Does a software vendor's perpetual and term software license agreements qualify for Illinois' exemption from Retailers' Occupation Tax and Use Tax as a non-taxable software license rather than a taxable retail sale?

Plain-English summary

A software company asked the Illinois Department of Revenue for a private letter ruling confirming that its perpetual and term software license agreements were exempt from Illinois Retailers' Occupation Tax and Use Tax, pointing to a 1999 PLR issued on nearly identical license language. The Department declined to issue a new PLR on that specific question because it stopped issuing private letter rulings years ago on whether a particular canned (prewritten) software license meets the exemption test — it considers its own regulation, 86 Ill. Adm. Code 130.1935, clear enough for taxpayers to apply themselves.

Instead of ruling on the specific facts, the Department issued this GIL restating the governing rule. A license of computer software escapes Retailers' Occupation Tax (i.e., is not treated as a taxable retail sale) only if it meets all five of these conditions: (A) it is evidenced by a written agreement signed by both 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 without the licensor's permission and continued control; (D) the licensor has a policy of providing a replacement copy at minimal or no cost, or of letting the licensee keep an archival copy, if the software is lost or damaged; and (E) the customer must destroy or return all copies at the end of the license period (perpetual licenses are deemed to satisfy this last element automatically). If any one requirement is missing, the license is a taxable sale of canned software.

The letter also flags a specific trap: click-through "I agree" acceptance does not count as a signed written agreement, though a verifiable, authenticable electronic signature can. It further notes that cloud-based software accessed remotely (never downloaded) is not taxed, but that providing an API, applet, or remote-access agent to reach a provider's network is still a transfer of computer software subject to tax unless it independently meets the license exemption.

What this means for you

Software vendors and licensors

If you sell or license prewritten (canned) software to Illinois customers, whether your license is taxable turns on the exact language of your license agreement, not on what you call the transaction. To claim the exemption, your agreement should be signed in a way that satisfies the written-signature requirement (not a bare "I agree" click-through), and it must contain restrictions on copying/use, sublicensing/transfer, and end-of-term return or destruction of copies, plus a stated replace-or-archive policy for lost or damaged software.

Businesses licensing software for internal use

If your vendor's license agreement fails any one of the five criteria, the license is treated as a taxable retail sale of tangible personal property in Illinois, and both the initial transfer and subsequent updates can be subject to tax. Custom software written to your specific order is generally not taxable, but merely assembling or lightly configuring canned/prewritten packages does not make software "custom."

Accountants and tax professionals

Do not expect the Department to issue a new private letter ruling simply because a client's license language is similar to an older, previously revoked PLR. The Department will decline PLR requests where it believes existing regulations are dispositive, per 2 Ill. Adm. Code 1200.110(a)(3)(D). Instead, apply the five-part test in 86 Ill. Adm. Code 130.1935(a)(1) directly to the current license text, and check whether any electronic-signature method used complies with the standard set out in the ST 06-0005-PLR, ST 18-0003-PLR, and ST 18-0010-PLR line of rulings.

Cloud/SaaS providers

Software delivered purely through a cloud-based system that is never downloaded to the customer's computer is not itself taxed. However, if you give a subscriber an API, applet, desktop agent, or remote-access agent to reach your network and services, that is a transfer of computer software and is taxable unless it separately qualifies as an exempt license under the five-part test — even if you don't bill for the API or agent separately. Illinois generally does not tax straightforward subscriptions.

Common questions

Q: Did the Department rule that this particular company's software licenses were tax-exempt?
A: No. The Department expressly declined to rule on whether these specific license agreements met the exemption criteria, because it no longer issues private letter rulings on that fact-specific question. It considers 86 Ill. Adm. Code 130.1935 clear enough for taxpayers to self-apply.

Q: What are the five requirements for a software license to be exempt from Illinois Retailers' Occupation Tax?
A: (1) a written agreement signed by both licensor and customer; (2) restrictions on the customer's duplication and use of the software; (3) a prohibition on the customer sublicensing or transferring the software to a third party without the licensor's permission; (4) a licensor policy to provide a low-cost/free replacement copy or to let the customer keep an archival copy if the software is lost or damaged; and (5) a requirement that the customer destroy or return all copies at the end of the license term (perpetual licenses satisfy this automatically).

Q: Does clicking "I agree" on an online license count as a signed written agreement?
A: No. The Department has held that a simple click-through "I agree" acceptance does not satisfy the written, signed agreement requirement. A verifiable and authenticable electronic signature attached to or made part of the license can satisfy the requirement, but bare click-through acceptance remains unacceptable.

Q: Is cloud-based or subscription software taxed in Illinois?
A: Software accessed only remotely through a cloud-based system, and never downloaded to the customer's device, is not subject to tax, and Illinois generally does not tax subscriptions. But if a provider gives a subscriber an API, applet, desktop agent, or remote-access agent to reach the provider's network, that is a transfer of computer software subject to tax unless it independently meets the license exemption.

Q: What is the difference between "custom" and "canned" software for tax purposes?
A: Canned (prewritten) computer software is treated as tangible personal property and is generally taxable regardless of the medium used to transfer or transmit it. Custom software prepared to the special order of a customer may not be a taxable retail sale. Simply assembling or selecting prewritten/canned components into a package does not make the result "custom" unless real and substantial changes are made to the programs or interfacing logic is created.

Citations and references

Statutes and regulations:

• 86 Ill. Adm. Code 130.1935 (five-part test for a non-taxable license of computer software)
• 86 Ill. Adm. Code 130.1935(c)(3) (custom vs. canned software distinction)
• 35 ILCS 120/2-25 (statutory definition of "computer software")
• 2 Ill. Adm. Code 1200.110 (Private Letter Ruling procedures; discretion to decline requests)
• 2 Ill. Adm. Code 1200.120 (General Information Letter procedures)

Related Department rulings cited:

• ST 06-0005-PLR (Dec. 16, 2006) (click-through "I agree" does not satisfy signed-agreement requirement)
• ST 18-0003-PLR (Feb. 8, 2018) (verifiable, authenticable electronic signature can satisfy the requirement)
• ST 18-0010-PLR (Sept. 26, 2018) (examples of acceptable written signatures)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2021.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2021/st21-0045-gil.pdf

Original ruling text

ST-21-0045 11/16/2021 COMPUTER SOFTWARE
This letter discusses computer software. See 86 Ill. Adm. Code 130.1935. (This
is a GIL.)
November 16, 2021
NAME/ADDRESS
RE: BUSINESS
Dear NAME,
This letter is in response to your letter received September 20, 2021, 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:
On behalf of our client, BUSINESS. (FEIN: XX-XXXXXXX), hereinafter
referred to as “Taxpayer”, we respectfully request the issuance of a private
letter ruling (“PLR”) by the Illinois Department of Revenue (“Department”)
pursuant to 2 Ill Adm. Code 1200.110. The current facts are very similar
to those reviewed by the Department prior to issuing the Taxpayer’s DATE
PLR (copy enclosed). Since the previous letter ruling, some of the
agreements were slightly modified, however, even with those minor
changes we believe the agreements meet the necessary requirements to
be exempt from tax. Due to the minor changes in the agreements and the
fact that the 1999 PLR was revoked a number of years ago under 86 Ill.
Admin. Code 1200.110(e). Taxpayer is looking to secure a new ruling.
FACTS

1. This Private Letter Ruling (“PLR”) is not requested with regard to
   hypothetical or alternative proposed transactions.

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2. The Taxpayer is not currently engaged in litigation with the
   Department in regard to this or any other tax matter.
3. The Taxpayer is not currently under audit by the Department in
   regard to this matter.
4. The Taxpayer requests that certain information be redacted from
   the PLR prior to dissemination to others. The Taxpayer requests
   that its name, all contractual parties’ names, its exhibits, and the
   name of its representative be redacted.
5. The Taxpayer knows of no authority contrary to the authorities
   referred to and cited below.
6. To the best of the knowledge of both Taxpayer and Taxpayer’s
   representative, the Department has not previously ruled on the
   same or a similar issue for the taxpayer or a predecessor within the
   past 10 years, nor has any representatives previously submitted the
   same or a similar issue to the Department but withdrew it before a
   letter ruling was issued.
   AUTHORITY
   Taxpayer believes that the software it sells under the two attached
   licenses qualifies for an exemption from the Retailers’ Occupation Tax
   under the provisions of 86 Illinois Administrative Code Section 130.1935
   and the attached PLR dated February 24, 1999. The representations in
   that ruling and the license provisions referenced remain the same.
   RULING REQUESTED
   Taxpayer requests that Department rule that its licenses provided are not
   subject to Illinois Retailer’s Occupation Tax and Use Tax.
   FACTS
   We have included the two different types of license agreements that
   Taxpayer uses for its customers:
7. Perpetual software license
8. Term software license
   Perpetual software license

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The perpetual software license contract is made up of three documents:
Software License Schedule (1A), General Terms and Conditions (1B), and
Maintenance Plan (1C).
The Software License Schedule is the document that is signed by both
parties. Section 5 of the Software License Schedule links to and
incorporates by reference the General Terms and Conditions that apply to
the license. These General Terms and Conditions are online and are not
separately executed because they are incorporated into the License
Schedule. Likewise, in Section 6 of the Software License Schedule, links
to and incorporate by reference the Maintenance Plan that applies to the
perpetual license. The Maintenance Plan is online and is not separately
executed because it is incorporated into the License Schedule.
We believe the requirements of a license of software to not be a taxable
retail sale under Section 130.1935 are met as follows:

1. 1A – bottom of page 3, signature line meets the requirement of
   Section 130.1935(1)(A).
2. 1B – Paragraphs 4, 5, and 6 restricts the customer’s duplication
   and use of the software to meet the requirements of Section
   130.1935(1)(B).
3. 1B - Paragraphs 3, 4, and 10 discusses prohibiting the customer
   from licensing, sublicensing or transferring the software to a third
   party without permission and continued control of the licensor to
   meet the requirements of Section 130.1935(1)(C).
4. 1B - Paragraph 4.3 discusses the permitting the licensee to make
   and keep an archival copy to meet the requirement of Section
   130.1935(1)(D).
5. 1B - Paragraph 5.2 discusses the requirement that the customer
   must destroy or return all copies of the software to the licensor at
   the end of the license period in order to meet the requirement of
   Section 130.1935(1)(E).
   Term software license
   The term software license is set up in a similar fashion to the perpetual
   software license, but it contains only two documents: Software License
   Schedule (2A) and the General Terms and Conditions (2B).
   The Software License Schedule is the document that is signed by both
   parties. Section 6 of the Software License Schedule links to and
   incorporates by reference the General Terms and Conditions that apply to
   the license. These General Terms and Conditions are online and are not

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separately executed because they are incorporated into the License
Schedule. Since maintenance fees are included in the annual license fee
for the term license model, there is no separate Maintenance Plan for the
term license. Rather, the maintenance services are described within the
General Terms and Conditions.
We believe the requirements of a license of software to not be a taxable
retail sale under Section 130.1935 are met as follows:

6. 2A – bottom of page 3, signature line meets the requirement of
   Section 130.1935(1)(A).
7. 2B – Paragraphs 4, 5, and 6 restricts the customer’s duplication
   and use of the software to meet the requirements of Section
   130.1935(1)(B).
8. 2B - Paragraphs 3, 4, and 11 discusses prohibiting the customer
   from licensing, sublicensing or transferring the software to a third
   party without permission and continued control of the licensor to
   meet the requirements of Section 130.1935(1)(C).
9. 2B - Paragraph 4.3 discusses permitting the licensee to make and
   keep an archival copy to meet the requirement of Section
   130.1935(1)(D).
10. 2B - Paragraph 5.2 discusses the requirement that the customer
    must destroy or return all copies of the software to the licensor at
    the end of the license period in order to meet the requirement of
    Section 130.1935(1)(E).
    We respectfully request a private letter ruling from the Department
    regarding this matter. Should you disagree with this opinion, please
    contact me to discuss this opinion prior to issuing a ruling. If you have any
    further questions or require any additional information, please contact me
    at PHONE #.
    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).
    Further, the Department’s regulations regarding Private Letter Rulings provide that “[i]f
    there is case law or there are regulations dispositive of the subject to the request, the

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Department will decline to issue a letter ruling on the subject."
1200.110(a)(3)(D).

86 Ill. Adm. Code

A number of years ago, the Department determined that it would no longer issue
Private Letter Rulings regarding whether a specific license of prewritten (canned)
computer software meets the requirements of subsection (a)(1) of 86 Ill. Adm. Code
130.1935. It is the Department’s position that its regulation at 86 Ill. Adm. Code
130.1935 is sufficiently clear for a licensee or licensor to determine whether a specific
license of prewritten computer software meets the requirements of subsection (a)(1).
“‘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

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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.
In order to comply with the requirements as set out in Section 130.1935(a)(1),
there must be a written “signed” agreement. A license agreement in which the
customer electronically accepts the terms by clicking “I agree” does not comply with the
requirement of a written agreement signed by the licensor and customer. The
Department previously held that an electronic signature did not comply with the
requirement of Section 130.1935(a)(1)(A) that the license be evidenced by a written
agreement signed by the licensor and the customer. ST 06-0005-PLR (December 16,
2006). In ST 18-0003-PLR (February 8, 2018), the Department decided that an
electronic license agreement in which the customer accepts the license by means of a
signature in electronic form that is attached to or is part of the license, is verifiable, and
can be authenticated will comply with the requirement of a written agreement signed by
the licensor and customer. See ST 18-0010-PLR (September 26, 2018) for examples of
acceptable written signatures. A license agreement in which the customer electronically
accepts the terms by clicking “I agree” remains unacceptable.
Computer software is defined broadly in the Retailers’ Occupation Tax Act.
However, 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. If a provider of a service provides to the
subscriber an API, applet, desktop agent, or a remote access agent to enable the
subscriber to access the provider’s network and services, the subscriber is receiving
computer software. Although there may not be a separate charge to the subscriber for
the computer software, it is nonetheless subject to tax, unless the transfer qualifies as a
non-taxable license of computer software. Illinois generally does not tax subscriptions.
I would note that since your private letter ruling was issued in February 1999, the
requirement in paragraph (D) of the Section 130.1935(a)(1) has been expanded to
provide an additional policy option. In addition to the licensor having a policy of
providing another copy at minimal or no charge if the customer loses or damages the
software, a licensor that has a policy of permitting the licensee to make and keep an
archival copy will also qualify under paragraph (D).

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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,
Richard S. Wolters
Associate Counsel
RSW:rkn