Did Illinois approve a medical-practice software license and maintenance contract as exempt from Retailers' Occupation Tax?

Plain-English summary

Illinois did not approve the requester's software and maintenance contract as tax-exempt. The Department declined to issue a Private Letter Ruling because it considered its existing software regulation sufficient for licensors and licensees to analyze their own contracts.

The GIL said prewritten or canned software was generally taxable regardless of delivery method. A license avoided Retailers' Occupation Tax only if it met all five requirements in Section 130.1935(a)(1): a signed written agreement; restrictions on duplication and use; restrictions on transfer to third parties; a replacement-copy or archival-copy policy supported in one of the listed ways; and destruction or return of copies when the license ended. A perpetual license was deemed to satisfy the last requirement without stating it.

A customer merely checking an online box did not count as a written agreement signed by both licensor and customer. The letter also distinguished custom software, patches or bug fixes, and software updates. Canned-software updates were taxable, and a maintenance agreement containing those updates could become entirely taxable if the update charges were not separately stated and taxed from training, assistance, installation, consultation, or other charges.

What this means for you

Review each license and maintenance agreement against every listed requirement. Delivery by download does not itself make prewritten software nontaxable, and a clickwrap process did not satisfy the signature requirement under this historical guidance.

Common questions

Q: Did the GIL determine that the requester's contract met the five-part exemption?
A: No. It expressly declined to make that contract-specific determination.

Q: Could taxable software updates make an entire maintenance agreement taxable?
A: Yes, if the agreement included canned-software updates and their charges were not separately stated and taxed from the other agreement charges.

Citations and references

• 2 Ill. Adm. Code 1200.110(a)(3)(D) and (a)(4)
• 86 Ill. Adm. Code 130.1935(a)(1), (b), and (c)
• 86 Ill. Adm. Code 140.301(b)(3)

Subject

Computer Software

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2010.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2010/st-10-0003.pdf

Original ruling text

ST 10-0003-GIL 01/29/2010 COMPUTER 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.
See 86 Ill. Adm. Code
130.1935. (This is a GIL.)

January 29, 2010

Dear Xxxxx:
This letter is in response to your letter dated November 3, 2009, in which you requested a
Private Letter Ruling. The Department issues two types of letter rulings. Private Letter Rulings
(“PLRs”) are issued by the Department in response to specific taxpayer inquiries concerning the
application of a tax statute or rule to a particular fact situation. A PLR is binding on the Department,
but only as to the taxpayer who is the subject of the request for ruling and only to the extent the facts
recited in the PLR are correct and complete.
Persons seeking PLRs must comply with the
procedures for PLRs found in the Department’s regulations at 2 Ill. Adm. Code 1200.110. The
purpose of a General Information Letter (“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.
See 2 Ill. Adm. Code
1200.120. You may access our website at www.tax.illinois.gov to review regulations, letter rulings
and other types of information relevant to your inquiry.
The nature of your inquiry and the information you have provided require that we respond with
a GIL. In your letter you have stated and made inquiry as follows:
In March of 2009, our organization entered into a contract to purchase and maintain
software for practice management and electronic medical records. Enclosed are copies
of the contracts and the invoice for the software and maintenance.
To the best of our knowledge, the department has not ruled previously on this issue.
Our organization was recently audited for the time up to December 2008. The audit has
not been finalized, but is completed by the local auditor, awaiting final ruling.
We feel that due to the contract language, this transaction should not be taxable under
Retailer’s [sic] Occupation Tax, and are hereby requesting that the department review
this transaction and inform us of the ruling.
Please contact me for further documentation or questions.

DEPARTMENT’S RESPONSE:

The Department’s regulation “Public Information, Rulemaking and Organization” provides that
“[w]hether to issue a private letter ruling in response to a letter ruling request is within the discretion of
the Department. The Department will respond to all requests for private letter rulings either by
issuance of a ruling or by a letter explaining that the request for ruling will not be honored.” 2 Ill. Adm.
Code 1200.110(a)(4). Further, the Department’s regulations regarding Private Letter Rulings provide
that “[i]f there is case law or there are regulations dispositive of the subject to the request, the
Department will decline to issue a letter ruling on the subject." 86 Ill. Adm. Code 1200.110(a)(3)(D).
We understand your letter as a request regarding whether the contract that was attached to
that letter qualified as a nontaxable license of prewritten computer software under the provisions of 86
Ill. Adm. Code 130.1935 of the Department’s administrative rules. The Department has determined
that it will no longer issue Private Letter Rulings regarding whether a specific license of prewritten
(canned) computer software meets the requirements of subsection (a)(1) of 86 Ill. Adm. Code
130.1935.
It is the Department’s position that its regulation at 86 Ill. Adm. Code 130.1935 is
sufficiently clear for a licensee or licensor to determine whether a specific license of prewritten
computer software meets the requirements of subsection (a)(1) of that rule. Although we cannot
provide you with a Private Letter Ruling, we hope the following general information will be of
assistance.
Generally, retail sales or transfers of “canned” computer software are taxable in Illinois
regardless of the means of delivery. For instance, the sale or transfer 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.
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.
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.

Please note that it is very common for software to be licensed over the internet and the
customer to check a box that states that they accept the license terms. Acceptance in this manner
does not constitute a written agreement signed by the licensor and the customer for purposes of
subsection (a)(1)(A) of Section 130.1935. To meet the signature requirement for an exempt software
license, the agreement must contain the written signature of the licensor and customer.
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.
In general, maintenance agreements that cover computer software are treated the same as
maintenance agreements for other types of tangible personal property. See 86 Ill. Adm. Code
130.1935(b). The taxation of maintenance agreements is discussed in subsection (b)(3) of Section
140.301 of the Department’s administrative rules under the Service Occupation Tax Act. See 86 Ill.
Adm. Code Sec. 140.301(b)(3). The taxability of agreements for the repair or maintenance of
tangible personal property depends upon whether charges for the agreements are included in the
selling price of the tangible personal property. If the charges for the agreements are included in the
selling price of the tangible personal property, those charges are part of the gross receipts of the retail
transaction and are subject to tax. In those instances, no tax is incurred on the maintenance services
or parts when the repair or servicing is performed. A manufacturer’s warranty that is provided without
additional cost to a purchaser of a new item is an example of an agreement that is included in the
selling price of the tangible personal property.
If agreements for the repair or maintenance of tangible personal property are sold separately
from tangible personal property, sales of those agreements are not taxable transactions. However,
when maintenance or repair services or parts are provided under those agreements, the service or
repair companies will be acting as service providers under provisions of the Service Occupation Tax
Act that provide that when service providers enter into agreements to provide maintenance services
for particular pieces of equipment for stated periods of time at predetermined fees, the service
providers incur Use Tax based on their cost price of tangible personal property transferred to
customers incident to the completion of the maintenance service. See 86 Ill. Adm. Code Sec.
140.301(b)(3). The sale of an optional maintenance agreement or extended warranty is an example
of an agreement that is not generally a taxable transaction.
If, under the terms of a maintenance agreement involving computer software, a software
provider provides a piece of object code (“patch” or “bug fix”) to be inserted into an executable
program that is a current or prior release or version of its software product to correct an error or
defect in software or hardware that causes the program to malfunction, the tangible personal property
transferred incident to providing the patch or bug fix is taxed in accordance with the provisions
discussed above.
In contrast to a patch or bug fix, if the sale of a maintenance agreement by a software provider
includes charges for updates of canned software, which consist of new releases or new versions of
the computer software designed to replace an older version of the same product and which include
product enhancements and improvements, the general rules governing taxability of maintenance
agreements do not apply. This is because charges for updates of canned software are fully taxable
as sales of software under Section 130.1935(b). (Please note that if the updates qualify as custom
software under Section 130.1935(c) they may not be taxable). Therefore, if a maintenance
agreement provides for updates of canned software, and the charges for those updates are not
separately stated and taxed from the charges for training, telephone assistance, installation,
consultation, or other maintenance agreement charges, then the whole agreement is taxable as a
sale of canned software.

I hope this information is helpful. If you require additional information, please visit our website
at www.tax.illinois.gov or contact the Department’s Taxpayer Information Division at (217) 782-3336.
Very truly yours,

Terry D. Charlton
Senior Counsel, Sales & Excise Taxes