Software Suicide

To the outside world, Seattle is known as a software hub--but that's not the opinion of software CEOs who actually live here. At least not judging from the e-mails they sent to Seattle city hall earlier this month in response to a proposed tax overhaul.

"I assure you," warned the CEO of Tangis, a local software company on Dexter Avenue North, "the decision to relocate out of the city would be an easy one."

"We prefer to stay in Seattle, but there are many other cities and states ready to lure... businesses away," wrote the CEO of 4thpass Inc., a software firm located in the International District.

"Fortunately, we are an industry that can easily move... someplace where we are wanted," wrote a software company CEO from Queen Anne.

At issue was a tax bill that, after squabbling with the software industry for two years, the city council voted into law on Monday, December 10. The ordinance declares that intellectual property development can be considered "manufacturing" for the purposes of tax collection. In short, Seattle software companies will be required to pay manufacturing taxes--.215 percent of total revenues--for creating code. (Manufacturing taxes are a subset of the city's business-and-occupation tax.)

Local software companies had disputed the tax, arguing that manufacturing companies with in-house intellectual property functions, like legal and advertising services, don't get taxed for those functions, so why should software companies get taxed for developing intellectual property? Some software firms, like Visio and WRQ, Inc., actually beat city lawyers in King County Superior Court over the issue.

However, the Washington Software Alliance was eventually forced to sign off on the city's new scheme or else face more costly court time against the city's finance director, Dwight Dively. The issue for the city was this: A software company (like, say, WRQ) sets up shop in lovely Seattle, develops code in lovely Seattle, and then uses plants in Fife, WA to turn the code into mass-produced software, generating revenues that Seattle tax collectors can't touch. (Big surprise: Fife doesn't collect B&O taxes at all.)

As a compromise with the Washington Software Alliance, the city agreed to let software companies subtract up to .67 percent of their research-and-development costs from their total tax bill.

Ultimately, the city was asking an important question: Just because software companies employ a different business model than traditional firms, should the software industry be a de facto tax shelter?

Unfortunately, the city's answer--levying taxes on the creation of intellectual property--set a disturbing precedent that could scare software companies out of town. As Lew McMurran, director of government and public affairs for the WSA, puts it: "Why would anybody subject themselves to having their creativity taxed?"

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