Was an annual software service plan taxable in Illinois, and how were maintenance, bug fixes, and software updates treated?

Plain-English summary

A customer questioned an annual software service plan described as telephone support with no physical goods. IDOR could not determine exactly what product or service the invoice covered and said the questioned $107.99 did not appear to be a sales-tax charge; the invoice total appeared to include tax.

The underlying tax depended on whether software was transferred. Canned software was taxable regardless of delivery method, while custom software and software licensed under all five conditions in Section 130.1935(a)(1) could be nontaxable.

A maintenance agreement included in the software's selling price was taxable as part of the retail sale. A separately sold optional agreement or extended warranty generally was not taxable when sold, but the service provider owed Use Tax on its cost of property transferred during maintenance. Patches and bug fixes followed those maintenance rules.

New releases or versions containing enhancements were taxable canned-software updates. If their charges were not separately stated and taxed apart from training, telephone help, installation, consultation, or other support, the entire agreement was taxable as canned software.

What this means for you

Software vendors should separate taxable update charges from support services and identify whether a plan is bundled with the original sale or sold optionally. Customers should not infer the tax amount from an unlabeled invoice total.

Common questions

Did IDOR decide whether this invoice was correct? No.

Was a separately sold support plan automatically taxable? Generally no, but transferred service parts or property could create tax for the provider.

Could bundled canned-software updates tax the whole plan? Yes, when update charges were not separately stated and taxed.

Citations and references

• 86 Ill. Adm. Code 150.1305, 130.1935, and 140.301(b)(3).

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2016.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2016/st-16-0029-gil.pdf

Original ruling text

ST 16-0029 GIL 07/20/2016

COMPUTER SOFTWARE

This letter discusses the taxability of computer software and charges related to the sale of
software. See 86 Ill. Adm. Code 130.1935. (This is a GIL.)

July 20, 2016
Dear Xxxxx:
This letter is in response to your letter dated May 31, 2016, in which you requested
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 received our notification from ABC that our “SERVICE PLAN” was renewed and
charged to our CHARGE card on May XX, 20XX. We are questioning the $107.99
sales tax charged on this invoice.
This “Service Plan” is charged to us every year and is essentially an insurance policy
should we need to call ABC to resolve issues with our software. There is no “hard”
goods involved. This is strictly an on-call telephone service program.
We called your representatives in Springfield and he advised us there should be no
sales tax charged for a service and suggested we contact your office for further
clarification. It appears they have charged our Company .05814% (sales tax) which
further made us question this charge. We believe they have been charging sales tax on
their “Service” invoices for some time. A copy of our “Invoice” is attached for your
review.
We would appreciate your reviewing the attached “Invoice” and advising us whether or
not this is a proper charge. If not, what further action can we take as ABC has advised
us their charge is correct and will stay.

DEPARTMENT’S RESPONSE:
We cannot determine exactly what type of product or service is reflected on the invoice which
you included with your letter, but the charge for $107.99 does not appear to be a charge for sales tax.
Rather, the total amount of $1965.37 appears to include sales tax. If a retailer is required or
authorized to collect Use Tax, the retailer’s invoice must state the tax separately unless the
Department finds that it is not possible for the retailer to collect the tax separately from the selling
price. See 86 Ill. Adm. Code 150.1305. However, whether sales tax applies at all in this transaction
depends on whether software is transferred as part of the plan.
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 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 or are provided in connection with a nontaxable license under Section 130.1935, 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.
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:bkl