When a software company licenses core products, optional add-ons, and maintenance together for one lump-sum, non-itemized price, does Tennessee's $1,600 'single article' local-tax cap limit the tax on that sale?

Plain-English summary

Tennessee's local-option sales tax (the extra tax counties/cities can add on top of the state rate) has a "single article cap": for any single article of tangible personal property, the local tax only applies to the first $1,600 of the sale price. There's a parallel state-level "single article" tax that adds 2.75% on the portion of a single article's price between $1,600 and $3,200. A software company that sells multiple software product families, each with core products plus optional add-ons, asked how these caps apply to its licensing deals -- where it bundles the core software, optional components, and maintenance together and negotiates one lump-sum, non-itemized price (the breakdown by product exists only in internal records, never shown to the customer).

The Department's answer: the caps don't apply at all to these bundled sales -- the full lump-sum price is subject to the full local option sales tax (and the state single-article tax doesn't apply either, since a sale must first qualify as a single article before that separate tax band even comes into play).

The reasoning traces through three Tennessee Supreme Court/Court of Appeals cases:

• Individual software products, standing alone, ARE "single articles." They're commonly understood as separate units capable of being sold independently (Honeywell Info. Sys. v. King; Executone of Memphis, Inc. v. Garner -- it's the inherent character of the item, not how the seller labels it, that decides this).
• But the statute itself says bundled units sold as a set/lot/suite at one price are NOT a single article (Tenn. Code Ann. § 67-6-702(d)), and Colemill Enterprises, Inc. v. Huddleston confirms the practical reason why: if a seller doesn't itemize the price of each component, the Department has no way to verify each piece was taxed correctly, so the whole bundle gets taxed at the full sales price instead of getting single-article treatment.
• Applying that here: because the company negotiates and invoices one non-itemized total for the core software, optional add-ons, and maintenance together, none of the individual products get single-article treatment -- the entire bundle's price is taxed. The Department noted explicitly that if the company itemized the price of each product/component on the invoice, each one would separately qualify as its own single article (getting its own $1,600 local-tax cap) -- itemization is the deciding factor.
• Software maintenance service charges never get single-article treatment either way, itemized or not, because the single-article cap only reaches sales of tangible personal property, and a maintenance service contract is a taxable service, not personal property.

What this means for you

Software companies and other sellers of multi-component bundles in Tennessee

Whether your bundled sale gets the benefit of the $1,600-per-item local tax cap comes down to one practical choice: do you itemize the price of each component on the invoice? Bundle everything into one non-itemized price, and the entire bundle is taxed as if it were one (uncapped) item. Break out the price of each core product and optional component separately, and each one can independently qualify as its own single article with its own $1,600 cap -- a potentially significant difference in local tax owed on large deals.

Accountants and tax professionals

This is a clean template for the "single article" analysis generally (not just software): apply the Honeywell/Executone "commonly understood as a separate unit" test to determine if an item is inherently a single article, then check Colemill and § 67-6-702(d)'s bundled-sets carve-out to see if bundling and non-itemized pricing removed it from single-article treatment. Remember maintenance/service contracts are categorically excluded from single-article treatment regardless of itemization.

Common questions

Q: Is prewritten software normally a "single article" under Tennessee's local tax cap?
A: Yes, standing alone -- it's commonly understood as a separate, independently sellable unit. The cap issue in this ruling arose only because multiple software products were bundled together for one price.

Q: How can a software company get the $1,600 single-article cap to apply to a bundled sale?
A: By itemizing the price of each core product and optional component separately on the customer invoice -- the Department confirmed that would make each one its own single article.

Q: Does itemizing maintenance service charges help get them the single-article cap?
A: No. Maintenance service contracts are taxable services, not personal property, so the single-article cap (which only applies to tangible personal property) never applies to them regardless of itemization.

Q: Can another software company or bundled-goods seller rely on this ruling?
A: No. A Tennessee letter ruling binds the Department only as to the specific taxpayer and facts it was issued to, and it can be revoked or modified by the Commissioner. Confirm your own invoicing practices with a tax professional.

Citations and references

Tennessee statutes (Tenn. Code Ann.):

• § 67-6-702(a)(1), (d) (Supp. 2010) (local option sales tax; $1,600 single article cap; "single article" definition; bundled sets/lots/suites excluded)
• § 67-6-202(a) (Supp. 2010) (state single article tax, 2.75% on the $1,600-$3,200 band)
• § 67-6-231(a), (b)(1) (Supp. 2010) (computer software and maintenance contracts taxable)
• § 67-6-102(92)(A) (Supp. 2010) ("tangible personal property," including prewritten software); § 67-6-102(71) ("prewritten computer software")
• § 67-6-102(81) ("sale," including licensing of computer software)
• § 67-6-387 (Supp. 2010) (exemption for self-designed software for own use)
• § 67-6-101 et seq. (Retailers' Sales Tax Act)

Tennessee cases cited by the ruling:

• Honeywell Info. Sys. v. King, 640 S.W.2d 553 (Tenn. 1982) (a taxpayer's own marketing/invoicing/recordkeeping treatment of components as separate sales supports single-article treatment)
• Executone of Memphis, Inc. v. Garner, 650 S.W.2d 734 (Tenn. 1983) (the inherent character of a component, not how the seller treats it, determines single-article status)
• Colemill Enter., Inc. v. Huddleston, 1996 WL 693677 (Tenn. Ct. App. 1996), rev'd on other grounds, 967 S.W.2d 753 (Tenn. 1998) (non-itemized bundled sale removed the single-article cap because the Department had no way to verify each component's price)

Source

• Landing page: https://www.tn.gov/revenue/tax-resources/legal-resources/tax-rulings.html
• Original PDF: https://www.tn.gov/content/dam/tn/revenue/documents/rulings/sales/11-34.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
LETTER RULING # 11-34

WARNING
Letter rulings are binding on the Department only with respect to the individual taxpayer
being addressed in the ruling. This presentation of the ruling in a redacted form is
informational only. Rulings are made in response to particular facts presented and are not
intended necessarily as statements of Department policy.
SUBJECT
The applicability of the Tennessee sales and use tax single article cap to the sale and licensing of
bundled software products.
SCOPE
This letter ruling is an interpretation and application of the tax law as it relates to a specific set of
existing facts furnished to the Department by the taxpayer. The rulings herein are binding upon
the Department, and are applicable only to the individual taxpayer being addressed.
This letter ruling may be revoked or modified by the Commissioner at any time. Such revocation
or modification shall be effective retroactively unless the following conditions are met, in which
case the revocation shall be prospective only:
(A) The taxpayer must not have misstated or omitted material facts involved in
the transaction;
(B) Facts that develop later must not be materially different from the facts upon
which the ruling was based;
(C) The applicable law must not have been changed or amended;
(D) The ruling must have been issued originally with respect to a prospective or
proposed transaction; and
(E) The taxpayer directly involved must have acted in good faith in relying upon
the ruling; and a retroactive revocation of the ruling must inure to the taxpayer’s
detriment.
FACTS
[TAXPAYER], [REDACTED], is engaged in the business of licensing prewritten computer
software [REDACTED]. The Taxpayer has [NUMBER] primary product families. Each
product family has core products and multiple optional products to choose from, and customers
have the ability to pick and choose the components that will meet their particular business needs.

The Taxpayer also sells related software implementation services, optional software maintenance
contracts, training services, and other professional services related to computer software.
The licensing of the Taxpayer’s software is contracted under an end-user license agreement; the
license agreement may be updated periodically, if necessary, by amendments to the original
agreement. The license agreement grants the licensee a perpetual, nontransferable and
nonexclusive license to use the products and related documentation. The agreement contains
provisions that, among other things, restrict the licensee’s duplication and use of the software. A
Product License and Technical Services Order Form (“PTSO”) is executed as an appendix to the
license agreement; the licensed software is itemized on the PTSO in detail as to the specific
product name, operating system, and license metric (as explained below, however, the portion of
the sales price that is allocable to each product is not listed separately on the PTSO). There are
various categories used to define the license metrics of a software product, including Maximum
Measured Service Units (“MSU”). An MSU’s rating, which the Taxpayer typically uses as the
license metric for its mainframe products, reflects a specific central processing unit’s processing
capacity and speed.
There are two elements that factor into the determination of the price for the licensed software.
The first element consists of the actual software product or products. The second element
consists of the license metric granted for the product or products.
The Taxpayer bundles the components of the software license and the maintenance for software
components and negotiates a single sales price. The consideration paid for the license and for
maintenance of each separate software product is not listed separately on the invoice or on the
PTSO. Rather, all software products sold in a single negotiation are totaled and invoiced as a
single amount.
However, the cost of each product and the respective maintenance cost are recorded in the
Taxpayer’s internal billing records, which are not provided to the customer. Records showing
the allocated cost of each software product and the maintenance charge for each product can be
produced from the Taxpayer’s internal billing system. Maintenance charges consist of tangible
personal property in the form of updates and upgrades, as well as the intangible service of
telephone support. There is no breakdown available in the billing system or anywhere else in the
Taxpayer’s records that specifies the portion of the maintenance charge that is attributable to the
sale of updates and upgrades versus telephone support.
QUESTIONS
1.

How is the “single article cap” for Tennessee’s local option sales tax applied to the
licensing of the Taxpayer’s software products?

2.

How is the Tennessee “single article” sales tax applied to the licensing of the Taxpayer’s
software products?

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RULINGS
1.

The Taxpayer’s software products are not subject to the single article cap for purposes of
Tennessee’s local option sales tax. Therefore, the entire sales price will be subject to the
local option sales tax.

2.

Because the Taxpayer’s software products are not subject to the single article cap for
purposes of the local option sales tax, the Taxpayer’s software products are not subject to
the Tennessee “single article” sales tax.
ANALYSIS

1.

The single article cap and the local option sales tax

The Taxpayer’s software products are not subject to the single article cap for purposes of
Tennessee’s local option sales tax. Therefore, the entire sales price will be subject to the local
option sales tax.
Under the Retailers’ Sales Tax Act, TENN. CODE ANN. § 67-6-101 et seq., retail sales of tangible
personal property in Tennessee are subject to sales and use tax. TENN. CODE ANN. § 67-6102(92)(A) (Supp. 2010) defines “tangible personal property” in pertinent part as “personal
property that can be seen, weighed, measured, felt, or touched,” and specifically includes
prewritten computer software.1 Additionally, TENN. CODE ANN. § 67-6-231(a) (Supp. 2010)
specifically provides that the sale or use of computer software is subject to the sales and use tax.2
TENN. CODE ANN. § 67-6-702(a)(1) (Supp. 2010) authorizes counties and incorporated cities to
impose an additional tax on the same privileges that are subject to the state sales and use tax (the
“local option sales tax”). However, the local option sales tax, when applied to the sale of any
single article of tangible personal property, only applies to the first $1,600 of that sale.3 TENN.
CODE ANN. § 67-6-702(d) defines the term “single article” for purposes of the local option sales
tax as “that which is regarded by common understanding as a separate unit exclusive of any
accessories, extra parts, etc., and that which is capable of being sold as an independent unit or as
a common unit of measure, a regular billing or other obligation.” Additionally, TENN. CODE
ANN. § 67-6-702(d) provides that “[s]uch independent units sold in sets, lots, suites, etc., at a
single price shall not be considered a single article.”

1

“Prewritten computer software” is “computer software … that is not designed and developed by the author or other
creator to the specification of a specific purchaser” and includes prewritten upgrades. TENN. CODE ANN. § 67-6102(71).
2

The term “sale” means in pertinent part “any transfer of title or possession, or both, lease or licensing, in any
manner or by any means whatsoever of computer software for a consideration, and includes the creation of computer
software on the premises of the consumer and any programming, transferring, or loading of computer software into a
computer.” TENN. CODE ANN. § 67-6-102(81). TENN. CODE ANN. § 67-6-387 (Supp. 2010) provides an exemption
for computer software that is designed by a person for the person’s own use.
3

The $1,600 limit is referred to for purposes of this letter ruling as the “single article cap.”

3

The Taxpayer’s sales of bundled software constitute taxable sales under Tennessee law, thereby
subjecting the sales of software to the local option sales tax. If the Taxpayer’s sales are sales of
single articles, then the local option sales tax will apply only to the first $1600 of each sale. But,
if the Taxpayer’s sales are not sales of single articles, then the local option sales tax will apply to
the entire sales price. Therefore, it is necessary to determine under what circumstances packaged
or prewritten computer software products are “regarded by common understanding as a separate
unit exclusive of any accessories, extra parts, etc., and that which is capable of being sold as an
independent unit.” TENN. CODE ANN. § 67-6-702(d).
Prewritten computer software, as defined for purposes of the sales and use tax, is commonly
understood to be a separate unit. Therefore, the single article cap generally will apply to the sale
of prewritten computer software. Similarly, the Department also considers a license agreement
that contemplates the transfer of rights to use certain prewritten computer software products to be
a single article for purposes of the local option sales tax and the state single article sales tax,
provided that the agreement separately itemizes the consideration to be paid for each separate
prewritten computer software product and license. See Honeywell Info. Sys. v. King, 640 S.W.2d
553 (Tenn. 1982) (stating that taxpayer must treat sales of components as individual sales and
not as a packaged sale for each component to be considered a single article).
In Honeywell Info. Sys., 640 S.W.2d at 553, the taxpayer plaintiff leased computer components.
The taxpayer’s method of marketing, invoicing and record-keeping clearly demonstrated that it
did not lease the component units of its computer systems as one single entity. Rather, it
invoiced its customer for each of the components, each bearing its own serial number, and a
specific monthly rental being charged for each component. The Tennessee Supreme Court held
that since the taxpayer did not treat these components as “a single article of personal property”
for purposes of its own leasing, invoicing and collections, the Commissioner for the Department
of Revenue was likewise justified in treating them separately.
In Executone of Memphis, Inc. v. Garner, 650 S.W.2d 734 (Tenn. 1983), the Tennessee Supreme
Court clarified that it is the character of each component, not how a taxpayer treats each
component, that determines its status as a single article. The court dismissed the plaintiff’s
argument that the plugs, the switching systems, and the telephone units in a digital telephone
switching system were components of a single article because no single component is sufficient
on its own. The Court held that:
In applying the considerations set out in Rule 6 to the present case, it requires no
distortion to conclude that the plugs, the switching systems, and the telephone
units, as they are described here, are “commonly understood” to be separate units.
The Plaintiff admits that these articles have unit prices, that they can be put
together to meet various office needs, and that if the occasion arose they could be
sold separately to one who needs a system alteration. To conclude that only the
system itself constitutes a single unit completely ignores the separate physical
character of each component part, both in the design of the system and in the
ultimate benefit to the customer.

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Executone of Memphis, 650 S.W. 2d at 737 (emphasis added). Thus, it is the character of each
component, not how a taxpayer treats each component, that determines its status as a single
article.
However, in Colemill Enter., Inc. v. Huddleston, No. 01A01-9605-CH-00218, 1996 WL 693677
(Tenn. Ct. App. Dec. 5, 1996), rev’d on other grounds, 967 S.W.2d 753 (Tenn. 1998), the
Tennessee Court of Appeals held that the single article cap did not apply to a rebuilt airplane,
because the plaintiff did not itemize the individual components and services separately on the
invoice, with the result being that the Commissioner of Revenue had no means to determine the
price of each individual component. The Colemill plaintiff rebuilt airplanes using numerous
components, and claimed that the single article cap applied to the sale of the entire rebuilt
airplane even though a portion of the sales price included charges for installation services (to
which the single article cap does not apply). The Tennessee Court of Appeals rejected this
argument, noting that the plaintiff charged one fee for an entire rebuilt airplane. Because the
plaintiff did not itemize the individual components and services separately on the invoice, the
Commissioner of Revenue had no means to determine the price of each individual component.
The court agreed with the Commissioner that assessing tax on the full sales price was the only
way the Commissioner could ensure that the full amount of the installation services were taxed,
and that the aircraft parts were properly taxed as well. The single article cap therefore did not
apply to the rebuilt airplane, and the entire sales price was subject to the local option sales tax.
Under the Honeywell and Executone analysis, software products are properly characterized as
single articles. However, in keeping with the Colemill analysis, the sale of more than one of
these items together for one price removes the sale from the limitation of the single article cap.
Furthermore, consistent with the Colemill analysis, TENN. CODE ANN. § 67-6-702(d) provides
that “[s]uch independent units sold in sets, lots, suites, etc., at a single price shall not be
considered a single article.”
Unlike the plaintiff in Honeywell Info. Sys., the Taxpayer sells everything for a single lump sum
price. Specifically, the Taxpayer bundles the components together and negotiates a single sales
price with a customer; the consideration paid to license each separate software package is not
listed separately on the invoice or on the PTSO. In a similar manner as the plaintiff in Colemill,
the Taxpayer charges one non-itemized price for the sale of the core or basic software products,
together with the optional components and the software maintenance.4
As illustrated in the Colemill decision and in TENN. CODE ANN. § 67-6-702(d), if a dealer does
not allocate or determine a sales price corresponding to each single article, the single article cap
generally will not apply, and the full sales price is subject to the local option sales tax. Because
the Taxpayer’s sale of the core or basic software products, the optional components, and the
software maintenance is not broken down but rather is negotiated with the customer for one
single price, the sale will not be treated as the sale of individual single articles. Accordingly, the
single article cap will not apply, and the total sales price of the software packages will be subject
4

Note that under TENN. CODE ANN. § 67-6-231(b)(1), the sale of a service contract covering the maintenance of
computer software is a taxable service, and as such is subject to the local option sales tax. However, the single
article cap only applies to the “sale or use of any single article of personal property.” TENN. CODE ANN. § 67-6702(a)(1) (emphasis added). Thus, the sale of computer maintenance services, as a sale of services rather than
personal property, is not subject to the single article cap, whether it is separately itemized or not.

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to the local option sales tax. As such, the entire price of the sale is subject to the local sales tax.
Note that if the Taxpayer itemized the prices for the core or basic software solutions and the
optional components on its customers’ invoices, each component of the sale would be considered
a single article, except for the maintenance services (see footnote #4).
In summary, the Taxpayer’s software products and maintenance services, when sold together for
one non-itemized price, are not subject to the single article cap for purposes of the local option
sales tax. The entire sales price therefore will be subject to the local option sales tax.
2.

The state single article tax

Because the Taxpayer’s software products are not subject to the single article cap for purposes of
the local option sales tax, the Taxpayer’s software products are not subject to the Tennessee
“single article” sales tax.
TENN. CODE ANN. § 67-6-202(a) (Supp. 2010) imposes an additional state tax at the rate of 2.75
percent on the amount over $1,600, but less than or equal to $3,200, on the sale or use of any
single article, as defined by TENN. CODE ANN. § 67-6-702(d), of tangible personal property (the
“state single article sales tax”). As discussed above, the Taxpayer’s sales of software products,
because they are sold together for one non-itemized price, do not qualify as sales of single
articles and as such are not subject to the single article cap. Therefore, it follows that the
Taxpayer’s sales are also not subject to the state single article tax.

Elizabeth Henderson
Tax Counsel

APPROVED:

Richard H. Roberts
Commissioner of Revenue

DATE:

7/21/11

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