The Wisconsin Court of Appeals recently affirmed a circuit court decision holding that, for the 2006-2009 tax years at issue, receipts from licensing the right to install and replicate proprietary software were not attributed to Wisconsin. 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. Under Wisconsin law for the tax years at issue, gross receipts from the use of computer software were attributed to Wisconsin if the licensee used the computer software at a location in the state. On audit, the Department of Revenue took the position that royalties related to the use of the software in Wisconsin by Wisconsin-based end users, should be sourced to the state. Microsoft, on the other hand, argued that the income-producing activity test applied to its receipts. After the Tax Appeals Commission and the circuit court ruled in the taxpayer’s favor, the Department of Revenue appealed.
On appeal, the key question before the court was whether the Wisconsin end-users were “licensees” of Microsoft that used the software in Wisconsin. The Department argued that, although the end-user agreement was a sublicense of the right to use Microsoft’s software, it was in fact a license with Microsoft for the end user to use that software. Further, the Department asserted that a sublicensee was still a licensee of the licensor. The court, however, disagreed, holding that the end-users were not Microsoft’s licensees by law or when viewing the transactions as a whole. Notably, the end-users were not customers of Microsoft and had no relationship with Microsoft directly. Further, the end-user agreements were between the OEMs and the end-user, not the end-user and Microsoft. The Department next argued that the OEMs acted as agents of Microsoft “for the limited purpose of granting sublicenses of Microsoft’s computer software to end-users.” Again, the court rejected this argument, noting that the Commission’s findings provided substantial evidence that the OEM’s were not Microsoft’s agents. Finally, the court rejected the Department’s position that the only relevant factor was where the software is used. In the court’s view, the statute clearly required that there must be a licensee using the software in Wisconsin for the sourcing rule to apply. For more information on Wisconsin Department of Revenue v. Microsoft Corp., please contact Brad Wilhelmson at 312-665-2076.