Was a monthly server-support/maintenance fee covering free Microsoft patches and upgrades taxable under Colorado's 2010–2012 software rules?

Plain-English summary

A tax-advisory firm asked, on behalf of a client, whether a maintenance agreement was taxable under Colorado's software rules in effect from March 1, 2010 to June 30, 2012. The client's out-of-state IT service company sells and sets up computers and installs canned software, bills hourly for general IT work, and — the issue here — charges an optional monthly server-support fee that includes searching for and remotely installing free Microsoft patches and software upgrades. The IT company doesn't sell those patches; Microsoft provides them free, usually through automatic updates, and the fee covers server software issues, not hardware. Genuinely new products (e.g., upgrading Windows 7 to Windows 8, or new antivirus) are billed separately, and the client already remits use tax on those.

The Department's general guidance: the monthly server-support fee looks like a non-taxable service. The framework:

• Colorado taxes the sale/use of tangible personal property, not services — but there are exceptions: a service charge not separately stated on an invoice that also includes taxable goods is taxed, and a service inseparable from a taxable sale is taxed even if separately stated (A.D. Stores).
• Timing matters. Beginning July 1, 2012, electronically transmitted software is not taxable at all. But during the March 1, 2010 – June 30, 2012 window, standardized software (prewritten, not developed to a specific purchaser's specs — including prewritten upgrades) was taxable regardless of how it was delivered or downloaded. Microsoft patches fall within "standardized software," which raises the goods-vs-service question.
• Under Leanin' Tree v. City of Boulder (Colo. 2003), Colorado uses a case-by-case, "totality of the circumstances" test, asking whether the transaction's true object / dominant purpose / essence is tangible property or an intangible right/service.
• Applying that, two facts point to a non-taxable service: (1) the fee is charged regardless of whether any patches/upgrades are actually transferred, and (2) the free patches are passed through without any markup (echoing GIL-09-001).

The Department wouldn't make a final determination in a GIL, but the indicators line up on the service side.

What this means for you

IT service providers and managed-service companies

A support/maintenance fee that mainly delivers free, passed-through software updates — and is owed whether or not any software actually changes hands — tends to read as a non-taxable service, even in the older period when prewritten software was taxable. The cleaner your facts on no markup and fee owed regardless of transfer, the stronger the service characterization. Selling a genuinely new software product is a separate, potentially taxable, transaction — keep it billed separately.

Businesses buying IT support

Don't assume a "software maintenance" line is automatically taxable. If it's really paying for labor/monitoring and passes through free vendor patches, it can be a non-taxable service. But watch the separate-statement and inseparability rules — bundling a service with taxable goods on one invoice can pull the service into the tax base.

Accountants and tax professionals

This is a true-object / mixed-transaction analysis under §§ 39-26-104(1)(a) and 202, governed by Leanin' Tree's totality test with the A.D. Stores separability overlay. Mind the date line: standardized software was taxable 3/1/2010–6/30/2012 regardless of delivery; electronically transmitted software became non-taxable 7/1/2012. The markers the Department weighed — fee charged regardless of transfer, free pass-through, no markup (GIL-09-001) — are the useful tells. Compare the later maintenance-agreement rulings [[gil-16-002-annual-software-updates-and-maintenance-agreements]] and [[gil-17-006-optional-maintenance-agreement]], and the separability reasoning in [[plr-13-002-private-letter-ruling]]. Watch the home-rule-city caveat below.

Common questions

Q: Was a software maintenance agreement taxable in Colorado in 2010–2012?
A: It depended on the true object. During that window prewritten ("standardized") software was taxable however delivered, but a maintenance/support fee that mainly installs free, passed-through patches and is charged regardless of any software transfer looks like a non-taxable service.

Q: What changed on July 1, 2012?
A: Electronically transmitted computer software became not subject to Colorado sales or use tax. The 2010–2012 rules taxing standardized software regardless of delivery no longer applied.

Q: Why did the free patches matter?
A: Because they were provided free by Microsoft and passed through without markup, and the fee was owed whether or not any patch was transferred — both signs the customer was buying a service, not software.

Q: What about buying a brand-new program, like a Windows upgrade?
A: That's a separate transaction. New software products were billed separately, and the client already remitted use tax on them.

Q: Can I rely on this letter?
A: No. A General Information Letter is general guidance, not binding on the Department, and makes no determination on specific facts. It also doesn't cover self-collected home-rule city taxes.

Citations and references

Statutes, cases, and guidance:
- §§ 39-26-104(1)(a), 39-26-202, C.R.S. (sales/use tax on tangible personal property, not services)
- § 39-26-102, C.R.S. (effective July 1, 2012, electronically transmitted computer software is not subject to tax)
- A.D. Stores v. Department of Revenue, 19 P.3d 680 (Colo. 2001) (inseparable services included in the sales price)
- Leanin' Tree v. City of Boulder, 72 P.3d 361 (Colo. 2003) (totality-of-circumstances / true-object test)
- Department FYI Sales 89 (Computer Software); GIL-09-001 (free pass-through patches as a non-taxable service)

Source

• Landing page: https://tax.colorado.gov/sales-use-tax-letter-rulings
• Original PDF: https://tax.colorado.gov/sites/tax/files/documents/GIL-13-007.pdf

Original ruling text

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

GIL-13-007
May 14, 2013
XXXXXXXXXXXXXXXX
ATTN: XXXXXXXXXXX
XXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXX
Re: Maintenance Agreements
Dear XXXXXXXXXX,
You submitted on behalf of XXXXXXXXXXXXX (“Company”) a request for guidance to
determine whether a maintenance agreement is subject to tax under the rules governing
software transactions from March 1, 2010 to June 30, 2012.
The Colorado Department of Revenue (“Department”) issues general information letters and private
letter rulings. A general information letter provides a general overview of the relevant tax issues
and is not binding on the Department. A private letter ruling provides a specific determination for a
specific set of facts, is binding on the Department but not on the taxpayer, and requires payment of
a fee. For more information about general information letters and private letter rulings, please see
Department regulation 24-35-103.5 at www.colorado.gov/revenue/tax > Tax Library > Rulings.
The Department initially treats your request as one of a general information letter. If you would like
the Department to issue a private letter ruling on the issues you raise, you can resubmit a request
and fee in compliance with regulation 24-35-103.5. It is important to remember that general
information letters, such as this one, are general discussions of tax law and are not a determination
of the tax consequence of any particular action or inaction.
Issue
Is the maintenance agreement subject to tax under the rules governing software transactions from
March 1, 2010 to June 30, 2012?
Background

Company provides guidance to customers regarding Colorado State, state-administered cities and
counties, special districts and home rule cities’ sales and use tax issues. Company’s client, which is
not located in Colorado, uses an Information Technology (IT) service company which performs
various services for client, including selling and setting up new computers for client, installing
canned software like Microsoft products, and shipping computers directly to Company’s client. The
IT services company bills hourly for general IT services, such as resolving problems with personal
computers, printers, email, etc.
Additionally, the IT service company charges an optional monthly server support fee that includes
searching for and remotely installing relevant free Microsoft product patches and software
upgrades. The IT service company represents that it does not sell the patches or other general
Microsoft product upgrades. The patches and upgrades are provided by the software manufacturer
free of charge and are typically received by users through the software company’s automatic
upgrades feature. The monthly server support fee covers server software issues and not hardware
issues. If any software upgrades are new products, such as switching from Microsoft’s Windows 7
to Windows 8 or installing new versions of antivirus, the IT service company separately charges
clients for such items. Company states that in circumstances where their client purchases new
products, the client remits use tax on purchased upgrades.
Discussion
Colorado levies sales tax on the sale or use of tangible personal property, but not on the sale of
services.1 There are, however, important exceptions to the non-taxability of services. For example,
charges for services are subject to sales tax if the charges are not separately stated on the
customer’s invoice and the invoice includes the sale of taxable goods.2 Services that are
inseparable from the sale of taxable tangible personal property are also included in the sales tax
calculation, even if the service charge is separately stated on the customer’s invoice.3
Beginning July 1, 2012, electronically transmitted computer software is not subject to sales or use
tax.4 However, the question at issue here is whether the maintenance agreement is subject to tax
under the rules governing software transactions occurring between March 1, 2010 to June 30,
2012. From March 1, 2010 to June 30, 2012, standardized software was subject to tax, regardless
of how the standardized software was acquired by the purchaser or downloaded to the purchaser’s
computer. Under these rules, standardized software means computer software, including
prewritten upgrades that is not designated or developed to the specifications of a specific
purchaser.5 Because Microsoft patches and software fall within the definition of standardized
software, the question arises whether the transaction is considered the sale of a service, even
though some tangible personal property is transferred to the buyer, or the sale of tangible personal
property.
In Leanin’ Tree v City of Boulder, 72 P.3rd 361 (Colo. 2003), the Colorado Supreme Court
reviewed a number of tests used in Colorado and other states in such an inquiry. The Court
ultimately adopted a case-by-case approach which looks to the “totality of the circumstances”
and whether the transaction is commonly viewed as a sale of services or sale of goods.
1
2
3
4
5

§§39-26-104(1)(a), and 202, C.R.S.
Hellerstein, State Taxation (WG&L), ¶ 17.12 (The Separate Statement Rule); Department Private Letter Ruling
2009-004; Department Private Letter Ruling 2010-001; Department Private Letter Ruling 2010-004.
A.D. Stores v Department of Revenue, 19 P.3rd 680 (Colo. 2001).
§39-26-102(), C.R.S.
FYI Publication Sales 89, “Computer Software.” To view this publication, please visit
www.colorado.gov/revenue/tax > Tax Library > FYI Publication > Sales > Sales 89.

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(“Varied as these analyses may be, they largely share in common some attempt to identify
characteristics of the transaction at issue that make it either more analogous to what is
reasonably and commonly understood to be a sale of goods, or more analogous to what is
generally understood to be the purchase of a service or intangible right.”6). Factors which the
Court considered included in the determination of this question were whether the “true object,
dominant purpose, or essence” of the transaction is, in fact, corporeal tangible property or an
intangible right or service.7
Although we do not determine this issue in general information letters, there are at least two
facts that suggest company’s monthly server support fee is a non-taxable service. First, the
charge is assessed regardless of whether tangible personal property (patches and upgrades) is
transferred to the client. Second, the free patches and upgrades appear to be passed through
without any specific mark-up. This also suggests that the charge is not a sale of the product.8
Miscellaneous
This letter represents the good faith opinion of Department personnel who are knowledgeable on
state taxes issues. However, the Department does not make a specific determination here on any
of the issues raised and the Department is not bound by this general information letter.
The Department administers state and state-administered local sales and use taxes. This letter
does not address sales and use taxes administered by home-rule cities and home-rule counties.
You may wish to consult with local governments which administer their own sales or use taxes
about the applicability of those taxes. Visit our web site at www.colorado.gov/revenue/tax for more
information about state and local sales taxes.
Enclosed is a redacted version of this letter. Pursuant to statute and regulation, this redacted letter
will be made public within 60 days of the date of this letter. Please let me know in writing within that
60 day period whether you have any suggestions or concerns about this redacted letter.
Sincerely,
Office of Tax Policy Analysis
Colorado Department of Revenue

6
7

8

Leanin’ Tree, supra.
Id. at 365.; see also Steven P. Young & Robert D. Walker, Current Developments: Colorado, 14 J. Multistate Tax
28, 4 1-45 (2004); Andrew W. Swain, The Taxability of Computer Software in Colorado, 32 Colo. Law. 91, 96
(Dec. 2003).
Department General Information Letter 09-001. To view this letter, please visit www.colorado.gov/revenue/tax >
Tax Library > Rulings > Rulings by Number > GIL-09-001.

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