Is an optional escrow fee charged so customers can claim a software's source code if the seller goes out of business subject to Texas sales tax?

Subject

Software — Escrow Fee Added To Sales Price In Order To Secure Source Code — Fee Is Optional And Renewable Annually

Plain-English summary

A software and publication company (referred to as "VI" in the letter, which specializes in sales, use, property, and payroll taxation software) sells a product called the "Q" Sales & Use Tax software. That software contains a copyrighted source code that customers cannot access directly.

When a customer buys the software, they can optionally pay an Escrow Fee. Paying it entitles the customer to file a claim with an escrow company that holds the source code, but only if VI ever ceases doing business. The fee is separately itemized on the invoice and is renewable each year at the customer's choice; if the customer declines to renew, they lose the right to make that future claim.

The Comptroller ruled on three questions the company asked:

1. Is the Escrow Fee for intangible property or tangible personal property? The Comptroller treated it as part of the total amount charged for the taxable item (the software itself), citing Texas Tax Code § 151.007's definition of "sales price."
2. Is the Escrow Fee taxable on the initial invoice? Yes.
3. Is the annual renewal fee taxable? Yes.

In short, even though the escrow fee is optional, separately stated, and tied to a service performed by a third-party escrow company rather than to the software itself, the Comptroller folded it into the taxable sales price of the software because it is charged in connection with the sale of that taxable item.

What this means for you

Software vendors who offer source-code escrow

If you sell software and offer customers an optional, separately stated fee to place your source code in escrow (so customers can access it if you go out of business), Texas treats that fee as part of the sales price of the software. That means you should collect sales tax on it both when a customer first elects it and on each annual renewal, not just on the base software price.

Customers/purchasers of escrowed software

Don't assume that because an escrow fee is optional or billed separately from the software license, it escapes sales tax. Under this ruling, the fee is treated as taxable because it is added to the price of a taxable item (the software), regardless of the fact that the underlying escrow service is performed by a separate company.

Accountants and tax professionals

The key hook here is Texas Tax Code § 151.007's broad definition of "sales price," which pulls in charges connected to the sale of a taxable item even when those charges are optional, separately itemized, and recurring. This ruling illustrates that being optional or separately stated on the invoice does not, by itself, take a charge outside the taxable sales price.

Common questions

Q: Is the escrow fee taxed as tangible personal property or intangible property?
A: The Comptroller treated it as part of the taxable sales price of the software (a taxable item), rather than analyzing it as a separate intangible property transaction, citing Texas Tax Code § 151.007.

Q: Is the escrow fee taxable when the customer first buys it?
A: Yes, according to the letter.

Q: Is the annual renewal of the escrow fee also taxable?
A: Yes, the letter states the annual renewal fee is subject to sales or use tax as well.

Q: Does it matter that the escrow fee is optional and separately itemized on the invoice?
A: No. Even though the fee is optional and shown as a separate line item, the Comptroller still counted it as part of the total amount charged for the taxable software.

Q: Could this answer change under different facts?
A: The letter states its opinion is based on the facts presented, and other, similar facts could produce a different result.

Citations and references

Statutes:

• Tex. Tax Code § 151.007 (definition of "sales price," used to include the escrow fee as part of the taxable amount charged for the software)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9608L1432G01

Original ruling text

August 12, 1996

Dear ***:

This is in response to your request for a ruling on the
taxability of the software sold by your company. Your company (VI) is a
software and publication company specializing in Sales, Use, Property and
Payroll Taxation. You are requesting a formal opinion on the application, if
any, of Sales/Use Tax on the following tansaction:

The VI "Q" Sales & Use Tax software contains a copyrighted calculation system
known as a source code. The source code is contained in our software, however,
our customers do not have access to the code.

Each customer purchasing our software system will be
given the option of paying an Escrow Fee. The Escrow Fee entitles the customer
to file a claim with an escrow company, which will retain the source code for
the software. A claim may only be filed if VI were to cease doing business. The
Escrow Fee will be separately line itemized on the invoice and renewable
annually at the customer's option. Should the customer decline to renew the
Escrow Fee, they will forfeit their right to file a claim with the escrow
company for the source code in the event VI ceases doing business.

Ouestions:

1. Is the Escrow Fee an intangible property or tangible personal property
   transaction? Response: Yes. The charge for escrow fee is considered part of
   the total amount for which the taxable item (software) is sold. See Texas Tax
   Code 151.007.

2. Is the Escrow Fee subject to Sales or Use Tax when the customer is invoiced
   for their initial purchase? Response: Yes.

3. Is the annual renewal fee subject to Sales or Use Tax? Response: Yes.

This opinion is based on the facts presented. Other facts though similar may
provide a different result. You may call me toll-free at 1-800-531-5441,
extension 3-4502. The direct line is 512/463-4502. You may also write to Tax
Policy Division, Comptroller of Public Accounts. My Internet address is:
[email protected].

Sincerely,

Gilbert Zamora
Tax Policy Division

NOTE: Previous Accession Number 9608603L