New York Advisory Opinion TSB-A-96(27)S: Does a banking-software license and maintenance contract signed in 1988 -- before a 1991 New York law change made pre-written software taxable -- still get the OLD exempt treatment for its ongoing annual maintenance fees, or does the new tax apply going forward regardless of when the contract was signed?

Plain-English summary

ALLTEL Financial Information Services, Inc. (formerly Systematics Financial Services, Inc.) provides packaged data-processing software for banks and other financial institutions -- an "investment charter agreement" bundling a software license, upgrades, documentation, training, corrections, replacements, installation help, and ongoing technical support/consultation, all sold as one indivisible package. Fees are paid partly at signing and then annually over the contract's life; the future services and upgrades are collectively called "software maintenance." Before September 1, 1991, this software was treated as exempt custom (intangible) property, so its maintenance was untaxed too. ALLTEL provided a sample contract signed November 7, 1988 (later amended in 1991) and asked whether its ongoing annual fees remain exempt under the old rule, given that the contract predates the 1991 law change.

The Department said no -- the new tax applies to fees from September 1, 1991 onward regardless of contract date. Chapter 166 of the Laws of 1991 reclassified pre-written computer software as taxable tangible personal property effective that date, and its transitional provision (§ 406(j)) is explicit: the new rule applies to "all sales or uses made on or after that date although made under a prior contract." There's a narrow exception for software sold under a pre-May-1-1991 written agreement where the specific software was already segregated and identified for that contract before May 1, 1991, and at least 10% of the price was paid before September 1, 1991 -- but ALLTEL's contract didn't show that kind of pre-segregation, so the exception doesn't apply. Because ALLTEL doesn't separately state its maintenance charge from the taxable software upgrades/enhancements bundled with it, the whole maintenance fee for periods on or after September 1, 1991 is taxable; maintenance furnished before that date stays exempt (consistent with the Department's own earlier Computer Language Research opinion). For an annual maintenance payment that straddles the changeover -- like a November payment covering a year that started before September 1 -- ALLTEL can pro-rate by month: only the portion of the payment corresponding to months on or after September 1, 1991 is taxable (two-twelfths of the November 1991 payment, in ALLTEL's own example), while every later year's full annual maintenance fee is fully taxable going forward.

What this means for you

Software vendors with long-running license/maintenance contracts predating a law change

A contract's signing date doesn't protect ongoing charges from a later tax-law change -- New York's transitional rules typically tax sales or uses occurring ON OR AFTER the effective date, "even under a prior contract," unless you meet a narrow, specific grandfather exception (here: pre-May-1991 written agreement, pre-May-1991 segregation/identification of the specific software, and a minimum 10% pre-payment before the new rule took effect). Review your own contracts' actual segregation/payment history against the specific grandfather conditions rather than assuming an old signing date is enough.

Businesses paying ongoing software maintenance fees under an older contract

If your vendor bundles maintenance with software upgrades/enhancements without separately stating the charges, expect the whole bundled fee to follow the tax treatment of the (now-taxable) pre-written software, not the historically exempt treatment your original contract may have had -- and expect a one-time pro-rated transition charge for any payment period that straddled September 1, 1991.

Common questions

Q: Why doesn't ALLTEL's 1988 contract qualify for the grandfather exception?
A: The exception requires the SPECIFIC software already sold under a written pre-May-1-1991 agreement to have been physically segregated from the vendor's other similar property and identified as appropriated to that particular contract before May 1, 1991, plus at least 10% of the price paid before September 1, 1991. Nothing in ALLTEL's facts showed that kind of pre-May-1991 segregation and identification, so the exception simply didn't apply.

Q: Could ALLTEL avoid the tax by separately stating its maintenance charge from software upgrades?
A: The opinion notes ALLTEL doesn't currently separately state these charges, so the whole bundled maintenance fee is taxed as pre-written software-related. Tax Law § 1115(o) does allow a service charge to be exempt if reasonably and separately stated when sold alongside tangible personal property -- but that requires the vendor to actually itemize it that way, which this contract's structure didn't do.

Q: How exactly does the pro-ration work for the year the law changed?
A: For an annual maintenance payment covering a period that spans the September 1, 1991 changeover, only the fraction of months from September 1 onward through the payment date is taxable -- in ALLTEL's own example (a November due date), that's two of the twelve months, i.e., two-twelfths of that single year's payment; all following years' annual maintenance charges are fully taxable start to finish.

Citations and references

Statutes and regulations:

• Tax Law § 1101(b)(6) (definition of tangible personal property)
• Tax Law § 1101(b)(14) (definition of pre-written computer software)
• Tax Law § 1105(c)(3) (installation/maintenance service tax)
• Tax Law § 1115(o) (computer software service exemption)
• Chapter 166 of the Laws of 1991, § 406(j) (transitional grandfather provision for pre-written software)

Prior rulings and cases referenced:

• Computer Language Research, Advisory Opinion, Commissioner of Taxation and Finance, June 7, 1989, TSB-A-89(13)S

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1996.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a96_27s.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-96 (27)S
Sales Tax
May 2, 1996

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S950811A

On August 11, 1995, a Petition for Advisory Opinion was received from ALLTEL Financial
Information Services, Inc. (formerly Systematics Financial Services, Inc.), 4001 Rodney Parham Rd.,
Little Rock, Arkansas 72212.
The issue raised by Petitioner, ALLTEL Financial Information Services, Inc., is whether sales
tax should apply to fees billed under a software license and maintenance agreement signed prior to
a change in the Tax Law effective September 1, 1991.
Petitioner provides the following facts. Petitioner provides software for the financial industry
to meet the data processing needs for all major applications of banks and other financial institutions.
The software is often provided in a packaged investment charter agreement which includes a
software license, software upgrades, documentation, training courses, corrections, replacements,
installation assistance, technical assistance and consultation throughout the life of the contract. All
of these services are packaged together and cannot be broken out separately for the client to purchase
part of the package and not the whole. Generally, fees are paid partially upon signing of the contract,
and then the remainder of the fees are paid annually over the life of the contract. The future services
and software upgrades are sometimes referred to as software maintenance.
The software is pre-written software that must be modified to some extent to adapt to the
customer's specific environment. An analysis of the customer's needs and the specific computer
equipment is required before the software can be licensed.
Prior to a change in the Tax Law, effective September 1, 1991, Petitioner's software was
considered custom software (intangible personal property) and exempt from sales tax. Maintenance
relating to the intangible software was also exempt from sales tax.
Petitioner now applies sales tax to all fees under investment charter software license
agreements signed after September 1, 1991. Under the amendments to the Tax Law effective
September 1, 1991, Petitioner's software is considered taxable tangible personal property because
it is pre-written software rather than being designed and developed for one specific user. Petitioner
states in its Petition that maintenance relating to this pre-written software is taxable under current
law. According to Petitioner, the entire charge for the maintenance is taxable because it includes
software upgrades and enhancements along with other services.
Petitioner has provided a sample contract and amendment for review. The contract includes
a fee payment schedule and a description of the services provided in the package.

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The contract was originally entered into on November 7, 1988 for a five (5) year term. The contract
was amended April 30, 1991 changing the effective date to November 7, 1996.
Effective September 1, 1991, Chapter 166 of the Laws of 1991 amended the Tax Law relating
to pre-written computer software. Section l101(b)(6) of the Tax Law was amended to define tangible
personal property, in part, as follows:
Tangible personal property. Corporeal personal property of any nature
.... Such term shall also include pre-written computer software,
whether sold as part of a package, as a separate component, or
otherwise, and regardless of the medium by means of which such
software is conveyed to a purchaser ....
Paragraph (14) was added to section ll01(b) of the Tax Law to read as follows:
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.
Subdivision (o) was added to section 1115 of the Tax Law to read as follows:
Services otherwise taxable under subdivision (c) of section eleven
hundred five or under section eleven hundred ten shall be exempt
from tax under this article where performed on computer software of
any nature;

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provided, however, that where such services are provided to a
customer in conjunction with the sale of tangible personal property
any charge for such services shall be exempt only when such charge
is reasonable and separately stated on an invoice or other statement
of the price given to the purchaser.
In addition, section 1105(c)(3) of the Tax Law imposes sales tax on the following:
(3) Installing tangible personal property, excluding a mobile home, or
maintaining, servicing or repairing tangible personal property,
including a mobile home, not held for sale in the regular course of
business, whether or not the services are performed directly or by
means of coin-operated equipment or by any other means, and
whether or not any tangible personal property is transferred in
conjunction therewith.
Section 406(j) of Chapter 166 of the Laws of 1991, pertaining to the effective date of the
above-referenced pre-written computer software provisions, states:
The provisions of sections one hundred fifty-four through one
hundred fifty-nine of this act shall take effect September 1, 1991, and
shall apply to all sales or uses made on or after that date although
made under a prior contract, except that a delivery or transfer of
possession of computer software on or after such date pursuant to an
agreement for the sale of such software made before May 1, 1991,
shall not be subject to tax if (1) such agreement for the sale of such
software was made in writing, (2) the software so sold or agreed to be
sold was segregated, before May 1, 1991, from any other similar
property in the vendor's possession and identified as having been
appropriated to such sale or agreement of sale, and (3) the purchaser,
before September 1, 1991, shall have paid to the vendor not less than
ten percent of the sale price of such software.
In the case of the sample contract provided by Petitioner the agreement to sell and maintain
the software was entered into prior to September 1, 1991, and signed by the purchaser on November
7, 1988. However, the transitional provisions of Section 406(j) of Chapter 166 of the Laws of 1991
provide that the pre-written computer software provisions enacted by Chapter 166 apply to sales or
uses of software and related services made on or after September 1, 1991, although made under a
prior contract. Accordingly, the software maintenance services furnished by Petitioner on

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or after September 1, 1991, which are not exempt from tax under Section 1115(o) of the Tax Law,
are subject to tax even though the services are performed under a contract entered into before
September 1, 1991.
In addition, Petitioner does not separately state the charges for software maintenance services
from the charges for software upgrades and enhancements. According to Petitioner, the software
upgrades and enhancements are pre-written software. Accordingly, the software maintenance
services furnished by Petitioner after September 1, 1991, are taxable since these services are sold in
conjunction with pre-written computer software which, after September 1, 1991, constitutes tangible
personal property. Although Section 406(j) of Chapter 166 of the Laws of 1991 provides for special
circumstances under which pre-written software sold after September 1, 1991, pursuant to a pre­
existing contract, will not be considered tangible personal property, it does not appear that these
circumstances apply in this case. There is no indication that the software upgrades and enhancements
furnished under Petitioner's contract on or after September 1, 1991, were segregated by Petitioner
from other similar property in its possession and identified as having been appropriated to the
contract before May 1, 1991. Therefore, to the extent they do not qualify under the transitional
provisions of Section 406(j) of Chapter 166, these software upgrades and enhancements, and the
software maintenance services provided in conjunction with them, which are sold on or after
September 1, 1991, are subject to State and local sales and use taxes. Maintenance services furnished
pursuant to Petitioner's contract prior to September 1, 1991, are not subject to tax. See Computer
Language Research, Adv. Op. Comm. Of Taxation and Finance, June 7, 1989, TSB-A-89(13)S.
Because Petitioner's maintenance agreement charges under the sample contract are due on
an annual basis, Petitioner may pro-rate the annual maintenance charge for the year 1991 by
comparing the number of months for the period September 1, 1991 to the annual payment date, to
the twelve month annual period ( i.e., two twelfths of the Petitioner's total maintenance charge due
in November 1991 is subject to the state and local sales and use taxes). The Petitioner's maintenance
charges for the remainder of the maintenance agreement after 1991 are also subject to the appropriate
state and local sales and use taxes.

DATED: May 2, 1996

/s/
Doris S. Bauman
Director
Technical Services Bureau

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