Are licenses to use customizable prewritten software taxable, and how is the tax sourced when users are in several states?

Plain-English summary

The petitioner is an international software company (with a New York office) that licenses a prewritten base software package -- used by customers like insurance companies to generate rate quotes, policies, and ID cards -- usually with separately charged custom modifications (linking to the customer's accounting system, custom reports). The software may sit on the customer's servers or the vendor's servers, in or out of New York, and the customer's employees access it from various locations. Monthly fees also cover software support (defect fixes/updates, training, helpdesk) and, when hosted by the vendor, a hosting fee plus database administration and production support. It asked whether its license receipts are taxable.

The Office of Counsel concluded the licenses are taxable prewritten software, sourced to New York users.

• Prewritten software is taxable tangible personal property (Tax Law 1101(b)(6)) regardless of the medium or where the code sits. Accessing it gives the customer constructive possession and the right to use/control it (20 NYCRR 526.7(e)(4); Adobe) -- so the license is taxable whether stored on the customer's or the vendor's servers.
• Sourced to the employee-user location. The situs is where the customer's employees use the software. If users are in and out of New York, the vendor collects tax only on the New York-user share (KPMG).
• Custom modification isn't taxable; the base and updates are. Combining prewritten programs stays prewritten (taxable). A reasonable, separately stated charge to custom-modify the base program for the customer who requested it isn't taxable (Tax Law 1101(b)(14); TSB-M-93(3)S) -- but the base program and software updates/patches are taxable. (Later resale of a program incorporating those modifications to others is taxable.)
• Bundled hosting/admin/support are taxable. Hosting, database administration, and production support are integral components of the license and taxable (even if separately stated) when sold in combination with the software (Penfold). Separately stated, reasonable training and helpdesk support can be excluded; a lump sum that buries them, or an unreasonable allocation, makes the whole charge taxable.

What this means for you

Software vendors and SaaS/hosted-software providers

Whether the software runs on your servers or the customer's, licensing prewritten software for access is a taxable sale -- the code's location is irrelevant; constructive possession and the right to use are what count. Tax follows the employee-user locations, so collect on the New York share and document the allocation. Hosting, DB admin, and production support bundled with the license are taxable; protect genuinely nontaxable custom modifications, training, and support by stating them separately and reasonably.

Business buyers of licensed software

Expect tax on the base license and updates allocated to your New York users. Reasonable, separately stated customization and training/support lines can be tax-free; a single lump-sum price generally is fully taxable.

Common questions

Q: The code is hosted out of state -- is the license still taxable in New York?
A: Yes. The location of the code is irrelevant. Accessing the software is constructive possession, taxed based on where your employee-users are -- the New York-user share is taxable.

Q: Is our custom modification taxable?
A: Not if it's a reasonable, separately stated charge to modify the base program for the customer who requested it. The base program and updates/patches remain taxable.

Q: Are hosting and support taxable?
A: Hosting, database administration, and production support are integral to the license and taxable. Separately stated, reasonable training/helpdesk can be excluded; a lump sum is fully taxable.

Citations and references

• Tax Law section 1105(a) (sales tax on tangible personal property)
• Tax Law section 1101(b)(6) (prewritten software is tangible personal property)
• Tax Law section 1101(b)(14) (combining prewritten programs; custom modification)
• 20 NYCRR 526.7(e)(4) (license to use = constructive possession/right to control use)
• TSB-A-08(62)S (Adobe Systems; software sitused to user location)
• TSB-A-03(5)S (KPMG; allocation between in/out-of-state users)
• TSB-M-93(3)S (sales tax on computer software; custom modification/support)
• Penfold v State Tax Commission, 114 AD2d 696 (bundled items taxed as one)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_2009.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a09_41s.pdf

Original ruling text

New York State Department of Taxation and Finance

Office of Counsel
Advisory Opinion Unit

TSB-A-09(41)S
Sales Tax
September 22, 2009

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S081202A

Petitioner name redacted asks whether the receipts from its licenses for the use of its software
are subject to New York State sales and use taxes.
We conclude that Petitioner’s receipts from the licenses for its software are receipts from the
sale of prewritten software, which are subject to sales tax to the extent that the software is accessed
by the customer’s employees in New York.
Facts
Petitioner is an international software company with an office located in New York. Petitioner
has customers and employees in several states including New York. Petitioner licenses a basic
software package that is usually further customized to the customer’s needs. Petitioner makes separate
charges to the customer for the cost of modifying the software to meet the customer’s needs.
Customization charges typically involve linking the base software to a customer’s specific accounting
system, including unique ledger account codes, file layouts, etc. In addition, the customers may
require unique reports that are customized to meet the customer’s requirements. Separately stated
charges for customization are billed the customer as performed and are not spread out over the
licensing period.
Petitioner’s customers (e.g., insurance companies) use the software to provide rate quotes,
insurance contracts, and other insurance documents to insureds and prospective insureds of the
customer. Petitioner provided the following illustration as a typical use of its software: A vehicle
owner contacts Petitioner’s customer and indicates that it is interested in purchasing an automobile
insurance policy. The customer logs into Petitioner’s software residing on a third party’s server in
Virginia using a URL address provided to the customer by Petitioner. The customer enters the vehicle
owner’s pertinent information (name, age, sex, location, etc.) into the software via the Internet
connection. Petitioner’s software processes the information entered in the system and produces a
quote for the insurance policy. If the vehicle owner indicates that it wants to purchase the policy, the
customer can immediately print an insurance ID card on the customer’s printer and the insurance
policy will be processed and issued overnight. The policy documents can be printed and mailed to the
vehicle owner by the customer or the documents can be e-mailed to the vehicle owner by the
customer.
The software (including the custom modifications) may be installed and stored on the
customer’s server(s) and is accessed from one or more of the customer’s locations. The customer’s
employees may access the software from the location where the software is stored or from other
locations both inside and outside the state where the software is stored.

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Sales Tax
September 22, 2009

The software may also be installed on servers located within and without New York owned by
Petitioner or its agents and accessed by the customer’s employees from within and without New York.
For customers who purchase the software for use on the customer’s servers, Petitioner bills a
flat fee for the license to use the base software package.
When the software is stored on servers owned by Petitioner or its agents, Petitioner is
responsible for the maintenance of the hardware and the software. In this case, Petitioner charges the
customer an additional separately stated “hosting fee.”
The customers are billed monthly. However, where applicable, customers are separately
billed for customization charges at the time that the customization services are performed. As part of
the monthly fees, customers receive software support (software defect fixes and updates, training and
helpdesk support), database administrative services (database monitoring, tablespace management,
performance tuning), and production support (batch monitoring, output print monitoring, interface
monitoring, and other activities required to maintain production day to day).
Analysis
Tax Law section 1105(a) imposes sales tax on the sale of tangible personal property.
Prewritten computer software is included within the definition of tangible personal property,
“regardless of the medium by means of which such software is conveyed to the purchaser.” Section
1101(b)(6) of the Tax Law. Thus, the sale of prewritten computer software is subject to tax as the sale
of tangible personal property. See sections 1101(b)(6) and 1105(a) of the Tax Law.
Sale is defined as “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.” Section 1101(b)(5) of the Tax Law. Section 526.7(e) of the Sales and
Use Tax Regulations provides generally that “a sale is taxable at the place where the tangible personal
property or service is delivered, or the point at which possession is transferred by the vendor to the
purchaser or his designee.” Section 526.7(e)(4) further provides that, with respect to a “license to
use,” a transfer of possession has occurred if there is a transfer of actual or constructive possession, or
if there has been a transfer of “the right to use, or control or direct the use of, tangible personal
property.” The location of the code embodying the software is irrelevant, because the software can be
used just as effectively by the customer, even though the customer never receives the code on a
tangible medium or by download.
The accessing of Petitioner’s software by Petitioner’s customers constitutes a transfer of
possession of the software, because the customer gains constructive possession of the software, and
gains the “right to use, or control or direct the use of," the software. See Adobe Systems, Inc Adv Op
Comm T & F, November 24, 2008, TSB-A-08(62)S.
The location of the code embodying the software is irrelevant. The software is used just as
effectively by the customer whether it is stored on the customer’s servers for access by the customer’s
employees or is stored on servers owned by Petitioner (or Petitioner’s agents) from which the
customer’s employees access the software. Whether the software is installed on the customer’s server

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or is stored on Petitioner’s servers, the access and use of the software by the customer’s employees is
effectuated. Accordingly, Petitioner's sale of the license to use its basic software package is subject to
sales tax under Tax Law §1105(a) regardless of where the software is stored. See Jeffrey J. Coren
CPA, TSB-A-09(19)S, May 21, 2009.
The situs of the sale for sales tax purposes is the location associated with the license to use
(i.e., the location of the customer’s employees that use the software). See Adobe Systems, Inc. supra.
In the present case, if the locations where the customer’s employees will use the software are both in
and out of New York State, Petitioner is only required to collect tax based on the portion of the taxable
receipts attributable to the employees’ use of the software at locations in New York. (See KPMG LLP,
Adv Op Comm T & F, January 31, 2003, TSB-A-03(5)S.) The determination of the proper local tax
rate and jurisdiction is also based on the locations associated with the licensees’ use.
Petitioner modifies and customizes its basic program depending upon the customer’s specific
needs. The combining of two or more prewritten software programs or prewritten portions of
such programs does not cause the combination to be other than prewritten software. See section
1101(b)(14) of the Tax Law. Therefore, petitioner’s receipts for the basic program remain subject to
sales tax. Petitioner’s charges to customers for providing modifications or customization to the basic
program presumably reflect Petitioner’s cost to modify the prewritten software. When there is a
reasonable, separately-stated charge for customization of the basic program, the charge for the
modification will not constitute a receipt from the sale of prewritten software and will not be subject to
tax when performed for and sold to the customer who initially requested the custom modification. See
section 1101(b)(14) of the Tax Law and TSB-M-93(3)S, State and Local Sales and Compensating Use
Taxes Imposed on Certain Sales of Computer Software, March 1, 1993. It should be noted that
subsequent sales of the basic program incorporating such modifications into programs provided to
other purchasers would be subject to tax as the sale of prewritten software.
Petitioner’s fees for software support encompass defect fixes and software updates and
training and helpdesk support. Fees for software updates and patches to fix defects are subject to sales
tax as the sale of prewritten software. Separately stated and reasonable fees for training and support
may be excluded from the receipt subject to tax. (See TSB-M-93(3)S, supra.) However, if a lump sum
charge is made to a customer that includes training and support, or if the separate charge for training
and support does not reasonably reflect the value of these items, then the entire charge will be taxable.
Other portions of Petitioner’s monthly fees (inclusive of the charges for hosting the software,
database administration, and production support whether or not separately stated) encompass activities
related to Petitioner’s overhead costs in ensuring that its software performs for customers as
guaranteed rather than activities separately purchased by users. Though the hosting and other services
by themselves may not be included among the enumerated services that are subject to tax ( See Alan J.
Goldstein/The Computer Studio, Adv Op Comm T&F, December 29, 1997, TSB-A-01(21)S; CAV
CORP d/b/a Stone Soup Multimedia, Adv Op Comm T&F, December 29, 1997, TSB-A-97(87)S),
when these services are sold in conjunction with prewritten computer software and it is not shown that
both these services and the software are each individually offered for sale and sold other than in
combination, the combination of items will be considered as one, and thus subject to tax as a single
purchase. This will be true even though the charges for the services and software are separately stated.
See Penfold v State Tax Commission, 114 AD 2d 696 [1985]. Thus, the fees Petitioner’s customers

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Sales Tax
September 22, 2009

pay for hosting and those other activities (database administration, etc.) are for integral components of
their licenses to use the software and are subject to tax. See Jeffrey J. Coren CPA, supra.

DATED: September 22, 2009

NOTE:

/S
Jonathan Pessen
Director of Advisory Opinions
Office of Counsel

An Advisory Opinion is issued at the request of a person or entity. It is
limited to the facts set forth therein and is binding on the Department only
with respect to the person or entity to whom it is issued and only if the person
or entity fully and accurately describes all relevant facts. An Advisory
Opinion is based on the law, regulations, and Department policies in effect as
of the date the Opinion is issued or for the specific time period at issue in the
Opinion.