Is a maintenance agreement covering hardware, technical support, warranty repairs, and canned-software updates taxable in Illinois?

Plain-English summary

The requester sold hardware appliances with embedded proprietary software and separately sold maintenance covering software updates, warranty repairs, and technical support. Illinois declined to issue a PLR and did not decide the exact agreement's treatment. It provided the following general rules.

Maintenance included in the sale price

When a repair or maintenance agreement was included in the selling price of tangible personal property, the agreement charge was part of taxable retail gross receipts. No separate tax was then incurred on covered maintenance services or parts when performed or supplied.

A manufacturer's warranty provided at no additional charge with a new item was the example given.

Separately sold optional agreements

A repair or maintenance agreement sold separately from the property was not itself a taxable transaction. When the provider later transferred parts or other property under that agreement, however, the provider incurred Use Tax on its cost price under the serviceman rules.

An optional maintenance agreement or extended warranty was the example given.

Patches versus canned-software updates

A patch or bug fix correcting an error or defect followed the ordinary maintenance-agreement rules.

A new release or version containing enhancements was a canned-software update. Those update charges were fully taxable unless the update was subject to a software license meeting every condition in 86 Ill. Adm. Code 130.1935(a)(1).

If a maintenance agreement included taxable canned-software updates and the update charges were not separately stated and taxed, the entire agreement was taxable as a sale of canned software.

The GIL did not decide whether software embedded in the requester's hardware appliance satisfied the qualifying-license rules.

What this means for you

Hardware and software vendors

Separate ordinary support, repair coverage, patches, and product-enhancing software updates in the contract and billing. Bundled taxable updates can make the entire agreement taxable under the rule stated.

Buyers reviewing maintenance invoices

Whether the agreement was included in the original property price, separately sold, or bundled with canned-software updates changed the treatment.

Common questions

Q: Did Illinois hold that this specific embedded-software agreement was exempt?
A: No. The Department declined the PLR and did not reach a final classification.

Q: Was a separately sold optional warranty taxable when sold?
A: Generally no under the GIL, although the provider owed tax on property later transferred during service.

Q: Could unseparated canned-software updates tax the whole agreement?
A: Yes.

Citations and references

• 86 Ill. Adm. Code 130.1935(b) — computer-software maintenance, patches, updates, and qualifying licenses.
• 86 Ill. Adm. Code 140.301(b)(3) — included and separately sold maintenance agreements.

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-11-0070.pdf

Original ruling text

ST 11-0070-GIL 08/24/2011 COMPUTER SOFTWARE
This letter concerns sales of software manufacturer agreements.
130.1935. (This is a GIL.)

See 86 Ill. Adm. Code

August 24, 2011

Dear Xxxxx:
This letter is in response to your letter dated October 5, 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 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 declines to issue a Private Letter Ruling. We are responding
instead with this General Information Letter that we hope will assist you.
In your letter you have stated and made inquiry as follows:
ABC respectfully requests the Illinois Department of Revenue to issue a Private Letter
Ruling pursuant to 2 Ill. Adm. Code 1200.110 with respect to the below factual situation.
This Private Letter Ruling (‘PLR’) is not requested with regard to hypothetical or
alternative proposed transactions. This PLR is requested to determine the Retailers'
Occupation Tax (‘ROT’), consequences of the actual business practices of ABC.
Information Required by 2 Ill. Adm. Code 1200.110(b)
1.

Compete Statement of Material Facts
ABC sells products that accelerate application performance and data transfer
over the wide area network (WAN). These products consist of hardware
appliances that are sold with proprietary software embedded in the appliance.
The hardware appliance is not sold separately from the software. In conjunction

with the purchase of ABC Steelhead products, customers separately purchase
maintenance services. The maintenance service agreement provides for
updates of canned software, warranty repairs and technical support. There is not
a separate charge for the updates. ABC currently charges ROT on both sales of
the appliances and on maintenance for the appliances.
Based on the material facts, we respectfully request a response to the following
question:
I. Whether the sale of maintenance services, which include updates for
software that would satisfy the conditions set forth in 86 Ill. Adm. Code
Sec. 130.1935(a)(1) if it was sold on a stand alone [sic] basis, would be
exempt from ROT if the software is embedded and sold in a hardware
appliance.
2.

All Relevant Documents
See attached ‘ABC Maintenance and Support Services’ for details regarding
ABC’s maintenance services.

3.

Tax Period Identification and Audit/Litigation Disclosure
ABC is not currently engaged in litigation with the Illinois Department of Revenue
(the ‘Department’) in regard to this or any other tax matter. ABC is not currently
under audit by the Department in regard to this or any other tax matter.

4.

Taxpayer’s Representation Regarding Originality of Request
To the best of ABC’s knowledge the Department has not previously ruled
regarding this matter for ABC. In addition, Company has not submitted the same
or similar issue to the Department.

5.

Taxpayer’s Analysis
A software license agreement (‘Agreement’) that satisfies each of the five
conditions outlined in 86 Ill. Adm. Code Sec. 130.1935(a)(1) qualifies as a nontaxable license of software. For purposes of this ruling request, it is assumed
that the underlying software embedded in the hardware appliance, meets the
requirements of 130.1935(a)(1).
Based upon a review of PLRs issued by the Department in regards to software
and 86 Ill. Adm. Code Sec. 130.1935(a)(1) it does not appear that a situation
similar to ABC’s has been addressed, i.e. maintenance for software that would
meet the requirements of 130.1935(a)(1), but that is also (1) sold as part of a
hardware appliance and that (2) provides updates of canned software.
ABC currently taxes the maintenance on the basis that the maintenance is for
both hardware and for software embedded in the hardware and that this, in
addition to the provision of software updates, causes it to fall outside the
exemption of 86 Ill. Adm. Code 130.1935(a)(1).

6.

Statement of Authorities Contrary to Taxpayer’s Views

ABC knows of no authority contrary to the authorities referred to and cited above.
7.

Request for Deletion of Information
ABC requests that certain information be deleted from the PLR prior to
dissemination to others. ABC requests that its name and address be deleted.

8.

Taxpayer Signature
See below.

ABC respectfully requests that the Department issue a ruling on the aforementioned
question. If the Department cannot conclude that these, [sic] we request that the
Department contact ABC to determine what additional information is required or all [sic]
the taxpayer to rescind this ruling request.

DEPARTMENT’S RESPONSE:
In general, maintenance agreements that cover computer software (i.e. agreements to provide
repair service for computer software for a stated period for a predetermined fee) 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 standard
maintenance agreement 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 are subject to a license
that meets all of the requirements under Section 130.1935(a)(1) they are not 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 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.
Sincerely,

Samuel J. Moore
Associate Counsel
SJM:msk