Was a $5,000 license for software developed for one Texas customer exempt as custom programming?

Plain-English summary

The company paid $5,000 for a nonexclusive, nontransferable license to use a program developed for its operations. It could buy additional licenses for resale for $4,000 each, while the developer retained legal rights to the program.

The Comptroller said the contract was taxable. The statutory exclusion covered a contract programmer's custom program only when the client retained the exclusive right or license and the program became the client's property.

The letter clarified an earlier statement: designing a program for a client's specific needs was nontaxable only when all legal rights to the program were retained by the client.

What this means for you

Customer-specific development alone did not make the transaction exempt. Ownership and licensing terms controlled: developer-retained rights and a customer license produced a taxable contract on these facts.

Common questions

Did it matter that the program was developed for this customer? That fact alone was not enough.

When was custom programming exempt? When the program became the client's property and the client retained the exclusive right or license.

Why was this contract taxable? The developer retained legal rights and sold the customer a nonexclusive license.

Citations and references

• Texas Tax Code § 151.0101(5)(D), effective October 1, 1989

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9203L1160E02

Original ruling text

March 24, 1992

Dear **:

Adina Whittemore forwarded your March 13th letter and attached documents
to me. She and I also discussed your telephone conversation with her.

Your company entered into a contract to have a program developed for your
company's use. The contract provides that the seller will grant your company a
non-exclusive, non-transferable license to use the program in your data
processing operations. Your company agreed to pay $5,000 for this license.
Additional licenses could be purchased (for resale) at a cost of $4,000 each.

You referred to one of our letters written May 23, 1990 to a computer
hardware and software company concerning that creation of a computer program.
The letter provided that "if you contract with a client to design a program
specifically for his or her needs, your services are not taxable."

You wrote at the bottom of the copy of the letter: "no matter what the
contract says, this is exactly what we did."

Section 151.0101 of the tax code deals with taxable services. Section
151.0101(5)(D), effective October 1, 1989, provides for an exemption for "the
repair, maintenance, creation, and restoration of a computer program, including
its development and modification, not sold by the person performing the repair,
maintenance, creation, or restoration service."

If your company had contracted with someone to create a program for your
company and your company retained the exclusive right or license to the
program, the service would have been exempt from tax. The exemption provided
in this subsection of the tax code covers contract programmers that produce a
custom program that becomes the property of the client. If the company that
developed the program sold you a license to use their program and that company
retained legal rights to the program, the contract is taxable.

Our previous letter would have been clearer if the statement had been
written as: "if you contract with a client to design a program specifically for
his or her needs and all legal rights to the program are retained by the
client, your services are not taxable.

This opinion is based on the facts presented. If there are additional or
different facts, the opinion could change.

If you have any questions, please write me at the Tax Administration
Division or call me toll free at 1-800-2525555, extension 3-4565. The direct
line is (512) 463-4565.

Sincerely,

Larry Koenig
Tax Administration Division