How are receipts from selling digital products apportioned for Texas franchise tax - as services or as license receipts?

Plain-English summary

A company sold digital products electronically - generic now, but potentially custom-made for specific customers later - licensing them for a one-time, no-royalty fee. It asked how those gross receipts are apportioned for the (pre-2008) Texas franchise tax. The Comptroller drew a line between custom and generic products.

• Custom products are services. If the company contracts to create specific digital products for a customer, the receipts are for services and are apportioned to the location where the service is performed (Rules 3.546(e)(38) and 3.557(e)(33)).
• Generic products are license receipts. To the extent the digital products are not created for any specific customer, the receipts are treated as receipts from the use of a license, and are included in Texas receipts to the extent the license is used in Texas (Tax Code Secs. 171.103(4) and 171.1032(a)(4); Rule 3.549(e)(30)(A)(iii)).

So the same business can generate both service receipts and license receipts, sourced by different rules depending on how each product is produced.

Currency note: This applies the pre-2008 franchise tax's apportionment rules, replaced by the current margin tax (House Bills 3 and 3928) effective January 1, 2008, which sources receipts under its own rules. Treat as historical.

What this means for you

Digital and software sellers

Whether your receipts follow the where-performed (service) or where-used (license) rule turned on customization. Bespoke deliverables were services sourced to where you did the work; off-the-shelf licenses were sourced to where the customer used them in Texas.

Accountants and tax professionals

Segregate custom-development revenue (service sourcing, Rules 3.546(e)(38)/3.557(e)(33)) from generic-license revenue (use-in-Texas sourcing, Secs. 171.103(4)/171.1032(a)(4) and Rule 3.549(e)(30)(A)(iii)). This custom-versus-generic distinction is specific to the pre-2008 rules.

Common questions

Q: How are receipts from custom digital products sourced?
A: As services, apportioned to the location where the service is performed.

Q: How are receipts from generic (non-custom) digital products sourced?
A: As license receipts, included in Texas receipts to the extent the license is used in Texas.

Citations and references

Statutes and rules:

• Tex. Tax Code Secs. 171.103(4), 171.1032(a)(4) (license receipts sourced to where used)
• 34 Tex. Admin. Code Secs. 3.546(e)(38), 3.557(e)(33) (service receipts sourced to where performed)
• 34 Tex. Admin. Code Sec. 3.549(e)(30)(A)(iii) (license used in Texas)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200401353L

Original ruling text

January 16, 2004

To: ** <**>

Dear **:

Thank you for your follow-up information regarding the digital products and
apportionment for Texas franchise tax.

The statutes and rules I mention below, as well as other related information,
can be found at http://www.window.state.tx.us/taxinfo/franchise/index.html.

You have indicated your client sells digital products electronically. The
products are currently generic, but the corporation could produce custom images
for specific customers in the future. Your client licenses the digital
products to customers for a no royalty one-time license fee.

You have asked how the gross receipts from these sales would be apportioned for
Texas franchise tax purposes.

If your client contracts to create specific digital products for a customer,
the receipts your client receives from that customer are for services and
should be apportioned to the location where the service is performed. See
Comptroller's Rule Sec. 3.546(e)(38) and Rule Sec. 3.557(e)(33).

To the extent the digital products are not created for any specific customer,
the gross receipts should be considered receipts from the use of a license.
These receipts should be included in Texas receipts to the extent the license
is used in Texas. See Texas Tax Code Sec. 171.103(4); Tax Code Sec.
171.1032(a)(4); and Rule Sec. 3.549(e)(30)(A)(iii).

This response is based on the facts presented and current law. If there are
different or additional facts, the response may change.

Our goal is to provide you with prompt, professional service. Please take a
moment to complete our online survey at
http://aixtcp.cpa.state.tx.us/surveys/tpsurv/.

If you need any additional information, please feel free to call me at
1.800.531.5441, extension 34629.

Sincerely,

Lowell Olsen Dunn
Tax Policy Division