Was software developed and heavily customized for one retail customer exempt from Florida sales tax, and was its maintenance agreement also exempt?

Plain-English summary

The Florida Department of Revenue ruled that the software license and the accompanying maintenance agreement were exempt from sales tax. The software was customized for the first customer under an agreement that existed before the software sale, making the transaction an exempt service rather than a sale of prepackaged tangible software.

The developer created a program for grocery stores and other retailers. Its first and only customer had retained the developer for a three-year period, and the work had already required about four person-years of customization with at least another year expected.

The agreement predated the software sale

The key evidence was an IT consulting agreement dated June 4, 2003. The Department found that it clearly established an arrangement to develop and customize the program before the later software license and maintenance agreements.

That sequence supported treatment as customer-requested development services rather than a sale of a finished canned product.

The program was not usable without substantial customization

The software processed proprietary input and output formats and required custom interfaces, testing, evaluation, and adjustment for each installation. The customer and developer both built parts of the first installation. The developer estimated that even a similar grocery chain would need one or two person-years of customization.

No shrink-wrapped production version existed. Although the developer hoped to adapt and license derivative software to other customers, those future plans did not change the customized nature of the transaction before the Department.

Maintenance followed the exempt software treatment

Rule 12A-1.105 excluded from the service-warranty definition agreements to maintain property whose retail sale would not be taxable. Because the customized software sale was exempt, the maintenance agreement sold with it was also not subject to sales tax.

What this means for you

Custom software developers

Contemporaneous agreements matter. A consulting or development contract executed before delivery can help show that the customer commissioned a service rather than bought an off-the-shelf program.

Software companies planning broader commercialization

An intent to build a reusable product later does not necessarily make the first customer engagement canned software. Focus on the actual state of the program and customization required at the time of sale.

Maintenance and support teams

The maintenance result depended on the underlying software being exempt. Separately priced hardware, taxable prepackaged software, or other tangible deliverables can require a different analysis.

Common questions

Q: What proved the software was commissioned before sale?
A: The June 4, 2003 IT consulting agreement between the developer and customer.

Q: How much customization had the first installation required?
A: About four person-years, with at least another 12 months expected.

Q: Could the software be installed for another similar retailer without changes?
A: No. The developer estimated one or two person-years of customization even for a similar grocery chain.

Q: Was there a shrink-wrapped version ready for sale?
A: No. The ruling says no shrink-wrapped production package existed.

Q: Was the maintenance agreement taxable?
A: No. It was sold in conjunction with software the Department determined was exempt custom software.

Citations and references

• Fla. Stat. § 212.02(15), (16), and (19) — sale, sales price, and tangible personal property
• Fla. Stat. § 212.05 — sales tax on retail tangible personal property
• Fla. Stat. § 212.08(7)(v)1. — professional service transactions with inconsequential sales elements
• Fla. Admin. Code r. 12A-1.032(4)-(5) — customized software and professional computer services
• Fla. Admin. Code r. 12A-1.105 — service-warranty treatment

Source

• Landing page: Florida Tax Law Library
• Advisement: TAA 05A-028

Original ruling text

SUMMARY
QUESTION: Is the software developed by a taxpayer considered customized and exempt from Florida sales tax? Is
the maintenance fee for customized software subject to sales tax?
ANSWER - Based on Facts Below: Yes. Evidence was provided to determine that an agreement existed between
the taxpayer and its customer prior to the development and sale of the software; therefore, the software is determined
to be customized and not subject to Florida sales tax. The sale of a maintenance agreement for software determined
to be tax exempt is not subject to sales tax?

June 13, 2005

Re: Technical Assistance Advisement 05A-028
Sales Tax - Software and Software Maintenance Agreement
Sections 212.02, 212.05 and 212.08, F.S.
Rules 12A-1.032 and 12A-1.105, F.A.C.
Dear:
This is a response to your letter dated January 29, 2005, in which you requested the issuance of a Technical
Assistance Advisement (TAA) concerning the above referenced matter. Your letter and the supporting documents
have been carefully reviewed, and the Department finds your request to be in compliance with the criteria set forth in
Chapter 12-11, F.A.C. This response to your request constitutes a TAA, and is issued under the authority of section
213.22, F.S.
Background
XXX, is representing XXX [Taxpayer]. Taxpayer has developed a software program that it plans to sell to grocery
stores and other retail outlets.
The following statements are being paraphrased from your letter referenced above:

1. XXX (hereafter "Customer") is the first and only customer for this software. The software cannot be installed or used
   by [Customer] or any contemplated customer without substantial customization by [Taxpayer]. In the case of
   [Customer], this has already comprised approximately four man years of customization. This customization will
   continue for at least another 12 months.
2. [Customer] has procured our services under a retainer agreement for a three year period because they understand
   the need for more customization to the software over that period.

3. Installing this software at another grocery retailer whose operations are similar to those of [Customer] might be
accomplished with significantly less effort. However, we are prohibited by contract from doing so for a period of 36
months from June 2004. This prohibition prevents the sale or licensing of the software to any other grocery or drug
retailer in the U.S. for the first 18 months and then to a list of 20 companies chosen by [Customer] for the second 18
months.

4. The software could not be installed at a retail grocery chain similar to [Customer] without at least one or two man
   years of customization.
5. [Taxpayer] plans to continue to develop the software and make it adaptable to different installations over the next
   12 months. It is our plan to license this derivative software to other retail grocery chains outside the U.S.
6. We hope to customize and license the software outside the grocery and drug industry in the U.S. No contact with
   such entity has been made, nor has the amount of modifications been determined. Any licensing of the software to
   these type entities will include substantial customization, testing, evaluation and adjustment prior to deployment.
7. The [Customer's] contract recognizes the intention of [Taxpayer] to license the software and sell its services to
   other retail organizations. To further reduce the chance that we will contract with a potential competitor, [Customer]
   has committed to helping us sell a project to ['Vendor'] with whom it has close management and financial ties.
8. The software is only capable of processing input data in a specific proprietary format and producing outputs in a
   different proprietary format. Every installation involves developing custom software to acquire the input data and
   deliver the output events to personnel and obtaining feedback from them. The software provides no value to the
   retailer without these customizations. In the case of [Customer] installation, we developed part of the customizations
   and [Customer] developed other parts.
9. [Taxpayer] is working on a simplified delivery mechanism to reduce the customization required for small retailers,
   but have not yet completed the proof of concept for this code. No shrink-wrapped software package is ready for
   production.
10. The software that [Taxpayer] licensed to [Customer] is not shrink-wrapped software. We believe that it meets all
    the criteria for custom software.
    You have provided copies of the following relevant documents:
    Invoice for XXX Software License."
    Invoice for XXX [Taxpayer's Software] Maintenance/Support and Service Fee."
    Service Order XXX dated June 7, 2004, between customer and taxpayer.
    Maintenance/Support and Service Agreement dated June 7, 2004.

Software License Agreement dated June 7, 2004.
Copy of Letter of Technical Assistance received from the Department of Revenue.
Pursuant to our telephone conference of June 2, 2005, you have forwarded to this office a copy of IT Consulting
Agreement dated June 4, 2003.
Requested Advisement and Taxpayer's Position
Your letter requests a binding opinion on the taxability of the software license and maintenance agreement between
[Taxpayer] and [Customer]. It is your opinion that the software in question meets the criteria necessary to qualify as
custom software and that it should not be subject to Florida sales tax.
Applicable Authority and Discussion
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, including the business of making mail order sales,
or who rents or furnishes any of the things or services taxable under this chapter, or who stores for use or
consumption in this state any item or article of tangible personal property as defined herein and who leases or rents
such property within the state....
Section 212.02, F.S., provides in pertinent parts:
(15) "Sale" means and includes:
(a) Any transfer of title or possession, or both, exchange, barter, license, lease, or rental, conditional or otherwise, in
any manner or by any means whatsoever, of tangible personal property for a consideration.

(16) "Sales price" means the total amount paid for tangible personal property, including any services that are a part of
the sale....
(19) "Tangible personal property" means and includes personal property which may be seen, weighed, measured, or
touched or is in any manner perceptible to the senses ....
Section 212.08(7)(v)1., F.S. provides:
(v) Professional services.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:
(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.
Rule 12A-1.105, F.A.C., provides in part:
(1)(a) Every person who solicits, offers, provides, enters into, issues, or delivers any service warranty, or who
receives, on behalf of another person, any consideration from a service warranty holder is exercising a taxable
privilege and shall register as a dealer with the Department of Revenue before such person may engage in or conduct
business in this state. See Rule 12A-1.060, F.A.C.
(b)1. The term "service warranty" means any contract or agreement which indemnifies the holder of the contract or
agreement for the cost of maintaining, repairing, or replacing tangible personal property, whether or not the contract
provides for the furnishing of parts. The term "service warranty" includes motor vehicle warranties issued under Part I
of Chapter 634, F.S., and service warranties issued under Part III of Chapter 634, F.S.

d. Example: A maintenance contract covering the cost of labor only to repair or maintain computer hardware is a
service warranty.

2. The term "service warranty" does not include contracts or agreements to repair, maintain, or replace tangible
   personal property if such property when sold at retail in this state would not be subject to sales tax.
   Section 212.05(1)(a)1.a., F.S., imposes a tax on the "... sales price of each item or article of tangible personal property
   when sold at retail in this state...." Section 212.02(15)(a), F.S., defines the term "sale" to mean and include "any
   transfer of title or possession, or both, exchange, barter, license, lease or rental, conditional or otherwise, of tangible
   personal property for a consideration." Further, "sales price" is defined under s. 212.02(16), F.S., to mean, "... the total
   amount paid for tangible personal property, including any services that are a part of the sale...."
   At issue is whether the software in question was customized by the taxpayer for its customer and was therefore, not
   subject to sales tax. The IT Consulting Agreement, dated June 4, 2003, clearly indicates that an agreement between
   [Taxpayer] and [Customer] for development and customization of the software program was executed prior to the sale

of the software itself.
The software is determined to be customized and is not subject to Florida sales tax. A maintenance agreement sold in
conjunction with the sale of customized software is not subject to sales tax.
This response constitutes a Technical Assistance Advisement under s. 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 s. 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
advice 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.
If you have any further questions with regard to this matter and wish to discuss them, you may contact me directly at
(850) 922-4839.
Sincerely,
Jean Davis
Senior Tax Specialist
Technical Assistance & Dispute Resolution
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