A subtle ruling on how software is delivered impacts whether it is subject to sales and use tax. Although this is not a new position, we wanted to pass this along for our clients that sell/license software.
Virginia: Renewal Fees for Prewritten Programs Are Taxable When the Initial Transfer is Conveyed via Tangible Means
The Virginia Department of Taxation recently addressed the taxability of software renewal fees and upgrades. The taxpayer at issue licensed computer software to customers located in Virginia. The licenses usually entitled the customer to use the software for a year, after which the licenses were generally extended or renegotiated. Support services and upgrades were not separately billed, but were granted as a part of the standard license agreement. In most cases, the software was initially transmitted to customers by tangible means, such as CD or DVD. However, renewals and upgrades were typically transmitted by email or through an online portal.
Under Virginia law, prewritten computer software delivered in tangible form is subject to sales and use tax. Custom software and software delivered electronically are not taxable. The Tax Commissioner ruled that fees to renew the licenses of prewritten computer software originally conveyed to the user by tangible means were subject to sales and use tax. Renewal fees associated with custom computer software or prewritten computer software delivered electronically were not taxable because the original transaction was not taxable. Likewise, when a prewritten software license agreement included upgrades conveyed electronically and the software was originally delivered by tangible means, the upgrades were considered part of the original transaction and were therefore taxable. However, in the event an upgrade was separately negotiated, was a transaction independent of any prior sale of software, and was separately billed, the charge for such upgrade would not be taxable if delivered by electronic means. For more information see Virginia Letter Ruling No. 12-6 (February 23, 2012).
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.