Were nonexclusive software-license fees exempt from Virginia use tax when the taxpayer accessed the software electronically and received no tangible copy?

Subject

Taxpayer markets healthcare plans through call centers located outside Virginia

Plain-English summary

Virginia removed the software-license fees from the use-tax audit because the taxpayer accessed the program electronically and never received it in tangible form. The Department treated that delivery method as exempt under Va. Code § 58.1-609.5(1).

The taxpayer did not win its separate custom-software argument. Although the dealer developed the program from the taxpayer's specifications and apparently had not licensed it to anyone else, the written agreement was nonexclusive and expressly allowed licenses to other entities. A Virginia custom program had to be specifically designed and developed only for one customer.

The Commissioner said the license terms controlled at the moment of the transaction. Years of sole use did not convert a program that remained available for licensing to others into custom software. The audit nevertheless had to remove the fees because there was no tangible transfer.

What this means for you

• A nonexclusive license can defeat Virginia's custom-program exemption even when the software was built for one customer's needs.
• Actual sole use is not the same as a contractual restriction limiting the program to one customer.
• Electronic access without a tangible copy received separate exempt treatment in this ruling.
• Contracts and delivery records should show both who may use the software and how it was delivered.

Common questions

Was the software a tax-exempt custom program? No. The dealer retained the right to license it to other customers.

Why were the fees removed from the audit anyway? The taxpayer accessed the software electronically on the dealer's server and never received it in tangible form.

Citations and references

• Va. Code § 58.1-602.
• Va. Code § 58.1-609.5(1) and (7).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 08-121

Original ruling text

June 26, 2008

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

Dear *:

This is in response to your letter in which you request correction of the consumer use tax assessment issued to * (the "Taxpayer") as a result of an audit for the period September 2000 through September 2007.

FACTS

The Taxpayer, headquartered in Virginia, markets healthcare plans through call centers located outside Virginia. An audit resulted in the assessment of use tax on various items of tangible personal property used or consumed by the Taxpayer in Virginia. The Taxpayer takes exception to the tax assessed on software leases and contends that these leases are exempt pursuant to the exemption for custom programs in Va. Code § 58.1-609.5 7. The Taxpayer maintains that the software was expressly designed by another company ("Software Dealer") based upon the needs and specifications provided by the Taxpayer. The Taxpayer also maintains that the software is not the combination of pre-written programs, but rather was the result of the efforts of the programmers of the Software Dealer to develop a computer program to meet the Taxpayer's specific needs.

The Taxpayer entered into a non-exclusive license agreement for the software. Notwithstanding, the Taxpayer contends that the Software Dealer did not provide its computer software expertise to any one else since entering into the license agreement with the Taxpayer. For this reason, the Taxpayer maintains that the software was in effect prepared for and used solely by the Taxpayer.

The Taxpayer also indicates that it does not have a copy of the software because it was never delivered to the Taxpayer, and the software remains on the file server of the Software Dealer. The Taxpayer has electronic access to the server to use it in conjunction with its database.

DETERMINATION

Virginia Code § 58.1-609.5 7 provides an exemption for a custom program as defined by Va. Code § 58.1-602, as follows:

Custom program means a computer program which is specifically designed and developed only for one customer . The combining of two or more prewritten programs does not constitute a custom computer program. A prewritten program that is modified to any degree remains a prewritten program and does not become custom. [Emphasis added.]

The sales and use tax is a moment of transaction tax. Thus, at the moment that the software was licensed to the Taxpayer, it entered into a non-exclusive agreement for the software. Furthermore, clause 5 of the agreement clearly states that the Software Dealer may license the software to other entities. Because the license agreement is non-exclusive, meaning that the software may be licensed for use by more than one customer, the license agreement does not conform to the exemption requirement that the computer program be specifically designed and developed only for one customer. Clearly, this nonexclusive language does not prohibit the Software Dealer from entering into agreements with other customers for the same software. The fact that the Taxpayer has been the sole user of the software over a number of years does not infer that the software was prepared for use solely by the Taxpayer. Thus, if the intent had been as claimed, then the license agreement should have been structured so that the Taxpayer was the exclusive user of the software. For these reasons, I find no basis to treat the software at issue as a custom program. Rather, I must conclude that the license agreement was originally intended as a non-custom or prewritten program that could be sold or leased to more than one customer.

The Department has long held that the sale of computer software transferred in tangible form is the taxable sale of tangible personal property. In contrast, computer programs transferred electronically are deemed to be nontaxable transfers because there is no transfer of tangible personal property. Furthermore, Virginia Code § 58.1­609.5 1 provides an exemption for "services not involving an exchange of tangible personal property which provide access to or use of the Internet and any other related electronic communication service, including software, data, content and other information services delivered electronically via the Internet."

Because the Taxpayer has only electronic access to the software and never received the software in tangible form, the software qualifies for the exemption granted by Virginia Code § 58.1-609.5 1. Accordingly, the software license fees will be removed from the audit.

CONCLUSION

The audit will be revised in accordance with this determination. An updated bill, with interest accrued to date, will be sent to the Taxpayer for the outstanding liability. The outstanding balance should be paid within 30 days of the bill date to avoid additional interest charges. The Taxpayer should remit its payment to: Virginia Department of Taxation, 3600 West Broad Street, Suite 160, Richmond, Virginia 23230, Attn: *. If you have any questions concerning payment of the assessment, you may contact at **.

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

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-2052766180.R