Were separately stated optional and mandatory maintenance charges taxable when tied to a qualifying software license?

Plain-English summary

Under the GIL's qualified-license assumption, support, maintenance, and update charges were not subject to Retailers' Occupation Tax whether the maintenance was billed under the license agreement or a separate agreement. The requester offered one optional and one mandatory software-maintenance plan, each separately stated.

The general maintenance rules remained important. A charge included in the selling price of taxable property was taxable. A separately sold maintenance agreement generally was not itself taxable, though the provider owed Use Tax on property transferred during service.

A corrective patch or bug fix followed those maintenance rules. In contrast, a new canned-software release with enhancements was a taxable update unless another exception applied. If taxable canned updates were not separately stated and taxed from training, telephone assistance, installation, consultation, or other charges, the entire agreement was taxable.

The Department declined the requested PLR and did not determine that the taxpayer's software license actually met all qualified-license criteria.

What this means for you

Do not rely only on the labels “optional,” “mandatory,” or “separately stated.” First verify the underlying license qualifies, then identify whether each deliverable is support, a corrective patch, a canned-software enhancement, or another service.

Common questions

Q: Did mandatory maintenance automatically become taxable?
A: Not under the qualified-license assumption stated in this GIL.

Q: Could a bundled agreement become fully taxable?
A: Yes, if it included taxable canned-software updates that were not separately stated and taxed.

Q: Did the Department issue a binding ruling for these plans?
A: No. It declined the PLR request and provided general information.

Subject

Computer Software

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2011.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2011/st-11-0005.pdf

Original ruling text

ST 11-0005-GIL 01/11/2011 COMPUTER SOFTWARE
This letter concerns computer software maintenance agreements. See 86 Ill. Adm. Code
130.1935. (This is a GIL.)

January 11, 2011

Dear Xxxxx:
This letter is in response to your letter dated April 1, 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, FIRM respectfully requests a Private Letter Ruling under Illinois
Regulation 1200.110 as to the proper application of Illinois retail [sic] occupation (ROT)
and use tax (UT) concerning optional and mandatory maintenance contracts as detailed
below where the price for each type of agreement is separately stated and both types of
agreements pertain and relate to the licensing of computer software which is exempt
pursuant to 86 III Adm. Code 130. 1935 (a).
STATEMENT OF FACTS
CLIENT, an out of state entity, which currently files Illinois retail [sic] occupation and use
tax returns, is in the business of licensing computer software. In conjunction with the
licensing of computer software, CLIENT offers the sale of two types of maintenance
contracts in connection with the licensing of computer software both of which are
separately stated on the invoice to the customer(s). The first type of maintenance
agreement is optional and is not required to be purchased as part of the licensing of the
software. As noted above, customers who purchase this optional maintenance
agreement, receive an invoice in which the price for this maintenance contract is
separately stated. The second of [sic] maintenance agreement is required to be
purchased as part of the licensing of the software, but the customers still receive an
invoice in which the price for this maintenance contract is separately stated.

ISSUE(S) FOR RULING
The above taxpayer seeks the Department’s guidance on the taxability of the following
two maintenance agreements which are illustrated by Exhibits A and B, respectively:
a)

b)

A maintenance agreement which is separately stated on invoices to
customer(s) and which is not required to be purchased as part of
the licensing of the software; and
A maintenance agreement which is separately stated on invoices to
customer(s) and which is required to be purchased as part of the
licensing of the software

ANALYSIS
By way of background, the underlying license of software, to which the above two
maintenance agreements pertain, are exempt. Specifically, pursuant to 86 III Adm.
Code 130. 1935(a), the licensing of software in Illinois is not considered a ‘retail sale’ if it
meets the following requirements: (1) if it is evidenced by a written agreement, (2) if it
restricts the customer’s duplication and use, (3) if it prohibits the customer from
licensing, sublicensing, or transferring the software to third parties, (4) the vendor will
provide another copy free or of minimal charge if the software is lost or damaged, and
(5) the customer must destroy or return all copies to the vendor at the end of the license
period. Thus, if transactions involving licensing of computer software meet the
requirements mentioned above, the transfer of software is deemed nontaxable.
According to the applicable authority CLIENT meets the requirement of 86 III Adm.
Code 130.1935 (a) and; therefore, is exempt from the retail [sic] occupation tax on the
licensing of computer software. Again, for the purposes of this ruling request, the
taxpayer is not questioning and/or seeking a ruling concerning the taxability of software
licenses as denoted above. Rather, the taxpayer is seeking a ruling on the
maintenance agreements associated with the licensing of computer software (an
exempt transaction).
With respect to software maintenance agreements, the taxability of maintenance
agreements is dependent upon whether or not the charge for the agreement is included
in the taxable selling price. If the charge for a maintenance agreement is included in the
taxable selling price, then that charge is considered part of the gross receipts of the
retail transaction and consequently subject to sales tax (ROT). If maintenance
agreements are sold separately, then the sale is not a taxable transaction, but rather the
company providing the maintenance or repair will be acting as a service provider under
the service occupation tax act (SOT). See 86 ILL ADM. CODE 130.1935(b) and 86 ILL.
ADM. CODE 140.301(b)(3).
In the instance case, it appears clear that the sale of optional maintenance contracts
associated with the licensing of computer software, with the price of the maintenance
contract being separately stated (Exhibit A), would not be taxable pursuant to 86 ILL
ADM. CODE 130.1935(b) and 86 ILL. ADM. CODE 140.301(b)(3). Similarly, since the
underlying license of software is exempt, a maintenance agreement which is separately
stated on invoices to customer(s) and which is required to be purchased as part of the
licensing of the software, should also be exempt. See 86 ILL ADM. CODE 130.1935(b)
and 86 ILL. ADM. CODE 140.301(b)(3).
REQUESTED RULING

CLIENT seeks guidance confirming its position that the sale of both optional and
mandatory maintenance agreements sold in connection with the licensing of business
software, wherein the price of both types of said maintenance agreements are
separately stated, are nontaxable.
If the Department has any questions or requires any additional information from CLIENT
in order to determine Illinois Retailers Occupational [sic] (sales and use) tax
consequences of the two types of maintenance contracts denoted above please contact
INDIVIDUAL. Thank you in advance for your cooperation and attention to this matter.

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). The Department has decided that it will not issue a Private Letter Ruling in
regards to your request. Although we cannot provide you with a Private Letter Ruling, we hope the
following general information will be of assistance.
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
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.
If all the criteria listed in subsection (a)(1) of Section 130.1935 are met, then neither a
transaction involving the licensing of computer software nor the subsequent software updates will be
considered a taxable retail sale subject to Retailers’ Occupation and Use Tax. See 86 Ill. Adm. Code
130.1935(a)(1)(A)-(E).
Assuming a license of software meets the requirements of subsection (a)(1) of 86 Ill. Adm.
Code 1935, any charges for support, maintenance or updates of the licensed software provided
pursuant to the qualified license agreement would not be subject to Retailer’s Occupation Tax,
whether or not the charges for support, maintenance or updates of the licensed software are billed
pursuant to the terms of the license agreement or the terms of a separate agreement.
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