CDTFA issues draft proposed emergency regulations on California’s new tax on digital products

Background

On June 29, 2026, California Governor Gavin Newsom signed SB 122 into law, which made a monumental change to California sales and use taxes by expanding the taxes to “digital products,” which is defined to primarily mean electronically delivered and remotely accessed prewritten computer software.

SB 122 authorizes the CDTFA to adopt emergency regulations to provide guidance on this expansion. In an effort to identify issues of primary importance to be addressed in the emergency regulations, the CDTFA held a workgroup discussion on July 21st. Although the CDTFA had not started to draft regulations in advance of the workgroup discussion, it was clear that they had thought about several issues and provided verbal feedback to questions and issues that were raised. The CDTFA also made clear that the Draft Regulations would only address issues that are needed to administer the tax beginning January 1, 2027, and that they would work on final regulations in the summer of 2027.

The Draft Regulations

The Draft Regulations in the Discussion Paper cover the following areas:

Tax Base and Exclusions. SB 122 added “digital product” to the tangible personal property definition. A “digital product” is defined as prewritten computer software transferred on tangible storage media, transferred electronically, or accessed remotely, but does not include things like a digital asset, digital audio work, digital audiovisual work, digital book, digital infrastructure, digital video game product, or a digital visual work. The Draft Regulations notes that “digital product” includes but is not limited to software-as-a-service (SaaS).

Consistent with the underlying statute, the Draft Regulations also include examples of the exclusions from the definition of "digital product". However, there are several unanswered questions with respect to the tax base that remain of concern and were not addressed in the Draft Regulations. Namely, the Draft Regulations did not fully address “digital infrastructure” or “artificial intelligence” offerings, though we are hopeful that these offerings will be addressed in later iterations of the Draft (or permanent) Regulations or through other guidance.

• First, the Draft Regulations exclude “digital infrastructure” from the definition of taxable digital products. While the Draft Regulations do not provide specific examples, digital infrastructure is described in the regulations as “cloud-based Infrastructure as a Service (IaaS) and Platform as a Service (PaaS) that allow customers to create, deploy, or run their own software application.” This was the first indication from CDTFA that PaaS offerings could be excluded from sales and use tax as digital infrastructure.
• Next, under Revenue and Taxation Code § 6010.9, “sale” and “purchase” do not include the design, development, writing, translation, fabrication, lease, or transfer of custom computer software prepared to the special order of a single customer, meaning such transactions are excluded from sales and use taxes. Importantly, an example in the custom software regulation indicates that AI is not exempt custom software. In the example, a vendor offers an AI-powered tax-analysis tool within its prewritten compliance platform that generates recommended filing categories based on patterns the model learns. To improve its predictions, the vendor trains the AI tool on California’s sales and use tax statutes, regulations, and historical legal opinions. The example states that even though the AI tool produces outputs that appear tailored to California tax rules, these outputs are not the result of computer software prepared to the special order of a single customer and thus are not custom computer software. There is no other guidance in the Draft Regulations addressing AI.
• Finally, consistent with SB 122, the Draft Regulations provide that a digital product that represents a service provided in electronic form is exempt if (i) the service primarily involves the application of human effort by the service provider, and (ii) the human effort originated after the customer requested the service. However, the Draft Regulations indicate that the exemption does not apply to the right to use the provider’s computer software running on a cloud infrastructure or accessed through a thin client interface (i.e., standard SaaS remains taxable).

“Multiple Points of Use” (MPU) Certificates. When there is a purchase of a digital product and the digital product will be used both inside and outside of California, SB 122 allows the CDTFA to set forth, authorize, or require alternative methods to calculate the tax due in California that fairly reflects the tax due on any digital product sold or purchased for use in California including licenses of digital products concurrently available for use in multiple locations.

The Draft Regulations allow the purchaser to use “any reasonable method that is consistent and uniform to calculate the measure of tax that fairly reflects the use of the digital product, including non-optional charges (e.g., mandatory maintenance contracts)[.]”

The CDTFA will presume that calculating the measure of the tax based on (1) the number of users or (2) computers inside California and outside California to be a “reasonable method.” However, CDTFA will not consider allocation based on the location of the servers that host taxable software to be a “reasonable method.”

If the purchaser presents the required MPU documentation to the seller, the seller is relieved of the obligation to pay sales tax or collect and remit the use tax on the calculated non-taxable measure based on the use of the digital product outside of California. However, notably the seller is still liable for collecting the taxable portion of the purchase in California (e.g., the amount of tax attributable to California users).

MPU documentation is “timely” if it is obtained by the seller (i) at any time before the seller bills the purchaser, (ii) at any time within the seller’s normal billing and payment cycle, or (iii) at any time at or prior to the digital product being transferred to or remotely accessed by the purchaser.

With respect to MPU documentation, the CDTFA will not issue a form MPU certificate for purchasers to use. Instead, a letter from the purchaser, or purchase order from the seller will constitute MPU documentation if it contains certain information -including (i) the purchaser’s signature, (ii) date of execution, (iii) the purchaser’s name, address, and telephone number, (iv) the purchaser’s tax account number, (v) a description of the digital product, and (vi) a clear identification of the calculated measure of the tax based on the use of the digital product in California and the calculated non-taxable measure based on the use of the digital product outside of California.

$5 Million “Tax Liability Threshold” for Digital Products. Under SB 122, a retailer is relieved of the obligation to pay sales tax or collect use tax if the gross receipts from the sale of digital products transferred electronically or accessed remotely to a single purchaser exceeds $5M (this threshold increases in 2031 based on a statutory CPI calculation). In these cases, the purchaser is required to self-assess use, obtain a direct payment permit, and pay the use tax directly to the CDTFA.

However, under SB 122, if the CDTFA determines that it is necessary for the efficient administration of the tax, it may waive the requirement for the purchaser to self-assess and pay taxes due directly to the CDTFA and instead the seller will continue to have the obligation to collect and remit the tax.

The Draft Regulation largely tracks the underlying statute but does not yet provide examples of how the threshold and mandatory direct pay permit would work in practice. The Draft Regulation only states that the $5M threshold will be in effect during the 2027 calendar year through the 2031 calendar year.

The Draft Regulation provides details about what information must be included on a waiver request including a statement about why the waiver will be to the mutual convenience of the CDTFA, the seller, and the purchaser. It also notes that the waiver requests must be submitted prior to the purchase of any digital products to which the purchaser intends the waiver to apply.

Technology Transfer Agreements. Based on SB 122’s amendments, the CDTFA determined that the existing application of sales tax to Technology Transfer Agreements (TTAs) as explained in Regulation 1507 is no longer applicable to the sale or purchase of prewritten computer software, including any associated copyright or patent interests. The Draft Regulations included proposed amendments to Regulation 1507 that provide that transactions involving prewritten computer software with associated copyright or patent interests will now be governed by the new digital products rules.

Interstate Commerce Exemption. The CDTFA also addresses the exemption for digital products purchased solely for use outside of California or in interstate or foreign commerce in the Draft Regulations. A written certificate claiming the exemption is timely if it is (i) at any time before the seller bills the purchaser, (ii) at any time within the seller’s normal billing and payment cycle, or (iii) at any time at or prior to the digital product being transferred to or remotely accessed by the purchaser.

Pre-Existing Contracts. The Draft Regulations provide guidance and examples of how the CDTFA will determine whether the expanded sales tax will apply to pre-existing contracts. The Draft Regulations provide that sale occurs when there has been a transfer of the right to the product, “regardless of when the consideration is satisfied in full and regardless of when the purchaser actually uses the digital product.”

The CDTFA’s Draft Regulations include five examples of instances where the purchase of a digital product would or would not be subject to sales tax effective January 1, 2027. These examples explain that if the right to access prewritten computer software is effective prior to January 1, 2027, the sale is not subject to California sales or use tax even if payment is made after January 1, 2027. Subscription offerings are considered a continuing sale and purchase and treated differently as described in the examples. 

• Example 1. On December 15, 2026, a purchaser pays for a one-time user license agreement to access a digital product that is to be transferred electronically. However, the purchaser does not have the right to access the digital product until January 1, 2027.  The sale is subject to sales or use tax.
• Example 2. On December 15, 2026, Company A enters into an agreement to purchase a digital product that is to be transferred electronically, payable in 2027. Company A obtains the right to access the digital product on January 1, 2027.  The sale is subject to sales or use tax.
• Example 3. On December 15, 2026, a digital product is transferred to a purchaser electronically, and the purchaser receives the right to access the digital product immediately; however, payment is not made to the retailer until January 1, 2027.  The sale is not subject to sales or use tax.
• Example 4. On December 15, 2026, a digital product that is to be transferred electronically is sold for a monthly subscription with a 12-month commitment. The contract specifies that the customer will pay $15.99 for the first 3 months of the subscription and then $29.99 per month for the remainder of the subscription. This is a continuing sale and purchase. Tax does not apply to the amounts charged for the continued right to access to the digital product in 2026.  Tax applies to the amounts charged for the continued right to access the digital product on and after January 1, 2027.
• Example 5. On December 15, 2026, a digital product is sold and transferred electronically, with access beginning on the date of sale. The contract specifies that the purchaser may pay $300.00  in full at the time of access  or they may enter into a financing agreement and pay $29.99 per month for twelve months. The sale occurs on December 15, 2026,  and is not subject to sales or use tax, regardless of the time payment is received.

Next Steps

CDTFA will hold an interested parties meeting to discuss the proposed emergency regulations and hear additional comments on September 10, 2026, from 10:00 a.m. – 12:00 p.m. PDT. An interested party can attend either in-person or online, with information available here. Written suggestions or comments, including any proposed regulatory language must be submitted by September 24, 2026, and the CDTFA expects to have finalized emergency regulations before the end of the year. Eversheds Sutherland will attend the September 10th meeting and continue to monitor this significant change in California sales tax policy.

If you have any questions about this Legal Briefing, please feel free to contact any of the attorneys listed or the Eversheds Sutherland attorney with whom you regularly work.