Tax Type
Retail Sales and Use Tax
Description
Computers, services, and software; Royalty payments for use of software
Topic
Royalties
Taxability of Persons and Transactions
Date Issued
07-06-1994
July 6, 1994
Re: §58.1-1821 Application: Retail Sales & Use Tax
Dear*****************
This will reply to your letter of January 24, 1994 in which you seek correction of a sales and use tax assessment of your company,*********** (the Taxpayer) for the period July 1990 through June 1993.
FACTS
The Taxpayer, involved in actuarial products sales and services for the insurance industry, has several divisions involved in software sales, consulting, marketing and seminars. It contests two items held taxable in a recent audit: royalty payments and maintenance contracts. The Taxpayer maintains that it does not "use" the software upon which royalties are paid and thus should not be held taxable on such. You point out that the royalty payments are based upon the Taxpayer's ability to sell certain software which is comprised of both another company's and the Taxpayer's programs.
The Taxpayer objects to the tax assessed on maintenance contracts since it maintains that maintenance contracts were removed from their first audit by the department. In the most recent audit, the auditor held the maintenance contracts taxable as they included the transfer of tangible personal property - updates of computer software.
The Taxpayer finally requests that all penalties and interest assessed in connection with the royalty payments and maintenance contracts be waived.
DETERMINATION
I will separately address below the issues raised by the Taxpayer:
Royalties
The Taxpayer enters into a contract with another company ("Company") for non-exclusive rights to integrate the Company s database software and updates into certain of the Taxpayer's computer programs for both use internally and for distribution to the Taxpayer's clients. Under the agreement, the Taxpayer agrees to pay the Company an initial royalty payment and make additional royalty payments each month. The Taxpayer charges sales tax on all software sales to its customers. You contend that the royalty payments are nontaxable as the Taxpayer does not use the software and that the royalties are based on revenue generated from software sales.
The department has consistently held that royalties paid for the use of prewritten computer programs provided on disks and tapes are taxable. See P.D. 91-256 (10/8/94), copy enclosed. While the department's regulations do not specifically address royalties, its policy with respect to such has been made public through the above cited and other ruling letters. Furthermore, the Taxpayer could have contacted the department regarding the tax status of the royalty payments had it been unclear as to the tax status of such. Accordingly, I find no basis for waiving the tax and interest assessed on royalty payments, but will agree to waive the penalty assessed on these payments since this was a new issue for the Taxpayer.
Maintenance Contracts
The Taxpayer maintains that during its prior audit, the auditor determined that the Taxpayer's sales of maintenance contracts were nontaxable. Relying on the auditor's determination, the Taxpayer had not been charging sales tax on its sales of such contracts.
While maintenance contracts which include the transfer of tangible personal property are clearly taxable under Virginia Regulation (VR) 630-10-62.1 [See also P.D. 91-102 (6/28/91) specifically relating to maintenance contracts providing computer updates, copy enclosed], I will agree to remove from the audit assessment the tax, interest, and penalties assessed on the Taxpayer's sales of maintenance contracts. However, from July 1993 forward, the Taxpayer is responsible for the tax on sales of maintenance contracts which provide computer software updates.
You should note that legislation exempting from the sales and use tax one-half of the total charge for maintenance contracts when such contracts provide for both repair or replacement parts and repair labor beginning January 1, 1996 (SB 28) was passed by the 1994 General Assembly. The department will be required to revise its regulations to reflect this change. We anticipate working with affected industries to ensure a smooth transition with respect to this change.
Accordingly, the audit assessment will be revised as set forth herein and a revised Notice of Assessment will be mailed to the Taxpayer as soon as practicable.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/7631H
Rulings of the Tax Commissioner