Is a custom software development contract taxable when a Texas consulting company builds a program from scratch for an out-of-state client and transfers all exclusive rights to the customer with no license fee?

Plain-English summary

A Texas computer consulting company contracted with a California customer to provide custom programming services — designing and building a computer program for use in the customer's business. Critically, this was not a combination or customization of existing software, but a complete design-and-build "from scratch." The consulting company would retain no rights or title to the program; the customer would own all aspects of it and control its use; and no license fee would be charged.

The Comptroller confirmed this charge is not taxable, applying 34 TAC § 3.308(b)(4): "Charges to create a program or modify an existing program not sold by the person doing the modification are not taxable." The Comptroller has extended this exemption specifically to software created from scratch for a customer, where the exclusive rights to the program are transferred to that customer. Because both conditions were met here — genuine from-scratch creation and full exclusive-rights transfer, with no license fee retained — the charge for the program is not taxable. The letter points to an earlier STAR ruling (accession number 9606L1416A03) for the fuller definitions of "exclusive rights" and "from scratch."

What this means for you

Software developers and computer consulting companies

If you build software completely from scratch for a client — not modifying or combining existing code you already have — and you transfer all exclusive rights to the customer without retaining a license fee, your development charge can be nontaxable under Rule 3.308(b)(4). Keep your contract language clear on both the from-scratch nature of the work and the full rights transfer.

Businesses commissioning custom software

Ask your developer whether the software is being built from scratch with full rights transferring to you — that structure can mean the development charge isn't subject to Texas sales tax, as opposed to a license or off-the-shelf software purchase, which typically is taxable.

Accountants and tax professionals

The two load-bearing terms here — "exclusive rights" and "from scratch" — have their own fuller definitions in STAR accession 9606L1416A03; pull that companion ruling when advising on a borderline case (e.g., partial code reuse, or a retained license).

Common questions

Q: Is custom software development always nontaxable in Texas?
A: Not automatically — it must be genuinely created from scratch (not a modification or combination of existing software) and the exclusive rights to the program must transfer to the customer.

Q: Does charging a license fee affect this exemption?
A: This letter's facts specifically note no license fee was charged; retaining a license fee (rather than fully transferring exclusive rights) could point toward a different, taxable characterization.

Q: Where can I find the fuller definitions of "exclusive rights" and "from scratch"?
A: The letter points to STAR accession number 9606L1416A03 for those definitions.

Q: Can any software developer rely on this exact answer?
A: Not directly. This is a Texas STAR letter ruling binding on the Comptroller only for the taxpayer it addresses (34 Tex. Admin. Code Rules 3.1, 3.10); confirm your own contract terms with a tax professional.

Citations and references

Rules and related guidance:

• 34 Tex. Admin. Code § 3.308(b)(4) (Computers — Hardware, Software, Services and Sales)
• STAR accession number 9606L1416A03 (definitions of "exclusive rights" and "from scratch")

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/200010762L

Original ruling text

October 4, 2000

From: Gilbert Zamora
[email protected]

To: **

Dear **:

I am responding to your e-mail inquiry submitted through our tax help Internet
address. You explained that you have a client who is a computer consulting
company. They were contracted with a California customer to provide custom
programming services and design and develop a computer program to be used in
the client's business. This program is being built as a result of the
development and design service performed by my client. This is not a
combination or customization of existing software, but a complete design and
build of software from scratch.

Your client does not retain any rights or title to the program. Your client's
customer will own all aspects of the program and control its use. Your client
will not charge a license fee to its customer.

You asked whether your client needs to assess sales tax on this contract.

Response: Subsection (b)(4) of Rule 3.308 - Computers - Hardware, Software,
Services and Sales, states "Charges to create a program or modify an existing
program not sold by the person doing the modification are not taxable." The
Comptroller has held that the exemption for software creation applies to
software created from scratch for the customer where the exclusive rights to
the program are transferred to the customer. Therefore, if your client is
creating a software program from scratch and will transfer the exclusive rights
to his customer, the charge for the program will not be taxable. For
definitions on "exclusive rights" and "from scratch" see STAR accession number
9606L1416A03.

Tax Statutes, Rules, and Publications are available at
http://www.window.state.tx.us/.

The State Tax Automated Research System (STAR), which provides viewing and
downloading edited letter rulings, hearings, AG opinions, etc., may also be
accessed through our website at http://window.state.tx.us/.

This opinion is based on the facts presented. Other facts though similar may
provide a different result.

I hope this information answers your questions. If you need additional
information, You may e-mail our tax help section at [email protected].
You may also call me toll-free at 1-800-531-5441, extension 3-4502. The
direct line is 512/463-4502. You may also write to Tax Policy Division,
Comptroller of Public Accounts.

Gilbert Zamora
[email protected]
Tax Policy Division