[Federal Register Volume 61, Number 220 (Wednesday, November 13, 1996)]
[Proposed Rules]
[Pages 58152-58158]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-29055]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-251520-96]
RIN 1545-AU70
Classification of Certain Transactions Involving Computer
Programs
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed regulations relating to the
tax treatment of certain transactions involving the transfer of
computer programs. The proposed regulations provide rules for
classifying such transactions as sales, licenses, leases, or the
provision of services or of know-how under certain provisions of the
Internal Revenue Code and tax treaties. This document also provides
notice of a public hearing on the proposed regulations.
DATES: Comments must be received by February 11, 1997. Requests to
speak (with outlines of oral comments) at a public hearing scheduled
for March 19, 1997, at 10 a.m. must be submitted by February 26, 1997.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-251520-96), room
5228, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. In the alternative, submissions may be hand
delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R
(REG-251520-96), Courier's Desk, Internal Revenue Service, 1111
Constitution Avenue NW., Washington, DC. Alternately, taxpayers may
submit comments electronically via the Internet by selecting the ``Tax
Regs'' option on the IRS Home Page, or by submitting comments directly
to the IRS Internet site at http:\\www.irs.ustreas. gov\prod\tax__regs\comments.html. The public hearing will be held in
the NYU Classroom, room 2615, Internal Revenue Building, 1111
Constitution Avenue NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, William H.
Morris, (202) 622-3880 or Carol P. Tello, (202) 622-3880; concerning
submissions and the hearing, Christina Vasquez, (202) 622-7180 (not
toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
These regulations are proposed to clarify the treatment under
certain provisions of the Internal Revenue Code (Code) and tax treaties
of income from transactions involving computer programs.
I. Introduction
Computer programs are generally protected by copyright law.
Typically the protection afforded by copyright law is a principal
source of the value of a computer program to the owner of the
copyright. Conversely, the principal source of the value of a computer
program to the purchaser of a copy of the program is not the protection
afforded by copyright law, but the right to use or sell the copy. In
this regard, computer programs are similar to other copyrighted works
such as books, records, motion pictures, etc. For example, when a copy
of a book is purchased, the purchaser does not thereby also acquire any
copyright rights. Accordingly, the proposed regulations generally
distinguish between transactions in a copyright and in the subject of
the copyright.
In developing regulations addressing the treatment of computer
programs, the IRS and Treasury generally have been guided by the
following principles: (i) the rules should take into account the
special features of computer programs, such as the ability to deliver
copies electronically as well as physically, and to make perfect copies
at little or no cost, and (ii) wherever possible, transactions that are
functionally equivalent should be treated similarly. For example, a
transaction that involves the transfer for internal use only of fifty
copies of a computer program should generally be treated the same as a
transfer of one copy (for internal use) with the right to make forty-
nine other copies all for internal use. Similarly, if the right to use
a computer program is limited in time, the transaction should generally
be treated the same irrespective of whether, at the end of the period
of permitted use, a disk containing the computer program must be
returned, or the program automatically deactivates itself.
II. Copyright Law Principles
Distinguishing between transactions in a copyright and in the
subject of the copyright requires an examination of U.S. and foreign
copyright law (e.g. EC Directive on Legal Protection of Computer
Programs, 1991 (91/250/EEC); and the Berne Convention (Paris Text, July
24, 1971)). An overview of U.S. copyright law as it relates to computer
programs is set forth below. However, the IRS and the Treasury do not
purport in these regulations to interpret U.S. copyright law and these
proposed regulations should not be taken as an expression of the legal
or policy views of the U.S. Copyright Office.
The Copyright Act of 1976, as amended (17 U.S.C. 101 et seq.),
provides protection against infringement of the exclusive rights of the
owner of a copyright in original works of authorship, fixed in any
tangible medium of expression, including literary works. (17 U.S.C.
102.) The term literary works is defined to include: ``* * * numbers,
or other verbal or numerical symbols or indicia, regardless of the
nature of the material objects, such as books, periodicals,
manuscripts, phonorecords, film, tapes, disks, or cards, in which they
are embodied.'' (17 U.S.C. 101.) Thus, computer programs are literary
works for purposes of the Copyright Act.
The Copyright Act grants five exclusive rights to a copyright
owner. Of these, three are most relevant in the case of computer
programs: the right to reproduce copies of the copyrighted work (17
U.S.C. 106(1)); the right to prepare derivative works, which may
themselves be separately copyrighted, based upon the copyrighted work
(17 U.S.C. 103 and 106(2)); and the right to distribute copies of the
copyrighted work to the public by sale or other transfer of ownership,
or by rental, lease or lending (17 U.S.C. 106(3)). Additionally, in
certain circumstances, the right to publicly perform the copyrighted
work (17 U.S.C. 106(4)) and the right to publicly display the
copyrighted work may also be relevant (17 U.S.C. 106(5)).
Thus, under U.S. copyright law, the user of a computer program who
does not possess any of those five rights (or parts of them) has
obtained only rights to use the copyrighted article it possesses.
Generally, that user is treated
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only as having received a copy of the copyrighted work. Under U.S.
copyright law, a copy is a material object in which a work is fixed by
any method now known or later developed, and from which the work can be
perceived, reproduced, or otherwise communicated, either directly or
with the aid of a machine or device (17 U.S.C. 101.). In these proposed
regulations a copy is also referred to as a ``copyrighted article.''
The distinction between copies and copyrights is made most clearly in
section 202 of the Copyright Act which provides:
Ownership of a copyright, or of any of the exclusive rights
under a copyright, is distinct from ownership of any material object
in which the work is embodied. Transfer of ownership of any material
object, including the copy or phonorecord in which the work is first
fixed, does not of itself convey any rights in the copyrighted work
embodied in the object; nor, in the absence of an agreement, does
transfer of ownership of a copyright or of any exclusive rights
under a copyright convey property rights in any material object.
Certain rights pass to the purchaser of a copy of a computer
program. The most important of these is the right to sell (but not,
without permission, to lease, rent, or lend) the copy to another
person. (17 U.S.C. 109.) Additionally, the owner of a copy of a
computer program has the right to make a copy of that copy as an
essential step in the utilization of the program (e.g., copying to the
memory of the computer) and may also make a copy for archival purposes.
(17 U.S.C. 117.) If, however, the owner of the copy sells that copy,
all copies made pursuant to the 17 U.S.C. 117 right must be destroyed.
III. The Proposed Regulations and Copyright Law Principles
Although the proposed regulations are guided by copyright law
principles in determining whether a copyright right or copyrighted
article has been transferred, the regulations depart in some cases from
a strict reliance on copyright law in order to take into account the
special nature of computer programs and to treat functionally
equivalent transactions in the same way. For example, the proposed
regulations do not treat the transfer of a right to copy as the
transfer of a copyright right, unless it is accompanied by the right to
distribute the copies to the public.
Thus, where a corporation obtains the right, under an agreement, to
make fifty copies of a program for use by its employees at one location
(a site license) the transaction is not, for all practical purposes,
any different from a transaction in which fifty individual disks are
purchased. Accordingly, the proposed regulations treat the transaction
as the transfer of a copyrighted article, rather than of a copyright
right, despite a copyright law requirement that the corporation receive
a ``license'' to make those fifty copies. Similarly, under the proposed
regulations, the transfer of a computer program in perpetuity for
internal use only on a single disk or set of disks in return for a one-
time payment, in a transaction styled as a license of copyright rights
(a so-called shrink wrap license), is treated as the sale of a
copyrighted article and not the transfer of a copyright right.
Therefore, such a transfer is classified solely as the sale of a
copyrighted article for the purposes of the proposed regulations.
IV. Explanation of Provisions
Section 1.861-18(a)(1) of the proposed regulations describes the
scope of the proposed regulations. These proposed regulations provide
rules for classifying transfers of computer programs for the purposes
of subchapter N of chapter 1 of the Internal Revenue Code, sections
367, 404A, 482, 551, 679, 1057, 1059A, chapter 3, chapter 5, sections
842 and 845 (to the extent involving a foreign person), and transfers
to foreign trusts not covered by section 679.
Section 1.861-18(a)(2) describes the categories of transactions
relating to computer programs. In particular, a transfer of a copyright
right may be either a sale or license of that right and a transfer of a
copyrighted article may be either a sale or lease of that copyrighted
article. Section 1.861-18(a)(3) defines the term computer program.
Section 1.861-18(b)(1) provides that a transaction involving the
transfer of a computer program will be classified as either the
transfer of a copyright right, the transfer of a copyrighted article,
the provision of services relating to the development of a computer
program, or the provision of know-how.
Section 1.861-18(b)(2) provides that a transaction involving
computer programs which consists of more than one of the categories in
paragraph (b)(1), is treated as separate transactions. Any resulting
transaction that is de minimis, however, taking into account all facts
and circumstances, will not be treated as a separate transaction.
Section 1.861-18(c)(1)(i) provides that the transfer of a computer
program will be classified as the transfer of a copyright right if the
transferee acquires one or more of the rights set forth in paragraph
(c)(2).
Section 1.861-18(c)(1)(ii) provides that if such rights are not
transferred and the transaction does not involve, or involves to only a
de minimis extent, the provision of services or know-how, then the
transaction will be classified solely as the transfer of a copyrighted
article.
Section 1.861-18(c)(2) identifies those rights that will be treated
as copyright rights for purposes of the proposed regulations. This list
differs from the list of rights set out in the Copyright Act to take
into account the special nature of computer programs. Specifically, the
copyright law right to copy will only be treated as a copyright right
for the purposes of the proposed regulations if it is accompanied by
the right to distribute such copies to the public. The copyright rights
that apply for purposes of this section are, in addition to the right
to copy and distribute to the public, the right to prepare derivative
computer programs, the right to make a public performance of the
computer program, and the right to publicly display the computer
program. The list of rights contained in Sec. 1.861-18(c)(2) rather
than those contained in the Copyright Act will apply for the purposes
of the proposed regulations.
Section 1.861-18(c)(3) defines a copyrighted article as a copy of a
computer program from which the work can be perceived, reproduced or
otherwise communicated.
Section 1.861-18(d) of the proposed regulations provides rules for
determining whether a transaction involving a newly-developed or
modified computer program will be treated as the provision of services
or another transaction described in paragraph (b)(1) of this section.
The determination is based on all facts and circumstances, including
how risk of loss is allocated and the intent of the parties as to
ownership of the copyright. See, e.g., Boulez v. Commissioner, 83 T.C.
584 (1984); Rev. Rul. 74-555 (1974-2 C.B. 202); Rev. Rul. 84-78 (1984-1
C.B. 173).
Section 1.861-18(e) provides rules for determining whether a
transfer of information related to a computer program will be
considered the provision of know-how. A provision of know-how will not
be considered to occur unless a party transfers information that (i)
relates to computer programming techniques, (ii) is not capable of
being copyrighted, and (iii) is protected by trade secret protection.
Under Sec. 1.861-18(f)(1), if a transfer involves copyright rights,
it will be further classified as either a sale or a license of
copyright rights. This classification will be made by
[[Page 58154]]
examining whether, taking into account all facts and circumstances, all
substantial rights, under the principles of sections 1222 and 1235,
have passed to the transferee.
Under Sec. 1.861-18(f)(2), if a transfer involves a copyrighted
article, it will be further classified as either a sale or a lease of a
copyrighted article. This classification will be made by examining
whether the benefits and burdens of ownership have passed to the
transferee. See, e.g., Grodt & McKay Realty, Inc. v. Commissioner, 77
T.C. 1221, 1237-38 (1981); Torres v. Commissioner, 88 T.C. 702, 720-27
(1987); Estate of Thomas v. Commissioner, 84 T.C. 412, 431-40 (1985).
Under Sec. 1.861-18(f)(3), the determination of the classification
of a transfer involving a copyright right or copyrighted article must
appropriately consider the special nature of computer programs in
transactions that take advantage of those characteristics. For example,
a transaction in which a person acquires a copyrighted article on disk
subject to a requirement that the disk be destroyed after a specified
period is generally the equivalent of a requirement that the disk be
returned after such period. Similarly, a transaction in which the
program deactivates itself after a specified period may also be treated
as the equivalent of returning the copy.
Section 1.861-18(g) of the proposed regulations provides certain
additional rules of operation. Section 1.861-18(g)(1) provides that
neither the form adopted by the parties to a transaction nor the
classification of a transaction under copyright law are determinative
for tax purposes. Therefore, as illustrated in Example 1, a transfer of
a computer program on a disk subject to a shrink-wrap license will
generally be a sale of a copyrighted article.
Section 1.861-18(g)(2) provides that the method of transferring the
computer program, for example by disk or electronically, shall not be
relevant in determining whether a copyright right or a copyrighted
article has been transferred.
The foregoing rules are illustrated by a number of examples
contained in Sec. 1.861-18(h).
Under Sec. 1.861-18(i), these regulations are proposed to apply to
all transactions occurring on or after the date that is 60 days after
the date the final regulations are published in the Federal Register.
No inference should be drawn from the proposed effective date
concerning the treatment of transactions involving computer programs
entered into before the regulations are applicable.
The application of these rules for purposes of the affected
Internal Revenue Code sections may result in a change in the method of
accounting for certain transactions involving computer programs by
certain taxpayers. If the final regulations are adopted, the IRS will
consider issuing an automatic change revenue procedure to address the
situation where the taxpayer is required to change its method of
accounting to comport with the new regulations.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. Therefore,
a regulatory assessment is not required. It also has been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regulations, and because the
regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Internal Revenue Code, this
notice of proposed rulemaking will be submitted to the Chief Counsel
for Advocacy of the Small Business Administration for comment on its
impact on small business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any comments that are submitted timely
(in the manner described in the ADDRESSES caption) to the IRS. All
comments will be available for public inspection and copying.
A public hearing has been scheduled for March 19, 1997, at 10 a.m.
in the NYU Classroom, room 2615, Internal Revenue Building, 1111
Constitution Avenue NW., Washington, DC. Because of access
restrictions, visitors will not be admitted beyond the Internal Revenue
Building lobby more than 15 minutes before the hearing starts.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons that wish to present oral comments at the hearing must
submit comments by February 11, 1997 and submit an outline of the
topics to be discussed and the time to be devoted to each topic (in the
manner described in the ADDRESSES caption) by February 26, 1997.
A period of 10 minutes will be allotted to each person for making
comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
Drafting Information
The principal authors of these regulations are William H. Morris
and Carol P. Tello, of the Office of Associate Chief Counsel
(International), IRS. However, other personnel from the IRS and
Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.861-18 is added to read as follows:
Sec. 1.861-18 Classification of transactions involving computer
programs.
(a) General--(1) Scope. This section provides rules for classifying
transactions relating to computer programs for purposes of subchapter N
of chapter 1 of the Internal Revenue Code, sections 367, 404A, 482,
551, 679, 1057, 1059A, chapter 3, chapter 5, sections 842 and 845 (to
the extent involving a foreign person), and transfers to foreign trusts
not covered by section 679.
(2) Categories of transactions. This section generally requires
that such transactions be treated as being solely within one of four
categories (described in paragraph (b)(1) of this section) and provides
certain rules for categorizing such transactions. In the case of a
transfer of a copyright right, this section provides rules for
determining whether the transaction should be classified as either a
sale or exchange, or a license generating royalty income. In the case
of a transfer of a copyrighted article, this section provides rules for
determining whether the transaction should be classified as either a
sale or exchange, or a lease generating rental income.
(3) Computer program. For purposes of this section, a computer
program is a set of statements or instructions to be used directly or
indirectly in a computer in order to bring about a certain result. For
purposes of this paragraph (a)(3), a computer program includes any data
base or similar item if the data base or similar item is incidental to
the operation of the computer program.
[[Page 58155]]
(b) Categories of transactions--(1) General. Except as provided in
paragraph (b)(2) of this section, a transaction involving the transfer
of, or the provision of services or of know-how with respect to, a
computer program (collectively, a transfer of a computer program) is
treated as being solely one of the following--
(i) A transfer of a copyright right in the computer program;
(ii) A transfer of a copy of the computer program (a copyrighted
article);
(iii) The provision of services for the development or modification
of the computer program; or
(iv) The provision of know-how relating to computer programming
techniques.
(2) Transactions consisting of more than one category. Any
transaction involving computer programs which consists of more than one
of the transactions described in paragraph (b)(1) of this section shall
be treated as separate transactions, with the appropriate provisions of
this section being applied to each such transaction. However, any
transaction that is de minimis, taking into account the overall
transaction and the surrounding facts and circumstances, shall not be
treated as a separate transaction, but as part of another transaction.
(c) Transfers involving both a copyright right and a copyrighted
article--(1) Classification--(i) Transfers treated as transfers of
copyright rights. A transfer of a computer program is classified as a
transfer of a copyright right if, as a result of the transaction, a
person acquires any one or more of the rights described in paragraphs
(c)(2)(i) through (iv) of this section. For example, if a person
receives a disk containing a copy of a computer program which enables
it to exercise, in relation to that program, a non-de minimis right
described in paragraphs (c)(2)(i) through (iv) of this section (and the
transaction does not involve, or involves only a de minimis provision
of services as described in paragraph (d) of this section or of know-
how as described in paragraph (e) of this section), then, under
paragraph (b)(2) of this section, the transfer is classified solely as
a transfer of a copyright right.
(ii) Transfers treated solely as transfers of copyrighted articles.
If a person acquires a copy of a computer program but does not acquire
any of the rights described in paragraphs (c)(2)(i) through (iv) of
this section (and the transaction does not involve, or involves only a
de minimis provision of services as described in paragraph (d) of this
section or of know-how as described in paragraph (e) of this section),
the transfer of the copy of the computer program is classified solely
as a transfer of a copyrighted article.
(2) Copyright rights. The copyright rights referred to in paragraph
(c)(1) of this section are as follows--
(i) The right to make copies of the computer program for purposes
of distribution to the public by sale or other transfer of ownership,
or by rental, lease or lending;
(ii) The right to prepare derivative computer programs based upon
the copyrighted computer program;
(iii) The right to make a public performance of the computer
program; or
(iv) The right to publicly display the computer program.
(3) Copyrighted article. A copyrighted article is a copy of a
computer program from which the work can be perceived, reproduced or
otherwise communicated, either directly or with the aid of a machine or
device. The copy of the program may be fixed in the magnetic medium of
a floppy disk or in the main memory or hard drive of a computer.
(d) Provision of services. The determination of whether a
transaction involving a newly developed or modified computer program is
treated as either the provision of services or another transaction
described in paragraph (b)(1) of this section is based on all the facts
and circumstances of the transaction, including, as appropriate, the
intent of the parties (as evidenced by their agreement and conduct) as
to which party is to own the copyright rights in the computer program
and how the risks of loss are allocated between the parties.
(e) Provision of know-how. The provision of information with
respect to a computer program will not be treated as the provision of
know-how for the purposes of this section unless the information is--
(1) Information relating to computer programming techniques;
(2) Not capable itself of being copyrighted; and
(3) Subject to trade secret protection.
(f) Further classification of transfers involving copyright rights
and copyrighted articles--(1) Transfers of copyright rights. The
determination of whether a transfer of a copyright right is a sale or
exchange of property is made on the basis of whether, taking into
account all facts and circumstances, there has been a transfer of all
substantial rights in the copyright. A transaction that does not
constitute a sale or exchange because not all substantial rights have
been transferred will be classified as a license generating royalty
income. For this purpose, the principles of sections 1222 and 1235
shall apply.
(2) Transfers of copyrighted articles. The determination of whether
a transfer of a copyrighted article is a sale or exchange is made on
the basis of whether, taking into account all facts and circumstances,
the benefits and burdens of ownership have been transferred. A
transaction that does not constitute a sale or exchange because
insufficient benefits and burdens of ownership of the copyrighted
article have been transferred, such that a person other than the
transferee is properly treated as the owner of the copyrighted article,
will be classified as a lease generating rental income.
(3) Special circumstances of computer programs. In connection with
determinations under this paragraph (f), consideration must be given as
appropriate to the special characteristics of computer programs in
transactions that take advantage of these characteristics (such as the
ability to make perfect copies at minimal cost). For example, a
transaction in which a person acquires a copy of a computer program on
disk subject to a requirement that the disk be destroyed after a
specified period is generally the equivalent of a transaction subject
to a requirement that the disk be returned after such period.
Similarly, a transaction in which the program deactivates itself after
a specified period is generally the equivalent of returning the copy.
(g) Rules of operation--(1) Term applied to transaction by parties.
Neither the form adopted by the parties to a transaction, nor the
classification of the transaction under copyright law, shall be
determinative. Therefore, for example, if there is a transfer of a
computer program on a single disk for a one-time payment with
restrictions on transfer and reverse engineering, which the parties
characterize as a license (generally referred to as a shrink-wrap
license), application of the rules of paragraphs (c) and (f) of this
section may nevertheless result in the transaction being classified as
the sale of a copyrighted article.
(2) Means of transfer not to be taken into account. The rules of
this section shall be applied irrespective of the physical or
electronic medium used to effectuate a transfer of a computer program.
(h) Examples. The provisions of this section may be illustrated by
the following examples. All of the following examples assume that all
parties are unrelated to each other:
[[Page 58156]]
Example 1. (i) Facts. Corp A, a U.S. corporation, owns the
copyright in a computer program, Program X. It copies Program X on
to disks. The disks are placed in boxes covered with a wrapper on
which is printed what is generally referred to as a shrink-wrap
license. The license is stated to be perpetual. Under the license no
reverse engineering of the computer program is permitted. The
transferee receives, first, the right to use the program on two of
its own computers (for example, a laptop and a desktop) provided
that only one copy is in use at any one time, and, second, the right
to make one copy of the program on each machine as an essential step
in the utilization of the program. The transferee is permitted by
the shrink-wrap license to sell the copy so long as it destroys any
other copies it has made and imposes the same terms and conditions
of the license on the purchaser of its copy. These disks are made
available for sale to the general public in Country Z. In return for
valuable consideration, P, a Country Z resident, receives one such
disk.
(ii) Analysis. (A) Under paragraph (g)(1) of this section, the
label license is not determinative. None of the copyright rights
described in paragraph (c)(2) of this section have been transferred
in this transaction. P has received a copy of the program, however,
and, therefore, under paragraph (c)(1)(ii) of this section, P has
acquired solely a copyrighted article.
(B) Taking into account all of the facts and circumstances, P is
properly treated as the owner of a copyrighted article. Therefore,
under paragraph (f)(2) of this section, there has been a sale of a
copyrighted article rather than the grant of a lease.
Example 2. (i) Facts. The facts are the same as those in Example
1, except that instead of selling disks, Corp A, the U.S.
corporation, decides to make Program X available, for a fee, on a
World Wide Web home page on the Internet. P, the Country Z resident,
in return for payment made to Corp A, downloads Program X (via
modem) onto the hard drive of his computer. As part of the
electronic communication, P signifies his assent to a license
agreement with terms identical to those in Example 1, except that in
this case P may make a back-up copy of the program on to a disk.
(ii) Analysis. (A) None of the copyright rights described in
paragraph (c)(2) of this section have passed to P. Although P did
not buy a physical copy of the disk with the program on it,
paragraph (g)(2) of this section provides that the means of
transferring the program is irrelevant. Therefore, P has acquired a
copyrighted article.
(B) As in Example 1, P is properly treated as the owner of a
copyrighted article. Therefore, under paragraph (f)(2) of this
section, there has been a sale of a copyrighted article rather than
the grant of a lease.
Example 3. (i) Facts. The facts are the same as those in Example
1, except that Corp A only allows P, the Country Z resident, to use
Program X for one week. At the end of that week, P must return the
disk with Program X on it to Corp A. P must also destroy any copies
made of Program X. If P wishes to use Program X for a further period
he must enter into a new agreement to use the program for an
additional charge.
(ii) Analysis. (A) Under paragraph (c)(2) of this section, P has
received no copyright rights. Because P has received a copy of the
program under paragraph (c)(1)(ii) of this section, he has,
therefore, received a copyrighted article.
(B) Taking into account all of the facts and circumstances, P is
not properly treated as the owner of a copyrighted article.
Therefore, under paragraph (f)(2) of this section, there has been a
lease of a copyrighted article rather than a sale. Taking into
account the special characteristics of computer programs as provided
in paragraph (f)(3) of this section, the result would be the same if
P were required to destroy the disk at the end of the one-week
period instead of returning it since Corp A can make additional
copies of the program at minimal cost.
Example 4. (i) Facts. The facts are the same as those in Example
2, where P, the Country Z resident, receives Program X from Corp A's
home page on the Internet, except that P may only use Program X for
a period of one week at the end of which an electronic lock is
activated and the program can no longer be accessed. Thereafter, if
P wishes to use Program X, it must return to the home page and pay
Corp A to send an electronic key to reactivate the program for
another week.
(ii) Analysis. (A) As in Example 3, under paragraph (c)(2) of
this section, P has not received any copyright rights. P has
received a copy of the program, and under paragraph (g)(2) of this
section, the means of transmission is irrelevant, P has, therefore,
under paragraph (c)(1)(ii) of this section, received a copyrighted
article.
(B) As in Example 3, P is not properly treated as the owner of a
copyrighted article. Therefore, under paragraph (f)(2) of this
section, there has been a lease of a copyrighted article rather than
a sale. While P does retain Program X on its computer at the end of
the one week period, as a legal matter P no longer has the right to
use the program (without further payment) and, indeed, cannot use
the program without the electronic key. Functionally, Program X is
no longer on the hard drive of P's computer. Instead, the hard drive
contains only a series of numbers which no longer perform the
function of Program X. Although in Example 3, P was required to
physically return the disk, taking into account the special
characteristics of computer programs as provided in paragraph (f)(3)
of this section, the result in this Example 4 is the same as in
Example 3.
Example 5. (i) Facts. Corp A, a U.S. corporation, transfers a
disk containing Program X to Corp B, a Country Z corporation, and
grants Corp B an exclusive license for the remaining term of the
copyright to copy and distribute an unlimited number of copies of
Program X in the geographic area of Country Z, prepare derivative
works based upon Program X, make public performances of Program X,
and publicly display Program X. Corp B will pay Corp A a royalty of
$y a year for three years, which is the expected period during which
Program X will have commercially exploitable value.
(ii) Analysis. (A) Although Corp A has transferred a disk with a
copy of Program X on it to Corp B, under paragraph (c)(1)(i) of this
section because this transfer is accompanied by a copyright right
identified in paragraph (c)(2)(i) of this section, this transaction
is a transfer solely of copyright rights, not of copyrighted
articles. For purposes of paragraph (b)(2) of this section, the disk
containing a copy of Program X is a de minimis component of the
transaction.
(B) Applying the all substantial rights test under paragraph
(f)(1) of this section, Corp A will be treated as having sold
copyright rights to Corp B. Corp B has acquired all of the copyright
rights in Program X, has received the right to use them exclusively
within a geographic area, and has received the rights for the
remaining life of the copyright in Program X. Under paragraph (g)(1)
of this section, the fact that the agreement is labelled a license
is not controlling (nor is the fact that Corp A receives a sum
labelled a royalty). (This would also be the case if the copy of
Program X to be used for the purposes of reproduction were
transmitted electronically to Corp B, as a result of the application
of the rule of paragraph (g)(2) of this section.)
Example 6. (i) Facts. Corp A, a U.S. corporation, transfers a
disk containing Program X to Corp B, a Country Z corporation, and
grants Corp B the non exclusive right to reproduce and distribute
for sale to the public an unlimited number of disks at its factory
in Country Z in return for a payment related to the number of disks
copied and sold. The term of the agreement is two years, which is
less than the remaining life of the copyright.
(ii) Analysis. (A) As in Example 5, the transfer of the disk
containing the copy of the program does not constitute the transfer
of a copyrighted article under paragraph (c)(1) of this section
because Corp B has also acquired a copyright right under paragraph
(c)(2)(i) of this section. For purposes of paragraph (b)(2) of this
section, the disk containing Program X is a de minimis component of
the transaction.
(B) Taking into account all of the facts and circumstances,
there has been a license of Program X to Corp B, and the payments
made by Corp B are royalties. Under paragraph (f)(1) of this
section, there has not been a transfer of all substantial rights in
the copyright to Program X because Corp A has the right to enter
into other licenses with respect to the copyright of Program X,
including in Country Z (or even to sell that copyright, subject to
Corp B's interest). Corp B has acquired no right itself to license
the copyright rights in Program X. Finally, the term of the license
is for less than the remaining life of the copyright in Program X.
Example 7. (i) Facts. Corp C, a distributor in Country Z, enters
into an agreement with Corp A, a U.S. corporation, to purchase as
many copies of Program X on disk as it may from time-to-time
request. Corp C will then sell these disks to retailers. The disks
are shipped in boxes covered by shrink-wrap licenses (identical to
the license described in Example 1).
(ii) Analysis. (A) Corp C has not acquired any copyright rights
under paragraph (c)(2) of this section with respect to Program X. It
has acquired individual copies of Program X,
[[Page 58157]]
which it may sell to others. The use of the term license is not
dispositive under paragraph (g)(1) of this section. Under paragraph
(c)(1)(ii) of this section, Corp C has acquired copyrighted
articles.
(B) Taking into account all of the facts and circumstances, Corp
C is properly treated as the owner of copyrighted articles.
Therefore, under paragraph (f)(2) of this section, there has been a
sale of copyrighted articles.
Example 8. (i) Facts. Corp A, a U.S. corporation, transfers a
disk containing Program X to Corp D, a foreign corporation engaged
in the manufacture and sale of personal computers in Country Z. Corp
A grants Corp D the non-exclusive right to copy Program X onto the
hard drive of computers which it manufactures, and to distribute
those copies (on the hard drive) to the public. The term of the
agreement is two years, which is less than the remaining life of the
copyright in Program X. Corp D pays Corp A an amount based on the
number of copies of Program X it loads on to computers.
(ii) Analysis. The analysis is the same as in Example 6. Under
paragraph (c)(2)(i) of this section, Corp D has acquired a copyright
right enabling it to exploit Program X by copying it on to the hard
drives of the computers that it manufactures and then sells. For
purposes of paragraph (b)(2) of this section, the disk containing
Program X is a de minimis component of the transaction. Taking into
account all of the facts and circumstances, Corp D has not, however,
acquired all substantial rights in the copyright to Program X (for
example, the term of the agreement is less than the remaining life
of the copyright). Under paragraph (f)(1) of this section, this
transaction is, therefore, a license of Program X to Corp D rather
than a sale and the payments made by Corp D are royalties.
Example 9. (i) Facts. The facts are the same as in Example 8,
except that Corp D, the Country Z corporation, receives physical
disks. The disks are shipped in boxes covered by shrink-wrap
licenses (identical to the licenses described in Example 1). Corp D
uses each individual disk only once to load a single copy of Program
X onto each separate computer. Corp D transfers the disk with the
computer when it is sold.
(ii) Analysis. (A) As in Example 7 (unlike Example 8) no
copyright right identified in paragraph (c)(2) of this section has
been transferred. Corp D acquires the disks without the right to
reproduce and distribute publicly further copies of Program X. This
is therefore the transfer of copyrighted articles under paragraph
(c)(1)(ii) of this section.
(B) Taking into account all of the facts and circumstances, Corp
D is properly treated as the owner of copyrighted articles.
Therefore, under paragraph (f)(2) of this section, the transaction
is classified as the sale of a copyrighted article.
Example 10. (i) Facts. Corp A, a U.S. corporation, transfers a
disk containing Program X to Corp E, a Country Z corporation, and
grants Corp E the right to load Program X onto 50 individual
workstations for use only by Corp E employees at one location in
return for a one-time per-user fee (generally referred to as a site
license). If additional workstations are subsequently introduced,
Program X may be loaded on to those machines for additional one-time
per-user fees. The license which grants the rights to operate
Program X on 50 workstations also prohibits Corp E from selling the
disk (or any of the 50 copies) or reverse engineering the program.
The term of the license is stated to be perpetual.
(ii) Analysis. (A) The grant of a right to copy, unaccompanied
by the right to distribute those copies to the public, is not the
transfer of a copyright right under paragraph (c)(2) of this
section. Therefore, under paragraph (c)(1)(ii) of this section, this
transaction is a transfer of copyrighted articles (50 copies of
Program X).
(B) Taking into account all of the facts and circumstances, P is
properly treated as the owner of a copyrighted article. Therefore,
under paragraph (f)(2) of this section, there has been a sale of
copyrighted articles rather than the grant of a lease.
Notwithstanding the restriction on sale, other factors such as, for
example, the risk of loss and the right to use the copies in
perpetuity outweigh, in this case, the restrictions placed on the
right of alienation.
Example 11. (i) Facts. The facts are the same as in Example 10,
except that Corp E, the Country Z corporation, acquires the right to
make Program X available to workstation users who are Corp E
employees by way of a local area network (LAN). The number of users
that can use Program X on the LAN at any one time is limited to 50.
Corp E pays a one-time fee for the right to have up to 50 employees
use the program at the same time.
(ii) Analysis. Under paragraph (g)(2) of this section the mode
of transmission is irrelevant. Therefore, as in Example 10, under
paragraph (c)(2) of this section, no copyright right has been
transferred and thus, under paragraph (c)(1)(ii) of this section,
this transaction will be classified as the transfer of a copyrighted
article. Under the benefits and burdens test of paragraph (f)(2) of
this section, this transaction is a sale of copyrighted articles.
Example 12. (i) Facts. The facts are the same as in Example 11,
except that Corp E pays a monthly fee to Corp A, the U.S.
corporation, calculated with reference to the permitted maximum
number of users (which can be changed) and the computing power of
Corp E's server. In return for this monthly fee, Corp C receives the
right to receive upgrades of Program X when they become available.
The agreement may be terminated by either party at the end of any
month. When the disk containing the upgrade is received, or if the
contract is terminated, Corp E must return the disk containing the
earlier version of Program X to Corp A, and delete (or otherwise
destroy) any copies made of the current version of Program X. The
agreement specifically provides that Corp E has not thereby been
granted an option to purchase Program X.
(ii) Analysis. (A) Corp E has received no copyright rights under
paragraph (c)(2) of this section. Under paragraph (d) of this
section, based on all the facts and circumstances of the
transaction, Corp A has not provided services to Corp E. Therefore,
under paragraph (c)(1)(ii) of this section, the transaction is a
transfer of a copyrighted article.
(B) Taking into account all facts and circumstances, under the
benefits and burdens test Corp E is not properly treated as the
owner of the copyrighted article. Corp E does not receive the right
to use Program X in perpetuity, but only for so long as it continues
to make payments. Corp E does not have the right to purchase Program
X on advantageous (or, indeed, any) terms once a certain amount of
money has been paid to Corp A or a certain period of time has
elapsed (which might indicate a sale). Once the agreement is
terminated, Corp E will no longer possess any copies of Program X,
current or superseded. Therefore under paragraph (f)(2) of this
section there has been a lease of a copyrighted article.
Example 13. (i) Facts. The facts are the same as in Example 12,
except that while Corp E must return copies of Program X as new
upgrades are received, if the agreement terminates, Corp E may keep
the latest version of Program X (although Corp E is still prohibited
from selling or otherwise transferring any copy of Program X).
(ii) Analysis. For the reasons stated in Example 10, the
transfer of the program will be treated as a sale of a copyrighted
article rather than as a lease.
Example 14. (i) Facts. Corp G, a Country Z corporation, enters
into a contract with Corp A, a U.S. corporation, for Corp A to
modify Program X so that it can be used at Corp G's facility in
Country Z. Under the contract, Corp G is to acquire one copy of the
program on a disk and the right to use the program on 5,000
workstations. The contract requires Corp A to rewrite elements of
Program X so that it will conform to Country Z accounting standards.
The services required to perform this task are de minimis taking
into account the facts and circumstances of this transaction. The
agreement between Corp A and Corp G is otherwise identical as to
rights and payment terms as the agreement described in Example 10.
(ii) Analysis. (A) As in Example 10, no copyright rights are
being transferred under paragraph (c)(2) of this section. Under
paragraph (b)(2) of this section, the services provided are de
minimis. This transaction will be classified, therefore, as a
transfer of copyrighted articles under paragraph (c)(1)(ii) of this
section.
(B) Taking into account all facts and circumstances, Corp G is
properly treated as the owner of copyrighted articles. Therefore,
under paragraph (f)(2) of this section, there has been the sale of a
copyrighted article rather than the grant of a lease.
Example 15. (i) Facts. Corp H, a Country Z corporation, enters
into a license agreement for a modified version of Program X only if
Corp A, a U.S. corporation, makes substantial modifications to the
program. Only the core idea of Program X will be used and a
considerable amount of labor will be expended in rewriting Program
X, which under applicable copyright law as a derivative work will be
a separate, new program. Corp A and Corp H agree that Corp A is
modifying Program X for Corp H and that, when modified Program X is
completed, the copyright in the modified program will belong to Corp
H. Corp H gives instructions
[[Page 58158]]
to Corp A programmers regarding program specifications. Corp H
agrees to pay Corp A a fixed monthly sum during development of the
program. If Corp H is dissatisfied with the development of the
program it may cancel the contract at the end of any month. In the
event of termination, Corp A will retain all payments, while any
procedures, techniques or copyrightable interests will be the
property of Corp H. All of the payments are labelled royalties.
There is no provision in the agreement for any continuing
relationship between Corp A and Corp H, such as the furnishing of
updates of the program, after completion of the modification work.
(ii) Analysis. Taking into account all of the facts and
circumstances, Corp A is treated as providing services to Corp H.
Under paragraph (d) of this section, Corp A is treated as providing
services to Corp H because Corp H bears all of the risks of loss
associated with the development of modified Program X and is the
owner of all copyright rights in modified Program X. Under paragraph
(g)(1) of this section, the fact that the agreement is labelled a
license is not controlling (nor is the fact that Corp A receives a
sum labelled a royalty).
Example 16. (i) Facts. Corp A, a U.S. corporation, and Corp I, a
Country Z corporation, agree that a development engineer employed by
Corp A will travel to Country Z to provide know-how relating to
certain techniques which are not generally known to computer
programmers which will enable Corp I to more efficiently create
computer programs. These techniques represent the product of
experience gained by Corp A from working on many computer
programming projects. Such information is not capable of being
copyrighted, but it is subject to trade secret protection.
(ii) Analysis. This transaction contains the elements of know-
how specified in paragraph (e) of this section. Therefore, this
transaction will be classified as the provision of know-how.
(i) Effective date. This section applies to transactions occurring
on or after the date that is sixty days after the date final
regulations are published in the Federal Register.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 96-29055 Filed 11-7-96; 3:11 pm]
BILLING CODE 4830-01-U