Are receipts from licensing prepackaged (canned) computer software, and from the support contracts that go with it, subject to New York sales tax?

Plain-English summary

Cognos Corporation licenses prepackaged (canned) computer software — a fourth-generation language called "Powerhouse" built to make Hewlett-Packard's HP3000 environment more efficient — delivered on magnetic tape for use by data-processing professionals. Each copy is licensed for a specific computer (by model, serial number, and location), and moving it to another system needs Cognos's consent. The license comes with software support: telephone advice during a support term, plus program enhancements and updated manuals on tape. Cognos asked whether the software licenses and support charges are taxable, and had filed for a refund of tax it had collected.

The Department held the licenses and support are not taxable.

• Why a license is normally taxable — but software is special. Tax Law § 1105(a) taxes retail sales of tangible personal property, § 1105(c)(3) taxes installing/maintaining/repairing it, and § 1101(b)(5) makes a license to use property a taxable "sale." But software gets special treatment under Technical Services Bulletin 1978-1(S).
• The analysis-or-adaptation test. Software is treated as intangible (and exempt) if either (A) preparing or selecting the program requires the vendor to analyze the customer's requirements, or (B) the program requires vendor adaptation to a specific environment. Off-the-shelf programs sold in stores and usable without such analysis are taxable tangible property.
• How Powerhouse qualifies. The software is not store-bought retail merchandise, is not readily transferable between computers, and Cognos's representatives analyze the customer's hardware configuration and application needs and test performance on the designated computer (via a demonstration tape). So it qualifies as an exempt prewritten application program — intangible personal property. The exemption extends to the instruction manuals and to post-installation modification and problem-solving support (services connected to intangible property).
• The catch — the vendor is the consumer of its own inputs. As the provider of these nontaxable sales and services, Cognos is deemed the ultimate consumer of all tangible personal property used to produce the exempt software and manuals — including property later transferred to customers. So Cognos's own purchases of equipment, utilities, materials, and supplies are taxable.
• Refunds. Cognos may seek a refund of tax it erroneously collected under § 1139(a) — but under 20 NYCRR 534.2(c)(1) it must first repay that tax to its customers before the Department can refund it.

Note: New York's sales-tax treatment of prewritten (canned) software has changed since 1988. This opinion reflects the 1988 framework; confirm current law before relying on the result.

What this means for you

In 1988, whether canned software was taxable turned on vendor involvement, not the label "prepackaged." Under the analysis-or-adaptation test, software the vendor analyzed the customer's needs for, or adapted to a specific environment, was exempt intangible property; truly off-the-shelf, store-bought, plug-and-play software was taxable.

Support tied to exempt software followed the software. Telephone support, enhancements, and post-installation modification/problem-solving were exempt because they related to intangible property.

But being exempt on the sale made the vendor a taxable consumer. A software vendor whose licenses are nontaxable is the ultimate consumer of everything it buys to produce that software — equipment, utilities, materials, supplies, even items later handed to the customer — and owes tax on those purchases.

Refunding over-collected tax requires refunding the customer first. You cannot recover tax you wrongly collected until you have repaid it to the customers who bore it.

Most importantly, this area of law has moved. New York's treatment of prewritten software changed after 1988, so do not assume this outcome still holds — check the current rules.

Common questions

Q: Was licensing "canned" software taxable in New York under this opinion?
A: Not automatically. If the vendor analyzed the customer's requirements or had to adapt the program to a specific environment, it was exempt intangible property. Only truly off-the-shelf software usable without that analysis was taxable.

Q: Were the support/maintenance charges taxable?
A: No. Support tied to the exempt software — telephone advice, enhancements, and post-installation modification and problem-solving — was exempt because it related to intangible property.

Q: If our software licenses are exempt, do we owe tax on anything?
A: Yes. As the provider of nontaxable software, you are the ultimate consumer of the equipment, utilities, materials, and supplies you use to produce it — including items later transferred to customers — so your purchases are taxable.

Q: We collected tax we shouldn't have. Can we get it back?
A: You can apply under § 1139(a), but you must first repay the tax to the customers who paid it before the Department will refund or credit it (20 NYCRR 534.2(c)(1)).

Q: Does this still apply today?
A: Be careful — New York's sales-tax treatment of prewritten software has changed since 1988. Check current law before relying on this result.

Citations and references

Statute and authority:

• Tax Law § 1105(a) — taxes receipts from retail sales of tangible personal property
• Tax Law § 1105(c)(3) — taxes installing, maintaining, and repairing property
• Tax Law § 1101(b)(5) — defines "sale" to include any rental, lease, or license to use property
• Tax Law § 1139(a) — allows refund/credit of tax erroneously, illegally, or unconstitutionally paid
• 20 NYCRR 534.2(c)(1) — erroneously collected tax must be repaid to the customer before the vendor can be refunded
• Technical Services Bulletin 1978-1(S) — the analysis-or-adaptation test that treats qualifying software as exempt intangible property

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1988.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a88_5s.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-88(5)S
Sales Tax
December 16, 1987

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S870624A

On June 24, 1987, a Petition for Advisory Opinion was received from Cognos Corporation,
2 Corporate Place 1-95, Peabody, MA 01960.
The issues raised are whether the sale of a license to use prepackaged (canned) computer
software and the receipts from service contracts supporting such software are subject to New York
State and local sales taxes.
The software, either owned by or licensed to the Petitioner, is provided to its customers on
magnetic encoded tape for use by data processing professionals in commercial data management
applications. A brochure appended to the Petition describes the software (called "Powerhouse") as
a Development Center Fourth Generation Language designed to increase the efficiency of Hewlett­
Packard's HP3000 software environment.
Petitioner and its licensors retain exclusive ownership of the software which is available to
customers for evaluation, lease or 20 year license periods. Each copy of the software is licensed for
use only on the computer system designated thereon by model, serial number and location. Transfer
from the licensed system to an alternate system requires the consent of the Petitioner.
Software support services ("Support") are included under a lease and, for a 30 day warranty
period commencing on delivery, under a license to use the software. Various levels of Support may
be purchased for renewable one year terms beginning after the warranty period. During a support
term, the customer is entitled to telephone advice to ensure operation of the software in accordance
with its documentation. The customer will also receive, on magnetic tape, any program
enhancements and updated manuals released in that term.
Section 1105(a) of the Tax Law imposes a tax on the receipts from every retail sale of
tangible personal property. Section 1105(c)(3) taxes installation, maintenance and repair of such
property. Sale, as defined in Section 1101(b)(5), includes any rental, lease or license to use tangible
personal property. For sales tax application, computers and peripheral devices commonly described
as "hardware" are considered tangible personal property.
The tax status of receipts from computer program ("software".) sales and services is
explained in Department of Taxation and Finance Technical Services Bulletin 1978-1(S), issued
February 6, 1978:

RODERICK G. W. CHU, COMMISSIONER
GABRIEL B. DiCERBO, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR
TP-8 (3/83)

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TSB-A-88(5)S
Sales Tax
December 16, 1987
Software [means] instructions and routines which, after analysis of the customer's
specific data processing requirements, are determined necessary to program the
customer's electronic data processing equipment to enable the customer to
accomplish specific functions with his EDP system. To be considered exempt
'software' for purposes of this bulletin, one of the following elements must be
present:
A.

Preparation or selection of the program for the customer's use requires an
analysis of the customer's requirements by the vendor.
or

B.

The program requires adaptation, by the vendor, to be used in a specific
environment i.e., a particular make and model of computer utilizing a
specified output device. For example, a software vendor offers for sale a pre­
written sort program which can be used in several computer models. Prior to
operation, instructions must be added by the vendor which specify the
particular computer model in which the program will be utilized.

The software may be in the form of:
a.

Systems programs (except for those instruction codes which are
considered tangible personal property in paragraph 1 above) ­
programs that control the hardware itself and allow it to compile,
assemble and process application programs.

b.

Application programs - programs that are created to perform business
functions or control or monitor processes.

c.

Pre-written programs (canned) - programs that are either systems
programs or application programs and are not written specifically for
one user.

d.

Custom programs - programs created specifically for one user.

Software meeting the above criteria, whether placed on cards, tape, disc pack or other
machine readable media or entered into a computer directly, is deemed to be
intangible personal property for sales tax purposes, and as such its sale is exempt
from New York State and local sales and use taxes. Software or programs which do
not meet the criteria are subject to tax.
*

*

*

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TSB-A-88(5)S
Sales Tax
December 16, 1987
[Example] E. A software supplier manufactures prepackaged programs for use with
home television games or other personal computer equipment. The programs are
marketed through retail stores, and the programs are fully usable by customers
without modifications. In selecting or preparing the program, the supplier does not
perform a detailed analysis of the customer's requirements. The program is viewed
as tangible personal property for sales tax purposes.
The software here at issue is not retail merchandise as described in the example, it is not sold
in stores and it is not readily transferable from one computer to another. Initial trouble shooting and
support service is included in the lease charge or license fee. Although the programs are pre-adapted
for use mainly on Hewlett Packard, Digital Equipment or Data General computers, Petitioner's
representatives analyze the customer's hardware configuration and application needs and test
program performance on the designated computer model by running a demonstration tape.
The software therefore qualifies for exemption as the type of prewritten application program
outlined in paragraph A. and c. above, which is considered intangible personal property. The
exemption extends to instruction manuals for the program.
Services involving software modification and problem solving after its installation,
accordingly, are exempt from tax because they are rendered in connection with intangible property.
See Technical Services Bulletin, 1978-1(S), para. 3.
Consequently, Petitioner's receipts from leasing or licensing the software at issue and from
charges for software support services are not subject to State or local sales or use taxes.
However, Petitioner as the provider of these nontaxable sales and services is deemed the
ultimate consumer of all tangible personal property necessary for the production of the exempt
software and manuals including property eventually transferred to the customer. Thus, Petitioners
purchases of equipment, utilities, material and supplies are taxable.
Petitioner states it has filed a request for refund of taxes collected from its customers on
charges for exempt software and support services.
Section 1139(a) of the Tax Law provides that the Commissioner of Taxation and Finance
shall refund or credit any tax, penalty or interest erroneously, illegally or unconstitutionally paid.

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TSB-A-88(5)S
Sales Tax
December 16, 1987
It should be noted, however, that any tax Petitioner has erroneously collected and remitted
must be repaid to the customer before the Commissioner of Taxation and Finance may grant a refund
or credit of such monies to the Petitioner. 20 NYCRR 534.2(c)(1).

DATED: December 16, 1987

NOTE:

s/FRANK J. PUCCIA
Director
Technical Services Bureau

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