Is tax-processing software that requires analysis of the customer's needs and program modification exempt as custom software, and are annual license renewals also exempt?

Plain-English summary

Computer Language Research, Inc. sells in-house tax-processing systems (trade name Fast-Tax) combining software and hardware. Preparing the software requires the company to analyze each client's specific data-processing requirements (corporate status, number of subsidiaries, filing frequency, existing hardware and software) and to modify the actual program so it works in the client's environment. The license fee entitles the client to the software and updates for a tax year and is renewable annually. The company asked whether the software is exempt custom software and whether the annual license renewals are exempt too.

The Department held:

• The test for exempt software. Under Technical Services Bureau Bulletin 1978-1(S), software is exempt intangible personal property if either (A) preparing or selecting the program for the customer requires the vendor to analyze the customer's requirements, or (B) the program requires adaptation by the vendor to run in the customer's specific environment.
• These programs qualify. Because the programs require both an analysis of the customer's requirements and modification of the program for the customer, they are intangible personal property and are not subject to New York State and local sales and use taxes.
• Licenses and renewals follow. As intangible property, the software's sale, licenses to use, and renewals of those licenses are all exempt — provided the software charge is separately stated on the invoice.
• But bundle it and you lose the exemption. If the company charges a single amount for taxable hardware and software together, the entire charge is taxable.
• The seller still owes some tax. The person selling exempt software must pay tax on any tangible personal property transferred to the customer with it, and the hardware, utility services, and supplies used to develop the exempt software are not exempt.

What this means for you

If you sell custom or customer-adapted software: New York treats qualifying software as intangible property, so its sale — and its license and annual renewal fees — can be exempt. The dividing line is whether you analyze the customer's requirements or adapt the program to the customer's environment (either one suffices). Pre-written "canned" software that needs neither is taxable.

Separately state the software charge — every time. The exemption for the software (and its renewals) depends on the charge being separately stated. If you invoice a lump sum for hardware plus software, New York taxes the whole thing.

You don't escape tax on your own inputs. Even when your software is exempt, you owe tax on any tangible items you hand the customer (disks, manuals) and on the hardware, utilities, and supplies you use to develop the software.

Common questions

Q: What makes software "custom" and exempt in New York?
A: Under Bulletin 1978-1(S), it's exempt intangible property if you must analyze the customer's requirements or adapt the program to the customer's specific environment. Meeting either test is enough.

Q: Are the annual license renewals taxable?
A: No — if the software qualifies as exempt intangible property and the charge is separately stated, the license and its renewals are exempt.

Q: What if we bill hardware and software as one price?
A: Then the entire charge is taxable. Separately state the software to keep it exempt.

Citations and references

Statute and guidance:

• Tax Law § 1105(a) — tax on retail sales of tangible personal property
• Technical Services Bureau Bulletin 1978-1(S) — defines software; exempt as intangible property where the vendor analyzes the customer's requirements or adapts the program; separately-stated requirement; seller owes tax on TPP transferred and on development hardware/utilities/supplies

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1989.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a89_13s.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-89(13)S
Sales Tax
June 7, 1989

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S890213B

On February 13, 1989, a Petition for Advisory Opinion was received from Computer
Language Research, Inc., 2395 Midway Road, Carrollton, Texas 75006.
The Petitioner raises two issues. First, do Petitioner's computer products qualify as custom
software exempt from New York State and local sales and use taxes. Secondly, if custom software
is exempt from sales tax, is the annual renewal of the license for such software similarly exempt
from tax.
Petitioner provides mainframe and microcomputer-based tax processing to accounting firms,
corporations, partnerships and banks under the trade name Fast-Tax. Petitioner also develops and
markets Electronic Form Systems for sale to forms-intensive businesses.
Petitioner has recently developed and is currently selling in-house tax processing systems
which encompass both software and hardware. In most cases, the price for a software license is
separately stated. The license fee initially entitles the customer to receive the software and updates
for a given tax year. It is renewable annually for an additional fee.
The following are examples of Petitioner's assessment and installation procedures:
1.

Petitioner's Tax Compliance Systems (TCS) and related software (marketed under the trade
name "System 5") is used by the corporate client to process its corporate tax returns and
related information on a microcomputer(s) located in the client's office. Petitioner's sales and
technical support personnel generally make four to seven calls on a prospective client. The
complexity of corporate tax compliance with federal, state, and local jurisdictions requires
Petitioner to gather a considerable amount of specific information about the client (corporate
status, number of subsidiaries, filing frequency, etc.) in order to have a clear understanding
of the client's compliance needs. In addition, Petitioner must analyze the functions and
operation of the client's tax compliance department. Using this information, Petitioner can
configure the proper combinations of software modules to meet the client's compliance and
operational needs. Additionally, Petitioner's support personnel must frequently modify the
systems to achieve compatibility with the client's existing hardware and software.

2.

Tax Processing Systems (TPS) software is used to process tax returns on mainframe
computers located at the corporate client's location. This software includes installation
materials consisting of: (1) the TPS software magnetic tape, (2) installation Job Control
Language (JCL) and (3) technical and user manuals. When a client orders the on-line option,

TP-9 (9/88)

-2­
TSB-A-89(13)S
Sales Tax
June 7, 1989

additional tapes and manuals are sent. The client's data processing department is required to
customize the installation JCL by modifying many system parameters. These parameters determine
the client's specific data processing standards and operating system requirements. Once the basic
TPS system is installed, the tax department may further customize the software by changing the
forms logic. Part of the TPS agreement includes an implementation session whereby Petitioner's
technical support group personnel are at the client's site to determine specific client requirements
prior to delivery of the TPS system tape.
Technical Services Bureau Bulletin 1978-1 defines software as:
"Instructions and routines (programs) which, after an analysis of the customers 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 adaption, 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.

System 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.

-3­
TSB-A-89(13)S
Sales Tax
June 7, 1989

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. The person selling exempt
software is required to pay the applicable sales or use tax on any tangible personal property
transferred to the customer in connection with the exempt service. In addition, the hardware, utility
services and supplies used to develop the exempt software are not eligible for any sales tax
exemptions. Taxpayer Services Bureau Bulletin, 1978-1(S).
Accordingly, as the computer programs (software) developed by Petitioner require an
analysis of the customer's requirements and modification of the actual program for use by such
customer, such programs are considered to be intangible personal property and therefore are not
subject to New York State and local sales and use taxes. Moreover, as intangible personal property,
its sale, including licenses to use and renewals of licenses to use, is not subject to New York State
and local sales and use taxes provided that the charge for such software is separately stated in
Petitioner's invoices to its customers. Should Petitioner charge a single amount representing charges
for taxable hardware and software, the entire charge is subject to tax.

DATED: June 7, 1989

s/FRANK J. PUCCIA
Director
Technical Services Bureau

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