The state of Wisconsin lost in an attempt to look further down the line to find an ultimate consumer to source sales in the case of Wisconsin Department of Revenue v. Microsoft Corporation, Court of Appeals, District IV, Appeal No. 2018AP2024.[1]

The case involves the state of Wisconsin looking to include in the sales factor fees paid to Microsoft for licensing Windows that are included in machines eventually purchased for use in Wisconsin. The purchasers of the computers enter into a sublicense with the manufacturer to use Windows.  The Wisconsin Department of Revenue argues that the licensing fee paid by the manufacturer when they installed Windows on the machine should be sourced to Wisconsin when sold to a Wisconsin resident.[2] 

The decision describes the licensing agreements as follows:

Relevant to the tax years in dispute, Microsoft entered into software copyright license agreements with OEMs.  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.

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.

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.

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. [3]

Under Wisconsin law, generally income is sourced to Wisconsin if the income-producing activity occurs in the state—and, in this case, the OEM’s royalty payments to Microsoft were triggered by their installation of the software on the machines when they were built.  That activity would rarely occur in Wisconsin.[4]

But there is a special rule that provides that gross receipts for computer software includes receipts from the use of computer software where the licensee uses the software at a location in Wisconsin.[5]  The Department of Revenue asserted that the ultimate customer, as sublicensee of the OEM that made the computer, is properly treated as having licensed the software from Microsoft and the fees paid by the OEM covers this use in Wisconsin.

Unfortunately for the Department of Revenue, the Tax Appeals Commission and the Appeals Court did not agree that a sublicensee of Microsoft’s customer represented a licensee of Microsoft in this case.

First, the Appeals Court did not accept the Department’s argument that, as a matter of , the sublicensee in this case was a licensee of Microsoft, finding they cited no precedential support for that proposition.  The Department argued:

Next, the DOR argues that the Commission's determination that the end-users were not licensees of Microsoft was “myopic” and “disregard[ed] the economic reality” of these transactions. The DOR contends that, although the OEMs were licensees of Microsoft, the end-users were also licensees of Microsoft when viewing the “transactions . . . as a whole.”[6]

The appellate court, however, emphasizes that the statute only refers to licensees, noting:

Initially, we note that the question of whether end-users had licenses with Microsoft as the DOR proposes, or instead the end-users did not have a contractual relationship with Microsoft and had only a sublicense with the OEMs as the Commission concluded, must be viewed in the light of the applicable statutory language. To repeat, the exception in the statutory subpart the DOR relies on, WISCONSIN STAT. § 71.25(9)(df), is limited to a “licensee” who uses Microsoft's software in Wisconsin. See § 71.25(9)(df). The text of the statutory provision makes no reference to use of the computer software in Wisconsin by a sublicensee. As already discussed, the terms “license,” “licensor,” “licensee,” “sublicense,” and “sublicensee” have commonly understood meanings in the law.7 In construing the subpart in this fact situation, we must be mindful of those meanings and the distinction between a license and a sublicense. See WIS. STAT. §990.01(1) (“All words and phrases shall be construed according to common and approved usage; but technical words and phrases and others that have a peculiar meaning in the law shall be construed according to such meaning.”) (emphasis added); see also State v. Hemp, 2014 WI 129, ¶31, 359 Wis. 2d 320, 856 N.W.2d 811 (appellate courts “should not read into [a] statute language that the legislature did not put in” (quoted source omitted)). We presume that the legislature chose the term “licensee” carefully to express the statute's intended meaning. See id.[7]

The appellate opinion agrees with the lower tribunal that Microsoft only had a licensing contract with their OEM customers, not with those that bought the computers that the OEMs loaded the software onto:

Upon our independent review of the end-user agreements, we agree with the Commission's interpretation that those were contracts only between OEMs and end-users. See Tufail v. Midwest Hosp., LLC, 2013 WI 62, ¶22, 348 Wis. 2d 631, 833 N.W.2d 586 (contract interpretation presents a question of law an appellate court reviews de novo). As noted in the Background section, the end-user agreements explicitly stated that the contracts were between the end-users and the OEMs, and the DOR does not contend that Microsoft was a party to the end-user agreements. It then follows that there could not have been mutual expression of assent to the end-user agreements, a requirement for a valid contract such as a license, by both Microsoft and an end-user because Microsoft was not a party to the end-user agreement. See Gustafson v. Physicians Ins. Co. of Wis., Inc., 223 Wis. 2d 164, 173, 588 N.W.2d 363 (Ct. App. 1998) (setting forth the requirements for a contract). Without that basic requirement for a contract, there were no licenses between Microsoft and the end-users, and the end-users were not licensees of Microsoft.[8]

Fundamentally, Microsoft was only paid by OEMs when they put Windows on the computers the OEM had built.

The Commission rejected this argument and found that “Microsoft’s gross receipts were not a function of use by actual end-users.” We affirm the Commission’s finding because substantial evidence in the record demonstrates that the amounts paid to Microsoft by the OEMs for the software licenses were not paid as a result of end-user payments to OEMs for the sublicenses as the DOR asserts. The Commission found, and the DOR does not dispute, that the obligations of the OEMs to pay royalties to Microsoft for licenses did not depend on the OEMs’ sales of the computers because OEMs were required to pay royalties to Microsoft even when the OEMs did not sell the computers on which the Microsoft software was installed. Microsoft, in briefing in this court, relies on evidence in the record that Microsoft was paid by the OEMs for the licenses months (if not years) before the OEMs sold the computers, with licensed Microsoft software included, to end-users. In reply, the DOR does not dispute those facts. The Commission further found, and the DOR does not dispute, that the royalties that the OEMs paid to Microsoft were not tied in any way to the prices for which the OEMs sold the computers, and that the OEMs, not Microsoft, were entitled to the sale proceeds and profits from the sales of all of the OEMs’ computers, including any amounts attributable to the software. Thus, the licensing royalties that the OEMS paid Microsoft were not paid indirectly by the end-users.[9]

[1] Wisconsin Department of Revenue v. Microsoft Corporation, Court of Appeals, District IV, Appeal No. 2018AP2024, October 31, 2019, https://www.wicourts.gov/ca/opinion/DisplayDocument.pdf?content=pdf&seqNo=249452,

[2] Wisconsin Department of Revenue v. Microsoft Corporation, p. 2

[3] Wisconsin Department of Revenue v. Microsoft Corporation, p. 3-4

[4] Wisconsin Department of Revenue v. Microsoft Corporation, p. 8

[5] Wisconsin Department of Revenue v. Microsoft Corporation, pp. 8-9

[6] Wisconsin Department of Revenue v. Microsoft Corporation, p. 11

[7] Wisconsin Department of Revenue v. Microsoft Corporation, pp. 11-12

[8] Wisconsin Department of Revenue v. Microsoft Corporation, pp. 13-14

[9] Wisconsin Department of Revenue v. Microsoft Corporation, p. 15