Are updates to 'canned' software and the support services in an optional maintenance contract taxable in Colorado, when sales tax was already paid on the original software license?

Plain-English summary

A company licenses canned (prewritten) HR-management software under a perpetual license, delivered on a DVD, and correctly collects sales tax on that original license. It also sells an optional annual maintenance contract that bundles software updates (delivered on DVD, including bug fixes) and telephone technical support. It asked whether the updates and support are taxable when tax was already paid on the original software.

Colorado taxes canned software that is capable of repeated sale/licensing, delivered on a tangible medium, under a non-negotiable license (Special Regulation 7). The maintenance answer turns on two distinctions:

1. Is the maintenance required or optional? If a retailer requires the buyer to also purchase maintenance/servicing as part of buying the taxable software, the service charge is taxable even if separately stated (§ 39-26-105(2)). If the buyer can buy the software without the maintenance, the service is not automatically taxed — and you move to the second distinction.

2. Is it an "update" (repair) or an "upgrade" (new property)?
- Updates that repair, correct, or maintain the original programming (e.g., bug fixes): the retailer is the consumer of that property, because it's fixing software the customer already bought. The retailer — not the customer — owes the tax, computed on its cost; for an update the retailer developed itself, it pays use tax on the upgrade's fair market value.
- Upgrades/enhancements that are something other than repairs — genuinely new software: the licensee is the consumer and owes sales tax if any is due. For an optional maintenance contract, only the upgrade portion is taxable, and only when the fees for consultation, support, error corrections, and training are separately stated (and the separate statement isn't a device to avoid tax on the upgrades/manuals). The upgrade is taxable only if it meets Special Regulation 7 (tangible media, non-negotiable license, not customized for one customer). If upgrade fees are not separately stated, the entire maintenance charge is taxable.

What this means for you

Software publishers selling maintenance/support

Structure and invoice deliberately. If your maintenance plan is optional and you want the non-upgrade pieces (phone support, error correction, training, consulting) to stay untaxed, separately state each of them from the upgrade fees — and don't use that line-item split to hide the real price of taxable upgrades. Lump it all into one undifferentiated "maintenance" fee and Colorado will tax the whole thing.

Know the update-vs-upgrade line

A bug fix that just makes the software you already sold work as promised is something you consume — you owe use tax on its value, the customer owes nothing extra. A new version or feature set is new taxable property the customer is buying — tax it (if delivered on tangible media under a non-negotiable license per Special Regulation 7). The label on the release matters less than whether it repairs or adds.

Don't make maintenance mandatory unless you want it taxed

If buyers must take the maintenance plan to get the software, § 39-26-105(2) makes the whole service charge taxable regardless of how you state it. Keeping maintenance genuinely optional is what preserves the favorable treatment for support/training.

Note: this 2008 letter predates Colorado's later changes to the taxation of software delivered electronically; it addresses canned software on tangible media. Confirm current rules for downloaded or cloud-delivered software.

Common questions

Q: I already paid tax on the software — are the updates taxed again?
A: Not as a second charge to you for bug-fix updates. Those are consumed by the seller, who owes use tax on their value. But new upgrades are new property and can be taxable to you.

Q: What's the difference between an update and an upgrade here?
A: An update repairs/maintains the program you already bought (seller is the consumer/taxpayer). An upgrade is new software you're acquiring (you're the consumer, and it's taxable if it's canned software on tangible media under a non-negotiable license).

Q: How do I keep phone support and training untaxed?
A: Keep the maintenance contract optional and separately state the support, error-correction, and training fees from the upgrade fees — without using the split to understate the upgrades. If you don't separate them, the entire maintenance fee is taxable.

Q: What if I require customers to buy maintenance with the software?
A: Then § 39-26-105(2) makes the maintenance/service charge taxable even if it's separately stated, because it's not separable from the taxable sale.

Q: Can I rely on this letter?
A: No. It's a General Information Letter — general guidance, not binding on the Department, and the Executive Director did not formally review it.

Citations and references

Statutes and regulations:
- § 39-26-104(1)(a), C.R.S. — imposition of Colorado sales/use tax on tangible personal property and some services
- § 39-26-105(2), C.R.S. — when maintenance/service is required as part of a taxable sale, the service charge is taxable even if separately stated
- Department Special Regulation 7 (Computer Software) — canned software taxable if capable of repeated sale/licensing, delivered on tangible media, under a non-negotiable license

Related Colorado software/bundling letters:
- [[gil-08-002-web-hosting-computer-software]] — SaaS/web hosting nontaxable, but licensed canned software can be taxable
- [[gil-08-001-telecommunications-computer-software-freight-training-repair]] — separability of services bundled with a taxable sale

Source

• Landing page: https://tax.colorado.gov/sales-use-tax-letter-rulings
• Original PDF: https://tax.colorado.gov/sites/tax/files/documents/GIL-08-016.pdf

Original ruling text

Office of Tax Policy
P.O. Box 17087
Denver, CO 80217-0087
[email protected]

GIL-2008-16

XXXXXXXXXXXX
Attn: XXXXXXXXX
XXXXXXXXXXXX
XXXXXXXXXXXX
February 28, 2008

Re: software updates and support services
Dear XXXXXXXXXX,
This letter is in response to your letter to the Colorado Department of Revenue, dated December 10,
2007, re: the taxability of software updates and support services.
Issues
1. Are software updates to “canned” software taxable if sales tax has already been collected on
the original software?
2. Are support services offered in conjunction with the software updates taxable?
Background
You provide the following background. [Company] develops, markets, and licenses web operable
human resource management software which the company offers under a traditional perpetual
license agreement. The software is characterized as “canned” and delivered to licensees on a DVD
media device. Sales tax is collected at the time of licensing.
[Company] also offers an annual maintenance contract for which it charges a fee. Although not
expressly stated in your letter, I assume [Company] recommends, but does not require, the licensee
purchase the maintenance contract as part of the software licensing agreement. As part of
maintenance contract, the company provides licensees with updates to the software. You state that
the updates are not necessarily related to the warranty, but they may be updates to fix “bugs” in the
programming. Updates are delivered on DVD media devices. The company also provides, as part of
the maintenance contract, telephone technical support.
Discussion
Colorado imposes sales and use tax on the sale, use, storage and consumption of tangible personal
property and some services. §39-26-104(1)(a), C.R.S. Computer software is taxable if it is prepackaged “canned” software capable of repeated sale or licensing, delivered to the customer in a

tangible medium, and has a non-negotiable license. See, Department Special Regulation 7
(Computer Software). It appears that the company correctly determined that the original sale
(licensing) of its software is taxable.
You ask for guidance regarding the taxability of the software updates and support services. When a
retailer requires that, as part of the sale of taxable tangible personal property, the consumer also
purchase services for the maintenance or servicing of the property, then the charge for the service is
taxable. See, §39-26-105(2), C.R.S. Tax applies to the service charge even if the charge is
separately stated in the contract or invoice.
If the customer has the option to purchase the property without also purchasing the warranty or
maintenance service, then the charge for such service is not taxable. In some cases, the retailer may
also transfer tangible personal property (e.g., a replacement part) to the customer as part of the
maintenance or service work. If the property is used to repair, correct, maintain, or otherwise service
the original property, then the retailer, not the customer, is considered the consumer of the property.
This is because the retailer is replacing defective, damaged, or worn property that was already
purchased by the customer. Therefore, the retailer, not the customer, is liable for sales or use tax on
such property. Tax is computed on the costs incurred by the retailer to purchase and/or manufacture
the warranty or maintenance property. In the context of a software update developed by the retailer,
the retailer pays a use tax based on the fair market value of the upgrade.
However, when a software retailer provides enhancements, upgrades, and other software that are
other than updates to repair, correct or maintain the original programming (collectively referred to
here as “upgrades”), the licensee is acquiring new property. In such cases, the licensee, not the
retailer, is the consumer of the property and is liable for sales tax, if any, due on that purchase. If the
maintenance contract is optional to the licensee of the canned software, then only the portion of the
maintenance fee representing upgrades is taxable, provided the fees for consultation, support
services, error corrections, and training services are separately stated and such separate statement
is not used as a means of avoiding imposition of tax upon the actual gross receipts from the
furnishing of upgrades or manuals. Tax is due on such upgrades if the upgrades meet the criteria set
forth in Special Regulation 7 (Computer Software) – i.e., are delivered to the consumer on tangible
media, are subject to non-negotiable license, and are not customized for any particular customer (i.e.,
are repeatedly sold as a pre-package software). If fees for upgrades are not separately stated, the
entire charge for the maintenance contract is taxable.
Finally, the Department makes a good faith effort to provide accurate and complete answers to
questions posed to it by taxpayers. However, the information and answers provided here are not
binding on the Colorado Department of Revenue, nor do they replace, alter, or supersede Colorado
law and regulations. The Executive Director, who by statute is the only person having authority to
bind the Department, has not formally reviewed and/or approved this response.
Respectfully,

Office of Tax Policy
Colorado Department of Revenue