Is a company's fee for subscription access to an Internet-filtering system — where the filtering software and a website-category database are downloaded onto the client's own server rather than sold as a disk or physical product — subject to New York sales tax as prewritten software?

Plain-English summary

Ernst & Young asked, on behalf of an unnamed Internet-management company ("Company A"), whether subscription fees for its Internet-filtering program are subject to New York sales tax. Company A's product has two components: application software that a client downloads onto its own server, and a master database (categorizing all known websites) that's also downloaded and refreshed nightly. Once both pieces are installed, the client sets its own Internet-access policies, and the software checks each employee's website request against the database to grant or deny access. Clients pay a one-to-three-year subscription, in full up front, and receive an access "key" once payment clears.

The Department rejected Company A's characterization of this as a pure "service." Looking at what actually happens technically, the entire filtering function — checking requests, applying policies, granting/denying access — is performed by software and a database that are physically transferred (downloaded) onto the client's own server. That makes the subscription fee a payment for a license to use prewritten computer software, which New York's definition of "tangible personal property" specifically reaches "regardless of the medium by means of which such software is conveyed to a purchaser" — meaning delivery over the Internet doesn't escape tax any more than delivery on a physical disk would. The Department also noted, as an aside, that if the website-category database were sold on its own (separate from the software), its fee would instead be taxed as an information service under a different provision — but since it's bundled with the software here, it's simply part of the taxable software transaction.

The one carve-out: if Company A performs genuinely separate services (like software maintenance or custom programming for a specific client), those charges escape tax — but only if they're reasonable in amount and separately stated on the customer's invoice; otherwise the whole combined charge is taxable.

What this means for you

Software-as-a-service (SaaS) and cloud-software providers

Labeling your product a "service" doesn't control the tax analysis — the Department looks at whether the actual functionality is delivered by software running on the customer's own infrastructure. If your software (even downloaded/streamed rather than shipped on media) does the real work, expect it to be taxed as licensed prewritten software.

Businesses buying access to hosted or downloaded filtering, monitoring, or management tools

If the vendor's software is installed on your own server and does the actual processing, the fee is likely taxable software, not an exempt pure service — plan for sales tax on the subscription regardless of how it's billed or delivered.

Vendors combining software with maintenance or custom work

To keep a maintenance or custom-programming charge nontaxable, make sure it's reasonable and separately stated on the invoice — a single bundled charge covering both the software license and other services will be taxed in full.

Common questions

Q: Does delivering software over the Internet (instead of on a disk) avoid sales tax?
A: No — New York's definition of taxable tangible personal property specifically includes prewritten software "regardless of the medium by means of which such software is conveyed to a purchaser," which reaches internet/electronic delivery the same as physical media.

Q: If a company calls its offering a "service," does that determine its tax treatment?
A: No — the Department looks past labels to what's actually happening: if software installed on the customer's own equipment does the real work, the fee is taxed as a software license regardless of how it's marketed.

Q: Would a stand-alone database subscription (without software) be taxed the same way?
A: No — a database sold separately would instead be taxed as an information service (since the categorized website data isn't personal/individual and is provided to multiple customers), a different (but still generally taxable) category.

Q: How can I keep a maintenance or custom-programming charge tax-free?
A: Only by making it a reasonable, separately stated charge on the invoice, distinct from the taxable software license fee — a single combined charge is taxed in full.

Citations and references

Statutes and regulations:

• Tax Law § 1101(b)(5) (sale, selling, purchase; license to use software), § 1101(b)(6) (tangible personal property; prewritten software), § 1101(b)(14) (prewritten computer software definition)
• Tax Law § 1105(a) (retail sales tax), § 1105(c)(1) (information services), § 1105(c)(9) (entertainment/information services via telephony)
• Tax Law § 1115(o) (nontaxable services/custom software exemption)
• TSB-M-93(3)S (State and Local Sales and Compensating Use Taxes Imposed on Certain Sales of Computer Software)

Cases and prior rulings referenced:

• Matter of Towne-Oller & Assocs. v. State Tax Commission, 120 A.D.2d 873 (3d Dep't 1986)
• Matter of Twin Coast Newspapers Inc. v. State Tax Commission, 101 A.D.2d 977 (3d Dep't 1984)
• OMR Systems Corporation, TSB-A-98(59)S

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_2003.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a03_28s.pdf

Original ruling text

New York State Department of Taxation and Finance

Office of Tax Policy Analysis
Technical Services Division

TSB-A-03(28)S
Sales Tax
June 24, 2003

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S020813A

On August 13, 2002, the Department of Taxation and Finance received a Petition for
Advisory Opinion from Ernst & Young LLP, 18111 Von Karman Avenue, Suite 1000, Irvine,
California 92612. Petitioner, Ernst & Young LLP, provided additional information with respect to
the Petition on September 25, 2002.
The issue raised by Petitioner is whether the sale of subscription contracts to an Internet
filtering program is subject to New York State sales and use taxes.
Petitioner submitted the following facts as the basis for this Advisory Opinion.
Company A, which is a C Corporation incorporated in Delaware with headquarters in
California, offers Internet management solutions. The primary function of Company A is to provide
its clients the ability to rapidly implement and configure Internet access policies in support of the
clients’ efforts to improve employee productivity through the use of Internet filtering capabilities.
Company A’s Internet filtering service utilizes two components: application software and
a master database. The application software is of no value in itself but is necessary to use the
company’s filtering services. The application software filters employee access to the Internet based
on Internet policies set by Company A’s clients. The application software (which is loaded on the
client’s server via the Internet) directs all employees’ Internet Web site (URL) requests to Company
A’s master database which is downloaded to the client’s server. The master database contains all
known Internet Web sites, which are categorized by Company A in its California facility. The
database is downloaded on a nightly basis to the client’s server from one of Company A’s three
servers (two in California and one outside of the US). Similar to the application software, the
database is of no value on a stand-alone basis. The client has the ability to implement and configure
Internet access policies after the software and database have been downloaded onto its server. The
employee’s URL request is processed in the database to determine whether the Web site requested
is approved for the particular user. Access to the Web site is either granted or denied based on the
Internet policies set forth in the application software. Company A’s clients access the application
software free via the Internet.
Company A’s revenue is generated by selling subscription contracts to clients for this
Internet filtering program. Subscription contracts range from one to three years with full up-front
cash payments made once a client accepts the contract. Upon acceptance of the contract terms, a
key (similar to a password) is sent to the client via the Internet, which allows the client access to
Company A’s software and database.

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TSB-A-03(28)S
Sales Tax
June 24, 2003

Applicable Law and Regulations
Section 1101(b) of the Tax Law provides, in part:
When used in this article for the purposes of the taxes imposed by
subdivisions (a), (b), (c) and (d) of section eleven hundred five and by section
eleven hundred ten, the following terms shall mean:
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*

(5) Sale, selling or purchase. Any transfer of title or possession or both,
exchange or barter, rental, lease or license to use or consume (including, with respect
to computer software, merely the right to reproduce), conditional or otherwise, in any
manner or by any means whatsoever for a consideration, or any agreement therefor,
including the rendering of any service, taxable under this article, for a consideration
or any agreement therefor.
(6) Tangible personal property. Corporeal personal property of any nature.
However, except for purposes of the tax imposed by subdivision (b) of section eleven
hundred five, such term shall not include gas, electricity, refrigeration and steam.
Such term shall also include pre-written computer software, whether sold as part of
a package, as a separate component, or otherwise, and regardless of the medium by
means of which such software is conveyed to a purchaser. . . .
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(14) Pre-written computer software. Computer software (including
pre-written upgrades thereof) which is not software designed and developed by the
author or other creator to the specifications of a specific purchaser. The combining
of two or more pre-written computer software programs or pre-written portions
thereof does not cause the combination to be other than pre-written computer
software. Pre-written software also includes software designed and developed by the
author or other creator to the specifications of a specific purchaser when it is sold to
a person other than such purchaser. Where a person modifies or enhances computer
software of which such person is not the author or creator, such person shall be
deemed to be the author or creator only of such person’s modifications or
enhancements. Pre-written software or a pre-written portion thereof that is modified
or enhanced to any degree, where such modification or enhancement is designed and
developed to the specifications of a specific purchaser, remains pre-written software;
provided, however, that where there is a reasonable, separately stated charge or an
invoice or other statement of the price given to the purchaser for such modification
or enhancement, such modification or enhancement shall not constitute pre-written
computer software.

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TSB-A-03(28)S
Sales Tax
June 24, 2003
Section 1105 of the Tax Law provides, in part:
On and after June first, nineteen hundred seventy-one, there is hereby
imposed and there shall be paid a tax of four percent upon:
(a) The receipts from every retail sale of tangible personal property, except
as otherwise provided in this article.
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(c) The receipts from every sale, except for resale, of the following services:
(1) The furnishing of information by printed, mimeographed or multigraphed
matter or by duplicating written or printed matter in any other manner, including the
services of collecting, compiling or analyzing information of any kind or nature and
furnishing reports thereof to other persons, but excluding the furnishing of
information which is personal or individual in nature and which is not or may not be
substantially incorporated in reports furnished to other persons, and excluding the
services of advertising or other agents, or other persons acting in a representative
capacity, and information services used by newspapers, radio broadcasters and
television broadcasters in the collection and dissemination of news, and excluding
meteorological services.
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(9)(i) The furnishing or provision of an entertainment service or of an
information service (but not an information service subject to tax under paragraph
one of this subdivision), which is furnished, provided, or delivered by means of
telephony or telegraphy or telephone or telegraph service (whether intrastate or
interstate) of whatever nature, such as entertainment or information services
provided through 800 or 900 numbers or mass announcement services or interactive
information network services. Provided, however, that in no event (i) shall the
furnishing or provision of an information service be taxed under this paragraph
unless it would otherwise be subject to taxation under paragraph one of this
subdivision if it were furnished by printed . . . matter or by duplicating written or
printed matter in any other manner. . . .
Technical Services Bureau Memorandum, entitled State and Local Sales and Compensating
Use Taxes Imposed on Certain Sales of Computer Software, March 1, 1993, TSB-M-93(3)S,
provides in part:

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TSB-A-03(28)S
Sales Tax
June 24, 2003
Effective September 1, 1991, State and local sales and compensating use
taxes are imposed on the sale or use of prewritten computer software and certain
related services.
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Prewritten computer software is any computer software that is not designed
and developed by the author or other creator to the specifications of a specific
purchaser.
The sale of prewritten software includes any transfer of title or possession,
any exchange, barter, rental, lease or license to use, including merely the right to
reproduce, for consideration. Thus, a payment made by a customer on or after
September 1, 1991, for a license to use, or for the rental or lease of prewritten
software is subject to sales or use tax. The transfer of public domain software
without any charge is not taxable because there is no consideration.
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*

Prewritten software is subject to tax whether sold as part of a package or
separately. Software created by combining two or more prewritten programs or
portions of prewritten programs is still prewritten software subject to tax. The
medium by which the software is transferred to the purchaser has no effect on the
software's taxability. Thus, prewritten software is taxable whether sold, for example,
on a disk, tape or by electronic transmission over telephone lines.
Prewritten software, even though modified or enhanced to the specifications
of a specific purchaser, remains prewritten software subject to tax. However, if a
charge for the custom modification or enhancement is reasonable and separately
stated on the invoice or billing statement, then the separately stated charge for the
custom modification or enhancement is not subject to tax.
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*

Programming and systems analysis are also exempt services. However,
where these services are rendered in conjunction with the sale of prewritten software,
the charge for the service is exempt from tax only when the charge for the service is
reasonable and separately stated on the invoice or billing statement given to the
customer.

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TSB-A-03(28)S
Sales Tax
June 24, 2003
Opinion
Company A’s Internet filtering program utilizes two components: application software and
a master database which contains all known Internet Web sites, which are categorized by Company
A. The primary function of Company A’s program is to provide its client with the ability to rapidly
implement and configure Internet access policies.
The application software is loaded on the client’s server via the Internet. The software
directs Internet Web site (URL) requests of the client’s employees to Company A’s database which
also resides on the client’s server. The database “updates” are downloaded to the client’s server
nightly. Prior to accessing Company A’s software and database via the Internet, the client is
required to agree to the terms of a subscription contract and make an up-front payment. The client
has the ability to implement and configure Internet access policies after the software and database
have been downloaded onto its server. The software and database provided by Company A direct
and filter the client’s employees’ Web site requests based on the client’s established policies, and
either grant or deny the employees access to the Web site requested.
While Petitioner describes Company A’s operation as a service, all tasks related to the
“filtering services” provided by Company A are performed by the software and master database.
The software and database provided by Company A direct and filter the client’s employees’ Web
site requests. The client establishes its policies and, through the use of Company A’s filtering
software, its employees are granted or denied access to certain Web sites. The software and
database are transferred to the client’s server. Therefore, the consideration received by Company
A is for providing the client with the use of its software application which controls Internet use by
the client’s employees. The fee paid for the lease or license to use or consume prewritten computer
software, regardless of the medium by means of which such software is conveyed to the purchaser,
is subject to New York State sales tax as provided in section 1105(a) of the Tax Law. See
section 1101(b)(6) of the Tax Law. Were the database sold separately from the application software,
the fees paid for the database (and its updates) would be subject to the tax imposed on information
services under section 1105(c)(1) or section 1105(c)(9) of the Tax Law since the information in the
database is not personal and individual in nature and is provided to multiple customers. See Matter
of Towne-Oller & Assocs. v. State Tax Commission, 120 A.D.2d 873 (3d Dep’t 1986); Matter of
Twin Coast Newspapers Inc. v. State Tax Commision, 101A.D.2d 977 (3d Dep’t 1984).
Accordingly, the payment received by Company A from the sale of subscription contracts for
Internet filtering services are subject to New York State and local sales and compensating use taxes.
To the extent that Company A performs nontaxable services such as software maintenance,
or provides custom software programming for the client, no tax is required to be collected with
respect to such services. See section 1115(o) of the Tax Law. If the customer is billed for both
taxable and nontaxable services, the total charge is subject to tax unless the charge for the
nontaxable service is reasonable and separately stated. See sections 1101(b)(14) and 1115(o) of the

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TSB-A-03(28)S
Sales Tax
June 24, 2003
Tax Law, and OMR Systems Corporation, Adv Op Comm T&F, September 9, 1998,
TSB-A-98(59)S. For additional information on the taxability of sales of computer software and
related services, Petitioner should refer to TSB-M-93(3)S, supra.

DATED: June 24, 2003

NOTE:

/s/
Jonathan Pessen
Tax Regulations Specialist IV
Technical Services Division

The opinions expressed in Advisory Opinions are
limited to the facts set forth therein.