Tax Type
Retail Sales and Use Tax
Description
Modifications/Updates to Prewritten Software
Topic
Collection of Tax
Payment and Refund
Statute of Limitations
Taxable Transactions
Date Issued
04-29-2013
April 29, 2013
Re: Request for Ruling: Retail Sales and Use Tax
Dear *****:
This is in response to your letter in which you request a ruling on the application of the retail sales and use tax to prewritten software, particularly software maintenance, modifications and updates to prewritten software, and training sold and furnished by ***** (the "Taxpayer).
FACTS
The Taxpayer raises questions as to whether retail sales and use tax applies to various transactions made over the past few years. For many years, the Taxpayer indicates that software was delivered both electronically and by compact disc (CD). However for the past year, all software licenses were electronically downloaded by the customer without the provision of any tangible medium. The Taxpayer seeks a ruling to determine whether it should seek refunds of erroneously charged tax on behalf of its customers.
The Department's records indicate that the Taxpayer has been reporting and remitting Virginia retail sales and use tax to the Department since February 2009. There are, however, a number of months in which the Taxpayer did not report and pay such tax to the Department.
RULING
The Taxpayer presents a number of scenarios and questions as discussed below.
Software Maintenance
Facts
The Taxpayer sold and taxed prewritten software transferred on a CD medium in May 2010. The Taxpayer also charged and collected the Virginia retail sales tax on the sale of an annual software maintenance contract but questions whether the tax should apply. The Taxpayer claims that no CDs or diskettes were provided for software maintenance. Rather, new releases of the prewritten software that change the original software program are delivered via an electronic link that the customer downloads on-line.
Question 1
Although the end user license agreement for the software (invoice #001679) and the software maintenance agreement (invoice #001680) are signed on the same day in May 2010, the Taxpayer feels that such agreements are independent transactions. Does the Department feel differently?
No. Although the license agreement and maintenance agreement are signed on the same day, there is no obligation in the license agreement requiring the customer to purchase the maintenance agreement. Furthermore, the agreements are separately signed and are structured separately and not as one overall agreement.1 While one of the conditions of the maintenance agreement requires the termination of such agreement if the license agreement is terminated, such condition by itself does not provide sufficient enough basis to treat the two agreements as one agreement.
Moreover, paragraph 8 of the software maintenance agreement expressly and plainly sets out the intention of the parties that their obligations in the maintenance agreement are separate and distinct from their respective obligations under the license agreement and, except as expressly set forth in the maintenance agreement, nothing in the maintenance agreement shall be deemed to merge any obligation in the maintenance agreement with any obligation under the license agreement. Accordingly, based on all of the foregoing reasons, I find basis for treating the agreements as separate and distinct transactions.
Question 2
Does the Taxpayer have sufficient evidence to support a claim that the new releases furnished under the maintenance contract are downloaded electronically? Does the Taxpayer have sufficient evidence to support a claim that the maintenance contract is a labor only contract that would allow it to request a full refund in connection with invoice #001680?
The software maintenance agreement does not specifically express the terms of delivery of any software releases, updates, etc. As such, I am of the opinion that the agreement would allow the Taxpayer to deliver a prewritten program by any means desired, including the delivery by any tangible medium, such as by CD, diskette, etc. Because the agreement does not specify and restrict delivery only to the electronic delivery of the software, it provides insufficient evidence to claim that a prewritten program is provided by electronic means only.2 Furthermore, the invoice provides no proof that the transfer of the software program was accomplished by electronic delivery only.3
Question 3
The annual software maintenance contract was renewed by the customer in 2011 and 2012. If the original contract is exempt, are the subsequent ones also exempt? If the Department rules that the original software maintenance contract is taxable on 50% of the contract price, are the subsequent maintenance contract renewals subject to the same tax treatment?
While the annual software maintenance agreement and license agreement may be treated as separate transactions in this case based on the reasons provided in the response to Question #1, there exists the problem of how to determine whether updates, upgrades and other enhancements of the prewritten program were transferred electronically or by tangible media. As the response to Question #2 indicates, the lack of delivery terms in the maintenance agreement could allow for either type of software transfer. Accordingly, for retail sales and use tax purposes, the software maintenance agreement should include specific language as to the type of transfers allowed and not allowed so that the intention of the parties is clearly made known. Documentation (invoices, internal documentation establishing electronic downloads, etc.) supporting the transaction needs to establish the exact method of delivery actually intended and used, and such method of delivery needs to be verifiable.
Modifications/Updates to Prewritten Software
Facts
For the computer software sold to a customer in May 2010, the Taxpayer also entered into an agreement (the modification proposal) in June 2010 to modify such software. Once the modifications were made, the Taxpayer emailed the customer with an electronic link to download the modifications. The Taxpayer also billed the customer for an additional amount to maintain the software modification.
Question 1
Are the modification proposal and the software agreement independent transactions?
Yes.
Question 2
Is modification invoice #001691 exempt of the tax? Is the documentation presented sufficient enough to conclude that the modification was sent electronically?
Invoice #001691 sets out a separately stated labor charge for certain modifications to the Taxpayer's software products. The modifications proposal agreed upon by the Taxpayer and the customer sets out the specific modifications desired by the customer to the Taxpayer's products.
Virginia Code § 58.1-609.5 6 provides an exemption from the tax 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." In P.D. 94-12 (1/11/94), the Tax Commissioner determined that separately stated labor to modify prewritten software, while furnished via a diskette, was not taxable pursuant to the exemption set out at Va. Code § 58.1-609.5 6. Because the modification is separately stated on the invoice and such modification can be verified by a review of the modifications proposal, the exemption cited above applies regardless of whether the modification was transferred by tangible or intangible means.
Question 3
How does the tax apply to the additional charges applied to maintenance of the modified software?
As set out in Va. Code § 58.1-602, a prewritten program that is modified to any degree remains a prewritten program and does not become a custom program. Accordingly, a modified prewritten program is still a prewritten program, and maintenance performed on a modified prewritten program constitutes maintenance of a prewritten program.
In determining the intent and, thus, the application of the tax to the transaction, the Department looks to the underlying documents that support the transaction.4 To establish the intent of electronic delivery, it is important to plainly state in written agreements that updates, upgrades and other maintenance enhancements to a prewritten program are only delivered electronically. It is also important to be able to establish that such electronic delivery actually occurred based on internal records of customer downloads. 5 Accordingly, provided the Taxpayer is able to document from records of the transaction that maintenance is performed by electronic means only, no tax will be imposed on the additional maintenance charges. Absent such documentation, the tax applies to the additional charges for maintenance of the modified software.
Question 4
In 2012, the customer was subsequently invoiced three more times for additional modifications and maintenance. In each instance, the Taxpayer sent emails to the customer to provide on-line links to enable the customer to electronically download the modified software. Are these transactions exempt from the tax? If these invoices are tax exempt, does not having an email confirmation make these taxable transactions?
Because charges for modification services are separately stated on these invoices, such labor or services are exempt pursuant to Va. Code § 58.1-609.5 6 regardless of whether the modification is transferred electronically or by a tangible medium.
As for the charge for software maintenance in connection with these three invoices, no maintenance documentation was furnished other than a copy of invoices #001948 and #002023, which list separately stated maintenance charges. Such invoices provide no evidence of the Taxpayer's intent to provide maintenance via electronic delivery only. Accordingly, other documents related to the transaction (e.g., maintenance agreement indicating the intended delivery and email records indicating how delivery was accomplished) are needed to establish that electronic delivery is intended as the only means of delivery of the product to the customer and that such intent was actually carried out.6
Question 5
The customer purchased an upgrade to its software license to change from a 4 user to a 5 user license. The Taxpayer emailed this feature to the customer with a link for downloading it. Has the Taxpayer furnished enough documentation to prove that the upgrade was electronically delivered?
The email documentation provided in support of invoice #002025 is not sufficient for establishing electronic delivery of an upgrade. The email documentation contains two attachments, which do not appear to be typical links for downloading software from an online site. If these attachments contain the on-line links, then additional documentation would be needed to clearly establish such links.
The emails presented also indicate temporary and permanent authorization codes. If all that is needed is an authorization code to enable the upgrade by merely keying the code into the software program, then it would appear that no tangible personal property is transferred. If this is the case, then a more detailed explanation of the upgrade is needed.
Training
On two occasions, the customer requested training. Per the software license agreement, two days of training are included with the base license. At the request of the customer, the Taxpayer also provided additional training or support that went beyond the scope of the maintenance agreement.
Question 1
The initial training was conducted in March 2010, a couple months prior to the purchase of the software and maintenance contract. The purpose of the training session was to answer any questions about how the Taxpayer's product could work for the customer. The Taxpayer contends that this mini-training session was not bundled with the original taxable purchase of the software. Is this training exempt from the tax?
A letter is furnished that the Taxpayer sent to the customer to confirm the Taxpayer's training proposal to conduct a mini-training and question/answer session in regard to how the Taxpayer's product could work for the customer. Invoice #001643 was subsequently submitted to the customer for the one day training session and included charges for meals, lodging and mileage for the trainer. There are no charges for books or other materials. As the Taxpayer did not commit to and thus purchase a license agreement until May 2010, this training session is not conducted in connection with the sale of tangible personal property. Accordingly, the transaction is for services only and is not taxable.
Question 2
The second training occurred in November 2011. The Taxpayer contends that such training was a stand-alone transaction (invoice #001910) and not tied to the original taxable purchase made in May 2010 and should be exempt from the tax.
Paragraph 8 of the software license agreement of May 2010 states that the Taxpayer "shall provide . . . person to train and instruct Licensee's employees in the use of the software on the multi-user system for a period of up to two (2) business days at (Taxpayer's) . . . location." [Emphasis and insert added.] Paragraph 1 (b) of the agreement further indicates that the Taxpayer is not under any duty to install or test the software or to provide instructional training to the licensee in the use and operation of the software, except for the instruction and training to be provided pursuant to paragraph 8 of such agreement. Moreover, paragraph 17 of the terms of payment of the agreement sets out that "[t]wo days of training are included with the base license." Thus, it appears that the software license agreement includes the cost of the software license and two days of training.
Invoice #001910 consists of charges for training, as well as expenses incurred by the Taxpayer for travel, hotel and food. In a letter to the customer preceding the training session, the Taxpayer confirmed two days of training to be held at the customer's location. Because this training is not conducted at the Taxpayer's location and the charge for such training is not included in the base license fee, I must conclude that this training is in addition to and separate from the original purchase of software and training. Accordingly, none of the charges imposed by invoice #001910 are taxable.
Refunds
Title 23 of the Virginia Administrative Code (VAC) 10-210-3040 sets out the general rules for refunds when sales tax is erroneously collected. As noted, the statute of limitations for requesting a refund is three years. Of additional importance is Title 23 VAC 10-20-180 and Va. Code § 58.1-1823 on amending returns claiming a refund.
CONCLUSION
This response is based on the facts provided as summarized above. Any change in the facts or the introduction of new facts may lead to a different result. If an audit were to reveal different facts than presented, the decisions in this ruling could be rendered inapplicable.
The Code of Virginia sections, regulations and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department's web site. If you have any questions about this ruling, you may contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
1.See Public Document (P.D.) 01-116 (9/11/01) on separate agreements.
2.See P.D. 11-70 (5/11/11).
3.For minimum documentation requirements, see P.D. 05-44 (4/4/05) and P.D. 09-83 (5/28/09).
4.See P.D. 07-22 (3/27/07).
5.Just because a vendor declares that electronic delivery is its standard method of delivery does not sufficiently establish, by itself, that the only method of delivery was by electronic delivery." See P.D. 11-112 (6/20/11).
6. Without proper documentation to support a claim of electronic delivery, the Department will deem that the software was delivered in tangible format. See P.D. 08-134 (7/30/08).
Rulings of the Tax Commissioner