer software, and 10 other states taxed canned software only.
From the standpoint of Maryland law, we conclude that the program copy acquisitions by Equitable are subject to sales tax for the following reasons.
We have indicated in parts (1) and (5) of this opinion both certain misconceptions in the technological underpinnings of the decisions holding taped copies to be intangible and our concerns with the apparent departures in reasoning from that usually applied in sales tax cases. Secondly, there is a substantial question whether the decision that set the course for the line of program cases, Universal Computer, supra, is consistent with existing Maryland law. That decision rested largely on Washington Times-Herald which held the acquisition of cartoon mats to be the purchase of personal services. Md. Code, Art. 81, § 326 (dd) exempts, inter alia, the sale of mats under circumstances therein set forth. The exemption was added by Chapter 530 of the Acts of 1973. At a minimum, enactment of the exemption indicates a legislative recognition that the sales tax statute could be applied to purchases of mats. Similarly, § 326 (k) exempts rentals of motion picture films to persons whose gross receipts are subject to amusement tax. The indication is that, absent the exemption, neither the artistic content nor the right to exhibit the film copy would be severed from the tangible medium and thereby placed beyond the reach of the sales tax act.
Additionally, this Court's discussion of computer software in the context of a bundled installation in the Greyhound case leads to the classification of the subject programs as tangible.
This passage reflects awareness of both operational and applicational programs, but makes no distinction between them as to their tangible nature, either in human readable documentation form or in machine readable tape or card form.
The Greyhound opinion went on to observe that
This portion again refers to tangible software, only a part of which is the operational program. Impliedly, tangible software also can include applicational programs on cards or tape. Greyhound suggested a distinction in property tax valuation between operational and applicational programs for the purpose of allocating the cost of a bundled installation. The reason given was that a computer cannot operate
Then, at page 679 of 271 Md. 55-56 of 320 A.2d, this Court said:
Two concepts are involved in this passage, tangibility and cost. While the passage may be dicta, it was nevertheless expressed for the guidance of the agency on remand. Our analogy to a phonorecord recognized both its tangibility and its valuation based on cost, including the entire cost of the privately commissioned performance assumed in the illustration. Similarly, in the property tax context, a newly acquired phonorecord owned by a commercial radio station would be taxed as tangible personal property. The assessment would not be based simply on the value of its tangible material; rather, original cost less depreciation or its market value would be used.
The phonorecord analogy is directly addressed by Equitable. It says that in the case of the recording "the intangible information has no value without the tangible record. ..." (Emphasis in original.) The same is true of the program copies Equitable acquired in the transactions being taxed. The millions of magnetic impulses which in their precise order have meaning were conveyed to the computer, in the transactions as carried out, by tapes. A meaningful sequence of magnetic impulses cannot float in space. Equitable's argument has merit, if the direct input by keyboard, without documentation, alternative (a service transaction) or the electronic transmission, without documentation, alternative (no tangible carrier) is the form of transaction under consideration. But, because a taxable transaction might have been structured in a nontaxable form, it does not thereby become nontaxable.
It is said each tape is used only once. But a dress pattern purchased at retail and used to make only one dress (or, even if never used) is taxable.
Equitable points to the provisions of the contract under which a delivery copy of a program, if lost or destroyed, will be replaced by the proprietor at minimal or no additional cost. On the other hand, the purchaser of a phonorecord which is lost or destroyed would have to replace it by paying the current price for another copy. This economic fact simply reflects that the proprietors of canned programs are better able to obtain thousands of dollars for a program copy by
Finally, Equitable argues that a purchased program "can be and was in fact severed and exists apart from the tangible transfer medium...." (Emphasis in original.) As shown above, the copy delivered to Equitable does not become severed in any physical sense from the tape when the tape is used to structure computer memory.
We do not discern any legally significant difference for sales tax purposes between the canned computer program on magnetic tape and music on a phonograph record. As stated in the National Commission on New Technological Uses of Copyrighted Works, Final Report at 10 (1978): "Both recorded music and computer programs are sets of information in a form which, when passed over a magnetized head, cause minute currents to flow in such a way that desired physical work is accomplished." In the case of the phonograph record, the sales tax statute in Maryland has never been viewed as conceptually severing the copy of the performance from the tangible carrier. We conclude that the statute does not sever copies of computer programs from the tangible carriers employed in the subject sales.
Judgment of the Circuit Court for Baltimore City reversed.
Case remanded to that Court for the entry of a judgment affirming the order of the Maryland Tax Court as to the assessment on computer programs.
Costs to be paid by Equitable Trust Company.
Note, Sales and Use Tax of Computer Software — Is Software Tangible Personal Property?, 27 Wayne L. Rev. 1503, 1508 (1981) (the Wayne Note). (Footnote omitted).