For Virginia's corporate sales factor, is electronically delivered canned software a sale of tangible personal property, and how are software updates and technical support sourced?

Plain-English summary

The taxpayer develops and licenses pre-written "canned" software that customers use as-is. Everything — the software, updates, and technical support — is delivered electronically; customers download it and pay a license fee, receiving no disc or other tangible medium. Because the taxpayer files income tax in several states and apportions its income, it asked how these receipts should be treated in Virginia's corporate sales factor: as sales of tangible personal property or of intangible property.

Software and updates — tangible personal property, sourced by destination. The Department has long treated sales of canned software as tangible personal property for sales-factor purposes (P.D. 94-181; P.D. 96-271), and this does not change merely because delivery is electronic. Sales of tangible personal property are attributed on a destination basis — to where the customer receives the software (Va. Code § 58.1-415; 23 VAC 10-120-220). So license fees for the canned software and its updates are sourced to the customers' locations.

Technical support — a service, sourced by cost of performance. Separate technical-support charges are a sale of a service. Under Va. Code § 58.1-416 and 23 VAC 10-120-230, a service sale is a Virginia sale only if the income-producing activity is performed in Virginia, or is performed both in and outside Virginia with the greater proportion, by cost of performance, occurring in Virginia. The Commissioner noted that after General Motors Corp. v. Commonwealth, 268 Va. 289 (2004), the cost-of-performance analysis for intangibles is not limited to direct costs (the regulatory language mirrors the financial-corporation regulation the Court addressed), and referenced Tax Bulletin 05-3. Sourcing a service sale is an all-or-nothing test — the entire receipt is a Virginia sale, or it isn't, depending on where the greater share of the costs occurred.

The Department expressly issued no opinion on what portion, if any, of this taxpayer's sales should actually be sourced to Virginia.

What this means for you

If you sell canned (pre-written) software, Virginia puts those receipts in your sales factor as tangible personal property sourced to the customer's location — and downloading instead of shipping a disc does not change that. Keep records of where your customers receive the software. Charges you break out for technical support, by contrast, are services sourced under cost of performance: the whole charge is a Virginia sale only if more of your income-producing activity (measured by cost, and not just direct costs) happens in Virginia than in any other single state. Because software companies often bundle license, update, and support fees, separating them cleanly matters — they follow different sourcing rules.

Common questions

Q: Our software is downloaded, not shipped. Is it still tangible property for the sales factor?
A: Yes. Canned software is treated as tangible personal property for Virginia's sales factor whether delivered on a disc or electronically, and is sourced on a destination basis (§ 58.1-415).

Q: How are technical-support fees sourced?
A: As a service, under the cost-of-performance test (§ 58.1-416): a Virginia sale only if the greater proportion of the income-producing activity, by cost of performance, is in Virginia — an all-or-nothing determination.

Q: Did the Department say how much of our sales are Virginia sales?
A: No. It explained the sourcing rules but expressly gave no opinion on what portion of this taxpayer's sales should be sourced to Virginia.

Citations and references

• Va. Code § 58.1-415 — sales of tangible personal property attributed on a destination basis
• Va. Code § 58.1-416 — sales other than tangible personal property; Virginia sale where the income-producing activity (by cost of performance) is greater in Virginia
• 23 VAC 10-120-220 and 23 VAC 10-120-230 — destination sourcing of tangible personal property; cost-of-performance sourcing of services
• P.D. 94-181 (6/13/1994) and P.D. 96-271 (10/7/1996) — canned software is tangible personal property for sales-factor purposes
• General Motors Corp. v. Commonwealth, 268 Va. 289 (2004), and Tax Bulletin 05-3 — cost of performance for intangibles is not limited to direct costs

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 20-128-0

Original ruling text

July 21, 2020

Re: Request for Ruling: Corporate Income Tax

Dear *:

This will respond to your letter in which you seek a ruling regarding the computation of the Virginia sales factor when a taxpayer licenses software that is delivered to customers electronically.

FACTS

The Taxpayer develops and licenses software. The software is pre-written “canned” software that is available to customers without any customization. The Taxpayer receives license fees from customers for use of the software. The Taxpayer also receives fees for product updates and technical support. All of the software and updates are delivered to the customers electronically when the customers download them from the Taxpayer’s website and pay the license fees. The customers do not receive any discs, tapes or any other tangible medium containing the software from the Taxpayer.

The Taxpayer is subject to income tax in a number of states and apportions its income accordingly. The Taxpayer requests a ruling regarding whether licensing the software for a fee and providing paid updates should be treated for Virginia corporate income tax purposes as sales of tangible personal property or intangible property.

RULING

Software and Updates

The Department has previously ruled that sales of prewritten “canned” software are considered sales of tangible personal property for purposes of computing a taxpayer’s Virginia sales factor. See Public Document (P.D.) 94-181 (6/13/1994) and P.D. 96-271 (10/7/1996). Virginia attributes sales of tangible personal property on a destination basis. See Virginia Code § 58.1-415 and Title 23 of the Virginia Administrative Code (VAC) 10-120-220. The Taxpayer explains that the software at issue would be considered “canned” in that it is pre-written and sold for use “as-is” without modification. Therefore, consistent with longstanding policy, sales of such software and any updates to it would be attributed on a destination basis.

Technical Support

The Taxpayer also charges fees for technical support. For corporate income tax purposes, such charges would be considered a sale of a service. Under Virginia Code § 58.1-416, sales, other than sales of tangible personal property, are deemed in Virginia if:

The income-producing activity is performed in Virginia; or

The income-producing activity is performed both in and outside Virginia and a greater proportion of the income producing activity is performed in Virginia than in any other state, based on costs of performance.

Pursuant to Title 23 VAC 10-120-230, sales of services from multistate activities are only included in the numerator of the Virginia sales factor if the greater proportion of the income-producing activity is performed in Virginia than in any other state, based on costs of performance. The regulation defines “cost of performance” as the cost of all activities directly performed by the taxpayer for the ultimate purpose of producing the sale to be apportioned. “Income producing activity” is the act or acts directly engaged in by the taxpayer for the ultimate purpose of producing the sale to be apportioned. Indirect expenses such as interest or activities produced by independent contractors are not included.

In General Motors Corporation v. Commonwealth of Virginia , 268 Va. 289, 602 S. E.2d 123 (2004), the Virginia Supreme Court held that Title 23 VAC 10-120-250 is inconsistent with Virginia Code § 58.1-418 when it limits the costs of performance used to apportion income of a financial corporation to direct costs, excluding costs of independent contractors. Because the language defining “cost of performance” and “income producing activity” in Title 23 VAC 10-120-230 is identical to the language in Title 23 VAC 10-120-250, the cost of performance for purposes of sales of intangibles may not be limited to direct costs and may not exclude indirect expenses such as interest or activities produced by independent contractors.

In response to the General Motors decision, the Department issued Tax Bulletin (VTB) 05-3 (4/18/2005). This bulletin explains that financial corporations may elect to file returns prepared in accordance with Title 23 VAC 10-120-250, pending the Department’s adoption of policies in response to the General Motors decision. The determination as to whether a transaction or sale is a Virginia transaction or sale is an all or nothing test. A taxpayer would first have to determine the direct cost associated with each transaction for a given taxable year. Then the direct costs would be attributed to the states in which they occurred. See Title 23 VAC 10-120-230 C 1. If the transaction resulted from direct costs occurring both in Virginia and outside Virginia, such transaction would be considered to be in Virginia if a greater portion of the direct costs occurred in Virginia than in any other state. See Title 23 VAC 10-120-230 C 2. Conversely, a transaction would not be a Virginia sale if a greater portion of the direct costs occurred in any state other than Virginia.

This ruling is based on the facts presented as summarized above. Any change in facts or the introduction of new facts may lead to a different result. The Department issues no opinion concerning what portion, if any, of the Taxpayer’s sales should be sourced to Virginia.

The Code of Virginia sections, regulations, public documents, and tax bulletin cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department’s web site. If you have any questions regarding this ruling, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/2082.M

Related Documents

94-181

96-271

16-135

05-3