Are invoices for a licensed software subscription's continued maintenance/access, and for additional software users, subject to Illinois Retailers' Occupation (sales) Tax?

Plain-English summary

A company with economic nexus in Illinois asked the Department to resolve a dispute with a client over whether two kinds of invoices were taxable: (1) an invoice for continued maintenance and access to software under a subscription agreement, and (2) a separate invoice for additional software users. The client's own review, applying the five-part license test in 86 Ill. Adm. Code 130.1935, had concluded the product was outside the scope of Illinois sales tax and instead subject to a city's personal property lease tax.

Because the inquiry required applying the law to a specific contract's facts, the Department could only issue a GIL (not a binding PLR) and walked through the general rules instead of deciding the taxpayer's case. It explained that "canned" (prewritten) computer software is generally taxable tangible personal property regardless of delivery method, while custom software prepared to a customer's special order may not be taxable. Critically, even canned software escapes tax if the license agreement meets all five criteria in Section 130.1935(a)(1): a signed written agreement, restrictions on duplication/use, a prohibition on unauthorized sublicensing or transfer, a policy for replacing lost/damaged copies, and a requirement to return or destroy copies at the end of the license (a requirement automatically satisfied by a perpetual license).

On maintenance, the Department explained that agreements bundled into the selling price of tangible personal property are taxed as part of that sale, while agreements sold separately are not themselves taxable retail sales (though the provider incurs Use Tax on its cost of any parts transferred while performing the service, per 86 Ill. Adm. Code 140.301(b)(3)). A patch or bug fix delivered under a maintenance agreement is taxed under those same rules. But charges for updates or new versions of canned software are fully taxable as software sales, and if those update charges aren't separately stated from other maintenance charges (training, phone support, installation, consultation), the whole maintenance agreement becomes taxable as a sale of canned software.

What this means for you

Software vendors and SaaS providers

If you sell software under a written license, check it against all five criteria in 86 Ill. Adm. Code 130.1935(a)(1) before assuming your product is taxable or exempt — missing even one (for example, using a mere "click to accept" agreement instead of a verifiable electronic signature) can make an otherwise-exempt license taxable. Separately state charges for canned-software updates/new versions from charges for training, phone support, installation, or consultation; otherwise the whole maintenance agreement becomes taxable.

Businesses purchasing software subscriptions

Whether your maintenance/access invoice or additional-user invoice is taxable depends on how your vendor's contract is structured: whether it is a qualifying license under Section 130.1935(a)(1), whether the software is canned or custom, and whether update charges are separately stated from other service charges. A vendor's own sales-tax coding of an invoice is not automatically correct — check the underlying license terms.

Accountants and tax professionals

This GIL is a useful general roadmap but resolves nothing specific: the taxpayer's underlying dispute (whether a particular subscription and per-user invoice were taxable, versus subject to a municipal personal property lease tax) would require a Private Letter Ruling under 2 Ill. Adm. Code 1200.110, since it turns on the specific contract's language against the five-part test.

Common questions

Q: Is prewritten (canned) computer software taxable in Illinois?
A: Generally yes, canned software is taxable tangible personal property regardless of the medium (download, disc, card, or other electronic means), unless the license meets all five criteria in 86 Ill. Adm. Code 130.1935(a)(1).

Q: What are the five criteria for a nontaxable software license?
A: (1) a written agreement signed by the licensor and customer; (2) restrictions on the customer's duplication and use; (3) a prohibition on sublicensing or transferring to a third party without the licensor's permission and continued control; (4) a licensor policy of providing a replacement copy at minimal/no cost if the customer's copy is lost or damaged; and (5) a requirement that the customer return or destroy all copies at the end of the license period (automatically met for a perpetual license).

Q: Does a click-through "I agree" license satisfy the written-agreement requirement?
A: No. The Department states that merely clicking "I agree" does not satisfy the signed-written-agreement requirement, but an electronic signature that is verifiable and authenticable, and attached to or part of the license, does satisfy it.

Q: Are software maintenance agreements taxable?
A: If the maintenance charge is bundled into the selling price of the software or other tangible personal property, it's taxed as part of that sale. If sold separately, the agreement itself isn't a taxable retail sale, but charges for updates/new versions of canned software are fully taxable, and if not separately stated from other maintenance charges (training, support, installation), the entire agreement becomes taxable.

Q: Did the Department decide whether this specific taxpayer's invoices were taxable?
A: No. Because the answer depends on the specific contract's terms, the Department could only issue a non-binding GIL describing the general rules; it did not rule on the taxpayer's actual invoices. A binding answer would require a Private Letter Ruling.

Citations and references

Statutes and rules:

• 86 Ill. Adm. Code 130.101 (Retailers' Occupation Tax on gross receipts from retail sales)
• 86 Ill. Adm. Code 130.1935 (canned vs. custom software; five-part license exemption test)
• 86 Ill. Adm. Code 130.1935(a)(1) (written-license criteria, A through E)
• 86 Ill. Adm. Code 130.1935(b) (maintenance agreements and canned-software updates)
• 86 Ill. Adm. Code 130.1935(c)(3) (custom computer program definition)
• 86 Ill. Adm. Code 140.301(b)(3) (Service Occupation Tax on separately sold maintenance/repair agreements)
• 2 Ill. Adm. Code 1200.110 (Private Letter Ruling procedure)
• 2 Ill. Adm. Code 1200.120 (General Information Letter procedure)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2022.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2022/st22-0023-gil.pdf

Original ruling text

ST-22-0023-GIL 10/19/2022 COMPUTER SOFTWARE
This letter discusses the taxability of computer software licenses and
maintenance agreements. See 86 Ill. Adm. Code 130.1935 and 86 Ill. Adm.
Code 140.301. (This is a GIL. )
October 19, 2022

COMPANY/ADDRESS
Dear XXX:
This letter is in response to your letter dated August 17, 2022, 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 have a question that needs a resolution. I have already called Illinois
Department of Revenue and they have directed me to Legal Services.
COMPANY has economic nexus in Illinois. We also have a client that
claims our invoices are non-taxable. Attached you will find the original
agreements, the renewal invoice and product invoice, our current
subscription agreement and Reg 130-1935.
Information concerning items being billed:
The invoice is for continued maintenance and access to the software.
However, we do have another invoice where they have purchased
additional users (separate from the maintenance and access to software
invoice).
Email detail from client:
“NAME1 – There is a five part test under REG 130.1935 to
determine the taxability of delivered software in Illinois. Those five tests
are:

COMPANY/NAME
Page 2
October 19, 2022
1.
2.
3.
4.

5.

Written agreement signed by licensor and customer outlining rights/
restrictions – Yes
Restricts duplication and use of software; - Yes
Prohibits licensing/transferring software to 3rd party w/o
permission/continued control of licensor; - Yes
Licensor has policy of providing another copy at minimal or no
charge if customer loses/damages the software, or permitting
licensee to make a copy; policy is either stated in license
agreement, supported by books and records or notarized statement

• Yes
  Customer must destroy/return all copies of software to licensor at
  the end of the license period; (if perpetual license, this provision is
  deemed met w/o being set forth in the license agreement) Perpetual therefore met
  My notes based on our analysis of the contract are above in red. If
  you meet these five requirements, the product is outside the scope
  of sales tax in Illinois. Based on our review and the review of
  TAXPAYER REPRESENTATIVE, this product is not subject to
  sales tax in Illinois and is therefore subject to personal property
  lease tax in the CITY. Please clarify based on the attached
  agreement which one of the 5 parts of this test are not qualified. If
  someone from your tax department would like to discuss they can
  reach out to me directly.
  Thanks
  NAME2
  TITLE
  o ###.###.####| c ###.###.####
  ADDRESS2*

How the tax is determined:
Currently, we use VENDOR as our sales tax vendor. We are using a code
that taxes the attached invoice as Computer software maintenance
contracts / agreements – optional – prewritten software (electronically
downloaded) for business use only – downloaded updates and support
services. When we bill for additional software or users, we use a code that
taxes based on Computer software (prewritten/canned) electronically
downloaded (business to business).
Question:
Are these invoices taxable or non-taxable? Does Reg 130-1935 apply to
these invoices? Can you provide regulation information concerning this
determination?
Very truly yours,
NAME1

COMPANY/NAME
Page 3
October 19, 2022
TITLE2
COMPANY

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. 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). Computer software that is not custom software is
considered to be canned computer 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

COMPANY/NAME
Page 4
October 19, 2022
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.
Please note that a license agreement in which the customer electronically
accepts the terms by clicking “I agree” does not comply with the requirement of a written
agreement signed by the licensor and the customer. However, an electronic agreement
in which the customer accepts the license by means of a signature in electronic form
that is attached to or is part of the license, is verifiable, and can be authenticated will
comply with the requirement in Section 130.1935(a)(1)(A).
If computer software, including canned software, is licensed and the license
agreement meets all of the criteria in subsection (a)(1) of Section 130.1935, the license
of the software is not a taxable retail sale. In addition, if the computer software is
custom software, as provided in subsection (c) of Section 130.1935, it is exempt from
tax under the Retailers’ Occupation Tax Act, Use Tax, Service Occupation Tax, and
Service Use Tax.
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. Such provisions
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.

COMPANY/NAME
Page 5
October 19, 2022
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.
Assuming the services provided, such as installation, phone support, training,
and seminars, do not require the transfer of tangible personal property to the recipients
of those services, charges for such services are exempt if they are separately stated
from the selling price of canned software. See Section 130.1935(b). If computer
software training or other support services are provided in conjunction with a sale of
custom computer software or a license of computer software, the charges for that
training are not 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,

Kimberly Rossini
Associate Counsel
KR:dlb