Ill Dept of Revenue Clarifies Rule on Taxation of Sales of Canned Computer Software

In a general information letter (“GIL”), the Illinois Department of Revenue (“Department”) has stated that neither the transfer of canned computer software nor the subsequent software updates will be subject to Retailers’ Occupation Tax under 86 Ill. Adm. Code 130.1935 if transactions for the licensing of computer software meet all of the criteria provided in subsection (a)(1) of Section 130.1935.

The purpose of a GIL is to direct taxpayers to Department regulations or other sources of information regarding the topic about which they have inquired. A GIL is not a statement of Department policy and is not binding on the Department.

By way of background, ABC is an out of state vendor who is required to collect Sales and Use Tax in the State of Illinois. It allows clients to access two of our software products for use via the Internet as an Application Service Provider and would like to request a letter ruling concerning the taxability of these products.

The Department explained that generally, sales of “canned” computer software are taxable retail sales in Illinois. Sales of canned software are taxable regardless of the means of delivery. For instance, the transfer or sale of canned computer software downloaded electronically would be taxable. However, if the computer software consists of custom computer programs, then the sales of such software may not be taxable retail sales. See 86 Ill. Adm. Code 130.1935(c). Custom computer programs or software must be prepared to the special order of the customer.

The Department further wrote that charges for updates of canned software are fully taxable pursuant to Section 130.1935. If the updates qualify as custom software under Section 130.1935(c), they may not be taxable. But, if maintenance agreements provide for updates of canned software, and the charges for those updates are not separately stated and taxed, then the whole agreements would be taxable as sales of canned software.

If transactions for the licensing of computer software meet all of the criteria provided in subsection (a)(1) of Section 130.1935, neither the transfer of the software nor the subsequent software updates will be subject to Retailers’ Occupation Tax. A license of software is not a taxable retail sale if:

A) It is evidenced by a written agreement signed by the licensor and the customer;

B) It restricts the customer’s duplication and use of the software;

C) It prohibits the customer from licensing, sublicensing or transferring the software to a third party (except to a related party) without the permission and continued control of the licensor;

D) The licensor has a policy of providing another copy at minimal or no charge if the customer loses or damages the software, or permitting the licensee to make and keep an archival copy, and such policy is either stated in the license agreement, supported by the licensor’s books and records, or supported by a notarized statement made under penalties of perjury by the licensor; and

E) The customer must destroy or return all copies of the software to the licensor at the end of the license period. This provision is deemed to be met, in the case of a perpetual license, without being set forth in the license agreement.

Accordingly, the Department concluded that a license of canned software is subject to Retailers’ Occupation Tax liability if all of the criteria set out in 86 Ill. Adm. Code 130.1935(a)(1) are not met.

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