Before September 1, 1991, did a software marketer owe use tax on the base bank-software it bought from its parent to customize and sub-license to end users?

Plain-English summary

A U.S. company had exclusive U.S. marketing rights to bank software ("The System") produced by its U.K. parent. It bought the base System from the parent, then customized and installed it — tailored to each bank end user — and sub-licensed the tailored package. It asked whether, for the period before September 1, 1991, its payments to the parent for the software were subject to New York use tax.

This turns on New York's old software rule (Technical Services Bulletin 1978-1(S)), which governed periods before September 1, 1991 — the date New York began taxing prewritten software as tangible personal property. Under that old rule, software counted as exempt intangible property only if either (A) preparing or selecting it for the customer required the vendor to analyze that customer's requirements, or (B) the program required the vendor to adapt it to a specific environment. Software that did not meet A or B was tangible personal property and taxable.

The Department found that when the marketer bought the base System from its parent, the software was not yet acquired to meet any particular customer's needs — the tailoring happened only later, after the marketer signed up an end user. So at the moment of purchase, the base System failed conditions A and B and was taxable tangible personal property. Result: the marketer's payments to the parent were subject to sales or use tax (§ 1105(a) / § 1110), while the payments it received from its bank customers for the customized System were not taxable, because by then it had become exempt intangible (custom) software.

What this means for you

Historical/audit context for software transactions

This opinion applies to pre-September-1, 1991 periods, when New York treated qualifying (analyzed/adapted) software as exempt intangible property and everything else as taxable tangible property. It matters mainly for audits, refund claims, or disputes reaching back to that era. After September 1, 1991, New York taxes prewritten software as tangible personal property regardless of the old analyze/adapt test, so the current rules differ.

Software marketers and licensors buying a base product to customize

The Department looked at the software's status at the moment you acquired it, not what you later did with it. Buying a generic base product that is only tailored after you land a customer meant you bought taxable property, even though your downstream customized license was exempt. The characterization can differ between your upstream purchase and your downstream sale.

Accountants and tax professionals

The key is the timing test under the 1978-1(S) bulletin: exemption required customer-specific analysis or environment-specific adaptation at acquisition. A base system bought "on the shelf" for later customization did not qualify, so the upstream payments were taxable while the downstream customized sub-licenses were exempt intangibles. Confirm which tax period applies before relying on this framework.

Common questions

Q: Did the marketer owe use tax on the software it bought?
A: Yes, for the pre-September-1991 period. Because the base System was not acquired to meet a specific customer's requirements at the time of purchase, it was taxable tangible personal property, so the payments to the parent were subject to sales or use tax.

Q: Were the marketer's own sales to banks taxable?
A: No. By the time the marketer sub-licensed the customized System to a bank end user, it had become exempt intangible (custom) software, so those receipts were not subject to sales tax.

Q: Why does the base software count as tangible property?
A: Under the old rule, software was exempt intangible property only if preparing it required analyzing that customer's requirements or adapting it to a specific environment. The base System met neither test when purchased, so it was taxable tangible personal property.

Q: Does this still apply today?
A: Not directly. This opinion governs periods before September 1, 1991. Since then New York taxes prewritten software as tangible personal property under different rules. Treat this as historical/audit guidance.

Q: Can another company rely on this opinion?
A: No. An advisory opinion binds the Department only as to the petitioner and the facts described. It illustrates the Department's reasoning, but your facts may differ.

Citations and references

Statutes and authorities:

• Tax Law § 1105(a) (tax on retail sales of tangible personal property)
• Tax Law § 1110 (compensating use tax on tangible personal property purchased at retail)
• Tax Law § 1101(b)(5) (definition of "sale" includes any rental, lease, or license to use)
• Technical Services Bulletin 1978-1(S) (pre-September-1, 1991 software rule; analyze/adapt test)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1993.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a93_12s.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-93 (12)S
Sales Tax
February 25, 1993

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S921110A

On November 10, 1992 a Petition for Advisory Opinion was received from Kapiti Inc., 114
West 47th St., New York, New York 10036.
The issue raised by Petitioner, Kapiti Inc., is whether for the period prior to September 1,
1991 certain payments made for certain computer software were subject to the use tax imposed under
Section 1110 of the Tax Law.
Kapiti Limited ("Ltd."), a United Kingdom corporation not engaged in a trade or business
in the United States, produces computer software ("The System") to be used by banks. Under a 1989
license agreement with Petitioner its wholly-owned United States subsidiary, Ltd. has granted
Petitioner exclusive marketing rights for the System in the United States.
The System, which is copyrighted, consists of one or more designated sets of programs
together with all manuals and documentation necessary to install and run the programs and all
modifications or improvements to the program developed subsequent to the licensing agreement.
The licensing agreement gives Petitioner the right to develop and sub-license The Systems
to end-users which were banks located in the United States. The System is customized and installed
by Petitioner, tailored to the specific requirements of the end-user. Before entering into a licensing
agreement with the end-user, Petitioner must notify Ltd. with respect to variations to The System,
payment schedule, type or computer and delivery date.
In a typical sub-licensing engagement in which Petitioner's staff is engaged, its staff spends
a period of time ranging up to six months studying and understanding the sublicensee's needs and
developing a tailored business system to meet these needs. As part of this procedure, Petitioner uses
The System, i.e. the base computer software system licensed from Ltd. This base system is
parameterized with respect to the sub-licensee's staff, financial products, the nature of the sub­
licensee (whether it is the branch office of an international based bank or a major money center
financial institution), the types of reporting such licensee is required to provide, how much of a
system is actually required, the licensee's hardware configuration, number of users and so on. Once
the customized system is developed, Petitioner has created a tailored software package which has
been designed to meet the specific needs of this particular licensee.
Section 1105(a) of the Tax Law imposes a tax on the receipts from every retail sale of
tangible personal property while Section 1110 imposes a compensating use tax upon".., tangible
personal property purchased at retail .... " Sale as defined in Section 1101(b)(5) of the Tax Law
includes any rental, lease or license to use tangible personal property.

-2­
TSB-A-93 (12)S
Sales Tax
February 25, 1993
The tax status of receipts from computer program ("software") sales and services is explained
in Department of Taxation and Finance Technical Services Bulletin 1978-1(s), issued February 1,
1978 and is applicable to taxable periods prior to September 1, 1991.
The Bulletin provides in part that:
Software [means] instructions and routines which, after analysis of the customer's
specific data processing requirements, are determined necessary to program the
customer's electronic data processing equipment to enable the customer to
accomplish specific functions with his EDP system. To be considered except
'software' for purposes of this bulletin, one of the following elements must be
present:
A.

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

B.

The program requires adaptation, by the vendor, to be used in a specific
environment i.e., a particular make and model of computer utilizing a
specified output device. For example, a software vendor offers for sale a pre­
written sort program which can be used in several computer models. Prior to
operation, instructions must be added by the vendor which specify the
particular computer model in which the program will be utilized.

The software may be in the form of:
a.

Systems programs (except for those instruction codes which
are considered tangible personal property in paragraph 1
above) - programs that control the hardware itself and allow
it to compile, assemble and process application programs.

b.

Application programs - programs that are created to perform
business functions or control or monitor processes.

c.

Pre-written programs (canned) - programs that are either
systems programs or application programs and are not written
specifically for one user.

d.

Custom programs - programs created specifically for one user.

Software meeting the above criteria, whether placed on cards, tape, disc pack or other
machine readable media or entered into a computer directly, is deemed to be
intangible personal property for sales tax purposes, and as such its sale is exempt
from New York State and local sales and use taxes. Software or programs which do
not meet the criteria are subject to tax.

-3­
TSB-A-93 (12)S
Sales Tax
February 25, 1993
The software produced by Ltd. and used by Petitioner was not acquired by Petitioner to meet
the requirements of a particular customer. Thus, at the time Petitioner purchased the software from
Ltd., it did not meet the conditions set forth in A or B above. It was only after Petitioner contracted
with its customers that it made changes in the software which enabled it to meet the specific needs
of a customer.
Consequently, Petitioner was purchasing tangible personal property from Ltd. which it then
converted to intangible property for use by its customers. Therefore, payments made by Petitioner
to Ltd. were subject to sales or use tax pursuant to the provisions of Sections 1105(a) or 1110 of the
Tax Law while the payments it received from its customers were not subject to sales tax as they were
receipts from the sale of an intangible.

DATED: February 25, 1993

/s/
PAUL B. COBURN
Deputy Director
Taxpayer Services Division

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