Were transfers of graphics source code and specifications, per-copy royalties on derived programs, and annual support and update charges taxable in Utah?

Plain-English summary

Utah Private Letter Ruling 93-003 classified three parts of a graphics-software licensing model.

The source code and formal specifications were taxable tangible personal property.

Royalties paid when licensees distributed derived programs were exempt.

Support, maintenance, and interim source-code updates were taxable even when separately stated or broken into components.

Software and license structure

The company created a high-level programming language and graphics source code.

Licensees received specifications and, at higher levels, source code that they could modify or port to their own computing environments.

They could compile derived programs and distribute object-code copies for use with their products.

The company charged:

• License fees for source code and specifications.
• Per-copy royalties on distributed derived programs.
• Annual support, maintenance, and interim-update fees.

Source code and specifications

The Commission treated the transfer of source code and specifications as a sale or rental of tangible personal property.

The transfer was therefore subject to Utah sales or use tax.

The response cited Utah Code section 59-12-103.

Derived-program royalties

The ruling assumed the royalty was charged when the original licensee distributed derived programs that used the company's source code.

On that understanding, the royalty was exempt.

The response did not explain a broader royalty doctrine or address different intellectual-property payments.

Support, maintenance, and updates

Annual support contracts included support, maintenance, and interim updates to source code and specifications.

The Commission treated those charges as taxable.

Breaking down the components or separately stating update charges did not change the result.

The response cited Utah Tax Commission Admin. Rule R865-19-92S.

Holding

Under the ruling:

• Source-code transfers were taxable.
• Specification transfers were taxable.
• The transfer was treated as a sale or rental of tangible personal property.
• Per-copy royalties on distributing derived programs were exempt.
• Support and maintenance were taxable.
• Interim updates were taxable.
• Separate statement did not change the support-and-update result.

What this means for you

Software companies and source-code licensors

A license can contain differently taxed components. Identify the code transfer, distribution royalty, support, maintenance, and updates.

Software licensees

The historical ruling distinguished the right to distribute a derived program from the original transfer of code and specifications.

Accountants and tax professionals

Reanalyze modern software delivery and license rights under current law. The 1993 tangible-property framework may not match cloud or electronic transactions.

Common questions

Q: Was the source-code transfer taxable?

A: Yes.

Q: Were the specifications taxable?

A: Yes.

Q: Were per-copy derived-program royalties taxable?

A: No, under the Commission's stated understanding.

Q: Were support and maintenance taxable?

A: Yes.

Q: Did separately stating updates make them exempt?

A: No.

Key source language

• Source code: “constitutes the sale or rental of tangible personal property and, as such, is subject to the Utah sales/use tax.”
• Royalty: “the royalty would be exempt.”
• Support: “Support and maintenance charges would be subject to the tax regardless of how the charges might be broken down or separately stated.”

Citations and references

• Utah Code Ann. § 59-12-103
• Utah Tax Commission Admin. Rule R865-19-92S

Source

• Landing page: Utah Private Letter Rulings
• Official ruling: Utah PLR 93-003
• Scope note: the royalty exemption was based on the Commission's understanding that the charge arose from distributing derived programs.
• Fetch note: the exact official URL returned HTTP 404 to a direct request and was then retrieved through Sofya.

Original ruling text

Response February 10,
1993

Request

Utah State Tax
Commission

Attn: Correspondence

160 East 300 South

Salt Lake City,
UT 84134

Dear Madam/Sir,

This letter represents
a request for a written ruling from the state of a sales tax issue.

XXXXX (XXXXX), is a
California based high technology company engaged in the business of manufacturing three dimensional graphics computer systems.

The corporation is
registered to collect sales and use tax in the state from its customers.

XXXXX is the inventor
and owner of a high level programming language for applications using three dimensional graphics, called, �XXXXX�. This program features graphics XXXXX (XXXXX).

XXXXX provides 2D and
3D graphics functions to software programmers.
The functions include modelling, transformations, lighting, color, shading and motion, and more advanced features like texture mapping and sophisticated frame buffer effects such as alpha blending and motion blur. The commands provide software developers advanced graphics capabilities in an elegant, easy to use programming environment.

Licensees integrate
XXXXX into various window and operating system environments, such as the XXXXX. The licensees adapt the XXXXX into a range of computing environments, from PC�s and Mac�s, to workstations, supercomputers, or proprietary graphics hardware.

XXXXX formal
specifications and source code are released to the Licensees by XXXXX. The licensee, is granted a limited, non-exclusive, non-transferable, royalty-bearing license and the right to use and modify the information and data contained in the specification and to use and modify the source code, solely to created a Derived Program.

�Derived Program�
means a binary (object code) version of a software program created by compiling (I) Licensee Source, and/or (ii) a version of an implementation or any portion of XXXXX Source that Licensee has modified and/or ported to be compatible with Licensee�s Product.

The licensee is
granted a limited, non-exclusive, non-transferable, royalty-bearing worldwide license and right to duplicate, use and distribute by sublicense copies of the Derived Programs for use with Licensee�s Product. A royalty is charged on a per copy basis for each XXXXX object code distributed by the Licensee.

XXXXX is licensable at
three levels,

Level 1 License: Designed to provide the XXXXX specification and necessary support information and code to licensees wishing to implement XXXXX internally. Licensees are permitted to redistribute XXXXX binaries to end users.

Level 2 License: Provides, in addition to Level 1 License, source code implementing the XXXXX to licensees. Licensees are permitted to redistribute XXXXX binaries to end users.

Level 3 License: Provides licensees the right to redistribute modified XXXXX source code to third parties who are already XXXXX source licensees. Includes all Level 1 and Level 2 license information and source code.

Support, maintenance and
interim updates for source codes and specifications are available to XXXXX licensees under annual support contracts with XXXXX. Different prices are charged for each Level of license.

The common features in
the three levels of the Licenses are:

(1) the transfer of
XXXXX source code and specifications, to the licensee, for a fee under the license agreement.

(2) the licensee has a right to duplicate, use
and distribute, by sublicense, copies of the Derived Programs for use with licensee�s product.

(3) a royalty charge, by XXXXX, to the licensee
of a per copy basis of the XXXXX object code distributed.

We seek your
clarifications on the following questions.

(1) Is the transfer of XXXXX source code and
specifications, to the licensee, under the situations described above, subject to sales tax in your State?

Please note that the
source code, by itself, is of little use to the licensee. It is the software programs the licensee derives from the source code that is material. In very basic terms, the source code can be described as a tool used by the licensee along with other tools, to derive a software program that can operate on the licensee�s products. Once the software program is derived, the licensee can sell, license or distribute copies to its customers.

(2) If the answer to question (1) is �NO�, what
documents must XXXXX keep for its records to substantiate the non-taxable nature of the transaction?

(3) If the answer to question (2) is �YES�, what is the code section/authority for such determination?

(4) Is the royalty paid to XXXXX subject to
sales tax in the State?

(5) Are the charges for support and maintenance
of the source code, which includes interim updates to the source code, subject to sales tax in the State?

Will the taxability
change if charges for updates are separately stated in the contract?

We would appreciate an
early response to the questions stated above.
If you have any questions please contact me at XXXXX.

Sincerely,

XXXXX

TO: XXXXX, Director

FROM: XXXXX, Secretary

DATE: XXXXX

SUBJECT: Request for Advisory opinion - No. 93-003DJ

Attached is a request
for a written ruling from XXXXX of XXXXX.
Will you please review the request of XXXXX regarding sales tax on transfer of XXXXX and specifications to the licensee.

Thank you.

XXXXX

Dear XXXXX:

In response to your
letter of XXXXX (copy attached), I am providing you with the following information.

(1) It is the opinion of this office that the
transfer of the source code and specifications as described in your letter constitutes the sale or rental of tangible personal property and, as such, is subject to the Utah sales/use tax.

(2) Not applicable.

(3) The statutory reference for the above
treatment is Utah Code Annotated Section 59-12-103 (copy attached).

(4) If the royalty charge is, as I understand
it, a charge for distribution of �Derived Programs� by the original licensee using your source code, the royalty would be exempt.

(5) Support and maintenance charges would be
subject to the tax regardless of how the charges might be broken down or separately stated. See Tax Commission Administrative Rule R865-19-92S.

If you have further
questions, please feel free to contact me.

In contacting the Tax
Commission, if special accommodations are needed in accordance with the Americans with Disabilities Act, please call (801) 530-6920, (801) 530-6077 or TDD (801) 530-6269 allowing three working days notice.

Respectfully,

XXXXX

Telephone No. XXXXX