Tax Type
Retail Sales and Use Tax
Description
Software production and sales
Topic
Taxability of Persons and Transactions
Date Issued
03-27-1987
March 27. 1987
Re:§58.1-1821 Application/Sales and Use Tax
Dear ******************
This will reply to your letter of September 15, 1986, in which you submit an application for correction of sales and use tax assessed to ****************.
FACTS
Based on the information available, *********** (Taxpayer) is engaged in the development of computer software programs for sale or resale and the modification of such programs. The taxpayer apparently contests the assessment of tax on software programs developed specifically for fuel oil dealers, contending that such programs are custom in nature. Further, it is understood that the taxpayer contests the taxation of licensed software, as well as the taxation of modifications to software. Lastly, the taxpayer questions the taxation of equipment used in the production of computer software products for sale or resale.
DETERMINATION
Before addressing the various issues that have been raised by the taxpayer, it should be noted that certain computer software transactions were in effect exempted from the sales and use tax effective July 1, 1986. "Custom" software programs were on that date excluded from the definition of tangible personal property subject to the tax, while separately stated labor or service charges in connection with the modification of prewritten software programs were excluded from the definition of "sales price" upon which the tax is based. However, as noted in the department's legislative impact statement on the legislation
see enclosed copy), the sale or lease of prewritten software remained subject to the tax.
§58.1-602.24 of the Code of Virginia defines a "custom program" as "a computer program which is specifically designed and developed only for one customer." However, the statute notes that "[t]he combining of two or more prewritten programs does not constitute a custom computer program" and that "[a] prewritten program that is modified to any degree remains a prewritten program and does not become custom."
§58.1-602.25 of the Code of Virginia defines a "prewritten program" as "a computer program that is prepared, held, or existing for general or repeated sale or lease, including a computer program developed for in-house use and subsequently sold or leased to unrelated third parties."
In light of the foregoing, following are my responses to the points raised by the taxpayer:
Custom Programs
All software meeting the above definition of "custom program" is exempt from the tax on and after July 1, 1986. In addition, the department is in the process of developing a comprehensive regulation on the subject of computer software.
As part of the proposed regulation, the department is contemplating a retroactive exemption from the sales and use tax for custom programs. Therefore, to the extent that custom programs sold before July 1, 1986 were included in the department's audit, I would encourage the taxpayer to pay the assessment and file a protective claim for refund under the provisions of §58.1-1824 of the Code of Virginia. In the event that custom software is retroactively exempted from the tax, the taxpayer would then be able to receive a refund of the tax paid on the programs, with accrued interest.
Software Programs for Fuel oil Dealers
It is my understanding that the programs in question were developed for 17 fuel oil dealers. The taxpayer contends that each program was developed to meet the specific needs of the individual dealer. Rather than start from scratch in developing each program, however, the taxpayer used the logic developed from the first such program in designing the remaining programs.
Based on the description provided, the transactions in question may represent the modification of a prewritten program rather than the creation of 17 separate custom programs. In such an event, the tax would apply, however, similar issues are now being considered by the department in connection with its regulation development process. As such, I would again encourage the taxpayer to file a protective claim for refund with respect to these transactions.
Licensing of Computer Software
The sales tax is imposed in §58.1-603 of the Code of Virginia upon the sale, lease or rental of tangible personal property. A licensing agreement often entails the granting of an intangible right or privilege, rather than the passage of tangible personal property to the licensee for his use. However, the licensing of tangible personal property ordinarily conveys not only the right to use the software, but also the tangible software itself. As such, the transaction represents the taxable sale, lease or rental of tangible personal property.
Software Modifications
§58.1-602.16 of the Code of Virginia includes within the definition of a taxable "sale" the "fabrication of tangible personal property for consumers who furnish, either directly or indirectly, the materials used in fabrication." The term "fabrication" is defined in Virginia Regulation 630-10-37 as "[a]n operation which changes the form or state of tangible personal property."
Based on the foregoing, charges prior to July 1, 1986 for the modification of customer provided computer software are subject to the tax as fabrication charges. Of course, separately stated labor or service charges in connection with the modification of prewritten software are nontaxable on and after July 1, 1986.
Manufacturing Equipment
Emergency Virginia Regulation 630-10-49.2 (see enclosed copy) provides that "[t]he production of computer software in tangible form for sale or resale constitutes industrial manufacturing." As such, the manufacturing exemption set forth in §58.1-608.1 of the Code of Virginia and explained in Virginia Regulation 630-10-63 is available for the production of prewritten computer software for sale or resale.
However, the exemption is not available for the production of custom computer software or the modification of prewritten software. In the event that manufacturing equipment is used in both taxable and exempt production activities, the application of the tax is determined based upon the preponderance of the equipment's use. If the equipment is used more than 50 % of the time in exempt activities, the exemption applies; however, if used 50% of the time or more in taxable activities, the tax applies in full.
I do not possess sufficient information on the types of production equipment and computers used by the taxpayer. However, after reading Emergency Virginia Regulation 630-10-49.2 and Virginia Regulation 630-10-63, the taxpayer may contact the department's Technical Services Section if it feels that any production equipment was improperly taxed.
The department will withhold collection action on this assessment for 45 days in order for the taxpayer to submit additional information on the use of its production equipment and to determine whether it will file a protective claim for refund on the issue of custom software.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner