A company hired me (a one-off contractor, not normally in this line of work) to design and develop custom software for a factory automation system. Do I need to charge Texas sales tax on this?

Plain-English summary

A contractor who wasn't normally in the software business had been hired to design and develop custom software for a factory automation system, and asked whether Texas sales tax applied — noting that the Comptroller's own web pages on sales tax and data processing didn't specifically address software development.

The Comptroller's answer: charges for custom-developed software are generally not taxable. Under Rule 3.308(b)(4), "charges to create a program or modify an existing program not sold by the person doing the modification are not taxable." The Comptroller has applied this exemption specifically to software created from scratch for the customer, where the exclusive rights to the finished program are transferred to that customer. So if this contractor built the automation software from the ground up and handed over exclusive ownership rights to the company that hired them, the charge for that work is not taxable. The letter points to a separate prior ruling (accession number 9606L1416A03) for the fuller definitions of "exclusive rights" and "from scratch" if more detail is needed.

What this means for you

Independent contractors and developers building custom software

If you're developing a program from scratch and transferring exclusive rights to the customer (not licensing it to multiple customers, not modifying/reselling something you already sell), your charge for that development work is not subject to Texas sales tax — even if software development isn't normally your regular line of business.

Businesses commissioning custom software

Confirm your development contract actually transfers exclusive rights to you as the customer — that's the fact that supports nontaxable treatment on the developer's side, distinguishing a true custom build from off-the-shelf or licensed software sales (which are generally taxable).

Accountants and tax professionals advising software developers

The controlling test under Rule 3.308(b)(4) has two parts: (1) the program is created from scratch (not modification of something the developer already sells), and (2) exclusive rights transfer to the customer. Both elements should be checked — and the letter flags a separate prior ruling with the fuller definitions of each term for edge cases.

Common questions

Q: Do I have to charge Texas sales tax for custom software I develop for a client?
A: Not if you create the program from scratch and transfer exclusive rights to the program to the client, under Rule 3.308(b)(4).

Q: Does it matter that I'm not normally in the software development business?
A: No — the exemption in Rule 3.308(b)(4) turns on the nature of the work (from-scratch creation with exclusive-rights transfer), not on whether software development is your regular trade.

Q: What if I'm modifying software I already sell to multiple customers, instead of building something new from scratch?
A: That's a different fact pattern than this letter addresses — the exemption described here is specifically for charges to create a program, or modify an existing program NOT sold by the person doing the modification.

Q: Can I rely on this letter for my own software development contract?
A: No. This opinion is based on the facts presented, and other facts, though similar, may provide a different result; it can be relied on only by the taxpayer it was issued to.

Citations and references

Statutes and rules:

• 34 Tex. Admin. Code Rule 3.308(b)(4) (Computers — Hardware, Software, Services and Sales — custom software creation/modification exemption)

The letter also references a separate prior Comptroller ruling (accession number 9606L1416A03) for the detailed definitions of "exclusive rights" and "from scratch" as applied to this exemption.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9902142L

Original ruling text

February 1, 1999

Subject: Do I need to charge sales tax?

Dear Mr. **:

This is in response to your request for a ruling on the following fact
situation and questions:

I recently was contracted by a company to design and develop the software for a
factory automation system. I am not normally in the business of doing this, so
I need to know whether or not I need to charge sales tax. I read your web pages
on sales tax and data processing, but they do not mention software development.
Can you help?

Response: Subsection (b)(4) of Rule 3.308 - Computers - Hardware, Software,
Services and Sales, states "Charges to create a program or modify an existing
program not sold by the person doing the modification are not taxable." The
Comptroller has held that the exemption for software creation applies to
software created from scratch for the customer where the exclusive rights to
the program are transferred to the customer. Therefore, if you are creating a
software program from scratch and will transfer the exclusive rights to your
customer, the charge for the program will not be taxable. For definitions on
"exclusive rights" and "from scratch" see accession number 9606L1416A03.

Sales tax rules are available on the Internet
www.sos.state.tx.us/tac/34/I/3/O/index.html.

The State Tax Automated Research system, which provides viewing and downloading
of edited letter rulings, hearings, rules, AG Opinions, etc., may be accessed
on the Internet at: http://www.window.state.tx.us/

You may download an application for a sales tax permit, which allows you to
issue resale certificates for taxable items that you will resell, at :

http://www.window.state.tx.us/taxinfo/taxforms/ap-100.html

This opinion is based on the facts presented. Other facts though similar may
provide a different result.

I hope this information answers your questions. If you need additional
information, please 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. You may also e-mail our tax help section at:
[email protected]

Gilbert Zamora
[email protected]
Tax Policy Division