Were hosted canned-software license fees and mandatory maintenance fees taxable when Illinois customers accessed the system online?

Plain-English summary

An out-of-state developer licensed a canned insurance-agency system hosted in its own data center. Illinois customers accessed it over the internet and, according to the request, never took possession of the software. The developer also charged mandatory monthly fees covering support, upgrades, and new releases.

IDOR did not classify the particular hosted system or contracts. It gave general software rules instead. Canned software is tangible personal property and generally taxable regardless of whether it is delivered by disk, card, electronic means, or another medium. A software license avoids Retailers' Occupation Tax only if it satisfies all five conditions in Rule 130.1935(a)(1), including a signed agreement, duplication and transfer restrictions, a replacement or archival-copy policy, and return or destruction at the end of the license.

Maintenance included in the software's selling price is taxable with the sale. A separately sold maintenance agreement generally is not taxable to the purchaser, although the service provider owes Use Tax on property transferred during service. If the agreement includes taxable canned-software updates and those charges are not separately stated from support or other services, the entire agreement is taxable as canned software.

The GIL also said retail sellers generally file Form ST-1 monthly; quarterly filing requires IDOR authorization and average monthly liability not exceeding $200.

Common questions

Did internet-only access make the hosted software nontaxable? The GIL did not decide that issue from the stated facts.

Are mandatory maintenance fees always taxable? No single answer was given; treatment depends on whether the fees are included in the software sale and whether taxable updates are separately stated.

Citations and references

• 86 Ill. Adm. Code 130.1935(a), (b), and (c)
• 86 Ill. Adm. Code 140.301(b)(3)
• 86 Ill. Adm. Code 130.501 and 130.502

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2013.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2013/st-13-0054.pdf

Original ruling text

ST 13-0054-GIL 09/19/2013 COMPUTER SOFTWARE
This letter discusses the taxability of computer software licenses and maintenance fees
and the filing of quarterly returns. See 86 Ill. Adm. Code 130.502. See also 86 Ill. Adm.
Code 130.1935 and 86 Ill. Adm. Code 140.301. (This is a GIL.)
September 19, 2013
Dear Xxxxx:
This letter is in response to your letter received in this office on August 9, 2013, 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:
We are a software developer who has developed an ‘System’ for insurance
agencies around the country. I would like to purpose [sic] some questions and get
some answers back for our documentation and support.
The software we license (sell) in STATE is considered canned software because it
is licensed (sold) to several agencies around the country.
My first question is are the start-up ‘License Fees’ taxable and second are the
‘Mandatory Software Maintenance Support Fees’ taxable?
The software is developed and hosted in our Data Center in STATE. The Illinois
Agencies (customers) obtain access via the internet into their org, but never take
procession [sic] of our software. So our question we purpose [sic] is, for Illinois
sales tax purposes, is this software (License Fees) considers [sic] tangible or
intangible and would the software sale be considered taxable?
Our second question is concerning the Mandatory Software Maintenance Fees.
The fees are billed monthly and provides the Illinois customers telephone support
(support is in STATE), upgrades and new releases (versions) via
electronically/internet (again no tangible personal property is ever involved). So,
would the monthly software maintenance fees be taxable for Illinois purposes?

We would also like to know if we as a STATE company and if the above is all
non-taxable if we are required to file quarterly sales tax returns. We are
requesting a Private Letter Ruling on the above tax questions.
Thank you in advance for your assistance in this matter.
questions, please do not hesitate to contact me.

If you have any

DEPARTMENT’S RESPONSE:
The Illinois Retailers’ Occupation Tax Act imposes a tax upon persons engaged in this
State in the business of selling tangible personal property to purchasers for use or consumption.
See 86 Ill. Adm. Code 130.101. The tax is measured by the seller's gross receipts from retail
sales made in the course of such business. "Gross receipts" means the total selling price or the
amount of such sales. The retailer must pay Retailers' Occupation Tax to the Department based
upon its gross receipts, or actual amount received, from the sale of the tangible personal
property.
Generally, sales of “canned” computer software are taxable retail sales in Illinois. Canned
computer software is considered to be tangible personal property regardless of the form in which
it is transferred or transmitted, including tape, disc, card, electronic means, or other media.
However, if the computer software consists of custom computer programs, then the sales of such
software may not be taxable retail sales. 86 Ill. Adm. Code 130.1935. Computer software that is
not custom software is considered to be canned computer software, whether it is “stand-alone” or
not. Custom computer programs or software are prepared to the special order of the customer.
The selection of pre-written or canned programs assembled by vendors into software packages
does not constitute custom software unless real and substantial changes are made to the programs
or creation of program interfacing logic. See Section 130.1935(c)(3).
If transactions for the licensing of computer software meet all of the criteria provided in
subsection (a)(1) of Section 130.1935, neither the transfer of the software nor the subsequent
software updates will be subject to Retailers' Occupation Tax. A license of software is not a
taxable retail sale if:
A)

It is evidenced by a written agreement signed by the licensor and the customer;

B)

It restricts the customer’s duplication and use of the software;

C)

It prohibits the customer from licensing, sublicensing or transferring the software
to a third party (except to a related party) without the permission and continued
control of the licensor;

D)

The licensor has a policy of providing another copy at minimal or no charge if the
customer loses or damages the software, or permitting the licensee to make and
keep an archival copy, and such policy is either stated in the license agreement,
supported by the licensor’s books and records, or supported by a notarized
statement made under penalties of perjury by the licensor; and

E)

The customer must destroy or return all copies of the software to the licensor at
the end of the license period. This provision is deemed to be met, in the case of a
perpetual license, without being set forth in the license agreement.

In your letter, you also mention that you charge mandatory monthly maintenance fees. 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.

Every person engaged in the business of selling tangible personal property at retail must
file a Form ST-1 on a monthly basis on or before the 20th day of each month as required by 86
Ill. Adm. Code 130.501. A taxpayer can be authorized by the Department to file a quarterly
return if provisions for filing quarterly (average monthly liability does not exceed $200) are
fulfilled. The provisions are described in 86 Ill. Adm. Code 130.502. The decision to permit
quarterly or annual filing will be based on information collected by the Department such as
registration and audit information regarding the retailer’s average monthly liability.
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.
Very truly yours,

Cara Bishop
Associate Counsel
CB: