California expands sales tax to electronically delivered software

Sales tax treatment of digital products

Digital products as taxable tangible personal property

Senate Bill 122 expands the definition of ‘tangible personal property’ to include digital products and related intellectual property interests for sales and use tax purposes, effective Jan. 1, 2027.  

Under the bill, a ‘digital product’ is defined as prewritten computer software delivered on tangible storage media, transferred electronically or accessed remotely. ‘Transferred electronically’ means obtained by the purchaser through means other than tangible media that allows the purchaser to open, view, access, download, copy, possess, store, manipulate, update or otherwise use the digital product. Accordingly, the expanded tax would include software purchased from many traditional SaaS providers.

Notably, a ‘digital product’ excludes traditional digital goods, such as:

• Digital assets, such as non-fungible tokens (NFTs)
• Digital audio works, such as music
• Digital audiovisual works, such as streaming services
• Digital books, such as e-books
• Digital video game products, including video games transferred electronically or accessed remotely
• Digital visual works, including artwork

Digital infrastructure, including cloud-based service provided remotely that allows a user to create, deploy, scale or run the user’s own computer software on the service provider’s digital platform, is also excluded from the tax under certain conditions.

Additional exemptions apply for purchases solely for use outside California, certain reproduction or resale rights and digital products representing services primarily involving human effort. Custom software remains exempt.  

Sourcing rules

The bill provides rules to determine where a digital product sale should be sourced. These rules vary depending on how the product is delivered.

• Tangible storage media: Sales are generally sourced to the physical location where the transfer occurs.
• In-person transactions (non-tangible delivery): Sales are typically sourced to the seller’s place of business.
• Remote or electronic delivery: Sales are generally sourced to the customer’s billing address.

If no applicable address in California can be identified, the sale may be treated as occurring outside the state and not subject to the tax.

The law establishes a framework under which retailers may be relieved of the collection obligation, shifting responsibility to the purchaser to remit use tax, if a purchaser exceeds a $5 million annual threshold of digital product purchases from a retailer. In those cases, the purchaser is required to self-assess and remit the applicable use tax directly.

Business and personal income tax changes

Senate Bill 122 extends the temporary $5 million tax credit cap under both personal and corporate income tax provisions for another three years, through the 2029 tax year. That cap was originally scheduled to expire at the end of 2026. The legislation also continues provisions related to the annual election to receive a refundable tax credit for 20% of the amount of qualified credits that exceed the $5 million cap. Consistent with current law, the refundable credit amount would first be available in the third tax year after the election is made, and any unused credits affected by the limitation would receive an additional year of carryforward for each year the limitation applies.

Beginning in the 2030 tax year, the business tax credit is permanently capped at $5 million or 70% of a company’s tax liability, whichever is greater. Taxpayers may continue to claim refundable credits generated under the prior-year temporary limitations in addition to the credit cap beginning in 2030.

Additional changes include:

• Taxing payments received from the U.S. Department of Justice’s Anti-Weaponization Fund at 100%
• Reducing the annual minimum franchise tax to $400 for the first year of operation during the 2027 through 2029 tax years