Were software royalties and maintenance fees exempt when the vendor said delivery was electronic but its contracts allowed tangible media?

Plain-English summary

Virginia upheld sales tax on the software company's royalty payments and maintenance revenue because its agreements did not establish electronic-only delivery. Although the taxpayer said the programs were distributed electronically, the contracts allowed delivery on recorded media, through an FTP site, or by licensed copies without fixing a required delivery method.

The Department said electronic delivery could qualify as a service transaction when no tangible personal property was transferred. But the invoice, contract, or other sales agreement had to expressly certify both electronic delivery and that no tangible medium had been or would be furnished. Without that proof, Virginia would assume tangible delivery and tax the transaction.

The same problem applied to maintenance updates and upgrades: the agreements did not specify how they would be delivered. The Department therefore held the entire assessment correct.

What this means for you

• A vendor's actual practice was not enough when the written agreements permitted tangible delivery.
• Electronic-only treatment required affirmative documentation retained by both vendor and customer.
• Maintenance and upgrade charges followed the same delivery-method analysis.
• This ruling concerns 2001-2005 transactions under 2007 guidance; verify current Virginia law and documentation rules.

Common questions

Was software always taxable in Virginia under this ruling?

No. The ruling recognized an exemption where software was delivered electronically without any tangible medium, but required express supporting documentation.

Why were the royalties taxable?

The agreements permitted or failed to exclude tangible delivery, so the taxpayer did not prove electronic-only delivery.

Why were maintenance fees taxable?

The agreements did not specify how updates and upgrades would be delivered.

Citations and references

• Va. Code §§ 58.1-602, 58.1-603, and 58.1-609.5(1).
• 23 VAC 10-210-470.
• The source also cites P.D. 87-29, 88-211, 96-66, 99-7, 01-103, and 04-52.

Subject

Tax on royalty payments and maintenance revenue from Virginia customers

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 07-22

Original ruling text

March 27, 2007

Re: § 58.1-1821 Application: Retail Sales and Use Tax

Dear *:

This is in response to your letter in which you seek correction of the retail sales and use tax assessment issued to * (the "Taxpayer") by the Department for the period January 2001 through February 2005. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer licenses, sells and supports software for the graphics arts and digital print markets. As a result of the Department's audit, the Taxpayer was assessed tax on royalty payments and maintenance revenue received from Virginia customers. The Taxpayer contends that these software programs are distributed electronically and do not require the distribution of any tangible property.

DETERMINATION

Royalty Payments

Pursuant to Va. Code §§ 58.1-602 and 58.1-603, the transfer of tangible personal property for a consideration to the consumer constitutes a retail sale subject to the Virginia retail sales and use tax. These statutes support the Department's longstanding policy to apply the tax to the licensing of prewritten computer software if the license provides the customer not only the right to use the software, but also a copy of the software in some tangible form. If the customer receives the right to use the software (a service), and no tangible personal property is transferred, Va. Code § 58.1-609.5 1 provides an exemption from the retail sales and use tax for:

Professional, insurance, or personal service transactions which involve sales as inconsequential elements for which no separate charges are made . . . and services not involving an exchange of tangible personal property which provide access to or use of the international network of computer systems commonly known as the Internet and any other related electronic communication service, including software, data, content and other information services delivered electronically via the Internet.

The application of the above statutes regarding software license agreements is set out in prior rulings of the Tax Commissioner. See, for example, Public Documents (P.D.) 88-211 (7/26/88), 96-66 (4/26/96), and 01-103 (8/15/01).

In determining the intent and, thus, the application of the tax to transactions, the Department looks to the underlying document(s) that support the transaction. See P.D. 04-52 (8/18/04). In this case, the auditor reviewed three license agreements between the Taxpayer and its clients. The OEM Standard License Agreement Section 10.1, "Payments," states, "a production version of the Licensed Programs shall be supplied to the Licensee within 10 days of signature of this agreement . . . ." In the Jaws Reproduction and License Agreement dated, April 18, 2001, Section 10.1, "Delivery," states, "At its discretion ** shall provide to Licensee the Licensed Programs on digitally recorded media ( e.g . CD-ROM) or through its password protected FTP sites." The third agreement, dated March 27, 1995 Section 10 "Payment," states that it "provides the Licensee with the right to use fifty (50) licensed copies of the Licensed Programs."

The agreements do not specify a required method of delivery for the software. They do provide for delivery in tangible form. At a minimum, a sales invoice, contract or other sales agreement must expressly certify the electronic delivery of the software and that no tangible medium for that software has been or is to be furnished to the customer. Both the vendor and the customer must retain such evidence for a number of years. See Title 23 of the Virginia Administrative Code 10-210-470. Without such proof, the Department will assume that the software is conveyed in tangible form and consider the software to be a taxable sale of tangible personal property.

Based on the foregoing, I find that the royalty payments received from the software were properly held taxable in the audit. My decision is supported by Public Document 87-29 (2/20/87), in which the Tax Commissioner determined that the tax applies to a contract so long as the contract entitles the purchaser to receive tangible personal property regardless of whether tangible personal property is actually received. This decision is also consistent with P.D. 99-7 (1/8/99).

Maintenance Revenue

With regard to the maintenance revenue, I find that the sales tax assessed on maintenance revenue is proper. The agreements fail to provide a delivery method for the updates and upgrades to existing software. Because the agreements do not specify a delivery method and for the reasons stated above relating to royalty payments, I find that the assessment is correct with regard to the maintenance revenue.

CONCLUSION

Based on the foregoing, the assessment is correct. A revised bill, with interest accrued to date, will be mailed shortly to the Taxpayer. No additional interest will accrue provided the outstanding assessment is paid within 30 days from the date of the bill. Please remit payment to: Virginia Department of Taxation, 3600 West Broad Street, Richmond, Virginia 23230, Attention: *. If you have any questions concerning payment of the assessment, you may contact at **.

The Code of Virginia sections and public documents cited, along with other reference documents, are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's website. If you have any questions about this determination, you may contact * in the Department's Office of Policy and Administration, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/56902.i