Case Name: SOUTH CENTRAL BELL TELEPHONE COMPANY, v. Sidney J. BARTHELEMY, et al.
Court: Louisiana Court of Appeal
Jurisdiction: Louisiana
Decision Date: 1994-01-27
Citations: 631 So. 2d 1340
Docket Number: No. 93-CA-1072
Parties: SOUTH CENTRAL BELL TELEPHONE COMPANY, v. Sidney J. BARTHELEMY, et al.
Judges: BYRNES and JONES, JJ., and JOHN A. DIXON, Jr., J. Pro Tem.
Reporter: Southern Reporter, Second Series
Volume: 631
Pages: 1340–1349

Head Matter:
SOUTH CENTRAL BELL TELEPHONE COMPANY, v. Sidney J. BARTHELEMY, et al.
No. 93-CA-1072.
Court of Appeal of Louisiana, Fourth Circuit.
Jan. 27, 1994.
Gregory D. Guth, Deputy City Atty., Bruce E. Naccari, First Asst. City Atty., Kathy Torregano, City Atty., New Orleans, for Sidney J. Barthelemy, et al.
William M. Backstrom, Jr., Edward D. Wegmann, Rosemarie Falcone, Jones, Walker, Waeehter, Poitevant, Carrere & Denegre, New Orleans, and Keith G. Landry, Bell-South Corp., Atlanta, GA, for BellSouth Telecommunications, Inc. d/b/a South Cent. Bell Telephone Co.
BYRNES and JONES, JJ., and JOHN A. DIXON, Jr., J. Pro Tem.

Opinion:
JOHN A. DIXON, Jr., Judge Pro Tem.
The issue in this appeal is whether computer software programs licensed for use by a business are tangible personal property under the City of New Orleans Code of Municipal Ordinances and, therefore, subject to a use tax. Also at issue is whether maintenance services provided for the software programs are taxable services.
In October 1990, the City notified Bell South Telecommunications, Inc. d/b/a South Central Bell Telephone Company (SCB) of a proposed assessment of taxes for, among other things, SCB's use of computer software and payments for maintenance of software for the taxable periods beginning on January 1st, 1986 and ending on April 30,1990. SCB paid the full amount of the proposed tax under protest.
SCB sued to recover the entire protested payment.
In August 1992, SCB filed a motion for partial summary judgment challenging the City's assessment of tax on payments for the license of and maintenance services for two kinds of software programs — switching system software and data processing center software. The City also filed a motion for summary judgment on the same issues.
In a December 22,1992 judgment, the trial judge denied the City's motion for summary judgment and granted SCB's motion for partial summary judgment, finding that the licensing of the data processing and switching software is not subject to the City's sales/use tax. On February 9, 1993, the trial judge amended the judgment to clarify that the maintenance services with respect to the software are not taxable and to enter judgment in favor of SCB and against the City in the amount of SCB's protested payment. The City appeals the December 22, 1992 and February 9, 1993 judgments. We affirm. FACTS:
The uncontested facts are that SCB owns and operates a telephone system in Louisiana and is engaged in the business of providing telephone service for compensation. As SCB explains, its "system" consists of many individual systems connected together with other systems to form a local, state, national and international network. At a telephone central office, telephone lines are connected by equipment which function to "switch" or route each call over the company's network to the line of the subscriber corresponding to the number dialed by the calling party. The routing is performed electronically by computer controlled "switches" housed in each central office. Each telephone central office is unique and processes telephone calls differently from other telephone central offices.
Each of the switching system software programs at issue was licensed for use by SCB at a specific telephone central office. All licenses for the right to use switching system software were contracted for and granted separately from the sale of any equipment or other item or article of tangible personal property. And, all charges for the right to use the switching system software were separately stated on each invoice or other billing record from the price of any equipment or other item of tangible personal property sold to SCB.
The switching system software programs at issue provided by the vendors were transmitted to SCB by electronic impulses on magnetic tapes. Apparently the switching system software programs could have been transmitted electronically and/or telephoni-cally without the use of any tangible medium or could have been input directly into a processor by representatives of the vendor. Once SCB received the switching system software on magnetic tapes, the electronic impulses of intelligence on the tapes were transferred and loaded into SCB's switching system processors. The magnetic tapes were used or discarded by SCB. Most of the vendors billed City taxes on the price of magnetic tapes and other articles of tangible personal property delivered to SCB. If a vendor failed to bill for City tax, SCB's mechanized payments and tax reporting system automatically accrued City taxes.
Each switching system software program was specifically tailored according to the unique requirements specified by SCB for a particular telephone central office. The vendors retained ownership of and proprietary rights to each of the switching system software programs licensed to SCB. The license agreements restricted SCB's use of the programs in various ways.
SCB also acquired the right to use data processing center software from various vendors. SCB's right to use this software was acquired through BellSouth Sendees, Inc., an affiliate of SCB, who would test, evaluate and adapt the software before transmitting it to the center in New Orleans. Unlike the switching system software, this software was transmitted electronically via telephone lines to New Orleans. The software vendors retained ownership and proprietary rights to each of the data processing software programs.
ANALYSIS:
The basic issue on appeal is whether computer software is tangible personal property as defined in Section 56-18 of the City Code. This provision states:
"Tangible personal property" means and includes personal property which may be seen, weighed, measured, felt or touched, or is in any other manner perceptible to the senses. The term "tangible personal property" shall not include stocks, bonds, notes or other obligations or securities.
Under Section 56-21 of the City Code, taxes are imposed upon the lease or rental of tangible personal property and upon the sale of services within the City, as well as the sale at retail, the use, the consumption, the distribution and the storage in the City of each item or article of tangible personal property. "Tangible personal property" as used in the City Code is synonymous with corporeal movable property as defined in La.C.C. art. 471. City of New Orleans v. Baumer Foods, Inc., 532 So.2d 1381, 1388 (La.1988).
The City argues that because the magnetic tapes, upon which the switching system software programs were placed, are corporeal movable property, the City can impose a tax on the programs. SCB responds that because it is undisputed that computer programs are "intellectual property" and therefore incorporeals, the programs are not taxable. Although the City's position is not without support in caselaw from other jurisdictions, SCB's, as well as the trial judge's, viewpoint is more reasonable.
Taxing statutes, which necessarily include definitional limitations like the one at issue, must be construed liberally in favor of the taxpayer and against the taxing authority. Goudchaux/Maison Blanche, Inc., v. Broussard, 590 So.2d 1159, 1161 (La.1991); Tarver v. World Ship Supply, Inc., 615 So.2d 423 (La.App. 4th Cir.), writ denied, 616 So.2d 672 (La.1993). The computer programs at issue in this case simply do not fall within the definition of tangible personal property. They do, however, fall within the definition of incorporeal property as "intellectual property." See, District of Colombia v. Universal Computer Assoc. Inc., 465 F.2d 615, 619 (D.C.Cir.1972), and Commerce Union Bank v. Tidwell, 538 S.W.2d 405 (Tenn.1976), both eases holding that intangible information stored on magnetic tapes or punchcards is not taxable.
The City's argument that the switching system software programs are part of the magnetic tapes on which they were delivered and should be grouped together with the relatively insignificant cost of the tapes and taxed as tangible personal property has been rejected by a number of courts. See, for example, James v. Tres Computer Service, Inc., 642 S.W.2d 347 (Mo.1982); First National Bank of Springfield v. Dept of Revenue, 85 Ill.2d 84, 51 Ill.Dec. 667, 421 N.E.2d 175 (1981). That the vendors who wrote the programs encoded the electronic impulses representing the program instructions onto magnetic tapes solely for delivery purposes is irrelevant to determining whether the software is tangible personal property. Rather, because the programs cannot be utilized by SCB until they have been copied into the memory of the electronic telephone switch, the magnetic tapes are inconsequential elements of the transactions.
Instead of focusing on the means for delivering software, courts should look the "essence of' or the "real object" of the transaction to determine taxation. The trial judge in the instant case reasoned that "under the essence of the transaction test that neither the data processing software nor the switching software is subject to the sale/use tax of the City of New Orleans."
Contrary to the City's assertion, the court, in McNamara v. Electrode Corp., 418 So.2d 652 (La.App. 1st Cir.), writ denied, 420 So.2d 986 (La.1982), embraced an "essence of the transaction" or "real object of the transaction" test, concluding that, given the facts in the case, the real object or essence of the transaction was the acquisition of tangible personal property.
In Electrode, the corporation leased technical equipment called dimensionally stable anodes to customers in Louisiana. The anodes were installed in large chlorine/caustic soda producing units called cells. Contracts with all of the customers were labeled "Anodes Lease Agreement." Contracts with two of the customers, in addition, were labeled "Technology and Patent License Agreement." The technology and patents which were the objects of the latter agreement presumably represented technological "know-how" that went into the development and manufacture of the tangible anodes. The lessor/taxpayer and its customers were attempting to separate the technological know-how from the anodes themselves to avoid Louisiana tax on the portion of the lease payments which they attributed to the technology.
The court determined that the transfer of technology without the tangible personal property (the anodes) was worthless and thus the technology, an intangible item, was merely incidental to the tangible item and subject to Louisiana tax. The court concluded that the true object of the contracts, regardless of their label, were the anodes. 418 So.2d at 662. The alleged technology or know-how, the court recognized, was an inseparable part of the hardware (anode) and for that reason must be included as part of the total price of the lease of the anodes. 418 So.2d at 662-663. No breakdown between "intangible technology" and "tangible personal property" was allowable in this case. Id.
The facts in the instant case are distinguishable from those in Electrode. In Electrode, the intangible property, the technological know-how, was inseparable from the tangible personal property, the anodes. In the instant case, the software programs are separable from any tangible property, including the magnetic tapes on which the switching system software programs were delivered. In fact, once the programs were copied from the magnetic tapes into the memory of the computer processors, the magnetic tapes were disposable. In the instant case, unlike Electrode, the real object of each license agreement was the right to use the program, not the acquisition of the magnetic tapes. The real object was intangible property.
The City argues that computer software is essentially the same as motion pictures, books, VCR tapes, phonograph records, cassette tapes, compact discs and Nintendo games. Some courts have use this reasoning, others have rejected it. Nevertheless, as to each of the items listed above, the true object and essence of each transaction is the purchase of the tangible medium itself, not the intangible property. Without the tangible medium — the tape, disc, reel, etc. — , the intangible property — the artist's expressions — is useless. Hence, these items are justifiably taxable whereas the programs in the instant case are not.
Moreover, as SCB asserts, the software programs at issue were separable from the magnetic tapes on which they were delivered. Indeed, the switching system software programs were not actually used by SCB until they are separated from the magnetic tapes and copied into the memory of the switching system hardware. The software programs at issue are clearly distinguishable from the examples given by the City. The City's analogy is without merit.
The City purports to establish a distinction between "canned" software versus "custom" software. Canned software, or pre-made programs, is what the City claims is at issue in this case instead of custom programs, those made for a particular customer. Assuming there is a relevant distinction in this regard, the uncontroverted facts in this case tend to establish that the programs at issue were a combination of canned and custom programs. The programs were pre-made, but apparently significant adaptations were required before SCB could use them. At any rate, a distinction between canned or custom programs comes from a few cases from other jurisdictions. The City Code is silent on this issue.
The City also contests the trial judge's finding that maintenance services to computer software are not taxable. The City imposes a sales tax on a limited number of services. See, Section 56-21 of the City Code. Section 56-15(7) of the City Code imposes limits on the taxing of repair services to repairs of tangible personal property. Assuming this type of maintenance service can be considered repair service, the software licenses obtained by SCB are intangible property and thus, not taxable. The services at issue — updating, enhancing and reformatting the software and advising SCB on various usages of the software — do not fit well into the concept of "repair". The maintenance services at issue are not taxable.
CONCLUSION:
The software programs are not subject to City taxes because the computer software at issue is not tangible personal property and is not encompassed within the definition of what is taxable in the City Code. Moreover, the programs are separable from the magnetic tapes on which they were delivered and the real object and essence of each transaction involving the software was the acquisition by SCB of a license of the right to use the software. The City, therefore, has no authority to impose a tax on these transactions. Likewise, taxing maintenance services for the software is not authorized nor correct.
Accordingly, the judgment granting SCB's motion for partial summary judgment is affirmed, and the tax assessed on SCB's license of and maintenance to the software programs, paid under protest, must be refunded by the City.
AFFIRMED.
. SCB paid $961,029.99 in tax, interest, penalties, and audit cost. .
. SCB's right to proportionate interest, penalties and costs on the proposed tax assessment for the computer software and any other amounts of tax at issue is still before the trial court.
.To direct the operations of the switching system hardware, SCB licensed a limited right to use switching system software from various switching system software vendors. The switching system is the complex method by which telephone calls are routed through one of the 16 telephone central offices in Orleans Parish.
. SCB operates a data processing center in Orleans Parish to process customer billings and payments, store and manage customer data and maintain a voucher and disbursement system, as well as other accounting functions. The data processing software guides the functions of computers located at the data processing center.
. Each license agreement prohibited SCB's subli-cense, assignment, sale or other transfer of the program. Also, SCB was restricted in its use of the software only to designated pieces of hardware. SCB had to maintain strict confidentiality of programs it licensed and could not use the programs after the license expired.
. Citizens and Southern Systems, Inc. v. South Carolina Tax Commission, 280 S.C. 138, 311 S.E.2d 717 (1984) and Chittenden Trust Co. v. King, 143 Vt. 271, 465 A.2d 1100 (1983).