Is the sale of software source code exempt from Texas sales tax when the buyer will fold it into another software program and resell the combined product?

Plain-English summary

A Texas software corporation had always licensed its medical-management software to end users, collecting and remitting sales tax on every sale. In 1997 it sold something different: the underlying source code itself, as its single remaining asset, to another corporation that planned to fold it into an existing software product and resell the combined program. The seller collected and paid sales tax on the sale (out of caution), then asked whether the sale was actually exempt and, if so, whether it could get that tax back.

The seller's own theory — that selling your one and only asset and shutting down means no tax is due — was wrong; Texas law doesn't have a "sale of a sole asset" exemption. But the Comptroller found a different, real exemption that applied: Rule 3.300(d)(2) exempts sales of component parts bought for use as an ingredient or component of a product that will be manufactured and sold at retail. Because the buyer was going to build the source code into another software program it intended to sell, the source code qualified as an exempt component part, and the seller could have accepted an exemption certificate instead of collecting tax.

Since tax had already been collected and remitted, the letter also spells out the refund path: the buyer provides an exemption certificate plus a written refund request, the seller refunds the buyer the tax collected, and the seller then recovers that amount from the state by amending the sales tax return for the period — following the procedure in Rule 3.325.

What this means for you

Software companies selling source code, algorithms, or other software components to another business

If your buyer will incorporate what you're selling into a product it will manufacture and resell, that sale can qualify as an exempt component-part sale under Rule 3.300(d)(2) — even though a license sale to an end user would normally be taxable retail software.

Businesses that sold their "last asset" and assumed that made the sale tax-free

There's no blanket Texas exemption for selling a company's sole remaining asset. Look for an exemption that actually fits the transaction (like the component-part exemption here) rather than relying on a "last sale, no more sales" theory.

Accountants correcting an over-collected sales tax

If tax was collected and remitted on a transaction that turns out to be exempt, Rule 3.325 lays out the mechanics: get the exemption certificate and refund request from the buyer, refund the buyer, then amend the sales tax return to recover the amount from the state — you don't need a separate refund claim process for that recovery.

Common questions

Q: Is selling software source code to another company always taxable, the way selling a software license to an end user is?
A: Not necessarily. If the buyer will make the source code part of another software product it manufactures for retail sale, the sale can qualify as an exempt component-part sale under Rule 3.300(d)(2).

Q: Is there a Texas exemption for selling your company's sole remaining asset?
A: No. The Comptroller specifically rejected that theory here; any exemption has to come from an actual statute or rule provision that fits the transaction.

Q: How do I get back sales tax I already collected and paid on a sale that turns out to be exempt?
A: Get an exemption certificate and a written refund request from the buyer, refund the buyer the tax you collected, then amend your sales tax return for the period to recover that amount from the state, per Rule 3.325.

Q: Can I rely on this letter for my own software sale?
A: No. This opinion is based on the specific facts presented, and different or additional facts could change the result; it binds the Comptroller only as to the taxpayer it was issued to.

Citations and references

• 34 Tex. Admin. Code Rule 3.300(d)(2) (exemption for component parts used in a manufactured product sold at retail)
• 34 Tex. Admin. Code Rule 3.325 (procedure for refunding tax via exemption certificate and amended return)

Subject

Software — Source Code Sold To Become Component Of Another Computer Program — Exemption Certicate May Be Accepted

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9712060L

Original ruling text

December 18, 1997

Dear**:

Thank you for your letter of December 15, 1997. You asked for a taxability
opinion on the sale of source code for a software program created by your
corporation.

As I understand it, your corporation is a Texas corporation that was formed in
1992 with the single purpose of developing and selling medical management
software. Over the years, a software product was developed and sold under a
user's license to multiple installations. All sales resulted in the assessment
and collection of sales tax, and those funds were paid to the comptroller's
office as prescribed by law. None of these sales involved the selling of the
source code for the product.

In August of 1997, your corporation entered into an agreement to sell the
source code of this software program to another corporation. The buyer will
incorporate this source code into an existing software program and sell a new
combined, completed program.

This source programming code was your corporation's single asset. After the
transfer of the source code, your corporation has not made any sales. It is
your understanding that if a corporation sells its single asset and
discontinues to sell products associated with that asset, sales tax is not due
on the asset sale.

Sales tax was paid to the comptroller's office on the initial payment for the
source code that was received in August of 1997. In our telephone conversation
of December 16, 1997, you asked if you could obtain a refund of this tax if the
sale is exempt.

Response: The Texas Tax Code does not exempt the sale of a single asset as you
were advised. However, this transaction does qualify for an exemption from the
sales tax. Section (d)(2) of Rule 3.300 provides an exemption from sales and
use tax for component parts purchased for use as an ingredient of or component
part of a product manufactured for ultimate sale at retail. Because the source
code you are selling will become a component of another software program that
will be sold, you may accept an exemption certificate from the purchaser in
lieu of collecting sales tax on the selling price of the source code.

To obtain a refund of the tax paid, the purchaser must provide you with an
exemption certificate and a letter requesting the refund. You may then refund
the purchaser the tax you collected. You may then obtain a refund from the
state of the tax you remitted with your sales tax return. You may do so by
amending the sales tax return on which the sale was reported by lowering the
taxable sales by the amount of the payment you received. Please refer to the
enclosed Rule 3.325.

If you have questions about refund procedures, please contact our Credit
Verifications Section at 463-4545. Refund requests should be mailed to the
following address:

Comptroller of Public Accounts
Credit Verifications/Revenue Accounting
P. O. Box 13528
Austin, TX 78711-3528

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

You may call me toll free at 1-800-531-5441, ext. 5-0037. The direct line is
512/475-0037. You also may write to Sales Tax Policy Division, Comptroller of
Public Accounts.

Sincerely,

Lindey Osborne
Sales Tax Policy Division