Is a transfer of prewritten software taxable in NY, and how is the sale sourced when the code sits out of state but is used here?

Plain-English summary

A company entered a "Consulting Services Agreement" with a New York-headquartered client and, as part of it, transferred prewritten software (for example, a travel-expense recording system its employees use as they travel). The software was installed on servers in Tennessee, invoiced to the client's agent in Tennessee, and the property was nominally held "in trust in New York" -- but the client used the software in New York and at other U.S. locations. The company asked whether the transfer is taxable and, if so, how to source it.

The Office of Counsel concluded the transfer is taxable and is sourced to where the software is used in New York.

• Taxable as prewritten software. Prewritten computer software is tangible personal property "regardless of the medium by means of which such software is conveyed" (Tax Law 1101(b)(6)). So the sale is taxable under 1105(a) -- the "consulting services" label and the electronic/no-medium delivery don't change that. (Prewritten software stays prewritten even when modified for a specific buyer.)
• The location of the code doesn't matter. A sale is taxed where possession transfers, and for a license to use, that includes transfer of constructive possession or the "right to use, or control or direct the use of" the property (20 NYCRR 526.7(e)(4)). When the client's employees access and use the software, the client gains constructive possession -- even though it never receives the code on a tangible medium or by download.
• Source to where it's used. The company must therefore collect tax based on where the software is used (Adobe Systems, TSB-A-08(62)S). If the client's employee-users are both in and out of New York, the company collects tax only on the portion of the receipt attributable to the NY users.
• The vendor can rely on the customer's information. To figure that NY portion, the company may rely on usage information from the client (KPMG, TSB-A-03(5)S; Tax Law 1132(c)(1), 1142(4)).
• Custom modifications. Separately stated, reasonable charges for custom modifications of the software are not taxable (TSB-M-93(3)S).

What this means for you

Selling software to multi-state customers

Where the code physically sits -- and where you bill -- doesn't control. Prewritten software is sourced to where the customer's people actually use it. If users are spread across states, you collect NY tax only on the NY-user share, and you can rely on the customer's good-faith usage data to apportion. Calling the deal "consulting" or delivering with "no medium" won't make taxable software nontaxable.

Keep custom work separate

Custom modifications can be carved out as nontaxable, but only if they're separately stated and reasonable. Lump them into the software price and they're taxed as part of the software.

Common questions

Q: Our software lives on out-of-state servers and we invoice an out-of-state office. Is it still NY-taxable? A: Yes, to the extent the customer's employees use it in New York. The code's location and the billing address don't control -- usage does.

Q: How do I figure the New York portion when users are in several states? A: Apportion by the share of employee-users located in New York. You may rely on the customer's information to do this (KPMG; Tax Law 1132(c)(1), 1142(4)).

Q: Are charges for customizing the software taxable?
A: Not if they're for genuine custom modifications and are separately stated and reasonable. Otherwise they're taxed with the software.

Citations and references

• Tax Law section 1105(a) (sales of tangible personal property)
• Tax Law section 1101(b)(6) (tangible personal property; prewritten software)
• Tax Law section 1132(c)(1) (vendor may rely on purchaser information)
• Tax Law section 1142(4) (purchaser information)
• 20 NYCRR 526.7(e) and 526.7(e)(4) (place of delivery; license to use; constructive possession)
• TSB-M-93(3)S (sales of computer software)
• TSB-A-08(62)S (Adobe Systems) (sourcing prewritten software to where used)
• TSB-A-03(5)S (KPMG) (vendor may rely on purchaser data)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_2010.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a10_28s.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-10(28)S
Sales Tax
July 2, 2010

Office of Counsel
Advisory Opinion Unit
STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S090223B

Petitioner, name redacted. asks whether the transaction described below, involving the transfer of prewritten software, is subject to tax, and if so how the sale should be sourced. We conclude that the transaction is subject to tax and should be sourced based on where the software is used in New York. Facts Petitioner entered into an agreement entitled “Consulting Services Agreement ("CSA") with Client A to provide Client A with computer-related consultation. Petitioner asserts that the CSA involves the sale of prewritten software (“property”). Any property sold or created as part of the CSA was necessary for completion of the covenants in the CSA. Client A is headquartered in New York but has operations throughout the United States. Pursuant to the CSA, any property created globally was to be held in trust in New York for Client A's benefit. Moreover, Client A retained the sole right to transfer such property among its other affiliates globally. The property was installed on servers in Nashville, Tennessee at the direction of Client A, and invoices were provided to an agent of Client A in Hermitage, Tennessee. That property, since its implementation, is used by Client A in New York and at other locations in the United States. The property would include, for example, a travel expense recording system that Client A’s employees’ use as they travel to customer sites all over the United States. Analysis Tax Law section 1105 imposes sales and use tax on retail sales of tangible personal property and enumerated services. 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.” Tax Law §1101(b)(6). Thus, petitioner’s sale of prewritten computer software to Client A is subject to tax as the sale of tangible personal property. See Tax Law §§1101(b)(6), 1105(a). 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. See Tax Law §1101(b)(6); State and Local Sales and Compensating Use Taxes Imposed on Certain Sales of Computer Software, TSB-M-93(3)S. 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.” Petitioner asserts that the CSA involves the sale of prewritten software. The location of the code embodying the software is irrelevant, because the software can be used just as effectively by the

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TSB-A-10(28)S
Sales Tax
July 2, 2010

customer, even though the customer never receives the code on a tangible medium or by download. The accessing of Petitioner’s software by Client A’s employees constitutes a transfer of possession of the software, because Client A gains constructive possession of the software and gains the “right to use, or control or direct the use of" the software. Therefore, petitioner should collect tax from Client A based on where the software is being used. See Adobe Systems, Inc., TSB-A-08(62)S. For this purpose, petitioner may rely on information received from Client A as described in the KPMG, LLC, Advisory Opinion, TSB-A-03(5)S. See Tax Law §§ 1132(c)(1), 1142(4). If the customer’s employees who use the software are located both in and out of New York State, Petitioner should collect tax based on the portion of the receipt attributable to the employee users located in New York. See Adobe Systems, Inc., supra. To the extent that the CSA also involves custom modifications of software, separate charges for that service would not be subject to tax if the charges are reasonable in relation to the total charges. See TSB-M-93(3)S, supra.

DATED: July 2, 2010

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.