Texas Letter Ruling 9209424L: Software — Contract Programmer Develops For A Specific Customer — If Exclusive Legal Rights Are Retained By Customer And Program Created From Scratch — Exclusion Applies

Subject

Software — Contract Programmer Develops For A Specific Customer — If Exclusive Legal Rights Are Retained By Customer And Program Created From Scratch — Exclusion Applies

Plain-English summary

The Texas Comptroller's Tax Policy Division responded to a contract programmer's audit questionnaire, walking through several specific situations to explain when custom-written software is taxable.

The general rule: a computer program is tangible personal property, and Texas taxes the sale, lease, or rental of tangible personal property. A "sale" is the transfer of title or possession for consideration. So selling a computer program in Texas is generally taxed — including the very first sale or creation of the program — if the creator/software company keeps the right to sell or license that program to others.

But if the customer (not the creator) ends up holding the right to sell or license the software, no taxable sale of a computer program has occurred. That is "contract programming," and it is not taxed. Contract programming happens when either (1) a program is created for a specific client and the creator does not keep the right to license or sell it, or (2) the creator modifies software that it did not itself sell to that customer.

The letter then applies this rule to the programmer's specific situations:

• Reusable modular programs assembled per client: The programmer had written multiple reusable accounts-receivable program modules and kept the right to sell or license them to other clients. Charges for these modules are taxed as sales of a computer program. If the programmer then modifies a program it had already sold to that same customer, the modification itself is also taxed.
• A conversion program package that had to be redone: The programmer was contracted to write a conversion program package; when it proved unusable, the programmer built a replacement 14-program package and credited back the original charge. Because no contract date was given, the Division gave two answers: if the sale happened before October 1, 1989, the charge is not taxed. If it happened on or after October 1, 1989, the answer depends on who kept the right to sell or license the custom programs — taxable if the programmer kept that right, nontaxable contract programming if the customer did.
• Two other situations with insufficient facts: For two more situations, the Division said it needed more information — specifically, whether the parties were creating software to sell, or the programmer was contracted to write software for the other party's own use, and who ended up with the rights. Based on the partial facts given, it looked like these were nontaxable contract programming, but the Division offered to confirm or correct that once more facts were provided.

The letter closes by noting the opinion is based on the facts presented and could change if the facts are different.

What this means for you

Contract programmers and software developers

Whether your work is taxable in Texas hinges on one question: who ends up with the legal right to sell or license the finished program? If you keep that right — for example, because you're reusing your own modular code across multiple clients — your charges are taxable, even on the very first sale to the very first client. If your customer alone holds the right to license or resell what you built for them, you've performed nontaxable contract programming. Also watch out for modifications: if you modify a program you previously sold to that customer, the modification charge is taxed separately, regardless of how the original programs were treated.

Businesses that hire custom software developers

If you're the customer commissioning custom software, ask your contract explicitly addresses who holds the right to sell or license the resulting program. That allocation — not just whether the software is "custom" versus "off-the-shelf" — is what determines whether your developer should be charging you Texas sales tax.

Accountants and tax professionals

This ruling predates a bright-line distinction: it notes there is no longer a distinction between "canned" and "custom" software for Texas sales tax purposes — both are subject to tax unless the contract-programming exclusion applies. The letter also flags an October 1, 1989 date as relevant to how a particular past transaction should be treated, so the effective date of a sale can matter when reconstructing older transactions.

Common questions

Q: I write software specifically for one client from scratch. Is that automatically tax-free in Texas?
A: Not automatically. It depends on who keeps the right to sell or license the program. If you keep that right, the sale is taxed even though the program was custom-built for that one client. Only if the client alone holds the right to license or resell it is the transaction nontaxable contract programming.

Q: I reuse my own code modules across different clients. Are my charges taxable?
A: Yes, according to this letter — because the programmer described kept the right to sell or license those reusable modules to other clients, the amount charged each customer for them is taxed as the sale of a computer program.

Q: What if I modify a program I already sold to a customer?
A: The modification is taxed, according to the letter, because you're modifying software you yourself had sold to that customer.

Q: What if I modify software the customer bought from someone else?
A: The letter distinguishes this: contract programming includes modification of software not sold by the person providing the modification, which is treated as nontaxable.

Q: Does the date of the transaction matter?
A: In one of the situations discussed, the Division noted the answer differs depending on whether the sale occurred before or on/after October 1, 1989, because it lacked the actual contract date.

Citations and references

Rules cited in the letter:

• Rule 3.308(b)(2) — cited for the taxability of charges for reusable computer program modules
• Rule 3.308(b)(3) — cited for the taxability of modifying software previously sold to the same customer

The letter cites these only by short rule number (no title designation given in the text); they are understood to be Texas Comptroller rules under 34 Tex. Admin. Code, consistent with the standard STAR citation format, but this is not independently verified against the current rule text.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9209424L

Original ruling text

September 16, 1992

Dear **:

Larry Koenig has asked that I review the tax issues submitted with your audit
questionnaire and prepare a written response for your future use. Before I
address your specific situations, I'd like to offer a general explanation.

For the application of sales and use taxes, a computer program is included in
the definition of tangible personal property. Texas imposes sales or use tax
upon the sale, lease, or rental of tangible personal property. A sale is
defined as the transfer of title or possession of tangible personal property
for consideration.

Therefore, the sale of a computer program within Texas is taxed.

If the creator/software company retains the rights to sell or license the
computer program, a taxable sale has occurred between the creator and the
purchaser, including even the first sale or creation. However, if the
purchaser/customer retains the right to sell or license the software, a taxable
sale of a computer program has not occurred.

Contract programming is not taxed. Contract programming occurs when either (1)
a computer program is created for a specific client and the right to license or
sell the program is not maintained by the creator or (2) modification of
software not sold by the person providing the modification.

In your first example, you explained that you write modular accounts receivable
programs allowing you to reuse code. You have a number of these programs
available that you put together for a particular client. If this particular
client needs a special feature, you will write a new program to perform the
particular task requested by this client. The auditor asked that you receive
clarification from Austin on this issue.

Response: In the first aspect of this situation, you have written multiple
programs that can be combined to perform various functions. You maintain the
right to sell or license these programs to other clients. The amount you charge
each customer for these programs is taxed as the sales price for a computer
program. See Rule 3.308(b)(2).

In the second aspect of this situation, you modified computer program(s) that
you had sold to your customer, therefore the modification is taxed. See Rule
3.308(b)(3).

In the second situation, you stated that you were contracted to write a
conversion program package. After a few weeks the customer called and explained
that the programs were not usable. You worked with them and designed a new
package containing a total of 14 programs. On the second billing, you credited
the customer the amount paid for the original package. You stated that you did
not charge the customer tax because this was a custom application.

Response: There is no longer a distinction between canned and custom software.
Both are subject to tax. (See page one.) In this situation, I am not provided a
contract date (date of sale). Therefore, I will give two responses: the first
applies if the sale occurred before October 1, 1989. The amount charged this
customer is not taxed.

The second applies if the sale occurred on or after October 1, 1989. If so, you
must determine whether you retained the right to sell or license the programs
created for this customer. If you do maintain the right to sell or license the
program(s) custom designed for this customer, then the amount you charged this
customer and subsequent customers for these programs must be taxed. If the
customer maintains the right to license or sell the programs, then you
performed contract programming and the amount is not taxed.

More information is necessary in order to provide specific answers to
situations three and four. For example', were you and the other parties
creating software to be sold? or, were you actually contracted with the other
parties to write programs for their own use? If so, who retained the rights to
the programs?

Based solely upon the partial information provided, it appears that you may be
providing contract programming in situations three and four which would be
nontaxable transactions. If so, the party with whom you are contracted will
maintain the right to sell or license the software. I will be glad to confirm
this response or correct it when more information is provided.

This opinion is based on the facts presented. If there are additional or
different facts, the opinion may change. You may also write to Tax
Administration Division, Comptroller of Public Accounts.

Sincerely,

Tax Policy Division