When did Illinois treat electronically delivered canned software, software licenses, and maintenance agreements as taxable?

Plain-English summary

Electronically delivered canned software was generally taxable under the rules stated in this 2010 GIL, but a qualifying software license was not. To qualify, the license had to meet all five requirements in 86 Ill. Adm. Code 130.1935(a)(1): a written agreement signed by licensor and customer; restrictions on duplication and use; limits on sublicensing or transfer without the licensor's permission and control; a replacement-copy or archival-copy policy supported in the specified way; and destruction or return of copies at the end of the license period. A perpetual license was deemed to satisfy the last requirement without stating it.

A customer merely checking a box online did not count as the signed written agreement required by the rule. If any criterion failed, the canned-software license was taxable. Custom software prepared to a customer's special order could be nontaxable.

Maintenance treatment depended on what the agreement covered and how charges were stated. A separately sold optional maintenance agreement was generally not itself taxable, although the service provider incurred Use Tax on tangible property transferred while performing it. Canned-software updates were taxable. If a maintenance agreement included those updates and did not separately state and tax them apart from training, telephone assistance, installation, consultation, or other charges, the whole agreement was taxable as canned software.

The Department also gave general 2010 nexus rules but did not issue a binding conclusion about the company's Illinois employee or registration duty.

What this means for you

Keep the signed license terms and maintenance pricing aligned with the claimed treatment. Separate taxable canned-software updates from support or training charges, and obtain a current nexus analysis rather than relying on the GIL's 2010 discussion.

Common questions

Q: Did electronic delivery by itself make canned software nontaxable?
A: No. The GIL said canned software was generally taxable regardless of delivery method.

Q: Was click-through acceptance enough for the license exemption?
A: No. The agreement had to contain the written signatures of both licensor and customer.

Q: Could a bundled maintenance agreement become fully taxable?
A: Yes. If taxable canned-software updates were included and not separately stated and taxed, the whole agreement was taxable.

Citations and references

• 86 Ill. Adm. Code 130.1935(a)(1), (b), and (c)
• 86 Ill. Adm. Code 140.301(b)(3)
• 86 Ill. Adm. Code 150.201(i) and 150.801
• Quill Corp. v. North Dakota, 112 S. Ct. 1904 (1992)
• Brown's Furniture, Inc. v. Zehnder, 171 Ill. 2d 410 (1996)
• 2 Ill. Adm. Code 1200.110 and 1200.120

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-10-0067.pdf

Original ruling text

ST 10-0067-GIL 08/10/2010 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.)

August 10, 2010

Dear Xxxxx:
This letter is in response to your letter dated June 30, 2010, in which you request information.
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:
On behalf of our Client (Company), a provider of software and related services, we
respectfully request an opinion regarding the application of Illinois sales/use tax law with
respect to the issue described below, as well as the filing requirements, if any of our
Client.
Background
Our Client, has developed a proprietary canned software program delivered
electronically which it sells and markets to businesses in various industry segments,
such as Banking, Finance, Pharmaceuticals, State Government Entities, to list a few.
Company, is headquartered in STATE, with no offices in the State of Illinois. The
Company employs a single employee, working out of a home office who files Income
and Payroll Taxes in Illinois. It is possible that our Client may conclude agreements
with Illinois based customers and is expecting to finalize these agreements within the
next few months. For a typical software license agreement/ contract, Company A
provides the following estimate breakdown:

A.
B.
C.

Software License (Electronic Delivery)
Annual Software Maintenance Agreement
Training, Support, and Related Consulting

$200,000.00
$36,000.00
$10,000.00

In general, Company indicates in its software license agreements that items A and B
above will be delivered electronically and once the customer has accepted the terms,
Client will email customer with detailed instructions on how to download the software
modules via a File Transfer Protocol (ftp) website address. Customers purchase a
perpetual license to access the Company’s software and under a separate support &
maintenance agreement, receive periodic updates, error corrections, bug fixes and
technical support via telephone assistance or internet communications. It is our
understanding that at no time is the software delivered via storage mediums such as
CDs and DVDs.
Items C above are optional services. These services may be delivered at the
customer’s locations as well as remotely via the internet and include, but may not be
limited to, training and technical support.
Issues Presented
1.

Are Company’s sales of software delivered electronically considered to be
taxable retail sales of tangible personal property subject to the Illinois Sales and
Use Tax?

2.

Are Company’s annual software maintenance agreements considered to be
taxable retail sales of tangible personal property subject to the Illinois Sales and
Use Tax?

3.

Are company’s training services considered to be taxable retail sales of tangible
personal property subject to the Illinois Sales and Use Tax?

4.

Do the Company’s Illinois employees create Nexus in the State? And if
Company’s products and services are considered subject to the Illinois Sales and
Use Tax, is the company required under Illinois Tax Law to register as a retailer
engaged in business in the state and collect and remit the Illinois Sales/Use Tax
on the software transactions?

We respectfully request that you provide guidance with respect to the application of
Illinois sales and use tax to the transactions described above. We appreciate your
consideration of this matter. If you have any questions or need any additional
information, please call me.

DEPARTMENT’S RESPONSE:
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.
An “Illinois Retailer” is one who either accepts purchase orders in the State of Illinois or
maintains an inventory in Illinois and fills Illinois orders from that inventory. The Illinois Retailer is
then liable for Retailers' Occupation Tax on gross receipts from sales and must collect the
corresponding Use Tax incurred by the purchasers.
Another type of retailer is the retailer maintaining a place of business in Illinois. The definition
of a “retailer maintaining a place of business in Illinois” is described in 86 Ill. Adm. Code 150.201(i).
This type of retailer is required to register with the State as an Illinois Use Tax collector. See 86 Ill.
Adm. Code 150.801. The retailer must collect and remit Use Tax to the State on behalf of the
retailer’s Illinois customers even though the retailer does not incur any Retailers' Occupation Tax
liability.
The United States Supreme Court in Quill Corp. v. North Dakota, 112 S.Ct. 1904 (1992), set
forth the current guidelines for determining what nexus requirements must be met before a person is
properly subject to a state's tax laws. The Supreme Court has set out a 2-prong test for nexus. The
first prong is whether the Due Process Clause is satisfied. Due process will be satisfied if the person
or entity purposely avails itself or himself of the benefits of an economic market in a forum state. Quill
at 1910. The second prong of the Supreme Court's nexus test requires that, if due process
requirements have been satisfied, the person or entity must have physical presence in the forum
state to satisfy the Commerce Clause. A physical presence is not limited to an office or other
physical building. Under Illinois law, it also includes the presence of any agent or representative of
the seller. The representative need not be a sales representative. Any type of physical presence in

the State of Illinois, including the vendor’s delivery and installation of his product on a repetitive basis,
will trigger Use Tax collection responsibilities. Please refer to Brown’s Furniture, Inc. v. Zehnder, 171
Ill.2d 410, (1996).
The final type of retailer is the out-of-State retailer that does not have sufficient nexus with
Illinois to be required to submit to Illinois tax laws. A retailer in this situation does not incur Retailers’
Occupation Tax on sales into Illinois and is not required to collect Use Tax on behalf of its Illinois
customers. However, the retailer’s Illinois customers will still incur Use Tax liability on the purchase
of the goods and have a duty to self-assess and remit their Use Tax liability directly to the State.
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,

Richard S. Wolters
Associate Counsel
RSW:msk