Were prepaid software-license fees and monthly license-and-support charges subject to Florida sales tax?

Subject

License Fees for the Use of Computer Software

Plain-English summary

The company's prepaid software-license fees and monthly license-and-support fees were taxable except when the customer licensed company-customized applications without buying the company's hardware in that transaction.

Client-selected set-up options and client use of a standard user-programming application did not make the standard software customized, because the company was not modifying the program. Those licenses were taxable sales of tangible personal property under the rule applied in 1994.

Even company-customized software became taxable when it was contractually bundled with the company's hardware, because the customization service was part of the hardware sale. By contrast, an additional application modified by the company for a customer's specific needs and licensed separately for already-owned hardware was treated as an exempt service; the associated monthly support fee was also exempt in that situation.

What this means for you

The ruling distinguished customer configuration from vendor customization and then asked whether the software transaction was tied to a hardware sale. Both the work performed and the contract bundle controlled the result.

Common questions

Did customer-installed set-ups make the software customized? No.

Was company-customized software always exempt? No. It was taxable when provided as part of the company's hardware sale.

When was the license fee exempt? When the company customized the application for the customer and licensed it without a related hardware purchase, as described in the ruling.

What happened to the monthly support fee in that exception? It was also not subject to sales or use tax.

Citations and references

• Fla. Stat. §§ 212.02(16)(a), (17), and 213.22
• Fla. Admin. Code r. 12A-1.032(1), (2), (4), and (5)

Source

• Landing page: Florida Tax Law Library
• Advisement: TAA 94A-054

Original ruling text

Oct 14, 1994

Re: Technical Assistance Advisement 94(A)-054
Sales Tax - License Fees for the Use of Computer Software
Taxpayer: XXX (Herein the "Company")
Address: XXX
Sales Tax Number: XXX
FEI#: XXX
Section 212.02(17), Florida Statutes (F.S.)
Rule 12A-1.032, F.A.C. (Florida Administrative Code)

Dear :

This response is in reply to your May 6, 1994 petition for the
Department's issuance of a Technical Assistance Advisement
("TAA") pursuant to s. 213.22, F.S. Your petition regards the
referenced matter and party. The Department has carefully
examined your petition and finds it to meet the criteria set
forth in Chapter 12-11, F.A.C., requisite to issuance of a TAA.
Therefore, the Department is by this response issuing the
requested TAA.

DISCUSSION OF FACTS

Your petition and supporting documents impart the following
significant information regarding the issues under advisement
herein:

"II. General Nature of Taxpayer's Business Activities:

"[Company] sells computer systems which include computer
hardware consisting of central processing units, peripheral
equipment and licenses various industry-specific computer
software applications to automobile, truck, motorcycle,
industrial vehicle and agricultural equipment dealers. The
separate software applications range from back-office
accounting and inventory control to front-office showroom
traffic tracking and vehicle financing. The size of the

dealer clients ranges from single brand dealers to `megadealers' who carry multiple brands. XXX client base
includes domestic and foreign automobile, truck,
motorcycle, industrial vehicle and agricultural franchises.

"III. Software Applications:

"(A). overview:

"[Company] offers approximately 30 software applications.
On average, large multi-franchise dealers (mega-dealers') license 20 applications while single-franchise dealers license an average of 9 applications. "Each of the 30 software applications represent[s] standard software offered universally to all clients. Each standard application has several alternativeset-up' modification
options (as defined in paragraph III(C)(1) and listed in
Exhibit II, most of which are installed or set-up' by clients. Also, in a few circumstances, the [Company] will reprogram orcustomize' a standard application to a
limited extent (see III (C) (3). Accordingly, the software
licensed by each client is different only to the extent
that set-up modifications may vary or, in limited
situations, to the extent that the standard application is
customized.

"(B). Description of Software Applications:

"Refer to Exhibit I for a description of each of the 30
software applications and to Exhibit II for a listing of
the appropriate `set-up' modifications.

"(C). Software Analysis:

"(1). Standard Applications:

`Set-ups':

"Each of the 30 standard applications [is] tailored to meet
the individual needs of each client through the use of
set-ups'. Exhibit II lists the variousset-up'

modifications.

"The client's requirements are generally defined by a
series of set-up' decisions that will control how the particular application (Inventory, Accounting, etc.) will function on a daily basis for that client. Aset-up'
would be defined as a feature within the software that
tailors the standard application to the client's needs. It
allows the dealer to choose options which alter the
functionality of the software application without actually
modifying the program.

"Virtually all set-ups' are installed by the client. Generally, client-installedset-ups' are those that
pertain to client-preference options. Examples include:
defining how many days supply for their stock order, the
number of invoices to print, the number of days to store
information, what accounts are to be scheduled or the
different types of MIS information the user may want from
the system.

"A few `set-ups' are installed by [Company]. Typically,
[Company] will install set-ups either because they are
standard across the industry or because of its complexity.
Examples include: setting up the software application
printers on specifically defined ports or helping the user
to set up a daily operating chart.

"(2). `User Programming' Application:

"The User Programming' Application is a separate application available to clients who wish to present or calculate their data in a manner different than what could be obtained from a standard application. This application allows clients the ability to retrieve data from standard application data files in order for the client to recalculate or present data in a different format or to store its data. It is the client, not XXX, that reformats or recalculates the information by means of the standardUser Programming' Application. However, [Company]
conducts the requisite training to educate clients in the

use of this application.

"(3). Custom Modifications of Standard Programs:

"In some instances, there is a need for [Company] to modify
the standard applications in order to meet the specific
needs of a client. This is required when neither the
standard set-ups' nor the standardUser Programming'
Application can meet the client's needs. When modifications
are made by XXX, they could range from small changes to an
extensive change, usually ranging from 1% to 10% of the
original program. Customization usually involves
reformatting or calculation of data in a non-standard
format. Examples of such custom modifications would
include: invoice print formats, Finance and Insurance
application calculations or third party interface to
[Company] applications.

"The number of clients to whom this type of customization
has been provided ranges from less than 1% for some
applications to 4% for others.

"Generally, customization can be performed without changing
the standard software code. In less than 1% of the
modifications, program code needs to be rewritten to some
extent.

"Customization is performed by the [Company] Special
Programming Group. Client requests are analyzed before a
decision is made by [Company] to accept the request. If
accepted, a specification is created and an estimate of
time and cost is provided to the client for approval.

"Once the custom programming is completed, the custom
software is installed on the client's computer by
[Company]. The client is either instructed via telephone,
documentation or both in the operation of the new software
program.

"The client is billed $90.00 per hour for custom
programming. This is a separate one-time charge and is in

addition to the standard contractual licensing fee paid on
the standard software.

"(4). Software License and Fees:

"The average term of a software licensing agreement is five
to seven years. For each application, there is a one-time
prepaid license fee and also a monthly license and support
fee. The prepaid license fees range from $300 to $3,000,
depending on the software application, with an average
license fee of approximately $900.00.

For any single software application, the list price fee is
the same from client to client. Any difference in such
fees is attributable to prices negotiated by the client and
is not due to the number of `set-ups'.

"IV. Presale Consultation and Analysis of User's
Requirements:

"Each [Company] sales representative spends a significant
amount of time in solicitation, consultation and
configuration of the hardware (PC's, printers, modems) and
software to be used at each prospective dealership client.
Most of the presale consultation is devoted to software.
Each dealership client has its own unique needs.

"After consulting with each of the dealership's five major
managers, the [Company] sales representative first
identifies the individual needs of that dealership and
determines the configuration of hardware and software
required to meet these needs. In presale consultation, the
sales representative and the dealership personnel work
together to determine whether the [Company] standard
software application(s) (with appropriate `set-up' options)
can meet the user's specifications. In cases where it does
not, [Company's] Special Programming group may supply more
customized features or programs.

"The average time spent dedicated to presale consultation
and analysis of the user's needs is detailed as follows:

"Detailed manager review: This represents a two to three
hour meeting with each of a dealer's five main managers in
order to determine the way the dealer's current system
works and to propose changes ([Company] software
applications) that would make the dealership more
efficient. 15 estimated man hours

"Product demonstration: This involves a comprehensive
hardware and software presentation with each of the
dealer's department managers emphasizing those features of
each software application, together with the appropriate
`set-up' options, relevant to each manager. A
demonstration can take from a minimum of 8 man hours to a
maximum of 48 man hours. Average: 16 estimated man hours

"Custom report analysis: Where the standard software
applications and available set-ups' do not entirely meet the needs of an individual prospective client, the sales representative identifies the specific concern or request and confers with [Company's] programmers and support people to determine whether [Company] can program the desired change. If so, and if a contract is executed, the standard application would then be customized for the client. See III(C) (3),Custom Modifications of Standard Programs' for
more details. Average: 16 estimated man hours, when
applicable

"All of the above represents an investment of approximately
30 to 50 hours prior to entering into a transaction with a
prospective client. Immediately after the client has
agreed to license the software, account executives,
conversion specialists, install coordinators, programmers
and trainers would invest approximately 100 additional
hours with each new client.

"V. POST-SALE ACTIVITIES:

"(A). Installation and Testing of Programs:

"When the computer system is initially shipped to the

client, it has been pre-loaded with the [Company] software
applications requested by the client. The system at this
point does not have the specific tables and `set-ups'
necessary to allow the software application(s) to execute
in accordance with the client's business needs and
requirements.

"The computer hardware is installed by [Company] at the
client site after which the client is responsible for
testing the application software and the custom set-ups', whether thoseset- ups' were installed by [Company] or the
client.

"(B). Training and Documentation:

"Training is always provided to client's management and
staff. Much of the training is accomplished in training
classes held at [a Company] office location. In some
instances, the training is done at the client's place of
business. It would be difficult for a client to
effectively operate the [Company] software applications
without preliminary training from [Company]. [Company]
also supplies documentation and user guides to its clients
(samples of which may be made available upon request). The
documentation varies by the software application involved.
In general, each application might have a User Guide
(defining daily functions), a Maintenance Guide (defining
setups) and a Manager's Guide. However, due to the number
of software applications offered and the various specific
`set-ups' for each client, the documentation and user
guides alone would not provide a complete understanding of
the system without personal training.

"The number of days required for training would vary
depending on the application. For core applications such
as Accounting, Inventory or Finance and Insurance, training
classes generally average five days for each application
and are provided to client's managers. Other applications
require three to five days of training for each
application.

"(C). Enhancements and Maintenance Support:

"(1). Software Maintenance and Updates:

"[Company] systems require that clients be able to interact
with [Company] via modem. This is referred to as on-line access'. This access provides for both electronic and manual update of the system software.Updates' generally
refer to database changes, such as changes in auto part
prices by manufacturers. These updates can be delivered
electronically or by magnetic tape. The software is not
useful without current data.

"Corrections to software can also be made by [Company] online. Corrections generally involve solving problems that
clients encounter when using the software.

"The on-line access also provides for a quick and easy
method for [Company] to respond to specific regulation
changes imposed by local, state and federal agencies.
Also, auto manufacturers make changes that require
[Company] to modify the standard software. Such changes
occur on a frequent basis.

"[Company] releases an average of 20 - 30 upgrades per
client each year or 2 - 4 upgrades per application. XXX
charges a separate development fee for some updates and
media and freight charges only for other updates. All
clients/licensees of a particular application receive the
same update.

"(2). Telephone Support:

"[Company] also provides telephone support to its clients.
The average client calls approximately 12 - 14 times per
month. Approximately 40 - 50% of these calls raise
questions pertaining to how to use' the applications. The remaining calls are either technical in nature or request assistance in implementing aset-up'.

"While the monthly fee for such telephone support averages

$92.00, the charge can vary between $25 and $300 per month
depending on the complexity of the application. Note that
this monthly fee is exhibited in the taxpayer's standard
contract (Exhibit III) as `software license and support
fees'. However, this monthly fee is primarily related to
telephone support. As noted previously, there is a
separate one-time upfront charge billed to clients for the
prepaid software application license fees. There is also a
separate charge billed to the clients for the upgrades.
The software telephone consultation support is not optional
to the client.

"VI. Supporting Documents:

"A copy of the [Company] - Dealer Services Division
Software License Agreement is attached for review Exhibit
III."

REQUESTED ADVISEMENT

You endeavor to elicit the Department's advice regarding the
following specific questions:

"Based upon the above description of the taxpayer's
software licensing activities and in conjunction with
numerous inquiries raised by its client base, the taxpayer
requests a determination by the Florida Department of
Revenue whether [Company's] software applications meet the
criteria under Rule 12A-1.032(4) for classification as
custom programs' which are not subject to sales tax. Under this Rule,retail sales of prepackaged programs
which are fully useable by the customer without
modifications and where the vendor does not perform a
detailed analysis of the customer's requirements in
selecting or preparing the programs are taxable as sales of
tangible personal property. However, where the vendor, at
the customer's request, modifies or alters a prepackaged
program to a customer's specification and charges the
customer for a single transaction, the charge is for a
customized software package and is exempt as a service
transaction'.

"The taxpayer, therefore, requests a determination from the
Department of Revenue as to whether Florida sales and use
tax applies to:

"1. The prepaid license fee for its software applications
offered to clients and described herein;

"2. The monthly charge for `software license and support'
as exhibited in the client contract (but which is in fact a
charge for telephone support)."

DISCUSSION OF LAW

It is necessary to consult the following statutory and
administrative law in addressing the matters under advisement
herein:

ADMINISTRATIVE LAW

Rule 12A-1.032, F.A.C.: "Computers and Related Systems.
"(1) Computer hardware' is defined as the machine and all of its components. Computersoftware' is the programming
needed to make computers operate.
"(2) The sale to a consumer of a computer and its related
components is taxable when delivered to a customer in this
state. The rental of a computer and its related components,
including terminal equipment (hardware) which is physically
located in this state, is taxable....
"(4) The charge which a computer technician makes for a
customized software package which includes such items as
instructional material, pre-punched cards or programmed
tapes is construed to be a service charge and exempt.
Retail sales of pre-packaged programs for use with
audio/visual equipment or other computer equipment, where
the programs are fully useable by the customer without
modifications and the vendor does not perform a detailed
analysis of the customer's requirements in selecting or
preparing the programs, are taxable as sales of tangible
personal property. However, where the vendor, at the
customer's request, modifies or alters a pre-packaged

program to the customer's specification and charges the
customer for a single transaction, the charge is for a
customized software package and is exempt as a service
transaction.
"(5) When a computer technician surveys a customer's needs
and as a result makes recommendations which may include
instructional material, diagrams and layouts, a software
package, including pre-punched cards or programmed tapes,
the charge made is construed to be for professional
services and is exempt...." (Emphasis Supplied)

STATUTORY LAW

Section 212.02(16)(a), F.S.: "`Sale' means and includes:
"(a) Any transfer of title or possession, or both,
exchange, barter, license, lease, or rental, conditional or
otherwise, in any manner or by any means whatsoever, of
tangible personal property for a consideration." (Emphasis
Supplied)

Section 212.02(17), F.S.: "Sales price' means the total amount paid for tangible personal property, including any services that are a part of the sale, valued in money, whether paid in money or otherwise, and includes any amount for which credit is given to the purchaser by the seller, without any deduction therefrom on account of the cost of the property sold, the cost of materials used, labor or service cost, interest charged, losses, or any other expense whatsoever.Sales price' also includes the
consideration for a transaction which requires both labor
and material to alter, remodel, maintain, adjust, or repair
tangible personal property...." (Emphasis Supplied)

CONCLUSIONS OF LAW

First, we consider the question of whether the Company's
software as described in your petition constitutes "prepackaged"
software (tangible personal property) or "customized" software
(a service). In those instances where the modification or
tailoring of the standard software is not performed by the
Company, but instead is performed directly by the customer using

the standard "set-up" features or the standard "user
programming" application, then we are compelled to conclude that
the transaction does not result in the license of customized
software as contemplated by Rule 12A-1.032(4), F.A.C. In such
cases, no customization is being perform by the Company. Under
such circumstances, the Company is granting a license to use
tangible personal property (the noncustomized standard
software). Recall, that the statutory definition of the term
"sale" includes a license to use tangible personal property.
Consequently, a software transaction of this sort by the Company
is subject to sales tax. Conversely, in those instances where
the Company performs modifications of the standard applications
in order to meet the specific needs of the customer as described
in item (3) on page 6 of your petition, it is our finding that
the Company is providing a customized software package as
contemplated by Rule 12A-1.032(4), F.A.C.

Recalling Item 3. of the additional terms and conditions of the
Software Service Agreement, such item effectively serves to
contractually bundle the purchase of the Company's application
software and support services (not optional) to the purchase of
and payment for Company's hardware products. Therefore, the
implication is that in order for the customer to license the
Company's software it must purchase the Company's hardware on
which to use it. Under such facts and circumstances, the issue
of whether software is considered "prepackaged" (tangible
personal property) or "customized" (a service) becomes moot.
Even in those instances where the Company is considered to be
providing a customized software packaged as discussed in the
preceding paragraph, it would constitute a service rendered as
part of the sale of the Company's hardware (tangible personal
property). Accordingly, when we apply the rationale of the
statutory framer's in s. 212.02(17), F.S. (definition of "sales
price", above), to such facts and circumstances, the license of
the Company's software must be viewed as a service rendered as
part of the sale of tangible personal property (computer
hardware) in any case in which the Company is also selling
hardware to the customer.

However, if the situation were to occur where the customer is
only licensing standard programs with customized modifications

performed by the Company not in connection with the purchase of
the Company's hardware, then the licensing of the additional
applications customized by the Company would constitute a
service transaction and, thus, the license fee and the monthly
support service fee would not be subject to sales or use tax. A
typical example of such situation would be where the customer
had already purchased the Company's hardware and licensed the
Company's software in a previous transaction and is now
licensing additional applications customized by the Company to
use on the same hardware.

In view of the foregoing, the Department hereby enters its
finding that both the prepaid license fees and the monthly
license and support fees are subject to sales tax except in the
case where the customer is licensing customized software
applications without the purchase of hardware as described in
the preceding paragraph.

This response constitutes a Technical Assistance Advisement
under s. 213.22, F.S., which is binding on the Department only
under the facts and circumstances described in the request for
this advice as specified in s. 213.22, F.S. Our response is
predicated on those facts and the specific situation summarized
above. You are advised that subsequent statutory or
administrative rule changes or judicial interpretations of the
statutes or rules upon which this advice is based may subject
similar future transactions to a different treatment than
expressed in this response.

You are further advised that this response and your request are
public records under Chapter 119, F.S., which are subject to
disclosure to the public under the conditions of s. 213.22, F.S.
Your name, address, and any other details which might lead to
identification of the taxpayer must be deleted by the Department
before disclosure. In an effort to protect confidential
information, we request you notify the undersigned in writing
within 15 days of any deletions you wish made to the request or
this response.

Sincerely,

Daniel M. Wagner, Jr.
Tax Law Specialist

DW/

Control No. 15608