When a state-contracted data center operator procures software licenses on behalf of tax-exempt government agencies, does the operator owe sales tax on those purchases?

Plain-English summary

The Texas Department of Information Resources (DIR) runs statewide data centers for other state agencies, which are required to participate on a cost-sharing basis. DIR contracts with a private operator to run the centers; under that contract, the operator also procures business application software on behalf of the participating agencies ("DCS customers") — all of which are tax-exempt governmental entities. The operator pays the software vendor, then bills the DCS customer for the cost (including reimbursement of any sales tax the operator paid). DIR asked whether the operator owes sales tax on these software purchases/renewals.

The Comptroller ruled no sales tax is due, based on three conditions all being met here:

1. The operator procures specific software at the request of the DCS customer under the contract's procurement provisions;
2. The software vendor licenses the software directly in the DCS customer's own name, for that customer's use (not the operator's); and
3. The contract requires the operator to relinquish custody of the software to the DCS customer if the contract ends.

Legally, licensing a computer program counts as a lease/rental of tangible personal property under Texas law (computer programs are TPP). Because the operator is buying that license for the purpose of reselling it — passing it through to the DCS customer in the same form — the purchase is an exempt sale for resale, not a taxable purchase by the operator. Separately (and independently of the resale point), the DCS customers themselves are exempt from sales tax on their own purchases as governmental entities, though out-of-state governmental units get only the more limited reciprocal exemption.

What this means for you

IT service providers and system integrators serving government agencies

If you procure software on a government customer's behalf — where the vendor licenses directly to the government entity and you don't retain the software if your contract ends — you're generally reselling, not consuming, that software. Structure the contract to make the pass-through nature explicit (vendor licenses in the customer's name; you relinquish custody on contract termination) to support resale-exemption treatment, and use a resale certificate with your software vendors accordingly.

State agencies and governmental data-center customers

Even setting aside the resale-certificate mechanics on your contractor's side, your own purchases as a governmental entity are separately exempt under § 151.309 — just note that this exemption is narrower for governmental units of other states, which get it "only to the extent allowed" by reciprocity under § 151.309(6).

Contractors who might retain rights to procured software

This ruling doesn't extend to arrangements where the contractor keeps ownership, control, or an ongoing license interest in software procured "on behalf of" a client — the exempt-resale analysis here specifically turned on the vendor licensing directly to the end customer and the contractor giving up custody if the relationship ends.

Common questions

Q: Does a contractor who buys software for a government client, and bills the client for the cost, owe sales tax on that purchase?
A: No — per this ruling, if the software vendor licenses the software directly in the government customer's name and the contractor relinquishes custody if its own contract ends, the purchase qualifies as an exempt sale for resale.

Q: Are computer program licenses treated as tangible personal property in Texas?
A: Yes — per Tex. Tax Code § 151.009 and this ruling, computer programs are TPP, and licensing one is legally equivalent to a lease/rental of TPP.

Q: Are out-of-state government agencies exempt from Texas sales tax the same way Texas agencies are?
A: Not automatically — per this ruling and § 151.309(6), governmental units of other states are exempt only to the extent reciprocity is allowed, a narrower exemption than Texas governmental entities get.

Citations and references

Statutes:

• Tex. Tax Code § 151.005 (Sale/purchase includes the lease or rental of tangible personal property)
• Tex. Tax Code § 151.009 (Computer programs are tangible personal property)
• Tex. Tax Code § 151.006(a) (Sale for resale — acquiring property to resell in the same form)
• Tex. Tax Code § 151.302 (Sales for Resale exemption)
• Tex. Tax Code § 151.309 (Governmental Entities exemption; subsection (6) governs out-of-state governmental units)

Cited prior guidance:

• Comptroller's Decision No. 36,237 (1998) — sales tax due on the sale, lease, or license of a computer program under Rule 3.308

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/201708003L

Original ruling text

August 18, 2017

Katherine R. Fite, Assistant General Counsel

Texas Department of Information Resources

PO Box 13564

Austin, Texas 78711-3564

Subject: Private Letter Ruling No. 2017010130

Texas Department of Information Resources

Dear Ms. Fite:

We issue this private letter ruling in accordance with Rule 3.1, Private Letter Rulings and General Information Letters. [endnote 1] We are responding to your December 21, 2016 letter requesting guidance on the taxability of software purchased through a contract with COMPANY A. Detrimental reliance relief is provided to the Texas Department of Information Resources (DIR) in accordance with Rule 3.10, the Taxpayer Bill of Rights.

Facts Presented

In 2005, the Legislature authorized DIR to create statewide data centers to provide services to governmental entities on a cost-sharing basis. Most state agencies are required to participate in the program.

DIR may operate a statewide data center directly or by contracting with a third party to operate the center. Currently, DIR contracts with COMPANY A to operate the data centers. Collectively, the goods and services COMPANY A provides through the data center contracts are referred to as Data Center Services (DCS). DIR and the agencies participating in the DIR data center program are referred to as DCS customers. All DCS customers are tax-exempt governmental entities.

Through the Master Service Agreement (Agreement), COMPANY A delivers infrastructure services for mainframes, servers, networks, and data center operations to DCS customers. Under separate provisions of the Agreement, COMPANY A also procures end-user, business application software at the request of, and on behalf of, DCS customers.

The Agreement between DIR and COMPANY A specifically addresses procurement of business application software. Under the Agreement, COMPANY A is required to make purchases at the request of DCS customers. COMPANY A initiates payment for new software, and any software renewals, on behalf of a DCS customer and bills the DCS customer for the cost, including reimbursement for any sales tax paid by COMPANY A. Specifically, COMPANY A must: (1) purchase products on behalf of DCS customers; (2) lease, or arrange for a third party to lease, such products to DCS customers; or (3) license, or arrange for a third party to license, such products to DCS customers. DCS customers pay COMPANY A, the supplier, third-party lessor, or third-party licensor, as applicable. Generally, COMPANY A cannot add any mark-up or margin to the costs of such items procured on DCS customers’ behalf.

When COMPANY A procures a particular software product, the software vendor issues a license in the DCS customer's name. The DCS customer may issue a letter to the software vendor that grants limited agency rights to COMPANY A to administer the license. The software resides on servers at the data centers managed by COMPANY A, or on DCS customer’s computers and equipment, and is used directly by the DCS customer's personnel.

If the contractual relationship between DIR and COMPANY A ends prior to the end of the software license, the responsibilities of care and custody of the software product revert back to the DCS customer as the licensee.

Question, Ruling and Analysis

Question: Is sales tax due on the purchase or renewal of business application software licenses by COMPANY A on behalf of DCS customers under the Agreement?

Ruling: No sales tax is due on the purchase or renewal of business application software licenses by COMPANY A on behalf of DCS customers when: 1) COMPANY A procures specific software at the request of a DCS customer under the procurement provisions of the Agreement; 2) the software vendor licenses the software directly in the name of the DCS customer for use by the DCS customer; and 3) the Agreement requires COMPANY A to relinquish custody of the software to the DCS customer if the Agreement ends.

Analysis:

The relevant statute and rules provide that the licensing of a computer program is the equivalent of a lease or rental of tangible personal property. See Section 151.005 (defining a “sale” or “purchase” to include the lease or rental of tangible personal property); Section 151.009 (stating computer programs are tangible personal property); and Comptroller’s Decision No. 36,237 (1998) (“Under Rule 3.308, ‘[s]ales tax is due on the sale, lease, or license of a computer program.’”)

Under Section 151.006(a), a sale for resale includes the sale of tangible personal property to a purchaser who acquires the property for the purpose of reselling it with or as a taxable item in the normal course of business in the form or condition in which it is acquired. The sale for resale of a taxable item is exempted from sales and use tax. See Section 151.302 (Sales for Resale).

Purchases of software by COMPANY A for resale to DCS customers qualify as exempt sales for resale under the circumstances described above.

In addition, DCS customers are exempt from sales tax on their purchases of software and other taxable items under Section 151.309 (“Governmental Entities”). If any DCS customers are governmental units of states other than Texas, their purchases are exempt only to the extent allowed by Section 151.309(6).

Comptroller’s Decisions cited can be found the Comptroller’s State Tax Automated Research (STAR) system. The Texas Tax Code, Texas Administrative Code, and the STAR system are accessible at www.comptroller.texas.gov/taxes/.

If you have questions about this private letter ruling, please email us through our website at https://comptroller.texas.gov/web-forms/tax-help/ and reference Private Letter Ruling No. 2017010130.

Sincerely,

Indirect Tax Section, Tax Policy Division

Texas Comptroller of Public Accounts

Cc: Chad J. Lersch, Assistant General Counsel, Texas Department of Information Resources

ENDNOTE:

1. Unless otherwise noted, all references herein to “Section” are to the Texas Tax Code, and all references to “Rule” are to Title 34 of the Texas Administrative Code.