Is a yearly subscription fee for using computer software (not owning it) subject to Illinois sales tax?

Plain-English summary

A taxpayer wrote to the Illinois Department of Revenue after being charged sales tax on a yearly computer subscription service. The taxpayer's email explained that it does not own any part of the software and only pays for a subscription to use it, and said it had been advised (apparently by the vendor or another party in earlier correspondence) that it should not be charged sales tax since it did not purchase the software; the taxpayer was told to email the Department to request a Private Letter Ruling (PLR).

Because the request didn't give the Department enough specific facts about the taxpayer's own transaction to resolve it as a binding PLR, the Department responded with a General Information Letter (GIL) instead -- a letter that explains the general legal framework but does not decide the taxpayer's individual case. The Department's response lays out how Illinois sales/use tax law treats computer software:

• Illinois "sales tax" is really two taxes working together: the Retailers' Occupation Tax (imposed on the retailer for selling tangible personal property in Illinois, 35 ILCS 120/2) and the Use Tax (imposed on the purchaser for using tangible personal property in Illinois, 35 ILCS 105/3). The retailer typically collects Use Tax from the purchaser and keeps it to cover its own Retailers' Occupation Tax liability.
• Sales tax does not apply to services themselves, but businesses that transfer tangible personal property (including computer software) as part of a service can owe Service Occupation Tax or Use Tax on that property, calculated by one of four methods set out in 86 Ill. Adm. Code 140.106, 140.108, and 140.109.
• "Computer software" is defined broadly in 35 ILCS 120/2-25 and 86 Ill. Adm. Code 130.1935(a) to include essentially any set of statements, data, or instructions used in a computer, in any form, including prewritten ("canned") software, operational software, applications, utilities, compilers, templates, and shells.
• Sales or transfers of canned software intended for general or repeated use are generally taxable retail sales, treated as tangible personal property no matter how they are transferred (tape, disc, card, electronic means, or other media) -- including software subject to a manufacturer's license restricting use or reproduction.
• However, a license of software is NOT a taxable retail sale if it meets all five conditions in 86 Ill. Adm. Code 130.1935(a)(1): (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 sublicensing or transferring the software to a third party without the licensor's permission and continued control; (D) the licensor has a policy (stated in the agreement, supported by its books and records, or supported by a notarized statement) of providing a free or minimal-cost replacement copy if the customer loses or damages the software, or of letting the licensee keep an archival copy; and (E) the customer must destroy or return all copies at the end of the license period (this last element is automatically satisfied for a perpetual license). If a canned-software license fails any one of these five criteria, the software is taxable.
• The letter specifically flags that clicking "I accept" on an online license does NOT satisfy the signed-written-agreement requirement in (A) -- a valid exempt license needs an agreement with the actual written signatures of both the licensor and the customer.
• A provider of "software as a service" is treated as a serviceman rather than a retailer, and does not incur Retailers' Occupation Tax as such, but Service Occupation Tax still applies to any tangible personal property (including computer software) transferred incident to that service.
• Critically, computer software delivered through a cloud-based system -- meaning the software is never downloaded onto the customer's computer and is only accessed remotely -- is NOT subject to tax. But if a service provider furnishes the subscriber an API, applet, desktop agent, or remote-access agent to enable access to the provider's network and services, the subscriber IS receiving computer software, and that is taxable (even if there's no separately stated charge for it) unless it independently qualifies as a non-taxable software license.
• A free download of software by an Illinois customer from an out-of-state retailer's out-of-state server involves no exercise of power or control over property in Illinois by the retailer, so no Use Tax is owed on that donation. The letter also states that Illinois "generally does not tax subscriptions."
• Custom computer software -- prepared to the special order of the customer, involving real and substantial changes to canned/pre-written code to meet the customer's specific individualized requirements, requiring the vendor to analyze the customer's requirements and adapt the program to the customer's specific environment -- is not subject to Retailers' Occupation Tax, Use Tax, Service Occupation Tax, or Service Use Tax under 86 Ill. Adm. Code 130.1935(c). But software that is merely selected from pre-written packages without real and substantial modification, or that is held for general or repeated sale/lease once modified, is still treated as canned software.

The letter never states whether the specific subscription that prompted the taxpayer's original complaint was or wasn't taxable -- it lays out the framework (canned vs. custom, license vs. sale, downloaded vs. cloud-based) without applying it to the taxpayer's particular subscription, which is typical of a GIL.

What this means for you

Businesses paying for software subscriptions

If you're being charged Illinois sales tax on a software subscription, this GIL explains the two situations where you would NOT owe tax: (1) the software is delivered purely through the cloud and never downloaded to your computer, or (2) the software is downloaded but the vendor is licensing it to you under a written agreement signed by both parties that meets all five conditions in 86 Ill. Adm. Code 130.1935(a)(1) (restricted duplication/use, no unauthorized sublicensing, a replacement/archival-copy policy, and destruction/return of copies at the end of the term). Clicking "I agree" to an online terms-of-service screen does not count as a signed written agreement for this purpose. If your subscription involves a downloadable client, agent, or app (not just browser-based remote access), the Department's letter suggests you are likely receiving taxable computer software even without downloading the "main" product.

Software vendors and SaaS providers

Structure your delivery and licensing carefully: purely cloud-based, remotely-accessed software (no download) falls outside the tax base described here. If your product requires the customer to install any local component -- an API, applet, desktop agent, or remote-access agent -- the Department's position is that the customer is receiving computer software subject to tax unless a qualifying written, signed license agreement is in place. If you provide software as part of a broader service, you may be a "serviceman" subject to Service Occupation Tax on the tangible personal property (including software) transferred incident to that service, calculated under one of the four methods in 86 Ill. Adm. Code 140.106, 140.108, and 140.109 rather than Retailers' Occupation Tax.

Accountants and tax professionals

This GIL is a good short refresher on Illinois's canned-vs-custom-software framework and the cloud-delivery carve-out, but remember it does not resolve the requesting taxpayer's own subscription -- the Department explicitly noted the request required a GIL response rather than a binding PLR. If a client needs a binding determination on a specific software transaction, they should pursue a PLR under 2 Ill. Adm. Code 1200.110 with complete facts about how the software is delivered, licensed, and whether any local component is installed.

Common questions

Q: Does this GIL say whether the taxpayer's specific software subscription was taxable?
A: No. The Department responded with a GIL, not a PLR, because a GIL only directs a taxpayer to the relevant regulations rather than resolving a particular fact pattern. The letter lays out the general rules on canned software, licenses, and cloud delivery but does not apply them to the taxpayer's own subscription.

Q: Is cloud-based software taxable in Illinois?
A: Generally no. Computer software delivered through a cloud-based system where it is never downloaded to the customer's computer and is only accessed remotely is not subject to tax. But if the provider gives the subscriber a downloadable API, applet, desktop agent, or remote access agent to connect to the provider's service, that IS treated as taxable computer software, even without a separate charge for it.

Q: When is a software license not a taxable sale?
A: When it meets all five criteria in 86 Ill. Adm. Code 130.1935(a)(1): a written agreement signed by both licensor and customer; restrictions on duplication and use; a prohibition on sublicensing/transferring to third parties without the licensor's permission; a licensor policy for replacement or archival copies; and a requirement that the customer destroy or return all copies at the end of the license (automatically met for perpetual licenses). Missing any one of these makes the software taxable.

Q: Does clicking "I accept" on an online license agreement satisfy the signed-agreement requirement?
A: No. The Department's letter specifically states that accepting license terms by checking a box online does not constitute a written agreement signed by the licensor and the customer for purposes of the exemption.

Q: What is custom software, and is it taxed differently?
A: Custom software results from real and substantial changes to canned/pre-written code to meet a customer's specific individualized requirements, where the vendor must analyze the customer's requirements and adapt the program for the customer's specific environment. Custom software is not subject to Retailers' Occupation Tax, Use Tax, Service Occupation Tax, or Service Use Tax. Software merely selected from pre-written packages without real and substantial modification remains canned (taxable) software.

Citations and references

Statutes:

• 35 ILCS 120/2 (Retailers' Occupation Tax Act - imposition of tax)
• 35 ILCS 120/2-25 (definition of "computer software")
• 35 ILCS 105/3 (Use Tax Act - imposition of tax)
• 35 ILCS 105/3-45 (collection of Use Tax by retailer)
• 35 ILCS 115/3 (Service Occupation Tax Act - imposition of tax)

Regulations:

• 86 Ill. Adm. Code 130.101 (Retailers' Occupation Tax - nature of tax)
• 86 Ill. Adm. Code 130.1935 (computer software, generally)
• 86 Ill. Adm. Code 130.1935(a) (canned software and license agreements)
• 86 Ill. Adm. Code 130.1935(a)(1) (five-part test for a non-taxable software license)
• 86 Ill. Adm. Code 130.1935(c) (custom computer software)
• 86 Ill. Adm. Code 140.101, 140.106, 140.108, 140.109 (Service Occupation Tax methods for servicemen)
• 86 Ill. Adm. Code 150.130(b), 150.401, 150.701(a) (Use Tax collection and self-assessment)
• 2 Ill. Adm. Code 1200.110 (Private Letter Ruling procedure)
• 2 Ill. Adm. Code 1200.120 (General Information Letter procedure)

Case law cited in the ruling:

• Kean v. Wal-Mart Stores, Inc., 235 Ill. 2d 351, 362 (2009) (cited for the proposition that the Retailers' Occupation Tax and Use Tax together are commonly known as "sales tax" in Illinois)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2023.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2023/ST-23-0018-GIL.pdf

Original ruling text

ST-23-0018-GIL 06/02/2023 COMPUTER SOFTWARE
This letter discusses computer software. See 86 Ill. Adm. Code 130.1935. (This
is a GIL).
June 2, 2023

COMPANY
ADDRESS

Dear NAME:
This letter is in response to your letter dated December 15, 2022, 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:
Good
Afternoon,
We pay for a computer subscription service yearly and this year we are
being charged sales tax. We do not own any part of the software and are
only paying for the subscription to use the software. Per the
correspondence below we should not be charged sale tax since we did not
purchase the software. I was advised to send this email to get a Private
Letter Ruling. Please let me know if you need any other information.
Thank You,
DEPARTMENT’S RESPONSE:

I.

Retailers’ Occupation Tax

COMPANY/NAME
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June 2, 2023
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. 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. 35 ILCS 105/3; 86 Ill. Adm. Code
150.101. These two taxes comprise what is commonly known as “sales tax” in Illinois.
Kean v. Wal-Mart Stores, Inc., 235 Ill. 2d 351, 362 (2009). If the purchases occur in
Illinois, the purchasers must pay the Use Tax to the retailer at the time of purchase. 35
ILCS 105/3-45; 86 Ill. Adm. Code 150.401. 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. 86 Ill. Adm. Code 150.130(b). If the purchases occur
outside Illinois, purchasers must self-assess their Use Tax liability and remit it directly to
the Department. See 35 ILCS 105/3-45; 86 Ill. Adm. Code 150.701(a).
II.

Service Occupation Tax

Retailers' Occupation Tax and Use Tax do not apply to sales of service. See 35
ILCS 120/2; 35 ILCS 105/3. 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 transfer of
tangible personal property to service customers may result in either Service Occupation
Tax liability or Use Tax liability for servicemen, depending upon which tax base they
choose to calculate their liability.
Servicemen may calculate their tax base in one of four ways: (1) separatelystated 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. See 86 Ill. Adm.
Code Sections 140.106; 140.108; and 140.109.
Using the first method, servicemen may separately state the selling price of each
item transferred as a result of sales of service. The tax is based on the separately
stated selling price of the tangible personal property transferred. If servicemen do not
wish to separately state the selling price of the tangible personal property transferred,
those servicemen must use the second method where they will use 50% of the entire
bill to their service customers as the tax base. Both of the above methods provide that
in no event may the tax base be less than the cost price of the tangible personal
property transferred. Under these methods, servicemen may provide their suppliers
with Certificates of Resale when purchasing the tangible personal property to be
transferred as a part of sales of service. They are required to collect the corresponding
Service Use Tax from their customers. See 86 Ill. Adm. Code 140.106.

COMPANY/NAME
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June 2, 2023
The third way servicemen may account for their tax liability only applies to de
minimis servicemen who have either chosen to be registered or are required to be
registered because they incur Retailers’ Occupation Tax liability with respect to a
portion of their business. Servicemen may qualify as de minimis if they determine that
their annual aggregate cost price of tangible personal property transferred incident to
sales of service is less than 35% of their annual gross receipts from service transactions
(75% in the case of pharmacists and persons engaged in graphic arts production). This
class of registered de minimis servicemen is authorized to pay Service Occupation Tax
(which includes local taxes) based upon the cost price of tangible personal property
transferred incident to sales of service. Servicemen that incur Service Occupation Tax
collect the Service Use Tax from their customers. They remit tax to the Department by
filing returns and do not pay tax to their suppliers. They provide suppliers with
Certificates of Resale for the tangible personal property transferred to service
customers. See 86 Ill. Adm. Code 140.109.
The final method of determining tax liability may be used by de minimis
servicemen that are not otherwise required to be registered under Section 2a of the
Retailers' Occupation Tax Act. Servicemen may qualify as de minimis if they determine
that the annual aggregate cost price of tangible personal property transferred as an
incident of sales of service is less than 35% of the servicemen's annual gross receipts
from service transactions (75% in the case of pharmacists and persons engaged in
graphic arts production). Such de minimis servicemen handle their tax liability by
paying Use Tax to their suppliers. If their suppliers are not registered to collect and
remit tax, the servicemen must register, self-assess, and remit Use Tax to the
Department. The servicemen are considered to be the end-users of the tangible
personal property transferred incident to service. Consequently, they are not authorized
to collect a "tax" from the service customers. See 86 Ill. Adm. Code 140.108.
If an entity 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.
III.

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. Computer software
includes all types of software including operational, applicational, utilities, compliers,
templates, shells and all other forms. 86 Ill. Adm. Code 130.1935(a).

COMPANY/NAME
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June 2, 2023
Generally, sales or transfers of “canned” computer software intended for general
or repeated use are taxable retail sales in Illinois. Canned 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. The sale or
transfer by a retailer of computer software which is subject to manufacturer licenses
restricting the use or reproduction of the software is also taxable. 86 Ill. Adm. Code
130.1935(a). However, if all of the criteria provided in subsection (a)(1) of Section
130.1935 are met, then neither the sale or transfer of the software nor the subsequent
software updates are subject to Retailers' Occupation Tax. Specifically, a license of
software is not a taxable retail sale if:
A)
customer;

It is evidenced by a written agreement signed by the licensor and the

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.

86 Ill. Adm. Code 130.1935(a)(1). If a license of canned computer software does not
meet all the criteria, the software is taxable.
Please note that it is very common for software to be licensed over the internet
and the customer to check a box that states that he or she accepts the license terms.
Acceptance in this manner does not constitute a written agreement signed by the
licensor and the customer for purposes of subsection (a)(1)(A) of Section 130.1935. To
meet the signature requirement for an exempt software license, the agreement must
contain the written signature of the licensor and customer.
A provider of software as a service is acting as a serviceman. As a serviceman,
the seller does not incur Retailers’ Occupation Tax. Service Occupation Tax is imposed

COMPANY/NAME
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June 2, 2023
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.
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.
If an Illinois customer downloads computer software for free from an out-of-state
retailer’s web site or server that is also located out of state, the retailer, even though it is
donating tangible personal property to the customer, has exercised no power or control
over the property in Illinois. In this instance, the donor would not have made any
taxable use of the property in Illinois. The customer, the donee, would incur no Use Tax
liability for the retailer to collect and remit to Illinois. Illinois generally does not tax
subscriptions.
Moreover, sales of custom computer programs prepared to the special order of
the customer may not be a taxable sale. 86 Ill. Adm. Code 130.1935(c)(1). Custom
software means the software which results from real and substantial changes to the
operational coding of canned or pre-written software in order to meet the specific
individualized requirements of the purchaser for his limited or particular use. 86 Ill.
Adm. Code 130.1935(c)(2). Custom computer software is not subject to the Retailers'
Occupation Tax, Use Tax, Service Occupation Tax or Service Use Tax if the following
elements are present:
A)

Preparation or selection of the program for the customer's use requires an
analysis of the customer's requirements by the vendor; and

B)

The program requires adaptation by the vendor to be used in a specific
work environment, e.g., a particular make and model of a computer using
a specified input or output device. 86 Ill. Adm. Code 130.1935(c)(1).

If modified software is held for general or repeated sale or lease, it is canned software.
86 Ill. Adm. Code 130.1935(c)(2). 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. 86 Ill. Adm. Code 130.1935(c)(3). Computer software that is not
custom software is considered to be canned computer software. See 86 Ill. Adm. Code
130.1935.

COMPANY/NAME
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June 2, 2023
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,

Katarzyna Kowalska
Associate Counsel
KK:dlb