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Wisconsin Department of Revenue v. Microsoft Corp.

Court of Appeals of Wisconsin, District IV

October 31, 2019

Wisconsin Department of Revenue, Plaintiff-Appellant,
Microsoft Corporation, Defendant-Respondent.

          APPEAL from an order of the circuit court for Dane County No. 2017CV2214: SHELLEY J. GAYLORD, Judge. Affirmed.

          Before Fitzpatrick, P.J., Blanchard and Kloppenburg, JJ.

          FITZPATRICK, J.

         ¶1 The Wisconsin Department of Revenue (DOR) appeals a Dane County Circuit Court order that affirmed a decision of the Tax Appeals Commission. The Commission determined that royalties Microsoft Corporation received from licensing its software to original equipment manufacturers (OEMs) that are not located in Wisconsin, but whose products are used in Wisconsin, should not be considered in calculating Microsoft's franchise tax liability to the State of Wisconsin for the tax years 2006 to 2009 under Wis.Stat. § 71.25(9)(d) (2005-06).[1] That statutory subpart concerns the franchise taxation of sales of intangibles if the income-producing activity occurs in Wisconsin. See § 71.25(9)(d). The DOR argues that the Commission erred in failing to apply a statutory exception to § 71.25(9)(d), under which franchise taxation of computer software occurs if a "licensee" uses the software in Wisconsin. See § 71.25(9)(df). According to the DOR, the § 71.25(9)(df) exception requires that the royalties Microsoft received from OEMs not located in Wisconsin must be considered in calculating Microsoft's franchise tax liability because the persons who use those OEMs' products in Wisconsin were, in effect, Microsoft's licensees. We reject the DOR's arguments and, therefore, affirm the circuit court's order that affirmed the Commission's decision.


         ¶2 The following facts are not disputed on appeal.

         ¶3 Microsoft is engaged in the business of developing, distributing, and licensing computer software. In this context, OEMs are businesses that manufacture, or at least assemble, computers, which incorporate Microsoft software. Examples of OEMs that incorporate Microsoft software include Dell and Hewlett Packard.

         ¶4 Relevant to the tax years in dispute, Microsoft entered into software copyright license agreements with OEMs.[2] Some OEMs with which Microsoft entered into license agreements were based in Wisconsin, but the vast majority were not based in Wisconsin. Because this appeal does not concern OEMs based in Wisconsin, for clarity from this point forward all references to "OEMs" are to those OEMs that were not based in Wisconsin.

         ¶5 Under the license agreements, the OEMs paid royalties to Microsoft, in exchange for which Microsoft granted the following non-exclusive rights to the OEMs: (1) to install Microsoft's software on computers; and (2) to distribute Microsoft's software that was installed on the computers and grant sublicenses for end-users to use the software.

         ¶6 OEMs sold the computers with the installed Microsoft software to consumers directly or through retailers such as Best Buy. The Commission referred to the consumers as "end-users," and we do the same. All that is at issue here is end use of the Microsoft software that occurred in Wisconsin, not end use that occurred outside Wisconsin.

         ¶7 Computers sold by the OEMs with Microsoft software installed came with End-User Licensing Agreements (which we will refer to as "end-user agreements"). By accessing and using the Microsoft software on the computers sold by the OEMs, end-users agreed to be bound by the terms of the end-user agreements. The terms of the end-user agreements were dictated by Microsoft. By their terms, the end-user agreements were contracts between the OEMs and the end-users which started with this sentence: "IMPORTANT-READ CAREFULLY: This [end-user agreement] is a legal agreement between you … and the manufacturer [OEM] of the computer system or computer system component ('HARDWARE') with which you acquired the Microsoft software product(s) identified above ('SOFTWARE')." The DOR does not contend that Microsoft was a party to the end-user agreements.

         ¶8 In calculating its franchise tax liability to the State of Wisconsin for tax years 2006 to 2009, Microsoft took the position that the software license royalties it received from OEMs should not be considered in calculating its franchise tax. The DOR subsequently conducted an audit and determined that Microsoft was required to include the royalties that it received from OEMs in its Wisconsin franchise tax calculations. Based on that determination, the DOR assessed against Microsoft additional franchise tax for the tax years 2006 through 2009 that, with statutory interest, totaled almost $2.9 million.

         ¶9 Microsoft petitioned the Commission for review of the additional assessed tax. Following a four-day trial, the Commission reversed the additional franchise tax assessed by the DOR against Microsoft.

         ¶10 The DOR appealed the Commission's decision to the circuit court, which affirmed the Commission's decision. The DOR appeals.

         ¶11 We will consider other pertinent facts in the Discussion that follows.


         ¶12 The DOR contends that the Commission erred when it determined that the software license royalties that the OEMS paid to Microsoft should not be considered in calculating Microsoft's Wisconsin franchise tax. We now set forth our standard of review, consider the relevant portions of the statutory scheme at issue along with the Commission's application of that scheme and the DOR's challenge to the Commission's decision, and explain why we reject the DOR's arguments in support of its challenge.

         I. Standard of Review and Statutory Interpretation.

         ¶13 In an appeal of a circuit court order affirming or reversing an agency decision, we review the decision of the agency, not that of the circuit court. Hilton ex rel. Pages Homeowners' Ass'n v. DNR, 2006 WI 84, ¶15, 293 Wis.2d 1, 717 N.W.2d 166.[3] When reviewing findings of fact made by the Commission, we will affirm the findings if those are supported by substantial evidence. See id., ¶30. "An agency's findings are supported by substantial evidence if a reasonable person could arrive at the same conclusion as the agency, taking into account all the evidence in the record." Clean Wis., Inc. v. Public Serv. Comm'n of Wis., 2005 WI 93, ¶46, 282 Wis.2d 250, 700 N.W.2d 768. When reviewing questions of law decided by an agency, including statutory interpretation, our review is de novo. See Wis. Stat. § 227.57(11) (2017-18), as amended by 2017 Wis. Act 369, § 80; Tetra Tech EC, Inc. v. DOR, 2018 WI 75, ¶84, 382 Wis.2d 496, 914 N.W.2d 21');">914 N.W.2d 21.[4]

         ¶14 This appeal concerns issues of statutory interpretation. Statutory interpretation begins with the statute's text. We give the text its common, ordinary and accepted meaning, except that we give technical or specially defined words their technical or special definitions. State v. Warbelton, 2008 WI.App. 42, ¶13, 308 Wis.2d 459, 747 N.W.2d 717. If the meaning of the statute is clear from its plain language, we do not look beyond that language to ascertain its meaning. Lake City Corp. v. City of Mequon, 207 Wis.2d 155, 163, 558 N.W.2d 100 (1997).

         II. The Software License Royalties Received by Microsoft from OEMs Were Not Subject to the Wisconsin Franchise Tax.

         A. Statutory Framework.

         ¶15 Wisconsin currently imposes, and during the tax years at issue imposed, a franchise tax on a corporation based on the corporation's income derived from, or attributable to, sources within Wisconsin. See Wis. Stat. §§ 71.23(2), 71.25 (2005-06) and (2017-18). When a corporation is engaged in business within Wisconsin and at least one other state, Wisconsin has adopted a method for determining the portion of the corporation's income that is subject to Wisconsin's franchise tax. That process is known as "apportionment," and we now discuss the aspects of that process as applied here. See § 71.25 (2005-06) and (2017-18).

         ¶16 The parties agree that Microsoft conducts business within and without Wisconsin and that Microsoft's business income is subject to apportionment between Wisconsin and other states.

         ¶17 Wisconsin Stat. § 71.25 divides the income of a corporation operating both "within and without" Wisconsin into "apportionable income" and "nonapportionable income." Sec. 71.25(5) (2005-06) and (2017-18). This case concerns only apportionable income, which is income that, for franchise tax purposes, must be allocated to Wisconsin and at least one other state in which the taxpayer, such as Microsoft, is carrying on business. Sec. 71.25(5)(a) (2005-06) and (2017-18).

         ¶18 Wisconsin franchise tax statutes include an "apportionment formula" that is used to calculate the portion of a corporation's income that is properly attributed to business transacted in Wisconsin and accordingly is taxable by Wisconsin. See Wis. Stat. § 71.25(5), (6) and (9) (2005-06) and (2017-18); see Consolidated Freightways Corp. of Del. v. DOR, 164 Wis.2d 764, 775, 477 N.W.2d 44 (1991); United Parcel Serv. Co. v. DOR, 204 Wis.2d 63, 65-66, 72-74, 553 N.W.2d 861 (Ct. App. 1996). During the tax years at issue, that apportionment formula included a percentage of Microsoft's sales, referred to in § 71.25(6) as the "sales factor." See § 71.25(6)(a)-(d). The dispute in this appeal centers on the sales factor segment of the apportionment formula.

         ¶19 The version of Wis.Stat. § 71.25 in effect during the tax years at issue defined the "sales factor" for a taxpayer corporation such as Microsoft as "a fraction," consisting of "[a] numerator … which is the total sales of the taxpayer in this state during the tax period, and [a] denominator … which is the total sales of the taxpayer everywhere during the tax period." Sec. 71.25(9)(a) (emphasis added). The resulting quotient represented the percentage of the sales of ...

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