When did Texas treat software work as nontaxable programming created from scratch rather than a taxable completed program?

Plain-English summary

Texas said creating a program "from scratch" meant developing a specific new program for a customer. The work could include systems analysis, functional specifications, coding, compiling, testing, debugging, and installation. Charges for that work, or for modifying an existing program the provider had not sold to the customer, were nontaxable contract programming under the letter.

The result changed if the provider later sold the completed program to another customer: those charges were taxable. The letter also explained that completed custom and canned programs became taxable on October 1, 1987, subject to a possible prior-contract exemption that expired after December 31, 1989.

What this means for you

The 1991 letter distinguished customer-specific development work from selling an existing completed program. It also involved historical effective dates and expired transition relief, so the STAR disclaimer's current-policy warning is especially important here.

Common questions

What counted as creating software from scratch? Developing a specific new program for a customer, including the listed analysis, specification, coding, compilation, testing, debugging, and installation work.

Was modifying an existing program always taxable? No. The letter treated modification as nontaxable contract programming when the provider had not sold the existing program to that customer.

What if the developer later sold the new program to someone else? The later sale was taxable.

What did the letter say about the 1985 agreement? Software of the described kind qualified as exempt custom software in 1985. If it was not created from scratch, collection generally should have begun in October 1987, unless the pre-July 22, 1987 contract met Rule 3.319's prior-contract guidelines; that relief ended after 1989.

Citations and references

• 34 Tex. Admin. Code Rule 3.308 — computer hardware and software; the letter cited subsections (b)(1), (2), and (4).
• 34 Tex. Admin. Code Rule 3.319 — prior-contract transition guidelines discussed in the letter.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9103L1098A08

Original ruling text

COMPTROLLER OF PUBLIC ACCOUNTS
STATE OF TEXAS
AUSTIN, 78774

JOHN SHARP March 28, 1991
Comptroller

Dear **:

Thank you for your letter dated March 6, 1991 concerning an agreement to
license proprietary software to a client. You indicated that the agreement,
which was entered into in March 1985, held back a portion of the source code
from the client. The client was provided with the object code only.

Software such as you described qualified for exemption from sales tax in
1985 as "custom" software. As of October 1, 1987, sales of completed computer
programs, including both custom and canned programs, became taxable. A copy of
the current rule on computer hardware and software (Rule 3.308) is enclosed for
your reference.

Charges to create a program "from scratch" or to modify an existing
program that you did not sell to the customer (contract programming) are not
taxable. Please refer to sections (b)(1), (2) and (4) of the rule. Creating a
program from scratch means developing a specific new program for a customer.
This would include things such as system analysis, development of functional
specifications, coding, compiling, testing, debugging, and installing the
program. If you subsequently sold this program to another customer, the
charges would be taxable.

If you created the program "from scratch" for the customer, tax is not
due on the charges for the software. If the software was not created "from
scratch" you should have begun collecting tax from your customer in October
1987. However, a contract in effect before July 22, 1987 may have qualified
for exemption from tax if the contract met the guidelines listed in Rule 3.319
on prior contracts. If the agreement did meet the requirements in Rule 3.319,
tax would not have been due until January 1, 1990. The exemption expired
December 31, 1989.

This opinion is based upon the facts you presented. If there are
additional or different facts, this opinion may change.

Please feel free to contact me if you have any additional questions. You
may write me, call toll free 1-800-252-5555 from anywhere in the United States
or phone 512/463-4600.

Sincerely,
Julie Pesl
Tax Administration Division