When were software service, travel, installation, and modification charges separate from a taxable prewritten-software license?

Subject

Licensing and billing of software program, maintenance fees for service support

Plain-English summary

Virginia removed charges for separate post-installation work orders, but kept lump-sum software-project charges taxable when exempt labor was not separately identified. The contract treated later work orders as outside the original statement of work, and the documented work orders covered services or travel rather than the software license.

Separately charged software installation and modification labor could qualify for exemption. But configuration, implementation testing, training, project management, and maintenance were taxable services connected with the prewritten software sale. When taxable and exempt work appeared in one lump-sum billing without a valid breakdown, the entire charge was taxable.

One documented pre-license travel item was removed. Other uncertain items stayed in the audit. The Commissioner also declined to waive interest because Va. Code § 58.1-1812 required interest on the unpaid assessment despite the appeal's delay.

What this means for you

• Use separate contracts, work orders, invoices, and line items for services genuinely independent of a software license.
• Separately state installation and modification labor if claiming the exemptions discussed.
• Lump-sum billing can make the whole charge taxable when it mixes exempt and taxable software services.
• An administrative appeal does not stop statutory interest from accruing on an unpaid assessment.

Common questions

Q: Why were the later work orders removed?
A: The agreement defined them as additional services outside the original statement of work, and the documented charges were for services or travel.

Q: Were all implementation services exempt?
A: No. Testing, configuration, training, management, and maintenance were not treated as installation or modification labor.

Q: Why was interest not waived?
A: The ruling said Virginia law required interest to accrue from assessment until payment.

Citations and references

• Va. Code §§ 58.1-609.5 2 and 6 and 58.1-1812.
• P.D. 07-92, P.D. 87-217, P.D. 02-96, and P.D. 94-351.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 08-135

Original ruling text

July 30, 2008

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

Dear *:

This is in response to your request for reconsideration of a portion of the prior determination, issued as Public Document (P.D.) 07-92 (6/1/07), with respect to the retail sales and use tax assessment issued to * (the "Taxpayer") as a result of an audit for the period May 1997 through December 2000. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer requests waiver of interest accrued from the original assessment date to present. The Taxpayer also requests revision of the audit with respect to the contracted transactions between the Taxpayer and * (Company C). The Taxpayer contends the following­:

Certain charges predate any license agreement.

Certain charges are not in connection with the software license.

Certain charges are exempt modification or installation labor.

Certain charges for project services and related travel expenses constitute exempt modification or installation labor.

An audit exception labeled as a missing return should be for labor and travel expenses billed to Company C.

DETERMINATION

Charges Predating License Agreement

The Taxpayer contends that line items #402 and #403 of the revised audit work papers reflect travel-related expenses that predate the execution of the license agreement with Company C. Invoice #1196 presented supports this contention with regard to line item #402, which will be removed from the audit.

Invoice #1208 for line item #403 was not presented. Rather, the other invoice presented is #1941, which is the invoice for line item #428. Invoice #1941 does not predate the license agreement. However, invoice #1941 represents project service expenses pursuant to addendum #1 of the software services agreement. That addendum is for services to provide an interface between the licensed software and a credit scoring company and to customize licensed software. Based on the addendum and the invoice, it is unclear whether the billing is for the provision of prewritten software, modification labor, or some other cost. Because of this uncertainty, I find insufficient basis to conclude that the project services are only for modification services pursuant to the exemption in Va. Code § 58.1-609.5 6. Accordingly, invoice #1941 will remain in the audit, as well as line item #403.

Charges Not in Connection With Software License

The Taxpayer contends that tax was assessed on service-related invoices and travel expense reimbursements in connection with separately executed and bargained for work orders that were issued after the underlying software was delivered and installed. The work orders are placed pursuant to section 3.3 of the software services agreement, which provides:

This agreement contemplates the future execution by Licensee and [the vendor] of one or more work orders to provide for additional services in connection with the Project (a "work order") which are outside the scope of the Statement of Work.

Based on this contract clause, I find basis for treating the work orders issued as separate and independent actions apart from the software services agreement. Because these work orders are only for services or travel expenses, I find basis to remove line items #422, #425, #427, #429, #431, #432, #433 and #435 from the audit.

Modification and Installation Labor

The Taxpayer contends that it is possible to confirm from the invoice detail that the transactions relate to exempt modification and/or installation labor. The Taxpayer uses line item #422 as an example, which relates to invoice #1837 that was issued pursuant to work order #0001. The Taxpayer contends that all activities furnished pursuant to work order #0001 relate to the installation of the software product and should be exempt on that basis. For instance, the work order sets out the general service requirements, such as the implementation and testing of the software product. It ends when the project team determines that the software is installed and working in the Taxpayer's test environment.

More specifically, the time sheets show the type of work done by each employee involved in the work order. The Taxpayer furnishes a chart that shows certain time sheet details for employees. For line item #422, which relates to work order #0001, an implementation activity is further described as software installation and batch testing. These descriptions also show separate charges. Although testing goes beyond mere installation of the software product, I would view the separate charge for software installation as an exempt charge. For line item #425, which also relates to work order #0001, an implementation activity is further described as to investigate a software problem and roaming issues. Such implementation activity is not an installation activity but appears to be a maintenance activity. Although the time sheets are useful in further clarifying the amounts charged on the invoice, I find no basis for concluding that all activities furnished pursuant to work order #0001 relate to exempt installation of the software product. Based on the information and documentation provided, I also find no basis for concluding that work order #0001 involved any modification labor.

Charges in Connection with Project Services

Line items #406 and #409 represent lump sum billings for project services necessary to implement and operate the kernel or core software. The services consist of software development, software installation, software configuration, software testing, formal training and project management and are described in the Schedule 1 - Statement of Work. The Taxpayer contends that these billings are exempt from the tax because they are integral (except for training) to the modification and installation of the software. Line items #419, #423 and #426 relate to travel expenses in connection with these services. The Taxpayer requests the removal of these five line items from the audit.

Pursuant to Va. Code § 58.1-609.5 2, an exemption applies when installation labor is separately charged. Pursuant to Va. Code § 58.1-609.5 6, an exemption applies when modification labor of prewritten programs is separately charged. In this case, however, there are no separate charges for installation or modification labor.

In P.D. 87-217 (10/2/87), the Department held that " other amounts charged for services in connection with sales of tangible personal property such as personnel training, on-site testing , and installation assistance are subject to the tax." [Emphasis added.] In P.D. 02-96 (6/25/02), the Department also determined that charges for configuration and integration were not part of the installation process. Even if a portion of the service charge is for installation, the Tax Commissioner has ruled that a single charge for taxable services and installation is taxable. See P.D. 94-351 (11/22/94).

Pursuant to the section 3.1 of the Schedule 1 - Statement of Work, no software modifications were to be made to the kernel software being implemented. However, specific features were custom developed by the vendor. Based on a review of the work statement, I must conclude that the project services relate to services for the installation, configuration and testing of the prewritten kernel software and services for the development, installation, configuration and testing of customized features. Training and project management are expenses that apply to both the kernel software and its customized features.

Based on the foregoing and absent a valid breakdown between taxable services (configuration, implementation testing, training and project management) and exempt services (modification and installation), the lump-sum billings are fully taxable because they are directly connected to the taxable sale of prewritten software, i.e. , the software license agreement. Accordingly, line items #406 and #409 will remain in the audit.

As for the travel expenses assessed in connection with the project services, based on the information provided there is no way of determining whether these travel expenses relate only to an exempt installation or modification labor activity. Accordingly, line items #419, #423 and #426 will remain in the audit.

Work Order

The auditor describes line item #434 as a "missing sales tax return to support sales/services." The Taxpayer contends, however, that the line item may actually be for a particular invoice occurring in the same month as line item #434. Invoice #2094 and the accompanying work order presented shows that the billing relates to the provision of separately stated charges for services in connection with the preparation and presentation of a revenue segmentation plan and services for project management. The total amounts shown for line item #434 and invoice #2094 are almost exactly the same, i.e. , only a few cents difference.

As previously discussed, work orders are issued for additional services that are outside the scope of the statement of work. Because invoice #2094 was issued pursuant to a work order for services and as it appears that line item #434 and invoice #2094 are one and the same, I will remove line item #434 from the audit.

Interest

Virginia Code § 58.1-1812 provides that in assessing omitted taxes, the Department "shall send a bill . . . to the taxpayer and the taxes, penalties and interest shall be remitted to the Department of Taxation within thirty days from the date of such bill." If the taxes, penalties and interest are not paid within such thirty days, this statute requires that "interest at the rate provided herein shall accrue thereon from the date of such assessment until payment."

The Department acknowledged receipt of the Taxpayer's initial appeal within eight days of receipt. In its acknowledgement letter, the Department specifically informed the Taxpayer that the law requires the accrual of interest on any outstanding balance. To avoid the accrual of additional interest, the Taxpayer was advised to make full payment of the assessment. The Taxpayer remitted no payment until after the contested assessment was revised and only remitted the revised amount due as of the date of assessment. While I regret the amount of time that elapsed between the submission of the Taxpayer's appeal and the audit revisions, I find no basis to waive the assessed interest. Pursuant to Va. Code § 58.1-1812, the Taxpayer remains liable for the interest that has accrued and remained unpaid since the date of assessment.

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. 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 and public documents 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

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