Is selling software via a free preview CD plus a paid 'electronic key' a taxable Utah sale, and are web design, web hosting, and internet-access charges taxable too?

Plain-English summary

A tax practitioner asked the Utah Tax Commission to address three separate questions for two clients:

1. Electronic keys for software. "Company A" manufactures CD-ROMs that are catalogs of software -- demo and full retail versions bundled together -- and gives the CDs away free (inside computer magazines, for example). If a customer wants the full version, they call or go online, pay by card, and receive an "electronic key" (a password) that unlocks the full retail application already sitting on the CD they already have. The Commission held this is a taxable Utah sale of the software if the buyer is in Utah -- the CD itself may be free, but the key is what completes the taxable transaction, under Utah Code Ann. § 59-12-103 and Rule R865-19S-92 (which treats "canned"/prewritten software as taxable tangible personal property). If the client is making Utah sales, it must get a Utah sales tax license and collect, report, and remit tax under §§ 59-12-106 and -107.

2. Web design and hosting. "ABC Co." designs and hosts websites using custom HTML programming and transfers no tangible personal property. The Commission held that web page design charges and internet-access subscription charges (e.g., for online games or chat rooms) are not subject to Utah sales tax.

3. Nexus thresholds. Both clients described maintaining an office, employees, or other physical presence in Utah. The Commission said that alone is enough to create nexus for both sales tax and corporate franchise tax purposes (it doesn't administer an excise tax). But the separate question of whether an out-of-state retailer creates nexus solely by running a web server located in Utah is fact-specific -- the Commission declined to give a general answer that would apply to every retailer.

What this means for you

Software companies using "try before you buy" distribution

Giving away a CD, disc, or file for free doesn't make the sale non-taxable if the customer later pays for a key, password, or unlock code that activates functionality already delivered to them. The Commission looks at the whole transaction, and the paid unlock is what triggers Utah sales tax.

Web designers, developers, and hosting providers

Charges for designing and hosting a website, and for internet-access subscriptions, were not taxable under this ruling. This tracks other 1990s-era Utah rulings distinguishing pure services and online access from taxable software or tangible goods.

Multistate businesses with any Utah presence

An office, employees, or other physical footprint in Utah is enough, by itself, to create nexus for sales tax and corporate franchise tax. If your only Utah connection is a web server, the Commission wouldn't commit to a general rule -- expect that question to turn on the specific facts, and note that nexus law changed substantially nationwide after the 2018 Wayfair decision, well after this 1997 ruling.

Accountants and tax professionals

This ruling usefully separates three distinct issues often bundled together in early internet-era tax questions: (1) taxable delivery of software via activation key regardless of the physical medium's cost, (2) non-taxable web design/hosting/access services, and (3) physical-presence nexus versus the then-unresolved server-only nexus question.

Common questions

Q: If a CD is free, is the software on it tax-free?
A: Not necessarily. If the customer later pays for an electronic key that unlocks the full version already on that CD, that payment is a taxable Utah sale.

Q: Are web design and website hosting taxable in Utah?
A: Under this ruling, no -- neither web page design charges nor hosting/internet-access subscription charges were subject to sales tax.

Q: Does having an office or employees in Utah create nexus?
A: Yes. The Commission said that alone creates nexus for both sales tax and corporate franchise tax purposes.

Q: Does hosting a web server in Utah, by itself, create nexus for an out-of-state seller?
A: The Commission wouldn't say in general -- it called that a fact-specific determination. Also, nexus law has changed significantly since 1997 (including after the 2018 Wayfair U.S. Supreme Court decision), so don't rely on this 1997 answer for current server-based nexus questions.

Q: Does this ruling apply to my business?
A: No. It binds the Commission only for the requesting clients and the facts described. Another taxpayer can't rely on it as binding, though it may carry some persuasive weight in a dispute with closely similar facts.

Citations and references

Statutes and rules:

• § 59-12-103 (imposition of sales tax)
• Utah Admin. Rule R865-19S-92 (canned/prewritten software taxable)
• §§ 59-12-106 and 59-12-107 (sales tax license, collection, remittance)

Source

• Landing page: https://tax.utah.gov/commission/rulings/
• Original page: https://files.tax.utah.gov/tax/commission/ruling/97-064.htm

Original ruling text

97-064

Response
November 18, 1997

September
26, 1997

Subjects: (1) Taxability of Electronic Keys

(2) Taxability of World Wide Web Design and
Hosting

(3) Nexus Thresholds

Dear
NAME:

It
would be very much appreciated if you would provide a timely (within 10
business days of receipt of this request) advisory opinion or letter ruling
addressing the taxability of electronic keys, the taxability of world wide web
design and hosting, and nexus thresholds.

ELECTRONIC
KEYS

The
COMPANY A is located in Utah. COMPANY A manufactures CD ROMs that are essentially
catalogs of software applications. The CDS incorporate both demonstration and
full retail versions of each application. The CDS are distributed to potential
customers through a variety of media, e.g. given away inside of computer
magazines. The CDs are never sold.

Software
vendors provide COMPANY A with master copies of their software and, for a fee,
COMPANY A loads the software onto a �catalog� CD. Customers may receive the COMPANY A CD inside of a computer
magazine to install on their computers and preview demonstrations of the
software. Customers wishing to purchase the software, contact COMPANY A via
phone or website and provide a charge/debit card account number as payment.
Once on-line authorization is confirmed, an electronic key is provided to the
customer that allows access to the full retail software application purchased
that is also on the CD the customer already has.

COMPANY
A is in the process of incorporating a subsidiary in the State of Utah. It will operate an office within the
State. The office will be staffed by
telemarketers, minimal management personnel, and potentially, a telephone
support staff. Production of the
COMPANY A CD's will most likely be outsourced to a vendor within the State of
Utah. The manufacturing process
(pressing of the CD's), will be completed on a just in time basis thus
minimizing inventories. A gold master copy will be used by the outsource
provider for duplication and will remain the property of COMPANY A.

What are the state sales and use tax
implications of the activities described above?

Please
cite the appropriate legal reference used as a basis for your opinion.

WEB
DESIGN AND WEB HOSTING

ABC
Co. designs and hosts world wide web sites on the Internet. Designing web sites
typically involves custom programming using the HTML programming language. Currently,
ABC is located and doing business with the State of Utah. ABC does not transfer any tangible person
property in conjunction with its services. The server (the computer hardware
that connects the web site to the Internet) is located within the State.

1. How does the State of Utah treat the taxability of designing
   and hosting services of world wide web sites?

2. Are charges for accessing web-sites, e.g subscriptions (to
   access on-line games, chat rooms, etc.), subject to sales tax?

3. Would the taxability be any different
   if the server was located out of the State?

4. If an out-of-state retailer whose only contact with the
   State is the use of a computer server on the Internet to maintain a web site
   considered to have substantial nexus for sales and use tax purposes within the
   State of Utah?

Please
cite the appropriate legal references used as a basis for your opinions.

NEXUS
THRESHOLDS

Please
provide the parameters that establish nexus for

1) income tax purposes,

2) franchise tax purposes, and

3) excise tax purposes.

If
you are not able to answer this question completely, please forward a copy this
letter to

the
appropriate state taxation party for a timely response. If I have addressed this request for an
advisory opinion or letter ruling to you in error, please accept my apologies
and forward this letter to the appropriate state taxation party. In your department's response letter, please
provide the name, direct telephone number, and mailing addresses of

1) a person whom I can contact in the
legal department for future correspondence

2) a person whom I can contact regarding
contractual or voluntary registrations.

I
will update my records upon receipt of your department's response.

Very
truly yours,

NAME

November
18, 1997

NAME

ADDRESS

CITY
STATE ZIP

Advisory
Opinion - Application of sales tax to sales of computer software and electronic
media services.

Dear
NAME,

We have received your request for
sales tax guidance pertaining to the sale of computer software and electronic
media services. We offer the following:

We begin by answering your questions
about nexus because that issue impacts a vendor�s responsibilities to collect
and remit sales and other taxes in Utah.
Enclosed is a publication that provides general information on nexus
thresholds. You have described two
scenarios in which your client maintains an office, employees or other physical
presence in Utah. That is enough to create nexus for both sales tax and
corporate franchise tax purposes. We do
not administer an excise tax.

Your first question concerns sales
of non-custom software. Your client
distributes CDS containing non-custom software to potential buyers. The CD itself is initially given to the
potential customer, but if the customer agrees to purchase the non-custom
software that resides on the CD, your client provides the customer with a password
or �electronic key� to access the software.
If that customer is in Utah, the sale is a Utah sale for purposes of
both sales tax and corporate franchise tax.
Utah Code Ann. �59-12-103 and Utah Admin. Rule R865-19S-92. If your client is making Utah sales, it must
obtain a Utah sales tax license and collect, report and remit the tax as
required by law. Utah Code Ann.
��59-12-106 and -107.

The production of the CDS may take
place in Utah. However, since your
client will outsource that production to another party, we will not go into
detail here about the sales tax obligations and manufacturing exemptions that
may come into play for the producer. If
you have questions on this issue, please let us know.

Regarding your client�s charges for
web page design and internet access subscription

charges,
these charges are not subject to sales tax in Utah. As to the nexus of an out-of-state retailer who solicits and
makes sales of products over the internet, the nexus determination depends upon
full consideration of the retailer�s activities in Utah. Because that is a fact-specific
determination, we cannot offer you a general response that will apply to all
retailers.

Requests for advisory opinions may
be addressed in writing to the Tax Commission in care of Irene Rees, 210 N.
1950 W., Salt Lake City, Utah 84134.
Requests for general taxpayer information may be directed to the
Technical Research Section of the Customer Service Division, either in writing
or by telephone at (801) 297-3257.

Please let us know if you have other
questions

For
the Commission,

Joe
B. Pacheco,

Commissioner

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