Tax Type
Retail Sales and Use Tax
Description
Database conversions and updates; Software modifications
Topic
Exemptions
Taxability of Persons and Transactions
Date Issued
01-11-1994
January 11, 1994
Re: §58.1-1821 Application: Retail Sales and Use Tax
Dear*************
This will reply to your letter of May 14, 1993 in which you seek correction of a sales and use tax assessment issued to the**************("the Taxpayer").
FACTS
The Taxpayer, a Virginia bank, was audited for the period November 1989 through October 1992 and was assessed for its failure to pay the tax on certain purchases. The Taxpayer contests the tax on specific database and computer software transactions maintaining that these transactions are exempt labor or services made in connection with the modification of prewritten programs. Also contested is the purchase of guidebooks issued by the National Automobile Dealers Association (NADA). In addition, the Taxpayer requests waiver of assessed penalty charges.
DETERMINATION
Each of the issues raised in your letter will be addressed separately as follows:
Database conversion and updates: A review of the two invoices submitted with your correspondence as Exhibit B shows, on the first invoice, contested charges for "initial conversion to create database" and "programming." The second invoice, from the same vendor, lists charges for the "update" of the Taxpayer's records. Furthermore, I understand that the conversion of the Taxpayer's records and the updates are made via the exchange of diskettes.
Va. Code §58.1-609.5(6) provides an exemption from the tax for amounts "separately charged for labor or services rendered in connection with the modification of prewritten programs as defined in §58.1-602." Va. Code §58.1-602 defines a prewritten program to mean "a computer program that is prepared, held or existing for general or repeated sales or lease...."
This exemption is limited in its scope and does not extend to all computer services. In the instant case the contested charges are for conversion of the Taxpayer's records and updates to the Taxpayer's records. Albeit that they may be computerized, the Taxpayer's records do not constitute a "prewritten program" as defined above. Therefore, because the converted records and updates were delivered to the Taxpayer in tangible form, any service charges made in connection with the sale are taxable, regardless that such charges are separately stated.
Furthermore, this determination is entirely consistent with the policy set forth in prior rulings. For example, the application of the tax to conversion services was set forth in the enclosed Public Document 87-88 (2/27/87). Also, see the enclosed P. D. 88-211 (7/26/88) which addresses computer software services. In light of these determinations, charges for the conversion and update of the Taxpayer's records were properly assessed.
Software modifications: The second group of contested charges are documented through fifteen work orders submitted with your correspondence as Exhibit C.
I note that three of the work orders (number 655 and two unnumbered orders which are dated 1/30/91 and 1/31/91) represent charges for services in which no diskettes or any other tangible personal property were delivered to the Taxpayer. These transactions will be removed from the assessment
Of the remaining twelve work orders, ten call for the customizing, alteration, or other modification made to the Taxpayer's existing computer software. Made by the same vendor who originally supplied the prewritten software to the Taxpayer, these modifications are delivered to the Taxpayer on a diskette. The Taxpayer is billed for the diskettes and a separate service charge is billed based on an hourly labor rate.
I find that these charges are for exempt labor or services made in connection with the modification of prewritten software. Because the labor or service charges are separately stated, ten of the contested transactions under your exhibit C will be removed from the assessment.
However, the remaining two work orders (numbers 660 and 650) appear to be for the sale of computer software in tangible form. Work order 660 is for adding a specific program to the Taxpayer's library. Similarly, work order 650 is for an enhanced version of a software program delivered to the Taxpayer on a diskette. It further appears that these programs are prewritten and not exempt custom programs as defined in Va. Code §58.1-602. Therefore, there is no authority to remove charges for the sale of these programs from the assessment.
Furthermore, through discussions with my Office of Tax Policy, I understand that subsequent to the audit period the Taxpayer began receiving all of its software transactions from this vendor via a modem, and the Taxpayer questions the correct application of the tax to these modem transactions.
The department has consistently deemed the transfer of computer programs in tangible form (such as a diskette) to be a taxable transfer of tangible personal property. However, computer programs transmitted by intangible means, i.e., over telephone lines or keyed directly into a computer through its keyboard, have been deemed to be nontaxable services. Therefore, when no tangible personal property is involved, the sales tax does not apply.
NADA Guides: The department addressed this issue in a prior determination dated April 21, 1983 (enclosed). Based on that determination, subscriptions for the NADA guides are taxable, and the charges for these subscriptions are correct as assessed.
Assessed penalty: In respect to assessed penalty charges, I do not agree that the auditor used an improper formula for computing the Taxpayer's use tax compliance ratio. As discussed in the attached P. D. 92-100 (6/15/92), the use tax compliance ratio specifically excludes purchases on which the tax was paid to vendors. This is so since the tax paid to vendors at the time of purchase is a sales tax, and not a use tax.
Nevertheless, a review of the Taxpayer's prior audits indicates that software maintenance contracts and database updates and conversions are first time audit issues and so these charges will be removed from the compliance ratio calculation. The audit deficiency will of course also be reduced by the exempt modifications to prewritten software discussed above. Hence, the compliance ratio will be recalculated. If the revised compliance ratio is within acceptable limits for a third generation audit, penalty charges will be removed from the audit.
Accordingly, the audit will be returned to the auditor and the assessment will be revised based on this determination but with interest accrued to date. A revised assessment will be issued as soon as practicable and must be paid within 30 days to avoid accrual of additional interest.
Sincerely,
W. H. Forst
Tax Commissioner
OTP/6992I
Rulings of the Tax Commissioner