Tax Type
Retail Sales and Use Tax
Description
Software Custom Modifications License & Services Agreement
Topic
Appropriateness of Audit Methodology
Computation of Tax
Subtractions and Exclusions
Taxpayers' Remedies
Date Issued
08-19-2003
August 19, 2003
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This is in response to your letter requesting correction of the retail sales and use tax assessment issued to ***** (the "Taxpayer") as a result of an audit for the period October 1998 through July 2001. I apologize for the delay in responding to your letter.
FACTS
The Taxpayer sells computer software and offers various computer services. As a result of the audit, the Taxpayer was assessed tax on certain sales of tangible personal property, including programming and consulting, travel, and administrative charges that the auditor maintains was made in connection with the sale of prewritten software. The Taxpayer contests the tax applied to all of the computer service and associated travel charges billed in connection with a "Software Custom Modifications License & Services Agreement, i.e., contract #4855 dated April 12, 2000. That same day and with the same customer, the Taxpayer entered into a Basic License Agreement (Contract #4854) for a prewritten software system.
According to the Department's auditor, the basis for taxing the contested charges is that these contracts are signed on the same day and the computer modification services provided are dependent upon the Taxpayer acquiring the prewritten software. On the other hand, you maintain that the contested charges are exempt because the two contracts noted above are separate and distinct contracts and, therefore, should not be taxed as one agreement.
DETERMINATION
Law of contracts
To determine whether the contested services are subject to taxation as being part of the retail sale of tangible personal property, we must first look at whether the contracts at issue are independent transactions or one transaction. To help us in this determination, we look to the law of contracts for Virginia that is generally set out in Michie's Jurisprudence ("M.J."). Specifically, § 49 of 4A M.J. on Contracts addresses whether separate writings are part of the same transaction, as follows:
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- Where two contracts are so connected as to be parts of the same transaction, they will be read together, and the court may look to one in construing the other. Thus, where two papers are executed at the same time, or contemporaneously, between the same parties, in reference to the same subject matter, they must be regarded as parts of one transaction and receive the same construction as if their several provisions were in one and the same instrument.
In this case, two contracts are executed on the same day and between the same parties. Contract #4854 is for the sale of prewritten software. Contract #4855 is for the modification of that same software. Accordingly, the essential nature or subject matter of both contracts is the prewritten software. Moreover, the prewritten software appears to be useless or ineffective to the customer without the desired modifications. Accordingly, these contracts do not appear to be separate, independent contracts. Rather, these contracts are parts of one transaction for customized prewritten software. This transaction constitutes the retail sale of tangible personal property and services that are generally subject to the retail sales and use tax.
Modification labor for prewritten computer software programs
Notwithstanding the foregoing, the Taxpayer remains eligible for the exemption from the retail sales and use tax under Va. Code § 58.1-609.5(6) for "[a]n amount separately charged for labor or services rendered in connection with the modification of prewritten programs as defined in § 58.1-602." The exemption has broad application and applies not only to the direct costs, such as programming and consulting services used to design, write, test and document modified software programs, but also to necessary associated costs, such as travel and living costs for programmers, engineers and consultants involved in the modification work, and incidental administrative costs related to the modification effort.
Contract #4855 is titled "Software Custom Modifications License & Services Agreement." This document demonstrates the customer's desire to "make certain enhancements or modifications to existing computer software programs and/or provide services in relation to such software." It also demonstrates that the Taxpayer is "willing to provide such services, and to develop custom modifications to such existing programs." In clause 2 of the document, the Taxpayer agrees "to provide the Services specified in Exhibit A relative to the design, programming, testing, and documentation of the Modifications at the billing rates contained in each Work Order." [Emphasis added.] In addition, clause 3 of Contract #4855 sets out the scope and estimated price of the work to include expenses directly related to the modification services, such as travel and living expenses, keypunching and computer processing expenses, and additional documentation costs. Based on the terms set out in Contract #4855, I must conclude that it is for the modification of prewritten software.
On the other hand, a review of Contract #4854 reveals that the only services related to the sale of the prewritten software license are for telephone consulting services, which are included in the price charged for the software license. Contract #4854 involves no programming, consulting, or other services related to the "modification" of the prewritten software.
Based on the foregoing, I find sufficient basis to conclude that the programming, consulting, travel and administrative charges assessed in the audit are services rendered in connection with the modification of the prewritten programs performed to comply with Contract #4855. Based on this determination, the contested assessment ***** will be abated in full.
In regard to the noncontested assessment ***** the Department's records show that it is only partially paid. Accordingly, a consolidated bill for the outstanding assessment, including interest accrued to date, will be mailed shortly to the Taxpayer. No further interest will accrue provided the outstanding assessment is paid within 30 days from the date of this letter.
The Code of Virginia sections cited are available on-line in the Tax Policy Library section of the Department of Taxation's web site, located at www.tax.state.va.us. If you have any questions about this determination, you may contact ***** in the Department's Appeals and Rulings unit, at *****.
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- Sincerely,
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- Kenneth W. Thorson
Tax Commissioner
- Kenneth W. Thorson
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AR/41613R
Rulings of the Tax Commissioner