Tax Type
Retail Sales and Use Tax
Description
Computer Software; Is Licensing Fee Taxable?
Topic
Property Subject to Tax
Taxability of Persons and Transactions
Date Issued
08-15-2001
August 15, 2001
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****
This is in reply to your letter in which you seek correction of a retail sales and use tax assessment issued to ***** (the "Taxpayer") for the period July 1995 through June 1998. I apologize for the delay in the department's response.
FACTS
The Taxpayer, as a franchisee, owns and operates restaurants in Virginia. The restaurants are equipped with a computer software operating system (the "software"), which may be used in connection with the collection, compilation and reporting of data to be used in the restaurant. The software is licensed from the Taxpayer's franchiser, who charges the Taxpayer a quarterly license fee.
An audit by the department revealed that tax was not paid on the license fee, and tax was assessed. The Taxpayer objects to the assessed tax and contends that: (1) the software is a custom program, and (2) the software is not tangible personal property. Therefore, the Taxpayer believes the license fee paid for use of the software is not taxable.
DETERMINATION
Custom and prewritten software
Pursuant to Code of Virginia § 58.1-609.5(7), the sale, lease or rental of custom computer software is exempt from the Virginia retail sales and use tax. Code of Virginia
§ 58.1-602 defines a custom program as "a computer program which is specifically designed and developed only for one customer. The combining of two or more prewritten programs does not constitute a custom computer program. A prewritten program that is modified to any degree remains a prewritten program and does not become custom."
Based on a review of the license agreement, it does not appear that the software at issue is a "custom program" as defined above. For example, the license agreement specifies that the Taxpayer receives "a nonexclusive and nontransferable right . . . to use the Licensed System" at the Taxpayer's restaurant location. Furthermore, other restaurants owned by the Taxpayer and other franchisees operating restaurants pursuant to an agreement with the franchiser are required to enter into a similar software licensing agreement with the franchiser. These facts strongly suggest that the software is not "specifically designed and developed for only one customer" as the statute requires. Instead, the software is designed and developed for all franchisees operating restaurants.
Licensing agreement
Code of Virginia § 58.1-603 imposes the tax on the sale, distribution or lease of tangible personal property in Virginia. As set in the enclosed public documents, the tax applies to the sale or lease of computer software that is provided to customers in tangible form. Similarly, the tax applies to the licensing of prewritten computer software if the license agreement permits the customer not only the right to use the software, but a copy of the software itself in some tangible form. On the other hand, computer programs transmitted electronically (through telephone lines, a modem, etc.) or keyed into the customer's computer by the software vendor are not considered the sale of tangible personal property. See P. D. 94-12 (1/11/94). Accordingly, the sale of computer software in such non-tangible forms is not taxable.
The manner in which the software is delivered to the Taxpayer is not clear from the license agreement and the auditor's report. If the franchiser or its designee loads the software into hardware that it purchases and ultimately sells to the Taxpayer, the sale of the product (which includes hardware and software) is deemed to be the taxable sale of tangible personal property. Accordingly, if the license fee represents a charge for the hardware and software and other services, the entire fee is taxable. On the other hand, if the software is electronically delivered to the Taxpayer (i.e., the software is not delivered in tangible form) and all updates are delivered electronically, the quarterly license fees are not taxable. See P. D. 99-80 (4/21/99).
I am returning this matter to the auditor so that a determination can be made concerning the manner in which the software is delivered to the Taxpayer. Once that determination is made, the auditor shall apply the tax in a manner consistent with the policy set forth in this letter and make the appropriate revisions (if any) to the audit.
If you have any questions regarding the audit, please contact ***** of the department's District Office at *****. Questions regarding this letter may be directed to ***** Office of Tax Policy, at *****.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/17819
Rulings of the Tax Commissioner