Were software-maintenance charges taxable when separately invoiced but governed by the same contract as a qualifying software license?

Plain-English summary

If the underlying software license satisfied every condition for a qualified license, support, maintenance, and update charges under that license were not subject to Retailers' Occupation Tax whether the terms appeared in the license agreement or a separate agreement. The requester sold optional maintenance on a separate invoice while placing the maintenance terms in the same contract as the license.

The GIL first explained the general maintenance rules. A maintenance charge included in the selling price of taxable property was taxable. A separately sold maintenance agreement generally was not itself a taxable sale, but the provider owed Use Tax on the cost of property transferred during service.

Software required additional distinctions. A patch or bug fix followed the maintenance rules. A new canned-software release or version with enhancements was a taxable software update unless another rule applied. If taxable canned updates were bundled with training, assistance, installation, consultation, or other charges without being separately stated and taxed, the whole agreement was taxable.

The Department declined a binding PLR and did not verify that the taxpayer's license actually met the qualified-license conditions.

What this means for you

Confirm the license satisfies every current regulatory condition before applying the qualified-license treatment. Separately identify taxable canned updates and distinguish them from corrective patches and service-only support.

Common questions

Q: Did using the same contract automatically make maintenance taxable?
A: No, assuming the software license qualified under Section 130.1935(a)(1).

Q: Were canned-software upgrades generally treated like bug fixes?
A: No. New releases with enhancements were treated as taxable canned-software updates unless another rule applied.

Q: Did the Department confirm this taxpayer's license qualified?
A: No. Its conclusion was expressly based on that assumption.

Subject

Computer Software

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2011.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2011/st-11-0004.pdf

Original ruling text

ST 11-0004-GIL 01/11/2011 COMPUTER SOFTWARE
This letter concerns computer software maintenance agreements. See 86 Ill. Adm. Code
130.1935. (This is a GIL.)

January 11, 2011

Dear Xxxxx:
This letter is in response to your letter dated April 5, 2010, in which you request information.
The Department issues two types of letter rulings. Private Letter Rulings (“PLRs”) are issued by the
Department in response to specific taxpayer inquiries concerning the application of a tax statute or
rule to a particular fact situation. A PLR is binding on the Department, but only as to the taxpayer
who is the subject of the request for ruling and only to the extent the facts recited in the PLR are
correct and complete. Persons seeking PLRs must comply with the procedures for PLRs found in the
Department’s regulations at 2 Ill. Adm. Code 1200.110. The purpose of a General Information Letter
(“GIL”) is to direct taxpayers to Department regulations or other sources of information regarding the
topic about which they have inquired. A GIL is not a statement of Department policy and is not
binding on the Department. See 2 Ill. Adm. Code 1200.120. You may access our website at
www.tax.illinois.gov to review regulations, letter rulings and other types of information relevant to your
inquiry.
The nature of your inquiry and the information you have provided require that we respond with
a GIL. In your letter you have stated and made inquiry as follows:

On behalf of our client, FIRM respectfully requests a Private Letter Ruling under Illinois
Regulation 1200.110 as to the proper application of Illinois retail [sic] occupation (ROT)
and use tax (UT) concerning maintenance contracts as detailed below where the price
for the maintenance contract is separately stated on the invoice from the invoice for the
software license, which is exempt pursuant to 86 III Adm. Code 130. 1935(a).
STATEMENT OF FACTS
CLIENT, an out of state entity, which currently files Illinois retail [sic] occupation and use
tax returns, is in the business of licensing computer software. In conjunction with the
licensing of computer software, CLIENT offers the sale of optional maintenance
contracts in connection with the licensing of computer software which is separately
stated on the invoice to the customer(s). Please see Exhibits A (license of software)
and B (maintenance fees) respectively which depict and reflect an example of separate
invoices for the license fee and the maintenance, respectively. Specifically, while this
type of maintenance agreement is optional and is not required to be purchased as part
of the licensing of the software, the terms of the license and maintenance are contained
in a single contract. Exhibit C is attached for your review and reflects a sample a [sic]
contract in which the terms of the exempt license fee pursuant to 86 Ill. Adm. Code

130.1935(a) are contained in the same contract as the terms of the maintenance
(section 5 of Exhibit C).
ISSUE(S) FOR RULING
a)

b)

The above taxpayer seeks the Department’s guidance on the taxability of
optional maintenance agreements that are separately stated on invoices to
customer(s) and which are not required to be purchased as part of the licensing
of the software.
Alternatively, in the event that the Department concludes that the mere fact that
the maintenance agreement and license fee are contained in the same
Agreement (Exhibit C) constitute a mandatory maintenance contract, the
taxpayer seeks the Department’s guidance that maintenance contracts pertaining
to an exempt transaction (the license of software) are nonetheless exempt.

ANALYSIS
By way of background, the underlying license of software, to which the above
maintenance agreements pertain, are exempt. Specifically, pursuant to 86 III Adm.
Code 130. 1935(a), the licensing of software in Illinois is not considered a ‘retail sale’ if it
meets the following five requirements: (1) if it is evidenced by a written agreement, (2) if
it restricts the customer’s duplication and use, (3) if it prohibits the customer from
licensing, sublicensing, or transferring the software to third parties, (4) the vendor will
provide another copy free or of minimal charge if the software is lost or damaged, and
(5) the customer must destroy or return all copies to the vendor at the end of the license
period. Thus, if transactions involving licensing of computer software meet the
requirements mentioned above, the transfer of software is deemed nontaxable.
According to the applicable authority, CLIENT meets the requirement of 86 III Adm.
Code 130.1935 (a) and; therefore, is exempt from the retail [sic] occupation tax on the
licensing of computer software. Again, for the purposes of this ruling request, the
taxpayer is not questioning and/or seeking a ruling concerning the taxability of software
licenses as denoted above. Rather, the taxpayer is seeking a ruling on the taxability of
maintenance agreements associated with the licensing of computer software (an
exempt transaction).
With respect to software maintenance agreements, the taxability of maintenance
agreements is dependent upon whether or not the charge for the agreement is included
in the taxable selling price. If the charge for a maintenance agreement is included in the
taxable selling price, then that charge is considered part of the gross receipts of the
retail transaction and consequently subject to sales tax (ROT). If maintenance
agreements are sold separately, then the sale is not a taxable transaction, but rather the
company providing the maintenance or repair will be acting as a service provider under
the service occupation tax act (SOT). See 86 ILL ADM. CODE 130.1935(b) and 86 ILL.
ADM. CODE 140.301(b)(3). In the instance case, our research indicates that the sale of
optional maintenance contracts associated with the licensing of computer software, with
the price of the maintenance contract being separately stated would not be taxable
pursuant to 86 ILL ADM. CODE 130.1935(b) and 86 ILL. ADM. CODE 140.301(b)(3).
Moreover, our research indicates that in the event the fact that maintenance and license
fees are contained in the same contract so as to possibly constitute a mandatory
maintenance agreement does not change the determination. Specifically, since the
maintenance pertains to an exempt transaction (the license of the software is exempt),

the maintenance would nonetheless still be exempt. 86 ILL ADM. CODE 130.1935(b)
and 86 ILL. ADM. CODE 140.301(b)(3).
REQUESTED RULING
CLIENT seeks guidance confirming its position that
a)

The sale of optional maintenance agreements sold in connection with the
licensing of business software, wherein the price of said optional
maintenance agreements is separately stated, is nontaxable.

Alternatively,
b)

in the event that the Department concludes that the mere fact that the
maintenance agreement and license fee are contained in the same
Agreement (Exhibit C) constitute a mandatory maintenance contract, the
taxpayer seeks the Department’s guidance that maintenance contracts
pertaining to an exempt transaction (the license of software) are
nonetheless exempt.

If the Department has any questions or requires any additional information from CLIENT
in order to determine Illinois Retailers Occupational [sic] (sales and use) tax
consequences of the above optional maintenance contracts as denoted above, please
contact INDIVIDUAL. Thank you in advance for your cooperation and attention to this
matter.

DEPARTMENT’S RESPONSE:
The Department’s regulation “Public Information, Rulemaking and Organization” provides that
“[w]hether to issue a private letter ruling in response to a letter ruling request is within the discretion of
the Department. The Department will respond to all requests for private letter rulings either by
issuance of a ruling or by a letter explaining that the request for ruling will not be honored.” 2 Ill. Adm.
Code 1200.110(a)(4). The Department has decided that it will not issue a Private Letter Ruling in
regards to your request. Although we cannot provide you with a Private Letter Ruling, we hope the
following general information will be of assistance.
In general, maintenance agreements that cover computer software are treated the same as
maintenance agreements for other types of tangible personal property. See 86 Ill. Adm. Code
130.1935(b). The taxation of maintenance agreements is discussed in subsection (b)(3) of Section
140.301 of the Department’s administrative rules under the Service Occupation Tax Act. See 86 Ill.
Adm. Code Sec. 140.301(b)(3). The taxability of agreements for the repair or maintenance of tangible
personal property depends upon whether charges for the agreements are included in the selling price
of the tangible personal property. If the charges for the agreements are included in the selling price
of the tangible personal property, those charges are part of the gross receipts of the retail transaction
and are subject to tax. In those instances, no tax is incurred on the maintenance services or parts
when the repair or servicing is performed. A manufacturer’s warranty that is provided without
additional cost to a purchaser of a new item is an example of an agreement that is included in the
selling price of the tangible personal property.
If agreements for the repair or maintenance of tangible personal property are sold separately
from tangible personal property, sales of those agreements are not taxable transactions. However,

when maintenance or repair services or parts are provided under those agreements, the service or
repair companies will be acting as service providers under provisions of the Service Occupation Tax
Act that provide that when service providers enter into agreements to provide maintenance services
for particular pieces of equipment for stated periods of time at predetermined fees, the service
providers incur Use Tax based on their cost price of tangible personal property transferred to
customers incident to the completion of the maintenance service. See 86 Ill. Adm. Code
140.301(b)(3). The sale of an optional maintenance agreement or extended warranty is an example
of an agreement that is not generally a taxable transaction.
If, under the terms of a maintenance agreement involving computer software, a software
provider provides a piece of object code (“patch” or “bug fix”) to be inserted into an executable
program that is a current or prior release or version of its software product to correct an error or
defect in software or hardware that causes the program to malfunction, the tangible personal property
transferred incident to providing the patch or bug fix is taxed in accordance with the provisions
discussed above.
In contrast to a patch or bug fix, if the sale of a maintenance agreement by a software provider
includes charges for updates of canned software, which consist of new releases or new versions of
the computer software designed to replace an older version of the same product and which include
product enhancements and improvements, the general rules governing taxability of maintenance
agreements do not apply. This is because charges for updates of canned software are fully taxable as
sales of software under Section 130.1935(b). (Please note that if the updates qualify as custom
software under Section 130.1935(c) they may not be taxable). Therefore, if a maintenance
agreement provides for updates of canned software, and the charges for those updates are not
separately stated and taxed from the charges for training, telephone assistance, installation,
consultation, or other maintenance agreement charges, then the whole agreement is taxable as a
sale of canned software.
If all the criteria listed in subsection (a)(1) of Section 130.1935 are met, then neither a
transaction involving the licensing of computer software nor the subsequent software updates will be
considered a taxable retail sale subject to Retailers’ Occupation and Use Tax. See 86 Ill. Adm. Code
130.1935(a)(1)(A)-(E).
Assuming a license of software meets the requirements of subsection (a)(1) of 86 Ill. Adm.
Code 1935, any charges for support, maintenance or updates of the licensed software provided
pursuant to the qualified license agreement would not be subject to Retailer’s Occupation Tax,
whether or not the charges for support, maintenance or updates of the licensed software are billed
pursuant to the terms of the license agreement or the terms of a separate agreement.
I hope this information is helpful. If you require additional information, please visit our website
at www.tax.illinois.gov or contact the Department’s Taxpayer Information Division at (217) 782-3336.
Sincerely,

Richard S. Wolters
Associate Counsel
RSW:msk