The Pennsylvania Supreme Court has ruled that royalties paid for intellectual property used in conjunction with the operation of games played on video machines are not subject to sales or use tax.
This case may put to rest the Commonwealth’s efforts to systematically extend the definition of ‘tangible personal property’ to transactions traditionally viewed as the sale of an intangible. The Commonwealth’s endeavor to subject such intangibles to tax by virtue of the transactions being integrated with tangible personal property appears to be put into check by requiring an analysis of whether the payments for the use of the intellectual property are distinct from the purchases of the tangible personal property. The Court essentially has reinstated a test whereby the nature of the transactions should be examined.
Taxpayers should consider structuring their transactions involving royalty payments for intellectual property in a manner intended to be consistent with this opinion. It remains to be seen how the Commonwealth interprets this decision with regard to transactions in which both nontaxable and taxable transactions are linked in some fashion (e.g., computer services and sale of software).