Could canned software be licensed tax-free in Illinois, and how was custom software treated?

Plain-English summary

An Illinois developer asked whether its software-license agreement made transactions in canned or customized financial-planning software exempt from Retailers' Occupation Tax.

IDOR explained that canned software generally was taxable tangible personal property regardless of whether it was delivered by tape, disk, electronic transmission, or another medium. A license of canned software was nevertheless not a taxable retail sale when it met every condition in Section 130.1935(a)(1). In that case, both the software transfer and later software updates were outside Retailers' Occupation Tax.

The five conditions required a written agreement signed by licensor and customer; restrictions on duplication and use; restrictions on licensing, sublicensing, or transfer without the licensor's permission and continued control; a supported replacement-copy or archival-copy policy; and destruction or return of all copies at the end of the license period. A perpetual license was deemed to meet the last condition without stating it.

Custom software prepared to a customer's special order was separately exempt from Retailers' Occupation, Use, Service Occupation, and Service Use Tax. Assembling prewritten programs did not make software custom unless the vendor made real and substantial program changes or created program-interfacing logic.

The Department gave these general rules in a GIL and did not expressly determine that the requester's particular agreement satisfied them.

What this means for you

Canned software was not automatically taxable when transferred under a qualifying license, but each of the five license requirements had to be supported. Customization also required more than packaging existing programs together.

Common questions

Could canned software qualify for nontaxable license treatment? Yes, if all five conditions were met.

Were later updates covered by a qualifying license taxable? No, under the rule described.

Did assembling canned programs alone create custom software? No.

Citations and references

• 86 Ill. Adm. Code 130.1935(a)(1) and (c)(3).
• 86 Ill. Adm. Code 130.101.

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2014.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2014/st-14-0052-gil.pdf

Original ruling text

ST 14-0052-GIL 12/18/2014 COMPUTER SOFTWARE
This letter discusses the taxability of computer software licenses. See 86 Ill. Adm. Code
130.1935.

December 18, 2014

Dear XXXX :
This letter is in response to your letter September 12, 2015, 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:
We are sending this request for a determination of whether our COMPANY Software
License Agreement (“Agreement”) is exempt from the Retailers’ Occupation Tax
(“ROT”) and issuance of a Private Letter Ruling (“PLR”) based on that determination.
We have reviewed Illinois Regulation Sec 130.1935, and believe the software licenses
we grant pursuant to these Agreements are exempt from application of the ROT.
This PLR is not requested for hypothetical or proposed transactions but is requested to
determine the ROT consequences of the actual business practices of COMPANY
(“COMPANY”). Accordingly, COMPANY respectfully requests the Department of
Revenue issue a PLR pursuant to 2 Ill. Adm. Code 1200.110 with respect to the
following factual information as required by 2 Ill. Adm. Code 1200.110(b)1.
Statement of Facts
COMPANY, is an Illinois corporation, with principal offices located at LOCATION,
Illinois, engaged in the business of developing and licensing software to assist banks,
credit unions and other financial institutions in forecasting, budgeting, asset
management and planning.

Enclosed please find a copy of our standard Agreement wherein we are the licensor
and our financial institution customers are the licensee/customer. Our licensing
arrangement as reflected in the Agreement meets the five requirements necessary to
qualify for exemption from the IL ROT as stated in IL Regulations, Sec. 130.1935(a)(1)
namely:
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).
D. The vendor will provide another copy at minimal or no charge if the customer loses or
damages the software. [sic] and
E. The customer must destroy or return all copies of the software to the vendor at the
end of the license period.
COMPANY is not aware of, nor have we been able to locate, any authority contrary to
our view.
Issues
1) If COMPANY software is licensed as ‘canned’ software and COMPANY’s Agreement
meets all the requirements in Sec. 130.1935(a)(1), parts A through E, then is
COMPANY’s transaction subject to ROT? Stated another way, is the exemption from
ROT as described in Sec. 130.1935(a)(1) only available for ‘custom’ software or does it
also apply to ‘canned’ software that meets the Sec. 130.1935(a)(1) requirements?
2) If COMPANY software as licensed is considered “custom” software and COMPANY’s
Agreement meets all the requirements in Sec. 130.1935(a)(1), parts A through E, then
is COMPANY’s transaction subject to ROT? Stated another way, is the exemption from
ROT described in Sec. 130.1935(a)(1) only available for ‘custom’ software or does it
also apply to ‘canned’ software that has been customized to the specifications of a
customer and that meets the Sec. 130.1935(a)(1) requirements?
We request a PLR to resolve the tax issues with our customers who have objected to
paying COMPANY for sales tax we have billed to them. COMPANY has routinely
submitted ROT to the Illinois Department of Revenue, COMPANY is not to its best belief
and understanding subject to or under an audit or pending litigation with the Illinois
Department and all of the foregoing is true and correct. To the best of our knowledge,
the department has not previously ruled on the same issue for COMPANY. COMPANY
considers the attached Agreement to be trade secret information and we request that
this information be deleted from the publicly disseminated version of the PLR.
We would appreciate Illinois Legal Counsel’s acceleration of a response to this request
for a PLR so we can resolve this outstanding tax issue as soon as possible [sic]

If you have any questions or need to further information, please contact us. Thank you
for your prompt attention to our request.
DEPARTMENT’S RESPONSE:
The Illinois Retailers’ Occupation Tax Act imposes a tax upon persons engaged in this State in
the business of selling tangible personal property to purchasers for use or consumption. See 86 Ill.
Adm. Code 130.101. The tax is measured by the seller's gross receipts from retail sales made in the
course of such business. "Gross receipts" means the total selling price or the amount of such sales.
The retailer must pay Retailers' Occupation Tax to the Department based upon its gross receipts, or
actual amount received, from the sale of the tangible personal property.
Generally, sales of “canned” computer software are taxable retail sales in Illinois. Canned
computer software is considered to be tangible personal property regardless of the form in which it is
transferred or transmitted, including tape, disc, card, electronic means, or other media. However, if
the computer software consists of custom computer programs, then the sales of such software may
not be taxable retail sales. 86 Ill. Adm. Code 130.1935. Custom computer programs or software are
prepared to the special order of the customer. The selection of pre-written or canned programs
assembled by vendors into software packages does not constitute custom software unless real and
substantial changes are made to the programs or creation of program interfacing logic. See Section
130.1935(c)(3).
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.

If computer software, including canned software, is licensed and the license agreement meets
all of the criteria in subsection (a)(1) of Section 130.1935, the license of the software is not a taxable
retail sale. In addition, if the computer software is custom software, as provided in subsection (c) of
Section 130.1935, it is exempt from tax under the Retailers’ Occupation Tax Act, Use Tax, Service
Occupation Tax, and Service Use Tax.

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,

Samuel J. Moore
Associate Counsel
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