Are sales of a licensed software product taxable when the maker embeds each customer's settings and identity into an otherwise standard program?

Plain-English summary

Astrogamma Inc. licenses Fenics, a specialized program that helps foreign-currency options traders calculate the theoretical fair price of an option — its pricing formula became a worldwide industry standard. Fenics is sold directly (not advertised, not in retail stores), delivered on floppy diskettes. Before shipping, Astrogamma sets each user's time zone and base currency in the program and embeds the institutional user's name and address in the code (for confidentiality and anti-piracy). It does not limit the number of copies at a location. Astrogamma asked whether its Fenics license sales are taxable for periods after August 31, 1991 (when New York began taxing software).

The Department's answer, under Tax Law § 1101(b)(14) and § 1105(a):

• Software became taxable on September 1, 1991. Effective that date, the Tax Law was amended to impose sales tax on pre-written computer software.
• Fenics is modified pre-written software. "Pre-written software" is software not designed and developed to a specific purchaser's specifications. Software that is pre-written but modified or enhanced to a specific purchaser's specifications remains pre-written software — provided, however, that where there is a reasonable, separately stated charge to the purchaser for the modification or enhancement, that modification/enhancement is not pre-written software. Fenics is pre-written software modified to meet specific purchasers' specs (time zone, currency, embedded identity).
• The whole charge is taxable unless the modification is separately stated. Accordingly, receipts from the sale of the modified pre-written software are entirely subject to sales tax — unless Astrogamma provides a reasonable, separately stated charge on its invoice for the custom programming, in which case only the charge for the pre-written portion is subject to sales and use tax (citing Garpac Corporation, TSB-A-92(8)S).

What this means for you

Software vendors selling a standard product with customer-specific tweaks

If you sell a pre-written program and then adjust it for each buyer (settings, embedded identifiers, configuration), the software stays "pre-written" and taxable. Embedding customer-specific values does not turn it into nontaxable custom software.

Separately state the custom-programming charge

The way to keep the modification portion out of the tax base is to give the purchaser a reasonable, separately stated charge for that custom work on the invoice. Do that, and only the pre-written base is taxed; fail to, and the entire charge is taxable.

"Reasonable" matters

The separately stated modification charge must be reasonable. A token or inflated allocation invites challenge; the charge should genuinely reflect the custom programming.

Accountants and tax professionals

This applies the post-9/1/1991 § 1101(b)(14) definition: pre-written software modified to a purchaser's specs remains pre-written (and fully taxable under § 1105(a)) unless a reasonable, separately stated charge carves the modification out of the base, leaving only the pre-written portion taxable (Garpac, TSB-A-92(8)S).

Common questions

Q: Is this licensed software taxable in New York?
A: Yes, for periods after August 31, 1991. Fenics is pre-written software, and pre-written software became taxable under §§ 1101(b)(14) and 1105(a) effective September 1, 1991.

Q: Doesn't customizing it for each buyer make it nontaxable custom software?
A: No. Pre-written software modified or enhanced to a specific purchaser's specifications remains pre-written software.

Q: How can the vendor reduce the taxable amount?
A: By giving the purchaser a reasonable, separately stated charge for the modification or enhancement. Then only the pre-written portion is taxable.

Q: What if the modification charge isn't separately stated?
A: Then the entire charge for the software — base plus customization — is subject to sales tax.

Q: Does embedding the customer's name or settings change the analysis?
A: No. Those customer-specific adjustments are modifications to pre-written software; they don't convert it into nontaxable custom software.

Citations and references

Statutes and authorities:

• Tax Law § 1101(b)(14) (definition of "pre-written computer software"; modification-to-specifications rule; separately stated charge proviso)
• Tax Law § 1105(a) (tax on receipts from retail sales of tangible personal property)
• Garpac Corporation, Adv. Op. Comm. of T&F, Feb. 6, 1992, TSB-A-92(8)S

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1992.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a92_50s.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-92 (50) S
Sales Tax
June 22, 1992

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S920513A

On May 13, 1992 a Petition for Advisory Opinion was received from Astrogamma Inc., c/o
Healy & Baillie, Esqs., 29 Broadway, New York, New York 10006.
The issue raised by Petitioner, Astrogamma Inc., is whether its sale of its Fenics software
licenses are subject to sales tax for taxable periods subsequent to August 31, 1991.
Petitioner is a corporation duly organized and existing under the laws of the State of New
York with its principal place of business at 3 Hanover Square, Apt. 3, New York, New York 10004.
Petitioner licenses a software system called Fenics. Fenics is a specialized program that assists
traders of options in foreign currencies to determine the theoretical fair price of an option. The most
valuable feature of the program is its unique formula for the calculation of the theoretical fair price
of the option. The Fenics program is sold throughout the world. The Fenics formula has become the
worldwide industry standard for pricing of options.
Fenics is sold directly by Petitioner. It is not advertised and is not available in retail stores.
To determine the appropriateness of the Fenics program and its various modules to a prospective
customer's operations, Petitioner provides individualized consultation together with a fully functional
demonstration copy of Fenics for use up to 3 months.
The Fenics program runs on DOS based micro-computers and is made available on 5.25" or
3.5" high or low density floppy diskettes, depending upon the customer's requirements. In order for
the program to perform its specialized function (determining the theoretical fair price of an option),
each user's time zone and the user's base currency must be set in the program. These programming
adjustments are performed by Petitioner prior to shipment to the customer. Further, the name and
address of the institutional user is imbedded in the program code prior to shipment. This
identification process is necessary in order to maintain confidentiality and to prevent piracy of a
customer's licensed program, as well as to assist in policing compliance by the customer's employees
with the terms of the license agreement with Petitioner.
Petitioner does not seek to control the number of copies of the program at any single location.
In fact, upon request by the customer, Petitioner provides multiple copies of the program (each with
the required time zone, base currency and customer name and address imbedded in the program) at
no additional charge.
Effective September 1, 1991, Section 1101(b) of the Tax Law was amended to impose sales
tax on computer software as follows:
TP-9 (9/88)

-2­
TSB-A-92 (50) S
Sales Tax
June 22, 1992
(b) 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:
*
*
*
(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.
In the instant case Petitioner's Fenics software is pre-written software that is modified or
enhanced to meet the specifications of specific purchasers. Accordingly, pursuant to Section
1101(b)(14) and Section 1105(a) of the Tax Law the receipts from the sale of said pre-written
software that has been modified or enhanced to meet the specifications of a specific purchaser is
entirely subject to sales tax unless 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. However,
if Petitioner charges a reasonable, separately stated charge on its invoice for the custom
programming, only charges for the pre-written portion of the program are subject to sales and use
taxes. Garpac Corporation, Adv Op Comm of T&F, February 6, 1992, TSB-A-92(8)S.

DATED: June 22, 1992

s/PAUL B. COBURN
Deputy Director
Taxpayer Services Division

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