In Virginia, is computer software taxable, and how are software maintenance contracts taxed -- especially when they are bundled with computer hardware?

Plain-English summary

A Virginia staffing and supply-chain company was audited for retail sales and use tax (February 2017 through January 2020) and assessed on untaxed purchases of software, maintenance contracts, licensing fees, and set-up fees. It paid the bill and appealed. The Tax Commissioner split the decision — removing some items and keeping others — and used the appeal to update the Department's proof rules for software delivery.

When is software taxable? Virginia looks at how the software was delivered. Software provided on a tangible medium (a disc, or bundled with hardware) is a taxable sale of tangible personal property; software transmitted electronically is a nontaxable service (Va. Code § 58.1-609.5 1). For a transaction that mixes property and services, the Department applies the "true object" test (23 VAC 10-210-4040 D): if the real object is to obtain the software program and any tangible property is not critical, it can be exempt; if the object is to get tangible property, the whole charge — including the software — is taxable.

The new documentation rule. Historically the Department presumed software was delivered in tangible (taxable) form, and the taxpayer had to produce an invoice or contract expressly certifying electronic delivery to rebut it. Citing the Richmond Circuit Court's decision that only minimal evidence is needed to show electronic delivery (Alcatel-Lucent USA Inc. v. Virginia Dept. of Taxation, published as P.D. 21-171), the Commissioner announced that going forward the Department will no longer require documentation expressly certifying electronic delivery. Software provided in connection with a sale of tangible personal property still remains taxable, and the Department may ask a taxpayer to show the software was not bundled with tangible property.

Maintenance contracts — and why the one-half rule did not save these. A maintenance contract that covers both repair/replacement parts and repair labor is normally taxed on one-half of its total charge (Va. Code § 58.1-609.5 10; 23 VAC 10-210-910). But when a maintenance contract is sold together with computer hardware and covers integrated software updates, the software updates are a component of the taxable hardware sale, so the full contract price is taxable — the half-tax rule does not apply.

How the four invoices came out:

• Invoice A (software upgrade) — REMOVED. The auditor kept it because the invoice had a "ship to" address and the taxpayer hadn't proven the original software was sent electronically. But the audit report never documented that the auditor actually requested corroborating evidence of the delivery method. An assessment is prima facie correct (§ 58.1-205), yet it "should be supported by documentation, or lack thereof, contained in an audit report" — and this one wasn't. Removed.
• Invoice B (computer equipment + maintenance contract) — KEPT, taxable in full. The maintenance contract bundled hardware, software updates, support, and maintenance with the equipment. Because the software updates were a component of a taxable hardware sale, the entire contract price is taxable even though the updates were delivered electronically and separately stated.
• Invoice C (maintenance for a network switch) — KEPT. A subscription license providing new software releases, knowledge-base access, web support, and phone consulting, sold in conjunction with hardware — the same analysis as Invoice B, so it stays in the audit.
• Invoice D (software-license/maintenance package from a reporting-software vendor) — REMOVED. A little more investigation showed this was a labor-only software license with no tangible personal property involved. Labor-only maintenance contracts are not taxable, so it should never have been an audit exception.
• Set-up / inbound-freight fees — REMOVED. The auditor agreed these were not taxable.

Because the assessment had already been paid, the taxpayer will receive a refund with accrued interest on the removed items (Invoices A and D and the set-up fees), while the assessment on Invoices B and C stands.

What this means for you

Businesses buying software and software services

Match the tax to the delivery method and the true object. Software you download or receive electronically is generally not taxed; software on a disc, or delivered as part of a hardware purchase, is taxed. The Department has relaxed its proof rules — you no longer need a contract clause expressly certifying electronic delivery — but keep enough documentation (invoices, vendor data sheets, product descriptions) to show the software was not bundled with tangible property, because it can still ask.

Anyone buying a "maintenance contract"

The label doesn't decide the tax. A genuine parts-and-labor maintenance contract is taxed on half its price. But if it's sold with computer hardware and covers integrated software updates, expect the whole price to be taxed — the software rides along with the taxable hardware. A truly labor-only maintenance contract (no parts, no tangible property) is not taxable at all. Read what the contract actually covers.

Businesses under audit

An assessment is presumed correct, but the audit report itself has to be supported by documentation. If an auditor includes a purchase without a record that the delivery method or other basis was actually requested and considered, that is a ground to challenge the item — as Invoice A shows.

Tax professionals

Note the policy shift: the old rebuttable presumption from P.D. 05-44 (requiring express certification of electronic delivery) is superseded prospectively by this determination, following Alcatel-Lucent (P.D. 21-171). Software bundled with tangible personal property remains taxable, and bundled hardware/software maintenance is fully taxable rather than half-taxable under § 58.1-609.5 10.

Common questions

Q: Is computer software taxable in Virginia?
A: It depends on delivery. Software transferred on a tangible medium, or bundled with a taxable hardware sale, is taxable tangible personal property. Software transmitted electronically is generally a nontaxable service (Va. Code § 58.1-609.5 1).

Q: Do I still need a contract clause proving my software was delivered electronically?
A: No. Going forward the Department will not require documentation expressly certifying electronic delivery. But software provided in connection with a sale of tangible property is still taxable, and the Department may ask you to show it wasn't bundled with tangible property.

Q: Aren't maintenance contracts only taxed on half the price?
A: Only when the contract provides both repair parts and repair labor (Va. Code § 58.1-609.5 10). If the maintenance contract is sold with computer hardware and covers integrated software updates, the full price is taxable because the software is a component of the taxable hardware sale. A labor-only maintenance contract is not taxable at all.

Q: The auditor included a purchase without asking me for proof. Can I contest it?
A: Possibly. An assessment is prima facie correct (§ 58.1-205), but it should be supported by documentation contained in the audit report. Where the report doesn't show that the relevant evidence was requested, the Department has removed the item (as it did with Invoice A here).

Citations and references

Statutes and regulations:

• Va. Code § 58.1-203 — Department's authority to interpret and enforce the tax laws
• Va. Code § 58.1-609.5 1 — exemption for services (including software) delivered electronically
• Va. Code § 58.1-609.5 10 — parts-and-labor maintenance contracts taxed on one-half the total charge
• Va. Code § 58.1-205 — assessment prima facie correct; burden on the taxpayer
• 23 VAC 10-210-4040 D — the "true object" test for mixed property/service transactions
• 23 VAC 10-210-910 — definition of a "maintenance contract"

Authorities the Commissioner relied on (described here, not linked): the Richmond Circuit Court's decision that only minimal evidence is needed to show electronic delivery, published as P.D. 21-171 (Alcatel-Lucent USA Inc. v. Virginia Dept. of Taxation); the strict-construction cases Commonwealth v. Research Analysis Corp., 214 Va. 161 (1973), Commonwealth v. Community Motor Bus, 214 Va. 155 (1973), and Golden Skillet Corp. v. Commonwealth, 214 Va. 276 (1973); and prior public documents on software delivery, bundling, and licensing (P.D. 96-143, 96-192, 05-44, 12-6).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 25-98

Original ruling text

June 30, 2025

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

Dear *:

This will respond to your letter in which you seek correction of the retail sales and use tax assessment issued to * (the “Taxpayer”) for the February 2017 through the January 2020 period.

FACTS

An audit was conducted on the books and records of the Taxpayer, a supplier of staffing and supply chain management services, for the period at issue. As a result of the audit, the Taxpayer was assessed sales and use tax for the purchase of software, maintenance contracts, licensing fees, and set-up fees that were not taxed. The Taxpayer paid the assessment and filed an application for correction, contending that the purchases and fees were not subject to tax.

ANALYSIS

The Department has the authority to interpret and enforce the laws of the Commonwealth governing taxes in accordance with Virginia Code § 58.1-203. With regard to such interpretations, the Virginia Supreme Court requires strict construction of sales tax exemptions. Where there is any doubt as to the application of an exemption, the doubt is resolved against the one claiming the exemption. See Commonwealth v. Research Analysis Corporation , 214 Va. 161 (1973), Commonwealth v. Community MotorBus , 214 Va. 155 (1973), and Golden Skillet Corp. v. Commonwealth , 214 Va. 276 (1973).

Sales of Software

Virginia Code § 58.1-609.5 1 exempts from sales and use tax services that 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. In Public Document (P.D.) 96-192 (8/6/1996), the Department determined that the medium in which the computer software is transferred is critical to the taxable status of the transaction. Thus, when software is provided in tangible form, the sale and all charges in connection transaction are deemed to be a taxable sale of tangible personal property. Conversely, if the software is transmitted via electronic means, the transaction is generally deemed to be a nontaxable service, and any additional charges included in the electronic transfer take on the same nontaxable status.

The taxability of a transaction involving both the sale of tangible personal property and the provision of services is generally applied to the full amount charged, regardless of whether the charges for the service and property components are separately stated. The Department will use the "true object" test, as explained in 23 VAC 10-210-4040 D, to determine the taxability of these transactions. If the object of a transaction is to obtain a software program and any tangible personal property included is not critical to the transaction, then the transaction may constitute an exempt sale. However, if the object of a transaction is to procure tangible property, then the entire charge, including the charge for any software provided, is taxable. See P.D. 24-40 (3/27/2024) concerning the true object tax with regard to services and intangible property.

Documentation Requirements

The Department historically imposed a rebuttable presumption that software was conveyed in tangible form and, therefore, taxable. See P.D. 83-90 (5/11/1983), P.D. 88-20 (1/4/1988), P.D. 05-44 (4/4/2005), P.D. 11-112 (6/20/2011), P.D. 15-118 (6/16/2015), P.D. 15-153 (7/16/2015), and P.D. 19-24 (4/8/2019). To rebut this presumption, the taxpayer was required to provide a sales invoice, contract, or other sales agreement expressly certifying the electronic delivery of the software and that no tangible medium for that software was to be furnished to the customer. See P.D. 05-44. If the taxpayer could demonstrate that the software was delivered electronically and that no tangible medium was provided to the customer before or after the electronic download of the software, the transaction was exempt from sales tax.

The process of delivering computer programs and software updates has evolved significantly since its inception. While it was once commonplace to pick up a box containing a desired software application from a local retailer, the development and widespread use of the internet has transformed how software is bought and sold. Additionally, the Circuit Court for the City of Richmond found that only minimal evidence was required to meet the burden of proof necessary to show that software was delivered electronically. See Alcatel-Lucent USA Inc. v. Virginia Department of Taxation, CL20-3591-7, (10/26/2021), published as P.D. 21-171 (5/11/2022).

Accordingly, the Department finds it necessary to update the documentation standards concerning the delivery of software. Going forward, the Department will not require the taxpayer to provide documentation expressly certifying the electronic delivery of the software. However, software programs provided in connection with sales of tangible personal property will remain taxable. The Department may request, and taxpayers may be required to provide, documentation demonstrating that software was not provided in connection with the sale of tangible personal property.

Invoice * (Invoice A)

The Taxpayer purchased a software upgrade from * (Vendor A). Relying on P.D. 12-6 (2/23/2012), the auditor included the purchase of this software in the audit on the basis that there is a “ship to” address on the invoice and that the Taxpayer has not provided evidence that the original software was sent electronically. The Taxpayer contends that the upgrade was shipped electronically.

In P.D. 12-6, the Department ruled that if the purchase of software was made via tangible means, any subsequent renewal or update is also taxable even if transferred electronically. As such, the auditor asserts that the upgrade from Vendor A is subject to tax since the Taxpayer is unable to provide proof that the original software was sent electronically.

Regarding Invoice A, neither the audit report nor auditor’s correspondence with the Taxpayer indicate that corroborating evidence was requested to show the method of transferring the original software. Even though an assessment of tax by the Department is deemed to be prima facie correct under Virginia Code § 58.1-205, any such assessment should be supported by documentation, or lack thereof, contained in an audit report provided to a taxpayer. The audit report, in this case, fails to meet this requirement.

Maintenance Contracts

Virginia Code § 58.1-609.5 10 provides that maintenance contracts, the terms of which provide for both repair or replacement parts and repair labor, are subject to tax upon one-half of the total charge for such contracts. Title 23 of the Virginia Administrative Code (VAC) 10-210-910 defines the term “maintenance contract” as “an agreement whereby a person agrees to maintain or repair an item of tangible personal property over a specified period for a fee that is determined when the agreement is made. A maintenance contract may provide for labor only, parts only, or labor and parts.”

Invoice * (Invoice B)

The Taxpayer purchased computer equipment and a maintenance contract from * (Vendor B) which is separately stated on the invoice. The maintenance contract included both the hardware, software updates, customer support, and maintenance. The auditor concluded that the entire purchase price for the computer hardware and maintenance contract was subject to tax because the software was delivered in tangible form. The Taxpayer asserts that the maintenance contract should be subject to tax at one-half the contract price since it includes both parts and labor.

The Taxpayer has provided a data sheet from Vendor B that specifies the provisions of the maintenance contract. This contract covers maintenance, replacement parts, and software updates. The Taxpayer indicates that the software updates are electronically delivered. A review of the invoice and data sheet does not show how the software is to be shipped.

In P.D. 96-143 (6/20/1996), the Department determined that licensing fees for software that was included in the purchase of a computer is subject to tax because the license allowed the continued usage of the computer. Further, when computer equipment is sold with the software and software updates installed, the software and software updates are a component part of the taxable sale of computer equipment. See P.D. 05-44. Because the maintenance contract included both hardware repair and integrated software updates, the full contract price is subject to tax even though software was electronically delivered and specified as a separate line item on the invoice.

Invoice * (Invoice C)

The Taxpayer purchased a maintenance contract from Vendor B for a computer network switch. A computer network switch is a device that connects multiple devices with a network and directs data between them. The maintenance contract provides for new software releases, knowledgebase access, web support, and phone consulting. The auditor asserts that the Taxpayer acknowledges this purchase to be related to switches and indicated that that the purchase was for the licensing of both hardware and software. The Taxpayer asserts that the maintenance contract was not subject to tax because it is for labor only. As with Invoice B above, however, the language of the subscription license includes the provision of services essentially the same as a maintenance contract for hardware and software together. Because maintenance contracts sold in conjunction with the purchase of computer hardware are subject to tax, Invoice C was properly included as an exception in the audit.

Invoice * (Invoice D)

The Taxpayer purchased an agreement from * (Vendor C) for software updates, product support, online knowledgebase, license changes, access to videos and tutorials, and a report template. The Taxpayer contends that the purchase of this package is for a non-taxable labor-only maintenance contract. The auditor asserts that the purchase of this package is for a license renewal based upon the original delivery of the product in tangible or electronic form.

While the invoice records the purchase of a maintenance contract, the accompanying document provided by the Taxpayer defines the package as a software license. Research into Vendor C’s business operations indicates that it provides reporting, analytics, and budgeting solutions for Microsoft software applications. Based on this information, the maintenance agreement did not include the provision of tangible personal property. While listing Invoice D as an exception initially appears warranted, a minimal amount of additional investigation shows that inclusion in the final audit was not warranted.

As stated above, for software to be subject to tax it must be connected with the transfer of tangible property. Labor-only maintenance contracts are not subject to tax. There is no evidence that the transfer of the software recorded in Invoice D was related to the transfer of tangible personal property or that the maintenance contract required anything other than labor.

Setup Fees

The Taxpayer contends that it was erroneously assessed sales tax on inbound freight or setup fees. The auditor agrees that these fees are not subject to tax. As such, they will be removed from the audit.

DETERMINATION

Therefore, sales of software products and software maintenance contracts are presumed to be sent electronically unless there is documentation to show physical delivery unless sold as part of a transaction with computer hardware.

Because the evidence fails to show that the delivery of software included the provision of tangible personal property, Invoices A and D will be removed from the audit. Further, the setup fees will be removed as indicated above.

Because transactions involving maintenance contracts that include care for both hardware and software are taxable, Invoices B and C will remain in the audit.

The audit will be returned to the appropriate audit staff to make the necessary adjustments. The Taxpayer will receive a revised report reflecting the adjustments. The assessments at issue have been paid in full. Accordingly, the Taxpayer will receive a refund with accrued interest based upon the audit adjustments required by this determination.

The Code of Virginia sections and regulations cited are available online at law.lis.virginia.gov. The public documents cited are available at tax.virginia.gov in the Laws, Rules, & Decisions section of the Department’s website. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy and Legal Affairs, Tax Adjudication and Resolution, at or **.

Sincerely,

James J. Alex

Tax Commissioner

Commonwealth of Virginia

AR/3732.B

Related Documents

88-20

96-143

96-192

05-44

09-83

11-70

11-112

12-6

15-118

15-153

19-24

19-60

21-171

24-40