Did IDOR determine that a reseller's software license met Illinois's five conditions for nontaxable treatment?

Plain-English summary

A software reseller had paid sales tax during a dispute over a client's license and asked IDOR for an official ruling that would help recover the payment. It supplied the end-user license agreement.

IDOR did not decide whether the particular license was exempt. Canned software generally was taxable tangible personal property, but a license was not a taxable retail sale when it met all five conditions in Section 130.1935(a)(1).

Those conditions required a signed written agreement; restrictions on duplication and use; no licensing, sublicensing, or third-party transfer without the licensor's permission and continued control; a supported replacement-copy or archival-copy policy; and destruction or return of copies at the end of the license period, with the last condition deemed met for a perpetual license.

IDOR said it had read the supplied agreement, particularly paragraph 3, but could not give a specific answer in a GIL. It warned that an agreement allowing transfer without the licensor's permission was taxable.

The letter also explained that separately sold optional maintenance generally was not taxable when sold, while canned-software version updates were taxable. If taxable updates were bundled without separate statement and tax, the whole maintenance agreement was taxable.

What this means for you

A software agreement needed clause-by-clause review. A transfer clause could defeat the license treatment even if other requirements appeared satisfied, and a GIL did not resolve the requester's refund dispute.

Common questions

Did IDOR approve the supplied EULA? No.

Did the license need all five conditions? Yes.

Could an unrestricted transfer clause make the license taxable? Yes.

Citations and references

• 86 Ill. Adm. Code 130.1935(a)(1), (b), and (c)(3).
• 86 Ill. Adm. Code 140.301(b)(3).

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2014.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2014/st-14-0034.pdf

Original ruling text

ST 14-0034-GIL 07/29/14 COMPUTER SOFTWARE
This letter discusses the taxability of computer software licenses. See 86 Ill. Adm. Code 130.1935.
(This is a GIL.)

July 29, 2014
Dear Xxxx:
This letter is in response to your letter dated June 13, 2014, 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:
My company, COMPANY A is seeking guidance or adjudication on a matter regarding
tax-exempt status of one of our clients.
Prior to January 1st 2014, my company was a branch of COMPANY B, under the name
of COMPANY C. During our time under COMPANY B, we sold a software solution to
our client COMPANY D. Our client stated that they were tax exempt, but there was a
disagreement at the time with our affiliates at COMPANY B. To move the project along,
we personally paid the sales tax of $x,xxx.xx for the invoice.
I have already spoken with representatives from the Department of Revenue, and have
confirmed that COMPANY D does in fact meet all 5 requirements to be exempt from the
sales tax. In an attempt to recoup the money involved, we have contacted COMPANY
B and informed them of the information gather [sic] via telephone from the Department
of Revenue.
COMPANY B is adamant regardless of any information I can relay to them, that
COMPANY D is not tax-exempt.
A ruling on this matter from your legal department is my final recourse. I am requesting
an official document from the Illinois Department of Revenue in order to recoup the
money from either our client, or our previous parent company COMPANY B.
Please know that the company that sells the software cannot sell them directly to the
client but only through a reseller like us.

COMPANY A
Page 2
July 29, 2014

Enclosed is the agreement with the client and the company that sells the software. Our
client cannot duplicate the software because there are restriction [sic] on the software
to-do so. They cannot license, sublicense or transfer the software to a third party. They
can get another copy through us if the software is damaged or lost at no charge. Once
the software is at the end of the license period it no longer works unless and [sic]
renewal key is sent to them.
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

COMPANY A
Page 3
July 29, 2014

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 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.

COMPANY A
Page 4
July 29, 2014

In order to be considered nontaxable, a license of software must prohibit the customer from
transferring the software to a third party without the permission and continued control of the licensor.
We have read the End User License Agreement that you have provided, in particular paragraph 3.
We cannot provide you with a specific answer in the form of a GIL. However, please note that
agreements which authorize the software to be transferred without the permission of the licensor are
subject to tax.
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:lkm