Is customized computer software and software maintenance taxable in New York, and how do separately stated charges affect the answer?

Plain-English summary

Garpac Corporation sells pre-written base software packages and also customizes programs to each customer's specifications; it separately states the pre-written and custom charges on the invoice and bills $150/hour for custom programming. It also sells maintenance agreements to keep enhancing the software to a customer's written specifications (but does not separately state the individual services under the agreement), and it sells to customers outside New York. It asked whether its software and maintenance receipts are taxable.

This opinion applies the software rules that took effect September 1, 1991:

• Modified pre-written software — taxable unless the custom work is separately stated. Under § 1101(b)(14), pre-written software that is modified or enhanced to a specific purchaser's specs remains pre-written (taxable) software — and is entirely taxable — unless there is a reasonable, separately stated charge for the modification/enhancement, in which case that custom portion is not pre-written software. The statute doesn't define "reasonable," but the Department found Garpac's $150/hour custom rate reasonable under the circumstances (other custom programmers charged up to $238/hour). Because Garpac separately states a reasonable custom charge, only the pre-written portion of the program is taxable.
• Maintenance agreements — fully taxable unless itemized. Under § 1115(o), services performed on software can be exempt, but where they're provided in conjunction with a sale, the charge is exempt only when reasonable and separately stated. Since Garpac does not separately state the taxable versus exempt services in its maintenance agreements, the entire maintenance charge is taxable.
• Out-of-state sales — not taxed (destination tax). Under Regulation § 525.3(a)(3), sales tax is a destination tax: the point of delivery or transfer of possession controls. Where software and maintenance are delivered to a purchaser outside New York, no New York sales or use tax is collected.

What this means for you

Separately stating custom work is what saves it from tax

Post-September 1, 1991, New York treats modified pre-written software as still taxable pre-written software — unless you carve out the customization with a reasonable, separately stated charge. If you bundle custom work into one lump price, the whole thing is taxable. Itemize the modification (at a defensible rate) and only the underlying pre-written package is taxed.

"Reasonable" is judged on the facts

There's no formula for a "reasonable" custom charge. The Department looked at Garpac's $150/hour against a market up to $238/hour and accepted it. Keep your custom rate in line with what comparable programmers charge — an inflated custom line (to shrink the taxable pre-written portion) risks being called unreasonable.

Software maintenance: itemize taxable vs. exempt services

Section 1115(o) can exempt services performed on software, but a maintenance agreement that lumps everything together is fully taxable. To get the exemption for the exempt services, separately state the taxable and exempt components on the invoice. Garpac's failure to itemize made its entire maintenance charge taxable.

Delivery location controls

New York's sales tax follows the destination. Software delivered to a customer outside New York isn't subject to New York tax — the tax incident and rate turn on where possession passes, not where the vendor sits.

Common questions

Q: Is customized software taxable in New York?
A: Modified pre-written software is taxable as pre-written software unless the modification is reasonably and separately stated. Here, because the custom work was separately stated at a reasonable rate, only the pre-written portion is taxed.

Q: What makes the custom charge "reasonable"?
A: There's no set formula. The Department accepted $150/hour given that comparable custom programmers charged up to $238/hour.

Q: Is a software maintenance agreement taxable?
A: The entire charge is taxable unless the taxable and exempt services are separately stated. Garpac didn't itemize, so its whole maintenance charge was taxable.

Q: Is software sold to out-of-state customers taxable?
A: No. Sales tax is a destination tax; no New York tax applies when delivery or possession passes to the purchaser outside New York.

Citations and references

Statutes, regulations, and authorities:

• Tax Law § 1101(b)(14) (definition of pre-written computer software; modified/enhanced software remains pre-written unless there is a reasonable, separately stated charge), effective September 1, 1991
• Tax Law § 1115(o) (services performed on software exempt; when provided with a sale, exempt only if reasonable and separately stated), effective September 1, 1991
• Sales and Use Tax Regulations § 525.3(a)(3) (sales tax is a destination tax; delivery/transfer-of-possession point controls the tax incident and rate)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1992.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a92_8s.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-92 (8)S
Sales Tax
February 6, 1992

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S910925A

On September 25, 1991 a Petition for Advisory Opinion was received from Garpac
Corporation, 254 W. 35th Street, New York, New York 10001.
The issues raised by Petitioner, Garpac Corporation, are:
1.

Whether the receipts from the sale of Petitioner's computer software are subject to
sales tax.

2.

Whether the receipts from the sale of maintenance agreements to continue to enhance
computer software to customer's specifications are subject to sales tax.

Petitioner sells pre-written base packages of computer software. In addition, Petitioner
customizes programs to meet certain specifications of customers. Charges for the pre-written
program and custom program are separately stated on customers invoice. Petitioner charges $150.00
per hour for custom programming. Other custom programmers charge as much as $238.00 per hour
for similar programming.
Petitioner writes software for one type of industry. Each customer signs a proposal and each
program is written separately. A change or enhancement is not copied from a previously written
program, even if several clients request the same change. There is no cross indexing of previously
written programs to determine if the program could be transferred to another customer to satisfy his
need. Petitioner rewrites each and every proposal.
Petitioner sells maintenance agreements to is customers to continue to enhance the software
to the customer's exact written specification. Petitioner obtains a signed and written proposal before
doing the customized program. Fees are not separately stated on the invoice as to the individual
charge for each service performed under the maintenance agreement.
Petitioner also sells computer software to customers outside New York State.
Effective September 1, 1991, Section 1101(b) of the Tax Law was amended imposing sales
tax on computer software as follows:
(14)
Pre-written computer software. Computer software (including
pre-written upgrades thereof) which is not software designed and developed by the
author or other creator to the specifications of a specific purchaser. The combining
of two or more pre-written computer software programs or pre-written portions
thereof does not cause the combination to be other than pre-written computer
software. Pre-written software also includes software designed and developed by the

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TSB-A-92 (8)S
Sales Tax
February 6, 1992

author or other creator to the specifications of a specific purchaser when it is sold to
a person other than such purchaser. Where a person modifies or enhances computer
software of which such person is not the author or creator, such person shall be
deemed to be the author or creator only of such person's modifications or
enhancements. Pre-written software or a pre-written portion thereof that is modified
or enhanced to any degree, where such modification or enhancement is designed and
developed to the specifications of a specific purchaser, remains pre-written software;
provided, however, that where there is a reasonable, separately stated charge or an
invoice or other statement of the price given to the purchaser for such modification
or enhancement, such modification or enhancement shall not constitute pre-written
computer software.
Section 1115 of the Tax Law was amended effective September 1, 1991, to add the
following:
(o)
Services otherwise taxable under subdivision (c) of section eleven
hundred five or under section eleven hundred ten shall be exempt from tax under this
article where performed on computer software of any nature; provided, however, that
where such services are provided to a customer in conjunction with the sale of
tangible personal property any charge for such services shall be exempt only when
such charge is reasonable and separately stated on an invoice or other statement of
the price given to the purchaser.
Section 525.3(a)(3) of the Sales and Use Tax Regulations provides as follows:
The sales tax is a "destination tax," that is, the point of delivery or point at
which possession is transferred by the vendor to the purchaser or designee controls
both the tax incident and the tax rate.
Accordingly, pursuant to Section 1101(b) of the Tax Law the receipts from the sale of pre­
written software or a pre-written portion thereof that is modified or enhanced to any degree to meet
the specifications of a specific purchaser is entirely subject to sales tax unless there is a reasonable,
separately stated charge or an invoice or other statement of the price given to the purchaser for such
modification or enhancement. The term "reasonable charge" is not defined by statute nor regulation.
Neither is there a formula to establish whether the charge for a modification is reasonable. However,
Petitioner charges of $150.00 per hour for custom programming are under the circumstances
described reasonable in nature. Therefore, since the Petitioner charges a reasonable, separately stated
charge on its invoice for the custom programming, only charges for the pre-written portion of the
program is subject to sales and use taxes.

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TSB-A-92 (8)S
Sales Tax
February 6, 1992

As for the sale of maintenance agreements, pursuant to Section 1115(o) of the Tax Law, the
entire charge for services performed under a maintenance agreement is subject to sales tax unless
the charge is separately stated between the taxable and exempt services provided under the
agreement. Thus, since Petitioner does not separately state the charges for the services it provides
under the maintenance agreement as required by Section 1115(o), the entire charge received from
the sale of the maintenance agreement is subject to sales and use taxes.
Concerning Petitioner's sale of computer software and maintenance agreements to customers
outside New York State, pursuant to Section 525.2(a)(3) of the Sales and Use Tax Regulations no
sales or use tax must be collected where delivery or possession is transferred to a purchaser outside
of New York State.

DATED: February 6, 1992

s/PAUL B. COBURN
Deputy Director
Taxpayer Services Division

NOTE: The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.