Are a software vendor's "system utility" data-entry and EDI products taxable as prewritten software, even though each customer's installation must be uniquely programmed to work?

Plain-English summary

TSI International Software develops two products -- "KEY/MASTER" (data-entry software) and "Trading Partner" (electronic data interchange software) -- that it describes as "system utility software": prewritten libraries of functions that must be uniquely configured at each customer's site before they'll actually do anything useful, since neither product produces a standard, ready-to-use output on its own. TSI charges customers separately for its own or the customer's programmers to do that site-specific configuration work. TSI asked whether sales tax applies to its sales (or leases) of these products, and to the separate programming charges.

New York's sales tax reaches "prewritten computer software" as tangible personal property -- meaning software not originally designed and developed to a specific purchaser's specifications by its own author. Once software is created as a prewritten product (as KEY/MASTER and Trading Partner both were, and are sold or leased to many different customers), it stays "prewritten" and taxable even when it's later customized or configured to a particular customer's environment -- the 1991 law change specifically broadened the tax to reach software that used to be treated as "custom" simply because a vendor customized a prewritten core. The fact that TSI's products are technically classified as "system utility software" (interacting with the operating system) rather than "application software" makes no legal difference; the statutory definition of prewritten software doesn't distinguish between the two. However, the reasonable, separately stated charges TSI bills for its programmers' actual customization work aren't taxed -- as long as those charges appear as their own line item on the invoice (not folded into the software price).

What this means for you

Software vendors selling "system," "utility," or platform-style software

Even if your product can't function until it's individually configured or programmed at each customer's site, it's still taxable "prewritten computer software" if you originally created it (rather than each customer's own author creating it from scratch) and sell copies of it to multiple customers -- the technical classification as system/utility software versus application software doesn't change that.

Vendors bundling software with customization or configuration services

Bill your customization, configuration, or programming work as a separate, reasonable, clearly stated line item -- doing so keeps that specific labor charge out of the sales tax base, even though the underlying software license itself remains taxable.

Accountants and tax professionals

This ruling is a clean application of the post-1991 "prewritten software stays prewritten even when customized" rule from TSB-M-93(3)S -- useful any time a software client argues its product should be treated as exempt custom software because of the customization required to make it work.

Common questions

Q: Does software stop being "prewritten" (and become tax-exempt custom software) once it's customized for a specific customer?
A: No -- prewritten software remains prewritten and taxable even when modified or enhanced for a specific customer, as long as the vendor (not the customer) originally created the core product.

Q: Are separately stated custom programming charges taxed the same as the software itself?
A: No -- reasonable charges for customization or programming that are separately stated on the invoice aren't subject to sales tax, even though the underlying prewritten software license is taxable.

Q: Does calling a product "system utility software" instead of "application software" change its tax treatment?
A: No -- New York's prewritten software tax doesn't distinguish between system/utility software and application software; both are taxed the same way if they meet the prewritten software definition.

Q: Does this ruling apply to my company's software products?
A: Not automatically. An Advisory Opinion binds the Department only for the taxpayer and facts it was issued to, and it can't be relied on by anyone else. Your own products and customization practices would need their own analysis.

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1997.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a97_59s.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-97(59)S
Sales Tax

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE

ADVISORY OPINION

PETITION NO. S970321C

On March 21, 1997, the Department of Taxation and Finance received a
Petition for Advisory Opinion from TSI International Software Ltd., 45 Danbury
Road, Wilton, Connecticut 06897-0840. Petitioner, TSI International Software
Ltd., submitted additional information pertaining to the Petition on July 15,
1997.
The issue raised by Petitioner is whether sales tax should be imposed upon
receipts from the sales of two of its software products.
Petitioner submitted the following facts as the basis for this Advisory
Opinion. Petitioner also provided copies of its Registration Statement with the
Securities and Exchange Commission, its prospectus and brochures on the software
in question.
Petitioner develops and markets software and related services that enable
organizations to facilitate the exchange of information among their own business
applications, as well as with external business partners.
The two software
products at issue in this Opinion are "KEY/MASTER" and "Trading Partner."
"KEY/MASTER" is a data entry software product. With "KEY/MASTER," data may
be input to production applications and databases from on-line terminals,
off-line personal computers (PCs) and local area networks (LANs), and from
non-keyed sources such as bar codes and scanners.
"KEY/MASTER" uses simple
screen painting and advanced validation and editing techniques. It operates in
a wide range of IBM (or compatible) hardware and software configurations.
"KEY/MASTER" allows the customer to analyze its requirements and resources,
choose the best way to capture data for each of its applications, and to design
a system that meets its requirements.
Petitioner holds a copyright on
"KEY/MASTER" and has been successful in defending this right in a lawsuit settled
in 1995.
"Trading Partner" is electronic data interchange (EDI) software. EDI is
the computer-to-computer exchange of business data among "partners" in a
standardized format as a component of electronic commerce (EC).
"Trading
Partner" was designed to provide everything needed to implement, integrate and
manage EDI processes and data in an IBM environment. "Trading Partner" allows
the customer to tailor and manage integrated solutions from handling external
trading specifications and internal application requirements to applying business
rules and intelligence to EDI processes and data. (It is noted, Petitioner’s
"Trading Partner PC" and "Trading Partner Kits" are not at issue in this Opinion.)

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TSB-A-97(59)S
Sales Tax

Both "KEY/MASTER" and "Trading Partner" were created by Petitioner and are
proprietary trade secrets.
"KEY/MASTER" and "Trading Partner" are also
registered trademarks.
Each of these computer software programs is a set of operating instructions
that is uniquely programmed either by Petitioner’s field engineers or the
customer’s management information systems (MIS) computer programming staff. The
operating instructions are a library of prewritten functions or routines used in
designing and developing a "custom software" program to the specifications of the
customer. The customer’s requirements and resources are analyzed and a system
is designed to meet these requirements quickly and economically. The software
cannot function unless program design and development takes place. After which,
a software product takes form. The software product cannot and will not be sold
in this exact form to any other customer. The software takes on a new form each
time it is sold and will not perform unless it has been customized each and every
time.
Petitioner categorizes "KEY/MASTER" and "Trading Partner" as system
software or system utility software. Software of this nature interacts between
operating system software (i.e., software designed to interact with computer
hardware to guide the overall operations of the computer) and application
software (i.e., software designed to run the business processes that are required
System software or system utility software
in an electronic environment).
differs in that there is no defined standard output from its use, and it must be
configured uniquely in each operating environment.
Petitioner’s software is
configured by each user to be a link between the operating system that is storing
data and managing its use and an application software layer that will actually
process the data for a standard business outcome. When the customer runs its EDI
translators, for example, there is no usable output other than a file of data
that is uniquely configured to be passed on to its selected application program
to process the data. (A "translator" converts programs written in one language
into programs in another language.) The software serves as the conduit of data
from an external partner, through the operating layer on its way to the
processing application. Without Petitioner’s software, the data would not be
able to be processed; with just the software, there would be no desired result.
This software acts as an aid or utility which is customized in each customer site
to provide the link that is required for its application system.
"KEY/MASTER" and "Trading Partner," can be purchased outright or leased for
a specified time.
Petitioner charges customers for programming by separate
invoice denoting professional service charges, plus any expenses incurred by its
systems engineers.
This programming may be done solely by Petitioner, by
Petitioner and the customer, or by the customer alone.
These products are sold to a wide variety of industries throughout the
United States and the world. They are not sold in any computer retail stores or
via Petitioner’s Web site. Sales are usually generated by word-of-mouth or by
Petitioner’s telesales group.

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TSB-A-97(59)S
Sales Tax

Applicable Law
Section 1101(b) of the Tax Law provides in part:
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:
*
*
*
(4) Retail sale. (i) A sale of tangible personal property to
any person for any purpose....
(5) Sale, selling or purchase.
Any transfer of title or
possession or both, exchange or barter, rental, lease or license to
use or consume (including, with respect to computer software, merely
the right to reproduce), conditional or otherwise, in any manner or
by any means whatsoever for a consideration....
(6) 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....
*

*

*

(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.

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TSB-A-97(59)S
Sales Tax

Section 1105(a) of the Tax Law imposes sales tax on the "receipts from
every retail sale of tangible personal property, except as otherwise provided in
this article."
Section 1115(o) of the Tax Law provides:
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; 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.
Technical Services Bureau Memorandum,
Compensating Use Taxes Imposed on Certain
TSB-M-93(3)S, March 1, 1993, provides in part:

State and Local Sales and
Sales of Computer Software,

Effective September 1, 1991, State and local sales and
compensating use taxes are imposed on the sale or use of prewritten
computer software and certain related services.
The effect of this change in the Tax Law is to broaden the
types of computer software that are subject to sales and use
taxes.... certain software previously considered "custom" may now be
considered prewritten computer software and subject to such taxes.
*

*

*

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.
*

*

*

The incidental use of a development language (e.g., COBOL,
BASIC, C, etc.) or of libraries of "prewritten" functions or
routines in designing and developing a "custom" software program to
the specifications of a specific purchaser will not, in and of
itself, make the sale of an otherwise custom program taxable. The
"custom" program must be examined as a whole to determine whether it
is exempt from tax.
If the prewritten components of a custom
program are sold separately, their sale is subject to tax.
The purchase of a development language or libraries of
software routines is subject to sales or use tax if it is used in
designing and developing custom software....

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TSB-A-97(59)S
Sales Tax

Opinion
Receipts from Petitioner’s sales (including leases) of "KEY/MASTER" and
"Trading Partner" in New York State are subject to State and local sales taxes.
Both "KEY/MASTER" and "Trading Partner" constitute "pre-written computer
software," as defined in Section 1101(b)(14) of the Tax Law, and as such,
tangible personal property.
However, receipts attributable to Petitioner’s
unique programming of these software products to meet the specifications of
customers are not subject to tax. This is so, provided that these charges for
programming are reasonable and continue to be separately stated on the invoices
given to customers.
Technical Services Bureau Memorandum TSB-M-93(3)S, supra, provides guidance
with respect to sales of computer software and related services. This memorandum
explains the Department of Taxation and Finance’s de minimis policy regarding the
"incidental" use of development languages and libraries of prewritten functions
and routines. Based on the information submitted, "KEY/MASTER" and "Trading
Partner" as sets of operating instructions that are used in the design and
development of custom software programs for customers are not "incidental" to
these overall programs, but rather are the cores of these programs. Moreover,
both "KEY/MASTER" and "Trading Partner" are sold separately by Petitioner,
allowing customers to perform their own custom programming. As provided in such
memorandum, the purchases of development languages and libraries of prewritten
functions and routines are subject to sales tax if used in designing and
developing custom software.
Whether these software products can be categorized as system software or
system utility software is of no consequence. The tax imposed on "pre-written
computer software " does not pertain exclusively to application software, nor are
any such distinctions made in the statutory definition of "pre-written computer
software."

DATED: September 30, 1997

NOTE:

/s/
John W. Bartlett
Deputy Director
Technical Services Bureau

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