Is sales tax owed on perpetual software license fees and annual maintenance fees for canned (non-custom) software like SAP?

Plain-English summary

A business that resells SAP Software Perpetual Licenses — plus annual maintenance fees covering software updates — asked the Illinois Department of Revenue to confirm it was right to charge Retailers' Occupation (sales) Tax on those licenses and maintenance fees. The seller noted the software isn't custom-built (it's configured/customized SAP software, not custom software) and asked whether an exemption for certain software licenses under 86 Ill. Adm. Code 130.1935(a)(1) might apply instead.

The Department's answer is conditional, not a flat yes or no. It confirmed the general rule: sales of "canned" (non-custom) computer software are taxable retail sales in Illinois, regardless of the medium used to deliver it, and that includes maintenance fees that provide software updates. But the Department also confirmed that a software license is not a taxable retail sale — meaning neither the initial transfer nor later updates are taxed — if the license agreement meets all five criteria in Section 130.1935(a)(1): it's a signed written agreement, it restricts the customer's duplication and use, it bars sublicensing/transfer without the licensor's continued control, it provides for replacement or archival copies, and it requires the software be destroyed or returned at the end of the license (a requirement automatically satisfied for a perpetual license).

Because the requester didn't spell out the exact terms of its SAP license agreement, the Department could not say definitively whether this particular arrangement qualifies. It also noted that a prior ruling the requester had cited (an earlier letter about a resale transaction) didn't apply here because this situation involves a retail transaction, not a resale.

What this means for you

Software resellers and licensors (like SAP resellers)

If you sell perpetual licenses for pre-written ("canned") software — even software your customers can configure or customize, as long as it isn't truly custom-built to their order — those sales are presumed taxable, and so are related maintenance/update fees. The only way to avoid Retailers' Occupation Tax on the license itself (and the updates bundled into maintenance) is if your written license agreement checks all five boxes in 86 Ill. Adm. Code 130.1935(a)(1): a signed writing, restrictions on duplication/use, a bar on sublicensing without your continued control, a replacement/archival-copy policy, and a return-or-destroy-at-end-of-term provision (automatically met for perpetual licenses).

Business owners who purchase enterprise software (SAP or similar)

Whether you owe sales tax on a software purchase turns on the fine print of the license agreement, not just on whether the software is "off-the-shelf" or configurable. Ask your vendor whether the license agreement meets the five criteria above — if it does, the license itself (and update/maintenance fees tied to it) should not be subject to Illinois Retailers' Occupation Tax.

Accountants and tax professionals

This GIL is a good illustration of how the canned-vs-custom-software line and the Section 130.1935(a)(1) license exemption interact. Note that the exemption applies to the license transaction meeting all five criteria — it isn't simply about whether the software is customizable. Also note the Department's caution that a general information letter or an older ruling addressing a different transaction type (here, a resale versus a retail sale) may not transfer to a new fact pattern; each situation should be checked against the current facts.

Common questions

Q: Is SAP software taxable in Illinois?
A: Sales of SAP software (or any pre-written/canned software that isn't custom-built to a customer's specifications) are generally taxable retail sales in Illinois. Configuring or customizing canned software for a client's use doesn't turn it into exempt "custom software" unless real and substantial changes are made to the programs or interfacing logic is created.

Q: Are annual maintenance fees for software updates taxable too?
A: If the underlying software sale is taxable, maintenance fees that include software updates are generally taxable as well, unless the license itself qualifies for the exemption below (in which case "the subsequent software updates" also escape tax).

Q: How can a software license avoid sales tax entirely?
A: Under 86 Ill. Adm. Code 130.1935(a)(1), a license is not a taxable retail sale if it meets all five conditions: (A) it's a written agreement signed by licensor and customer; (B) it restricts the customer's duplication and use; (C) it prohibits sublicensing or transferring to third parties without the licensor's permission and continued control; (D) the licensor has a policy of providing replacement or archival copies; and (E) the customer must destroy or return the software at the end of the license term (automatically satisfied for a perpetual license).

Q: Did the Department rule that this taxpayer's SAP licenses were exempt?
A: No. The Department explained the rule but said it wasn't clear from the information provided exactly what the SAP license agreement's terms were. It stated that if the agreement meets all five criteria (A through E), the license is not a taxable retail sale — but it didn't confirm the taxpayer's specific agreement qualifies.

Q: Does a prior letter ruling about a similar topic automatically apply to a new situation?
A: Not necessarily. The Department noted that a ruling the taxpayer cited didn't apply here because it addressed a resale transaction, while this inquiry involved a retail transaction — a reminder that the type of transaction matters, not just the general subject matter.

Citations and references

• 86 Ill. Adm. Code 130.101 (imposition of Retailers' Occupation Tax on sales of tangible personal property)
• 86 Ill. Adm. Code 130.1935 (taxability of computer software; canned vs. custom software; license exemption criteria)
• 86 Ill. Adm. Code 130.1935(a)(1) (five-part test for a software license to be a nontaxable license rather than a taxable retail sale)
• 86 Ill. Adm. Code 130.1935(c)(3) (definition of custom computer programs/software)
• 2 Ill. Adm. Code 1200.110 (procedure for requesting a binding Private Letter Ruling)
• 2 Ill. Adm. Code 1200.120 (General Information Letters are not binding Department policy)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2017.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2017/st-17-0038-gil.pdf

Original ruling text

ST 17-0038-GIL 12/28/2017 COMPUTER SOFTWARE
This letter discusses the taxability of computer software. See 86 Ill. Adm. Code 130.1935.
(This is a GIL.)

December 28, 2017

Dear Xxxxx:
This letter is in response to your letter dated August 23, 2017, in which you requested
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 writing to obtain clarification and a ruling on the sales tax we have been
charging on our sales to clients.
We sell SAP Software Perpetual Licenses, as well as annual maintenance fees on that
software, to our clients. The SAP software is sold with perpetual licenses to use the
software. All purchases differ as each client can choose different products or licenses
within the SAP Software World. The SAP Software can be configured for different uses
and or customized but it is not considered custom software. Our client is the end user
of the software.
We have been charging State Sales Tax on the software licenses as well as the annual
maintenance fees as they include software updates, and would like confirmation this is
correct as our initial understanding is that this would be “canned software” and therefore
taxable.

We have been questioned if this is taxable due to the exemption criteria in the section
under Computer Software that states the following and the 5 points are met through our
sales process;
“If a transaction for the licensing of computer software meets all of the criteria provided
in Section 130.1935(a)(1), neither the transfer of the software nor the subsequent

ST 17-0038-GIL
Page 2
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.”
We have been provided with the following ruling, but it is not clear if this is applicable to
our
situation,
http://tax.illinois.gov/LegalInformation/LetterRulings/st/2012/ST-120022.pdf.
I have included a sample contract for your review and would be happy to discuss this
further if any of the above is not clear or clarification is required.
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. Computer software that is not custom
software is considered to be canned computer software, whether it is “stand-alone” or not. 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).

ST 17-0038-GIL
Page 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.
From the information provided, it is not clear exactly what the terms of the software license
agreement are. If, however, the software license agreement consists of a written agreement signed
by the licensor and the customer and otherwise meets the requirements of A through E above, then
the license is not a taxable retail sale.
The General Information Letter you referenced in your request does not appear to apply to the
situation described here because that letter deals with the taxability of a resale transaction and not a
retail transaction as you describe here.
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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