July 21, 2020
Re: Request for Ruling: Corporate Income Tax
Dear *****:
This will respond to your letter in which you seek a ruling regarding the computation of the Virginia sales factor when a taxpayer licenses software that is delivered to customers electronically.
FACTS
The Taxpayer develops and licenses software. The software is pre-written “canned” software that is available to customers without any customization. The Taxpayer receives license fees from customers for use of the software. The Taxpayer also receives fees for product updates and technical support. All of the software and updates are delivered to the customers electronically when the customers download them from the Taxpayer’s website and pay the license fees. The customers do not receive any discs, tapes or any other tangible medium containing the software from the Taxpayer.
The Taxpayer is subject to income tax in a number of states and apportions its income accordingly. The Taxpayer requests a ruling regarding whether licensing the software for a fee and providing paid updates should be treated for Virginia corporate income tax purposes as sales of tangible personal property or intangible property.
RULING
Software and Updates
The Department has previously ruled that sales of prewritten “canned” software are considered sales of tangible personal property for purposes of computing a taxpayer’s Virginia sales factor. See Public Document (P.D.) 94-181 (6/13/1994) and P.D. 96-271 (10/7/1996). Virginia attributes sales of tangible personal property on a destination basis. See Virginia Code § 58.1-415 and Title 23 of the Virginia Administrative Code (VAC) 10-120-220. The Taxpayer explains that the software at issue would be considered “canned” in that it is pre-written and sold for use “as-is” without modification. Therefore, consistent with longstanding policy, sales of such software and any updates to it would be attributed on a destination basis.
Technical Support
The Taxpayer also charges fees for technical support. For corporate income tax purposes, such charges would be considered a sale of a service. Under Virginia Code § 58.1-416, sales, other than sales of tangible personal property, are deemed in Virginia if:
- The income-producing activity is performed in Virginia; or
- The income-producing activity is performed both in and outside Virginia and a greater proportion of the income producing activity is performed in Virginia than in any other state, based on costs of performance.
Pursuant to Title 23 VAC 10-120-230, sales of services from multistate activities are only included in the numerator of the Virginia sales factor if the greater proportion of the income-producing activity is performed in Virginia than in any other state, based on costs of performance. The regulation defines “cost of performance” as the cost of all activities directly performed by the taxpayer for the ultimate purpose of producing the sale to be apportioned. “Income producing activity” is the act or acts directly engaged in by the taxpayer for the ultimate purpose of producing the sale to be apportioned. Indirect expenses such as interest or activities produced by independent contractors are not included.
In General Motors Corporation v. Commonwealth of Virginia, 268 Va. 289, 602 S. E.2d 123 (2004), the Virginia Supreme Court held that Title 23 VAC 10-120-250 is inconsistent with Virginia Code § 58.1-418 when it limits the costs of performance used to apportion income of a financial corporation to direct costs, excluding costs of independent contractors. Because the language defining “cost of performance” and “income producing activity” in Title 23 VAC 10-120-230 is identical to the language in Title 23 VAC 10-120-250, the cost of performance for purposes of sales of intangibles may not be limited to direct costs and may not exclude indirect expenses such as interest or activities produced by independent contractors.
In response to the General Motors decision, the Department issued Tax Bulletin (VTB) 05-3 (4/18/2005). This bulletin explains that financial corporations may elect to file returns prepared in accordance with Title 23 VAC 10-120-250, pending the Department’s adoption of policies in response to the General Motors decision. The determination as to whether a transaction or sale is a Virginia transaction or sale is an all or nothing test. A taxpayer would first have to determine the direct cost associated with each transaction for a given taxable year. Then the direct costs would be attributed to the states in which they occurred. See Title 23 VAC 10-120-230 C 1. If the transaction resulted from direct costs occurring both in Virginia and outside Virginia, such transaction would be considered to be in Virginia if a greater portion of the direct costs occurred in Virginia than in any other state. See Title 23 VAC 10-120-230 C 2. Conversely, a transaction would not be a Virginia sale if a greater portion of the direct costs occurred in any state other than Virginia.
This ruling is based on the facts presented as summarized above. Any change in facts or the introduction of new facts may lead to a different result. The Department issues no opinion concerning what portion, if any, of the Taxpayer’s sales should be sourced to Virginia.
The Code of Virginia sections, regulations, public documents, and tax bulletin cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department’s web site. If you have any questions regarding this ruling, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/2082.M