Was a cloud-based physician-records service nontaxable when its agreements appeared to provide an API or desktop client?

Plain-English summary

A company licensed a cloud-based records system to physician offices, stored the records on out-of-state servers, and had been collecting Illinois sales tax. It said customers received no tangible personal property, but its agreements appeared to provide an application programming interface or desktop software client.

IDOR declined to issue the requested binding private letter ruling and instead provided general guidance. It treated the company as a serviceman. At the time, software never downloaded to the customer and only accessed remotely through a cloud system was not taxable.

An API, applet, desktop agent, remote-access agent, or desktop client provided to reach the service could be computer software under Illinois's broad definition. The transfer was taxable under service-transaction rules even without a separate charge unless the license met every condition in Section 130.1935(a)(1). A qualifying unregistered de minimis serviceman could elect to pay Use Tax on its cost price.

What this means for you

Medical SaaS vendors should verify whether customers actually install an API or client rather than relying only on the description of the main product as web-based. Contract language indicating a transfer can undermine a claim that the service is entirely remote.

Common questions

Was pure remote cloud access taxable under this 2016 guidance? No, when no software or other property was transferred.

Did IDOR conclusively determine this company's liability? No.

Could an access client be taxable even if free? Yes.

Citations and references

• 35 ILCS 120/2 and 120/2-25; 35 ILCS 105/3; 35 ILCS 115/3.
• 86 Ill. Adm. Code 130.1935 and 140.101.

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2016.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2016/st-16-0033-gil.pdf

Original ruling text

ST 16-0033-GIL 08/17/2016

COMPUTER SOFTWARE

A provider of software as a service is acting as a serviceman. If the provider does not the
transfer any tangible personal property to the customer, then the transaction generally would
not be subject to Retailers’ Occupation Tax, Use Tax, Service Occupation Tax, or Service Use
Tax. If the provider transfers to the customer an API, applet, desktop agent, or a remote
access agent to enable the customer to access the provider’s network and services, it appears
the subscriber is receiving computer software that is subject to tax. See 86 Ill. Adm. Code
Parts 130 and 140. (This is a GIL.)

August 17, 2016
Dear Xxxxx:
This letter is in response to your letter dated January 21, 2016, 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.
In your letter you have stated and made inquiry as follows:
We are sending this request for a determination of whether our PRODUCT 1 is exempt from
Retailers’ Occupation Tax and issuance of a Private letter Ruling on that determination. We
have been informed in a non binding internet reply that the product is web/cloud based and
therefore non taxable.
Statement of Facts:








PRODUCT licenses are purchased by physician offices for our PRODUCT 2 or PRODUCT 3.
There is no transfer of tangible personal property.
A license agreement is signed before the system can be used. (copy attached)
The system is accessed electronically utilizing a username and password.
The physician’s records are stored on our servers in STATE 1.
The fee for the license is paid monthly, quarterly, semiannually, or annually. Additionally, a
perpetual license agreement is offered.
Service is suspended for non-payment.
To the best of our knowledge, the Department has not ruled on this or a similar situation for
COMPANY. Additionally, there is no pending audit or litigation.
COMPANY considers the attached Agreement to be trade secret information and we request
that the information be deleted for the public disseminated version of the PLR.

To date we have been collection [sic] state sales tax in the amount of X.XX%. This is the
result of an audit in 20XX, after which we were informed that we were not required to collect
local tax. At that time our product only consisted of PRODUCT 3 and we were not informed
that it was non taxable.
We request a PLR to resolve tax issues with customers who have objected to paying the sales
tax we have billed them. In addition, we request the PLR as a binding determination before we
make any permanent changed [sic] to our billing system.
Enclosed are copies of our current brochure and contract. If necessary, additional information
can be found on our website: http://WEBSITE
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 recently met and determined that it would decline to issue a
Private Letter Ruling in response to your request. We hope, however, the following General
Information Letter will be helpful in addressing your question.
Sales Tax:
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 35 ILCS
120/2; 86 Ill. Adm. Code 130.101. In Illinois, Use Tax is imposed on the privilege of using, in this
State, any kind of tangible personal property that is purchased anywhere at retail from a retailer. See
35 ILCS 105/3; 86 Ill. Adm. Code 150.101. These taxes comprise what is commonly known as
“sales” tax in Illinois. If the purchases occur in Illinois, the purchasers must pay the Use Tax to the
retailer at the time of purchase. The retailers are then allowed to retain the amount of Use Tax paid
to reimburse themselves for their Retailers' Occupation Tax liability incurred on those sales. If the
purchases occur outside Illinois, purchasers must self-assess their Use Tax liability and remit it
directly to the Department.
Service Transactions:
Retailers' Occupation Tax and Use Tax do not apply to sales of service. Under the Service
Occupation Tax Act, businesses providing services (i.e., servicemen) are taxed on tangible personal
property transferred as an incident to sales of service. See 86 Ill. Adm. Code 140.101. The purchase
of tangible personal property that is transferred to the service customer may result in either Service
Occupation Tax liability or Use Tax liability for the servicemen depending upon his activities. The
serviceman’s liability may be calculated in one of four ways:
(1)

separately-stated selling price of tangible personal property transferred incident to
service;

(2)

50% of the serviceman's entire bill;

(3)

Service Occupation Tax on the serviceman's cost price if the serviceman is a registered
de minimis serviceman; or

(4)

Use Tax on the serviceman's cost price if the serviceman is de minimis and is not
otherwise required to be registered under Section 2a of the Retailers' Occupation Tax
Act.

The Department does not consider the viewing, downloading or electronically transmitting of
video, text and other data over the internet to be the transfer of tangible personal property. However,
if a company provides services that are accompanied with the transfer of tangible personal property,
including computer software, such service transactions are generally subject to tax liability under one
of the four methods set forth above.
If a transaction does not involve the transfer of any tangible personal property to the customer,
then it generally would not be subject to Retailers’ Occupation Tax, Use Tax, Service Occupation
Tax, or Service Use Tax.
Computer Software
“‘Computer software’ means a set of statements, data, or instructions to be used directly or
indirectly in a computer in order to bring about a certain result in any form in which those statements,
data, or instructions may be embodied, transmitted, or fixed, by any method now known or hereafter
developed, regardless of whether the statements, data, or instructions are capable of being perceived
by or communicated to humans, and includes prewritten or canned software.” 35 ILCS 120/2-25.
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. 86 Ill. Adm.
Code 130.1935. However, if the computer software consists of custom computer programs, then the
sales of such software may not be taxable retail sales. 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 86 Ill.
Adm. Code 130.1935(c)(3). Computer software that is not custom software is considered to be
canned 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. 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 a license of canned computer software does not meet all the criteria the software is taxable.
It appears from your letter that the Company is making sales of service and is a serviceman.
As a serviceman, the Company does not incur Retailers’ Occupation Tax. Service Occupation Tax is
imposed upon all persons engaged in the business of making sales of service on all tangible personal
property transferred incident to a sale of service, including computer software (35 ILCS 115/3), and is
calculated as explained above. Currently, computer software provided through a cloud-based
delivery system – a system in which computer software is never downloaded onto a client’s computer
and is only accessed remotely – is not subject to tax. The Department continues to review cloudbased arrangements. If, after review, the Department determines that these transactions are subject
to tax, it will only apply this determination prospectively.
You state in your letter that a customer of the services the Company provides does not receive
any tangible personal property. You do not make any representations regarding the transfer of
computer software to your customers. However, the License and Service Agreement and the License
and Services Terms and Conditions seem to indicate that the customer receives an application
program interface (API) or desktop software client as part of the service. Computer software is
defined broadly in the Retailers’ Occupation Tax Act. If a provider of a service provides to the
customer an API, applet, desktop agent, or a remote access agent to enable the customer to access
the provider’s network and services, it appears the customer is receiving computer software.
Although there may not be a separate charge to the customer for the computer software, it is
nonetheless subject to tax, unless the transfer qualifies as a non-taxable license of computer
software. If the provider, as a serviceman, is not otherwise required to be registered under Section
2a of the Retailers' Occupation Tax Act and qualifies as a de minimis serviceman, the provider could
elect to pay Use Tax on its cost price of the computer software.
I hope this information is helpful. If you have further questions related to the Illinois sales tax
laws, please visit our website at www.tax.illinois.gov or contact the Department’s Taxpayer
Information Division at (217) 782-3336.
Very truly yours,

Debra M. Boggess
Associate Counsel
DB:bkl