Does Illinois sales/use tax apply to computer software, including software as a service (SaaS)?

Plain-English summary

A taxpayer running two LLCs that sell a mix of products and services asked the Illinois Department of Revenue to tell it exactly what was taxable in Illinois so it could register and collect the right amount of sales tax as it expanded into the state. The Department declined to answer the specific request — nexus determinations and product-by-product taxability calls are "very fact specific" and, in the Department's view, are better handled by auditors doing a fact-intensive investigation than by a General Information Letter (GIL). Because a GIL is not a statement of Department policy and is not binding, the letter instead walks through the general legal framework for sales/use tax, nexus, service transactions, and — most relevantly for this ruling's title — computer software.

On computer software specifically, the letter lays out several distinct rules rather than a single yes/no answer:

• "Canned" (prewritten) software is generally taxable as a retail sale of tangible personal property, regardless of the medium it's delivered on (disc, tape, electronic download, etc.).
• Custom software prepared to a customer's special order is generally not a taxable retail sale. Simply assembling or lightly modifying pre-written/canned programs does not make software "custom" unless real and substantial changes or interfacing logic are created.
• Software licenses can avoid tax entirely if the license meets all five specific criteria in 86 Ill. Adm. Code 130.1935(a)(1) (signed written agreement, restrictions on duplication/use, restrictions on sublicensing, a replacement-copy policy, and a return/destroy-at-end-of-license requirement). A license that fails any one of these criteria is taxable, and clicking "I agree" online does not satisfy the signed-written-agreement requirement.
• Software-as-a-service and cloud-based software (never downloaded, only accessed remotely) is currently not taxed, because the Department does not consider viewing, downloading, or electronically transmitting data over the internet to be a transfer of tangible personal property. The letter notes the Department was continuing to review cloud-based arrangements and that any change would apply only prospectively.
• A pure service provider ("serviceman") that transfers no tangible personal property to the customer is not subject to Retailers' Occupation Tax, Use Tax, Service Occupation Tax, or Service Use Tax on that transaction. If tangible personal property (including computer software) is transferred incident to the service, the serviceman owes tax calculated under one of four methods described in the regulations.
• Maintenance agreements are taxed differently depending on structure: if bundled into the selling price of the software/property, they're taxed as part of that sale; if sold separately, the agreement itself isn't taxed, but a "patch" or "bug fix" delivered under it is taxed based on the provider's cost, while a full version/release update to canned software is fully taxable as a software sale (unless separately stated correctly, in which case only the update portion is taxed, or the update itself qualifies as custom software).

What this means for you

Software vendors and SaaS companies

If you sell software into Illinois, the tax outcome hinges on how you deliver and structure the transaction, not on what the software does. Purely cloud-hosted software that customers only access remotely (never downloaded) was, at the time of this letter, not taxed because no tangible personal property changes hands. Downloaded or disc-delivered "canned" software is taxable unless it qualifies as custom software or is licensed under an agreement meeting all five criteria in 86 Ill. Adm. Code 130.1935(a)(1) — note in particular that "click-to-accept" online licenses do not satisfy the signed-writing requirement.

Businesses selling both products and services across state lines

This letter is a useful illustration of what a GIL will and won't do: the taxpayer asked for a definitive, product-by-product taxability list to support multistate registration, and the Department refused, saying nexus and fact-specific taxability questions require an auditor's investigation, not a GIL. If you need a binding answer for your specific facts, you generally need to request a Private Letter Ruling (PLR) under 2 Ill. Adm. Code 1200.110, not a GIL.

Businesses offering software maintenance or support

If you sell maintenance/support agreements alongside software, watch how you state your pricing. Charges for updates/new releases of canned software are fully taxable as software sales; if those update charges aren't separately stated from other maintenance items (training, phone support, installation), the whole agreement becomes taxable. A discrete "patch" or "bug fix" is treated differently and taxed on the provider's cost of the tangible property transferred.

Accountants and tax professionals

The letter is a good roadmap to the interlocking regulations (86 Ill. Adm. Code Parts 130, 140, 150, 270) but reaches no conclusion on the taxpayer's actual products because it declined to apply the rules to specific facts. Use it for the framework, not as authority for any particular transaction — remember a GIL is expressly non-binding and not a statement of Department policy.

Common questions

Q: Did the Department tell this taxpayer whether its specific products are taxable in Illinois?
A: No. The Department expressly declined, stating that nexus determinations and the taxpayer's specific product-by-product requests are "very fact specific" and better suited to an auditor's investigation than a General Information Letter. The letter instead explains the general rules.

Q: Is software-as-a-service (SaaS) taxable in Illinois under this letter?
A: A provider of software as a service is treated as a "serviceman." If the provider does not transfer any tangible personal property to the customer — which the Department says includes viewing, downloading, or electronically transmitting data over the internet — the transaction generally is not subject to Retailers' Occupation Tax, Use Tax, Service Occupation Tax, or Service Use Tax. The letter notes the Department was continuing to review cloud-based software arrangements and that any future taxability determination would apply only prospectively.

Q: What's the difference between "canned" and "custom" software for Illinois tax purposes?
A: Canned (prewritten) computer software is generally taxable tangible personal property regardless of delivery medium. Custom software prepared to a customer's special order is generally not a taxable retail sale, but merely assembling or lightly tweaking canned/pre-written programs does not make software "custom" — real and substantial changes or creation of interfacing logic is required.

Q: Can a software license avoid sales tax?
A: Yes, if it meets all five criteria in 86 Ill. Adm. Code 130.1935(a)(1): a signed written agreement between licensor and customer, restrictions on the customer's duplication and use, a prohibition on sublicensing/transfer without the licensor's continued control, a policy for replacing lost/damaged copies (or allowing an archival copy), and a requirement that the customer destroy or return all copies at the end of the license. A license that fails any one criterion is taxable, and an online "I agree" click-through does not satisfy the signed-writing requirement.

Q: Are software maintenance agreements taxable?
A: It depends on structure. If maintenance charges are bundled into the software's selling price, they're taxed as part of that sale. If sold separately, the agreement itself isn't taxed, but a patch/bug fix delivered under it is taxed based on the provider's cost, and charges for full updates/new releases of canned software are fully taxable as software sales unless properly separately stated (or the update itself qualifies as custom software).

Citations and references

• 35 ILCS 120/2-25 (definition of computer software under the Retailers' Occupation Tax Act)
• 35 ILCS 115/3 (Service Occupation Tax imposed on tangible personal property transferred incident to a sale of service, including computer software)
• 35 ILCS 105/2(1.1) and 2(1.2) (Use Tax Act nexus/"retailer maintaining a place of business" provisions)
• 86 Ill. Adm. Code 130.101 (Retailers' Occupation Tax imposition)
• 86 Ill. Adm. Code 130.1935 (taxation of computer software, canned vs. custom, and software licensing criteria)
• 86 Ill. Adm. Code 140.101 (Service Occupation Tax on tangible personal property transferred incident to sales of service)
• 86 Ill. Adm. Code 140.106, 140.108, 140.109 (serviceman tax liability calculation methods)
• 86 Ill. Adm. Code 140.301(b)(3) (taxation of maintenance agreements)
• 86 Ill. Adm. Code 150.101 (Use Tax imposition)
• 86 Ill. Adm. Code 150.130 (Use Tax credit for Retailers' Occupation Tax paid)
• 86 Ill. Adm. Code 150.201(i) (definition of retailer maintaining a place of business in Illinois)
• 86 Ill. Adm. Code 150.801 (Use Tax collector registration)
• 86 Ill. Adm. Code 270.115 (selling activities that trigger Retailers' Occupation Tax nexus)
• 2 Ill. Adm. Code 1200.110 (Private Letter Ruling procedures)
• 2 Ill. Adm. Code 1200.120 (General Information Letter procedures)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2017.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2017/st-17-0024-gil.pdf

Original ruling text

ST 17-0024-GIL 06/28/2017 COMPUTER SOFTWARE
A provider of software as a service is acting as a serviceman. If the provider does not the
transfer any tangible personal property to the customer, then the transaction generally would
not be subject to Retailers’ Occupation Tax, Use Tax, Service Occupation Tax, or Service Use
Tax. See 86 Ill. Adm. Code Parts 130 and 140. (This is a GIL.)

June 28, 2017

Dear Xxxxx:
This letter is in response to your letter dated May 4, 2017, 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 are currently doing business under 2 separate LLC’s originally organized in STATE
on MONTH 25, 20XX. Our first day of operations for these 2 companies was MONTH
1, 20XX and our home base and operations are in CITY, STATE 1.
As COMPANY is looking to establish nexus in your state and we are looking to you to
provide guidance on each of the category of items below so we can be assured we are
collecting and remitting the correct amount of taxes for your state.
The two attached pages (one for each company), contain a summary of the products
and services each company offers. Please give me a call if you need additional
information or have questions. We kindly request information as to what is taxable and
what is not when the customer is residing in your state.
DEPARTMENT’S RESPONSE:
Determinations regarding nexus are very fact specific and cannot be addressed in the context
of a General Information Letter. We believe that nexus determinations are best made by auditors who
are able to conduct the fact-intensive investigation that is required to make these determinations.

ST 17-0024-GIL
Page 2
The Department also cannot provide the answers to your specific requests in the context of a General
Information Letter We hope, however, the following information will be helpful in addressing your
question.
Sales Tax
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. In Illinois, Use Tax is imposed on the privilege of using, in this State, any kind of
tangible personal property that is purchased anywhere at retail from a retailer. See 86 Ill. Adm. Code
150.101. These taxes comprise what is commonly known as “sales” tax in Illinois. If the purchases
occur in Illinois, the purchasers must pay the Use Tax to the retailer at the time of purchase. The
retailers are then allowed to reduce the amount of Use Tax they must remit by the amount of
Retailers' Occupation Tax liability which they are required to and do pay to the Department with
respect to the same sales. See 86 Ill. Adm. Code 150.130.
Nexus
An “Illinois Retailer” is one who makes sales of tangible personal property in Illinois. The Illinois
Retailer is then liable for Retailers' Occupation Tax on gross receipts from sales and must collect the
corresponding Use Tax incurred by the purchasers. Our regulations were amended in response to
the Illinois Supreme Court’s decision in Hartney Fuel Oil Co. v. Hamer, 2013 IL 115130. The
regulations specify the selling activities that trigger Retailers’ Occupation Tax liability in Illinois. See
86 Ill. Adm. Code 270.115.
Another type of retailer is the retailer maintaining a place of business in Illinois. The definition
of a “retailer maintaining a place of business in Illinois” is described in 86 Ill. Adm. Code 150.201(i).
This type of retailer is required to register with the State as an Illinois Use Tax collector. See 86 Ill.
Adm. Code 150.801. The retailer must collect and remit Use Tax to the State on behalf of the
retailer’s Illinois customers even though the retailer does not incur any Retailers' Occupation Tax
liability.
The United States Supreme Court in Quill Corp. v. North Dakota, 112 S.Ct. 1904 (1992), set
forth the current guidelines for determining what nexus requirements must be met before a person is
properly subject to a state's tax laws. The Supreme Court has set out a 2-prong test for nexus. The
first prong is whether the Due Process Clause is satisfied. Due process will be satisfied if the person
or entity purposely avails itself or himself of the benefits of an economic market in a forum state. Quill
at 1910. The second prong of the Supreme Court's nexus test requires that, if due process
requirements have been satisfied, the person or entity must have physical presence in the forum
state to satisfy the Commerce Clause. A physical presence is not limited to an office or other
physical building. Under Illinois law, it also includes the presence of any agent or representative of
the seller. The representative need not be a sales representative. Any type of physical presence in
the State of Illinois, including the vendor’s delivery and installation of his product on a repetitive basis,
will trigger Use Tax collection responsibilities. Please refer to Brown’s Furniture, Inc. v. Zehnder, 171
Ill.2d 410 (1996).
The final type of retailer is the out-of-State retailer that does not have sufficient nexus with
Illinois to be required to submit to Illinois tax laws. A retailer in this situation does not incur Retailers’
Occupation Tax on sales into Illinois and is not required to collect Use Tax on behalf of its Illinois

ST 17-0024-GIL
Page 3
customers. However, the retailer’s Illinois customers will still incur Use Tax liability on the purchase
of the goods and have a duty to self-assess and remit their Use Tax liability directly to the State.
Beginning July 1, 2011, the definition of a “retailer maintaining a place of business” was
amended to include additional types of retailers. A retailer maintaining a place of business also
includes a retailer having a contract with a person located in this State under which:
A.

The retailer sells the same or substantially similar line of products as the person located
in this State and does so using an identical or substantially similar name, trade name, or
trademark as the person located in this State; and

B.

The retailer provides a commission or other consideration to the person located in this
State based upon the sale of tangible personal property by the retailer. See 35 ILCS
105/2(1.2).

These provisions only apply if the cumulative gross receipts from sales of tangible personal
property by the retailer to customers in this State under all such contracts exceed $10,000 during the
preceding 4 quarterly periods. Please note that in Performance Mktg. Ass'n, Inc. v. Hamer, 998
N.E.2d 54 (2013) the Illinois Supreme Court struck down 35 ILCS 105/2(1.1) and 35 ILCS 110/2(1.1),
a “click-thru nexus provision” enacted in 2011. However, new provisions became effective January 1,
2015. The following provisions address the court’s concerns in Performance Mktg. Ass'n, Inc. v.
Hamer, 998 N.E. 2d 54 (2013).
Beginning January 1, 2015, a retailer maintaining a place of business also includes a retailer
having a contract with a person located in this State under which the person, for a commission or
other consideration based upon the sale of tangible personal property by the retailer, directly or
indirectly refers potential customers to the retailer by providing to the potential customers a
promotional code or other mechanism that allows the retailer to track purchases referred by such
persons.
Examples of mechanisms that allow the retailer to track purchases referred by such persons
include but are not limited to the use of a link on the person's Internet website, promotional codes
distributed through the person's hand-delivered or mailed material, and promotional codes distributed
by the person through radio or other broadcast media. These provisions apply only if the cumulative
gross receipts from sales of tangible personal property by the retailer to customers who are referred
to the retailer by all persons in Illinois under such contracts exceed $10,000 during the preceding 4
quarterly periods ending on the last day of March, June, September, and December. A retailer
meeting these requirements shall be presumed to be maintaining a place of business in Illinois but
may rebut this presumption by submitting proof that the referrals or other activities pursued within this
State by such persons were not sufficient to meet the nexus standards of the United States
Constitution during the preceding 4 quarterly periods. See 35 ILCS 105/2(1.1) and 86 Ill. Adm. Code
150.201.
Service Transactions
Retailers' Occupation Tax and Use Tax do not apply to sales of service. Under the Service
Occupation Tax Act, businesses providing services (i.e., servicemen) are taxed on tangible personal
property transferred as an incident to sales of service. See 86 Ill. Adm. Code 140.101. The purchase
of tangible personal property that is transferred to the service customer may result in either Service

ST 17-0024-GIL
Page 4
Occupation Tax liability or Use Tax liability for the serviceman depending upon his activities. See 86
Ill. Adm. Code 140.106, 140.108 and 140.109. The serviceman’s liability may be calculated in one of
four ways:
A.

separately-stated selling price of tangible personal property transferred incident to
service;

B.

50% of the serviceman's entire bill;

C.

Service Occupation Tax on the serviceman's cost price if the serviceman is a registered
de minimis serviceman; or

D.

Use Tax on the serviceman's cost price if the serviceman is de minimis and is not
otherwise required to be registered under Section 2a of the Retailers' Occupation Tax
Act.

The Department does not consider the viewing, downloading or electronically transmitting of
video, text and other data over the internet to be the transfer of tangible personal property. However,
if a company provides services that are accompanied with the transfer of tangible personal property,
including computer software, such service transactions are generally subject to tax liability under one
of the four methods set forth above.
If a transaction does not involve the transfer of any tangible personal property to the customer, then it
generally would not be subject to Retailers’ Occupation Tax, Use Tax, Service Occupation Tax, or
Service Use Tax.
It appears from your letter that the Company is making sales of service and is a serviceman.
As a serviceman, the Company does not incur Retailers’ Occupation Tax. Service Occupation Tax is
imposed upon all persons engaged in the business of making sales of service on all tangible personal
property transferred incident to a sale of service, including computer software (35 ILCS 115/3), and is
calculated as explained above.
Computer Software
“‘Computer software’ means a set of statements, data, or instructions to be used directly or
indirectly in a computer in order to bring about a certain result in any form in which those statements,
data, or instructions may be embodied, transmitted, or fixed, by any method now known or hereafter
developed, regardless of whether the statements, data, or instructions are capable of being perceived
by or communicated to humans, and includes prewritten or canned software.” 35 ILCS 120/2-25.
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. 86 Ill. Adm.
Code 130.1935. However, if the computer software consists of custom computer programs, then the
sales of such software may not be taxable retail sales. 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 86 Ill.
Adm. Code 130.1935(c)(3). Computer software that is not custom software is considered to be
canned computer software.

ST 17-0024-GIL
Page 5

Charges associated with optional training, telephone assistance, installation and consultation
are exempt from tax if they are separately stated from the selling price of "canned software."
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.

If a license of canned computer software does not meet all the criteria the software is taxable.
A license agreement in which the customer electronically accepts the terms of the license by clicking
“I agree” does not comply with the requirement of a written agreement signed by the licensor and
customer set out in (a)(1) of Section 130.1935.
Currently, computer software provided through a cloud-based delivery system – a system in
which computer software is never downloaded onto a client’s computer and is only accessed
remotely – is not subject to tax. The Department continues to review cloud-based arrangements. If,
after review, the Department determines that these transactions are subject to tax, it will only apply
this determination prospectively.
Maintenance Agreements
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

ST 17-0024-GIL
Page 6
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.
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,

Richard S. Wolters
Associate Counsel

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