When a Texas software company licenses a computer program and does custom programming, is out-of-state delivery exempt, and when is software consulting taxable?

Plain-English summary

A software company posed four related situations. In Situation #1, it licenses a computer program module to a client (retaining legal title) and also does additional custom programming — both the license fee and the programming services are taxable. The company asked whether it must collect Texas tax for out-of-state clients. The Comptroller answered by citing Tax Code § 151.009 (a computer program is tangible personal property) and § 151.330: property shipped by the seller to a point outside Texas — via the seller's own facilities, delivery to a carrier for an out-of-state consignee, or delivery to a forwarding agent for shipment to another state — is exempt from sales tax. So software (and upgrades) delivered to the customer IN Texas is taxable, while the same software delivered to the customer OUTSIDE Texas is exempt, regardless of where the client's corporate headquarters bills from.

Situation #2 (same facts, but no license fee charged) couldn't be answered without seeing the actual license agreement.

Situation #3 asked about an analysis-and-design proposal that would incorporate a license fee and customization services. The Comptroller explained that professional consultation services centered on expert/professional opinions are not taxable if unrelated to a sale of taxable items — but if the software's creator retains any right to sell or license the program, that's a taxable sale. If instead the customer gets all rights and title to the software, the creator is treated as having acted in an employee-like relationship to the customer, and the arrangement is not taxable.

Situation #4 involved general software consulting unrelated to any license — building a customized database using Lotus Notes, without selling a license or the Lotus Notes software itself. The Comptroller held that creating such applications is taxable as data processing.

What this means for you

Software companies with out-of-state customers

Sourcing turns on where the software is actually delivered, not where the client is billed or headquartered: shipment to a Texas point is taxable, shipment (by your own means, a carrier, or a forwarding agent) to a point outside Texas is exempt under § 151.330.

Software consultants and developers

The taxability of a customization or consulting engagement often comes down to a single question: who ends up with title/rights to the resulting software? Keep any license rights yourself, and it's a taxable sale; transfer all rights to the customer, and the arrangement can be treated as nontaxable employee-like services. Building custom database applications (e.g., with off-the-shelf platforms like Lotus Notes) without any license sale is taxable as data processing regardless of who ends up owning it.

Common questions

Q: Is software delivered to an out-of-state customer taxable in Texas?
A: No, if the seller ships it (by its own means, a carrier, or a forwarding agent) to a point outside Texas, per Tax Code § 151.330 — even if the customer has some presence in Texas or is billed from an out-of-state headquarters.

Q: When is custom software development/consulting nontaxable?
A: When the customer obtains all rights and title to the resulting software, making the developer's role akin to an employee relationship — as opposed to retaining rights to sell or license the program, which is a taxable sale.

Q: Is building a custom database application (e.g., in Lotus Notes) taxable?
A: Yes, as data processing, even without selling any software license.

Q: Can another software company rely on this exact letter?
A: No. This is a Texas STAR letter ruling binding on the Comptroller only for the taxpayer it addresses (34 Tex. Admin. Code Rules 3.1, 3.10); confirm your own facts with a tax professional.

Citations and references

Statutes:

• Tax Code § 151.009 (computer program is tangible personal property)
• Tax Code § 151.330 (exemption for property shipped to a point outside Texas)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9710936L

Original ruling text

October 6, 1997

Dear ****:

Thank you for your recent letter which is restated in part with responses
below.

Situation #1
We sell a license to a client for a computer program module. We retain legal
title to the program. We also do additional computer programming services to
this client to customize the software for the client. It is my understanding
that the license fee and the additional computer programming services are
taxable services to this client.

The following questions are trying to determine if it is our responsibility to
access Texas sales & use tax for out of state customers:

What if our client is not in the state of Texas and has no known Texas
locations?
What if our client is not in the state of Texas but has known Texas locations?
We actually bill the client at the corporate headquarters outside of Texas.

Response: Tax Code 151.009 defines the term tangible property to include a
computer program. Tax Code 151.330 makes the following provisions for sales
of such property.

(a) The sale of tangible personal property that under the sales contract is
shipped to a point outside this state is exempted from the sales tax imposed by
Subchapter C of this chapter if the shipment is made by the seller by means of:
(1) the facilities of the seller;
(2) delivery by the seller to a carrier for shipment to a consignee at a
point outside this state; or
(3) delivery by the seller to a forwarding agent for shipment to a location
in another state of the United States or its territories or possessions.

Accordingly, software that is sold and delivered to the customer in Texas is
subject to sales tax while such property that is delivered to the customer at
points outside Texas is exempt. The same would apply to software upgrades sold
to the customer.

Situation #2
Same as Situation #1, but we do not charge the client for the license fee. Are
the computer programming services taxable to the client to customize the
software, if we give them a license?

Response: I need to see the license agreement before responding. Please mail
a copy to my attention.

Situation #3
A client has asked us to do an analysis and design project. This analysis and
design will result in a proposal to our client and will incorporate a license
fee and related computer programming services to customize for this client. Is
the initial analysis and design taxable as well as the license fee and related
computer programming services?

Response: Consultation services central to which are the expert or
professional opinions of the consultant are not taxable if they are not related
to sales of taxable items. If the creator of the software retains any rights to
sell or license the computer program, a taxable sale has occurred. However, if
the customer obtains all rights and title to the software, the creator of the
software is considered to have been acting in an employee relationship to the
customer and the sale is not taxable .

Situation #4
This question pertains to general software consulting not related to a license
fee. For several of our clients, we provide a database setup/design using
Lotus Notes. The database is customized to the clients' expectations using the
Lotus Notes product. We do not sell Lotus Notes software to our client. We do
not sell a license fee. Is this a taxable service to our clients?

Response: Creation of applications using Lotus Notes is taxable as data
processing.

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

You may call me toll free at 1-800-531-5441, ext. 3-4680. The direct line is
512/463-4680. You may also write to Tax Policy, Comptroller of Public
Accounts. The email address is .

Sincerely,

Al Van Allen
Tax Policy Division