Court Opinion

ID: 4472816
Source: CourtListenerOpinion
Date Created: 2020-01-14 19:34:56.295044+00
Date Added: 2024-06-11T08:49:07.321642
License: Public Domain

KÓRNER, J., dissenting: The majority, relying on Norwest Corp. & Subs. v. Commissioner, 108 T.C. 358 (1997), filed this date, concludes that the computer software in issue is tangible for purposes of the investment tax credit and for purposes of the accelerated cost recovery system (acrs). I disagree with the conclusion reached in Norwest, and respectfully dissent from its application to this case. I. Majority Opinion The majority holds that based on Norwest, the software is tangible, and further that Sprint was the owner of the software. I did not have a vote in Norwest, and therefore was unable to voice my opposition at the time of its adoption. In Norwest, the Court offers an expansive analysis that discredits the intrinsic value test; unfortunately, its analysis of its own test is nowhere near as thorough. Indeed, one of the faults the Court found in Ronnen v. Commissioner, 90 T.C. 74 (1988), was that it lacked “rigorous analysis”. Norwest Corp. & Subs. v. Commissioner, supra at 369. One would expect that the Norwest majority, in light of such murky reasoning as it perceived in Ronnen, would take the opportunity to clear the air with a definitive test, or at the very least offer some compelling reasoning to abandon the established precedent of this Court. Instead, they summarily conclude, with virtually no analysis, that the software was tangible. This conclusion is based on their interpretation of the legislative history of the investment tax credit that the tangibility requirement should be construed broadly. Their conclusion may also be based (it is not clear) on the fact that Norwest did not possess the right to distribute, sell, lease, or license the software it purchased (the “copyright rights”). A. Attack on the Intrinsic Value Test The Norwest majority attacks this Court’s implicit conclusion in Ronnen that computer programs were different from the seismic data at issue in Texas Instruments, Inc. v. United States, 551 F.2d 599 (5th Cir. 1977), and that the inextricable connection which existed between the seismic data and tapes in Texas Instruments was not present between the software and disks in Ronnen. Norwest Corp. v. Commissioner, supra at 369. I disagree with the Court’s conclusion that there is no fundamental difference between seismic data and a computer program. The distinction made in Ronnen v. Commissioner, supra, was appropriate and warranted by the facts. The seismic data consisted of the recording of a natural phenomenon. Although a recording of a natural phenomenon is the result of human exertion, it is neither the expression of an idea nor an unobvious improvement of prior technology or art. Accordingly, copyright or patent protection is not available for it.1 Software, which is the result of human creativity (not mere exertion), can exist as source code on tapes, disks, or computer memory, or written out on paper. As the result of human creativity and design, copyright or patent protection2 is available for it. I would therefore conclude that there exists a material difference between the sound recordings in Texas Instruments and the computer software purchased by Sprint, and at issue in Ronnen, and Norwest. B. Majority’s “Traditional Approach” The Norwest result is based upon an interpretation of the legislative history of the ITC that the term “tangible” should be construed broadly and possibly in the absence of copyright rights. I agree with Judge Jacobs and the other dissenters in Norwest that the majority’s reading of the legislative history is inappropriate for the reasons stated therein. No purpose would be served to repeat those arguments. There is, however, an additional factor in Sprint not present in Norwest. Section 168 requires that property must be tangible to qualify for ACRS treatment. The majority points out that the ITC and ACRS were considered by Congress to be in pari materia, and therefore they extend their expansive construction of “tangible” property to ACRS. Because I disagree that the legislative history requires such a broad construction for purposes of the ITC, I similarly disagree with its extension to ACRS. 1. Absence of Intellectual Property Rights The second basis of the Norwest majority’s holding is that no copyright rights were passed to Norwest (or Sprint). In Norwest the Court failed to offer any analysis or cite any cases which indicate why the presence or absence of such rights should control the character of the tangible medium which, as the majority itself points out, is distinct and separate property from the copyright rights. Norwest Corp. v. Commissioner, supra at 374. The notion that copyright rights are separate and independent from a tangible embodiment is well supported. In Rev. Rul. 80-327, 1980-2 C.B. 23, the rights to manufacture and distribute books were acquired with the plates used in the printing of the books. The Service analyzed the two types of property separately and ruled that the plates were tangible, while the distribution rights were intangible. There simply is no rational basis to conclude that the presence or absence of one separate and distinct property interest, the intangible copyright right, should control the character of other separate and independent property. Furthermore, this approach ignores the fact that the computer source code, which is intellectual property, is property separate and distinct from the copyright rights and the tangible medium. As the Court of Appeals for the Sixth Circuit indicated in Comshare, Inc. v. United States, 27 F.3d 1142, 1145 (6th Cir. 1994), computer software can consist of three types of property: The tangible computer tapes and disks, the intangible source code found on the disks, and the intangible copyright rights. Each of these types of property must be analyzed separately, unless there is some compelling reason to analyze them together. A computer program, which may be the creative expression of an idea, or an unobvious improvement on existing technology or art, can be protected by copyright and/or patent. Part of this property is the copyright rights. This intellectual property can exist in multiple forms, such as on disk, tape, computer memory, or written out on paper. An analysis must take place when a program is purchased as to what exactly was purchased. The components must be identified, and it must be determined whether there is any compelling reason to consider one or more of the components together. The fallacy of the Norwest approach, and the majority here, is illustrated by considering that if the same property had been transferred to Norwest (or Sprint), coupled with a copyright right, then the property would become intangible. Further, consider that if software was purchased in one year, and the next year the right to reproduce and sell was acquired, where the controlling factor for character determination is the presence of that right, then the property would be tangible in year 1 and intangible in year 2, despite the fact that it was the same property. 2. Majority Opinion in Conflict With Case Law The majority’s reliance on the presence or absence of one or more intangible intellectual property rights to control character is in direct conflict with the case law. In Comshare, Inc. v. United States, supra, the taxpayer received (by purchase) the right to distribute the software. Despite the presence of this intangible property right, the court went on to conclude that the software was tangible. Thus, Norwest is in direct conflict with Comshare. The application of the rationale in Norwest to this case likewise brings this case in conflict with Comshare. II. Conservative Approach Rather than dispose of a hazy test which this Court adopted in Ronnen v. Commissioner, 90 T.C. 74 (1988), for another one which is just as hazy and not supported by any case law, I think we should clarify the test in Ronnen and attempt to distinguish Comshare, Inc. v. United States, supra. To do so would leave intact our own precedent, as well as its progeny that relied upon it. A. Identify the Subject Property The first step in applying the intrinsic value test is to identify the subject property, or in other words, determine what exactly the taxpayer has purchased or created. In Texas Instruments, Inc. v. United States, 551 F.2d 599 (5th Cir. 1977), the court found that seismic data did not exist without the tapes upon which the data was stored, and accordingly that the data and tapes were inextricably connected. The intangible information could not exist without the tangible medium. See Bank of Vermont v. United States, 61 AFTR 2d 88-788, at 88-790, 88-1 USTC par. 9169, at 83,250 (D. Vt. 1988). Thus, the subject property was the tape that contained the seismic data. In Comshare, the court found that the source code was the subject property, but like the seismic data in Texas Instruments, that it could not exist without the disks upon which it was stored. Thus, there the subject property was the unit consisting of the tapes and disks which contained the source code. In Ronnen v. Commissioner, supra, the subject property was the source code. We did not find the same “inextricable connection” that existed between the seismic data and tapes in Texas Instruments. We instead found that the disks containing the source code were but one type of conduit for the ideas contained on it. In Rev. Rub 80-327, supra, plates to print books were purchased with the copyright rights to reproduce and sell copies of the books. The physical plates containing the creative work product were the subject property (while the copyright rights were analyzed separately). In this case, the subject property is the source code. Sprint paid a fixed amount for the right to one working copy of that software. There was not simply one embodiment of the software (as was the case in Comshare). Rather, the intellectual property existed in more than one locale, and Sprint purchased the right to use, or possess, a working copy of that intellectual property. Sprint possessed two copies, while the manufacturer possessed one. The record indicates that if Sprint had lost one of its copies, or if one had been destroyed, it would have been provided with another by the manufacturer. The copies were interchangeable. There was no significance as to which copy it used, where it existed, or in what form it existed. Sprint purchased the right to use the intellectual property of the manufacturer. The nexus between the intangible information and the tangible medium is far more attenuated here than in Texas Instruments, and like the software in Ronnen, is independent of the tapes upon which it was received. See Bank of Vermont v. United States, supra. B. Characterize Property Once the subject property is identified, it must be characterized. This is a facts and circumstances analysis, the focus of which is upon the relationship between the intangible intellectual property and any tangible medium upon which it exists. In Texas Instruments, the subject property, consisting of the intangible information (seismic data) and the tapes, was permanently embodied and inextricably bound. Therefore, the property was tangible. Although in Texas Instruments, the subject property was not software, we nevertheless borrowed the analysis and applied it to software in Ronnen. Although our analysis was less than thorough,3 we concluded that “the intrinsic value of the [subject] software is attributable to its intangible elements rather than to its tangible embodiments.” Ronnen v. Commissioner, supra. Although this phrase is somewhat ambiguous, because it appears immediately after the Texas Instruments analysis, I would interpret it to mean that in Ronnen, the integral connection between the intangible and tangible present in Texas Instruments did not exist between the software and the physical medium. The taxpayer’s investment was not in an intangible which was inextricably bound to the specific tangible medium upon which it existed, but rather was in the intangible alone. Turning to the software purchased by Sprint, an examination of what Sprint purchased, the right to a copy of source code that would operate its switches, leads to the conclusion that the property right is intangible. III. Conclusion Based on the foregoing, I cannot agree with the majority that software is tangible. Therefore, the software is not eligible for the ITC or ACRS treatment. I believe the following analysis regarding depreciation of the software, in light of its intangible character, is appropriate. Petitioner contends that its costs should be amortized over a period no shorter than 60 months pursuant to section 4.01(2) of Rev. Proc. 69-21, 1969-2 C.B. 303. Respondent contends that the software should be depreciated over 18 years, the asset guideline period for central office equipment (COE), for the software was an integral part of the COE. Rev. Proc. 69-21, supra, provides in section 4.01: (.01) With respect to costs of purchased software, the Service will not disturb the taxpayer’s treatment of such costs if the following practices are consistently followed: 2. Where such costs are separately stated, and the software is treated by the taxpayer as an intangible asset the cost of which is to be recovered by amortization deductions ratably over a period of five years or such shorter period as can be established by the taxpayer as appropriate in any particular case if the useful life of the software in his hands will be less than five years. Under this revenue procedure, if the taxpayer uses a period shorter than 5 years, he must establish that the useful life is less than 5 years; otherwise, the Commissioner will let stand the amortization period. The software was separately stated on petitioner’s books and in its purchase invoices from the assets from which it was purchased. The only issue is whether petitioner treated the software as an intangible asset. Petitioner did not originally amortize the software pursuant to this revenue procedure but rather treated the software and COE as one whole asset and depreciated that whole asset pursuant to ACRS. Sec. 168(c)(2)(B); Rev. Proc. 83-35, 1983-1 C.B. 745, 758. Petitioner amortized all other software as an intangible and amortized it pursuant to Rev. Proc. 69-21, supra, over a 5-year period. Respondent argues that petitioner did not treat the software as an intangible and amortize it on its income tax returns for the years in issue, and that petitioner has not shown that a 5-year amortization period is appropriate. Petitioner does not need to show that a 5-year period is appropriate, for it did not claim an amortization period less than 5 years.4  Respondent looks to the treatment of the COE into which the software went, coe’s belong to asset guideline class 48.12, which has an asset guideline period of 18 years for purposes of the class life asset depreciation range system. Rev. Proc. 83-35, 1983-1 C.B. 745. Under section 168(c)(2)(B), such property is treated as 5-year property and depreciated over 5 years. However, as we have held, the software is intangible and therefore does not qualify for acrs. Accordingly, respondent has determined that ACRS treatment is not available for the software, but the software is still part of the COE, and therefore depreciable over 18 years. Cohen, Chabot, Jacobs, Gerber, and Laro, JJ., agree with this dissent.   Although a recording of music is a recording of a natural phenomenon which can be copyrighted, it is the creative element that is copyrightable. See infra.    Traditionally, software, which is fundamentally a written set of instructions, was protected under copyright law, and infringement actions first were brought under copyright lav/. Later came a trend to allow patent protection for the design portion of computer applications. Petry, Taxation of Intellectual Property, secs. 1.08, 3.04 (1980).    This discussion illustrates the hazards of adopting a standard that is less than clear. I cannot adequately emphasize how improper it would be to abandon our own precedent on the grounds that it is not fully developed only to replace it by an analysis that is equally undeveloped.    If I had to decide whether a shorter period was appropriate, I would take particular notice of the fact that the software loads were updated as often as every 6 months, but at least every 2 years.