Was a prepackaged software program modified to a customer's unique specifications exempt as customized software?

Plain-English summary

Florida concluded that the described software modification and license could be an exempt customized-software service if the vendor charged for one integrated transaction. The vendor started with a prepackaged program but changed it to solve the customer's unique processing problem before the final customized version was accepted and licensed.

The customer managed about 350,000 software-application elements and used subsystem-specific data-set naming. The standard product could not protect duplicate code entries at the necessary system level. The customer therefore asked the vendor to expand the program's filtering feature.

The work went beyond selling modifiable software

The documented process included:

• Meetings to analyze the customer's deficiencies and requirements.
• A development plan for the requested customization.
• Creation of a new program version.
• Customer testing and requests for enhancements.
• Weekly reviews between the customer's service-control team and the vendor's development and quality-assurance teams.
• Repeated modification, testing, and problem resolution until acceptance.

Under section 212.08(7)(v) and Rule 12A-1.032, that single customized-software transaction was an exempt professional service when any tangible sales element was inconsequential and separately uncharged.

Transaction timing controlled the result

If the vendor first licensed the standard canned program and only later agreed to modify it, the initial license remained taxable. At that point, the customer had purchased software that was merely “modifiable” or “customizable,” not software already modified to its specifications.

The ruling applied only to the modification-and-subsequent-license transaction described in the submitted exhibits.

What this means for you

Software vendors

Document customer-specific analysis and development before the license is complete. Separate contracts or charges for canned software and later customization can produce separate tax results.

Enterprise software buyers

Unique requirements, iterative testing, enhancement requests, and acceptance of a changed product supported service treatment. Simply buying a standard product capable of future changes did not.

Accountants and tax professionals

Review order, contract, and invoice timing. The same technical work can be treated differently depending on whether customization is part of the original transaction or follows a completed canned-software license.

Common questions

Q: Was the customized software transaction taxable?
A: No, if the modification and license were billed as one transaction on the stated facts.

Q: Did starting from a prepackaged program defeat the exemption?
A: No. The rule allowed a prepackaged program modified at the customer's request and specifications to qualify as customized software.

Q: What if canned software was licensed first?
A: The initial canned-software license was taxable even if the vendor customized the program later.

Q: Why did the Department view the work as professional services?
A: The vendor analyzed unique needs, developed a new version, repeatedly tested and enhanced it with the customer, and delivered the accepted customized version.

Citations and references

• Fla. Stat. § 212.05 — sales tax on retail tangible-personal-property sales
• Fla. Stat. § 212.08(7)(v)1. — professional services with inconsequential sales elements
• Fla. Admin. Code r. 12A-1.032(4), (5) — prepackaged software, customized software, and computer professional services
• Fla. Stat. § 213.22 — Technical Assistance Advisements

Source

• Landing page: Florida Tax Law Library
• Advisement: TAA 04A-021

Original ruling text

SUMMARY

QUESTION: Is the specific transaction described below a
sale of customized software, and therefore, not subject to
sales tax?

ANSWER - Based on Facts Below: The taxpayer, at Customer's
request, modifies the prepackaged [Software] program to
Customer's specification. So long as the taxpayer charges
Customer for a single transaction, the charge would be for
a professional service pursuant to section 212.08(7)(v),
F.S., and Rule 12A-1.032, F.A.C., and is exempt from tax.
However, if Taxpayer licenses canned software to Customer,
and later modifies or customizes it, the charge for the
initial license of canned software would be subject to tax,
since the sale is only for "modifiable" or "customizable"
software, not modified or customized software, as required
by Rule 12A-1.032, F.A.C.

Mar 24, 2004

Subject: Technical Assistance Advisement 04A-021
Software Licenses
Sales and Use Tax
Sections 212.05 and 212.08, F.S.
Rule 12A-1.032, F.A.C.
Taxpayer Federal Identification Number: XX

Dear :

This response is in reply to your petition received January 14,
2003, requesting the Department's issuance of a Technical
Assistance Advisement pursuant to s. 213.22, F.S., and Chapter
12-11, F.A.C., regarding the above referenced matter and
parties. An examination of your petition has established that
you have complied with the statutory and regulatory requirements
for issuance of a TAA. Therefore, the Department is hereby
granting your request for issuance of a TAA.

ISSUE

Whether the specific transaction described below is subject to
sales tax.

FACTS

The preliminary facts are as follows:

[The taxpayer] is in the business of licensing computer
software. The software consists of products that operate in
conjunction with the operating system software across a
large range of computer designs, brands and models, ranging
from desktop devices to mid-range and mainframe hardware.
[Customer] engages [the taxpayer] on a periodic basis to
acquire software....

You provide the following additional detail in your letter
received January 14, 2003:

...[W]e have attached Exhibit A and B to illustrate [the
customization] process. Exhibit A explains the most recent
customization effort required by [Customer] and Exhibit B
reflects the steps involved in the customization
transaction for this effort. Please keep in mind that this
is just one example of ongoing customization efforts
between [the taxpayer] and [Customer] in which the same
types of steps are followed during the transaction....

Exhibit A: [Software] Customization Example

[Software] is a product licensed by [Customer] that manages
all in-house developed software applications and elements
(e.g., JCL, Programs). [Customer] has approximately
350,000 application elements that are managed by
[Software]. The [Customer] magazine and fulfillment data
processing requirements are unique in that the various data
set naming conventions in its source and load libraries are
separated by subsystem code. When programmers enter code,
there are duplicate entries that could not be saved or

protected under the standard prepackaged [Software] product
design. This protection could only be accomplished through
the modification and expansion of [Software]'s filtering
feature to prevent duplicates at the system level versus
the global level allowed under the standard packaged
version of [Software]. Based on these unique processing
requirements, [Customer] requested [the taxpayer] to modify
[Software] to allow the most recent version of the code to
be saved and protected at the system level.

Exhibit B: [Software] Customization Steps

1. [Customer] and [the taxpayer] meet to discuss
   [Software] product deficiencies and requirements to
   meet [Customer] unique processing requirements.
2. [The taxpayer] prepares development plan to customize
   [Software] to meet [Customer] requirements.
3. [The taxpayer] develops new version of [Software] to
   provide code protection at the system level.
4. [The taxpayer] sends customized version of [Software]
   to [Customer] to begin testing.
5. [Customer] Service Control Dept. begins testing and
   communicating/requesting enhancements to customized
   version of [Software].
6. Weekly status review meetings and teleconferences held
   between [Customer] Service Control Dept and
   [taxpayer]'s Development and Quality Assurance Dept to
   discuss enhancement requests, improvement suggestions,
   and problem resolution. Ad hoc meetings held as
   needed (when major issues were identified between
   weekly status meetings).
7. Steps 4, 5, and 6 repeated until customization
   requirements are met.
8. Final customized version is accepted by [Customer] and
   implemented.

DOCUMENTS PROVIDED BY TAXPAYER

1. License Agreement between the taxpayer and Customer
   dated March 17, 1993.
2. Amendment to License Agreement dated March 17, 1993

between the taxpayer and Customer dated March 30,
2001.

3. Taxpayer Order Form for Customer dated January 7,
   2000.
4. Addendum to Order Form of Customer and Taxpayer dated
   January 7, 2000.
5. Amendment Number 1 to Order Form and MIPS Based
   License Addendum Effective December 31, 1999 (the
   "License") between the taxpayer and Customer signed
   January 7, 2000.
6. Amendment Number 2 to Order Form and MIPS Based
   License Effective December 23, 1999 (the "License")
   between Customer and the taxpayer, signed October 31,
   2000.
7. Amendment Number 2 to Order form and MIPS based
   License Addendum Effective December 31, 1999 (the
   "License") between Customer and Taxpayer signed
   September 27, 2000.
8. Amendment Number 3 to Order Form and Addendum Thereto
   Effective December 23, 1999 and Amendments thereto
   (the "License") between Customer and Taxpayer
   effective as of March 15, 2001.

TAXPAYER POSITION

The transaction described in Exhibits A and B meet the
customization requirements referenced in Rule 12A-1.032(4) and
(5), F.A.C.

APPLICABLE STATUTES AND RULES

Section 212.05, F.S., provides in part:

It is hereby declared to be the legislative intent that
every person is exercising a taxable privilege who engages
in the business of selling tangible personal property at
retail in this state...

Section 212.08(7)(v)1., F.S., provides in part:

1. Also exempted are professional, insurance, or personal

service transactions that involve sales as
inconsequential elements for which no separate charges
are made.

Rule 12A-1.032, F.A.C., provides in part:

(1) Computer "hardware" is defined as the machine and all
of its components. Computer "software" is the programming
needed to make computers operate.

(2) The sale to a consumer of a computer and its related
components is taxable when delivered to a customer in this
state. The rental of a computer and its related components,
including terminal equipment (hardware) which is physically
located in this state, is taxable.

(4) The charge which a computer technician makes for a
customized software package which includes such items as
instructional material, pre-punched cards or programmed
tapes is construed to be a service charge and exempt.
Retail sales of pre-packaged programs for use with
audio/visual equipment or other computer equipment, where
the programs are fully useable by the customer without
modifications and the vendor does not perform a detailed
analysis of the customer's requirements in selecting or
preparing the programs, are taxable as sales of tangible
personal property. However, where the vendor, at the
customer's request, modifies or alters a pre-packaged
program to the customer's specification and charges the
customer for a single transaction, the charge is for a
customized software package and is exempt as a service
transaction.

(5) When a computer technician surveys a customer's needs
and as a result makes recommendations which may include
instructional material, diagrams and layouts, a software
package, including pre-punched cards or programmed tapes,
the charge made is construed to be for professional
services and is exempt....

ANALYSIS

Section 212.05, F.S., imposes a tax on every person who engages
in the business of selling tangible personal property at retail
in this state. Subparagraph 212.08(7)(v)1., F.S., provides an
exemption for "professional, insurance, or personal service
transactions that involve sales as inconsequential elements for
which no separate charges are made." Rule 12A-1.032(5), F.A.C.,
provides that, "[w]hen a computer technician surveys a
customer's needs and as a result makes recommendations which may
include instructional material, diagrams and layouts, a software
package, including pre-punched cards or programmed tapes, the
charge made is construed to be for professional services and is
exempt."

RESPONSE

According to Exhibits A and B, the taxpayer, at Customer's
request, modifies the prepackaged [Software] program to
Customer's specification. So long as the taxpayer charges
Customer for a single transaction, the charge would be for a
professional service pursuant to section 212.08(7)(v), F.S., and
Rule 12A-1.032, F.A.C., and is exempt from tax. However, if
Taxpayer licenses canned software to Customer, and later
modifies or customizes it, the charge for the initial license of
canned software would be subject to tax, since the sale is only
for "modifiable" or "customizable" software, not modified or
customized software, as required by Rule 12A-1.032, F.A.C.

Please be advised that this response applies only to the
transaction outlined in Exhibits A and B involving the
Taxpayer's modification and subsequent licensing of Software to
Customer.

This response constitutes a Technical Assistance Advisement
under Section 213.22, F.S., which is binding on the Department
only under the facts and circumstances described in the request
for this advice as specified in section 213.22, F.S. Our
response is predicated on those facts and the specific situation
summarized above. You are advised that subsequent statutory or
administrative rule changes, or judicial interpretations of the
statutes or rules, upon which this advisement is based, may

subject similar future transactions to a different treatment
than expressed in this response.

You are further advised that this response, your request and
related backup documents are public records under Chapter 119,
F.S., and are subject to disclosure to the public under the
conditions of s. 213.22, F.S. Confidential information must be
deleted before public disclosure. In an effort to protect
confidentiality, we request you provide the undersigned with an
edited copy of your request for Technical Assistance Advisement,
the backup material and this response, deleting names, addresses
and any other details which might lead to identification of the
taxpayer. Your response should be received by the Department
within 15 days of the date of this letter.

Sincerely,

Kelley A. Cramer
Attorney
Technical Assistance and Dispute Resolution
(850) 922-4835

KC/
Ctrl# 58309
Enclosure