If a customer redirects a software delivery into Texas for installation, is Texas sales tax due even though the customer's employees only ever use the software remotely from outside Texas?

Plain-English summary

A software company (the "Client") originally received a purchase order to ship network-monitoring software to its customer at a location outside Texas. Before delivery, the customer changed its instructions and had the Client ship and install the software on computers in Texas instead (the computers belonged to a corporate affiliate of the customer, not the customer itself). The customer's own employees, however, only ever accessed and used the software remotely, from outside Texas -- they never physically entered Texas.

The Client billed and collected Texas sales tax on the sale. The customer refused to pay it, arguing (1) the software only "benefited" the customer where its employees actually used it (outside Texas), (2) the transaction would have been untaxed if delivered as originally planned outside Texas, and (3) the seller lacked Texas nexus. The Client self-accrued and paid the tax out of its own funds, then asked the Comptroller to referee the dispute.

The Comptroller sided entirely with the Client. Software is tangible personal property under Texas law, and sales/use tax on tangible personal property is sourced to where the item is delivered -- not allocated based on where the ultimate user benefits from it (that "benefit of use" allocation applies only to certain taxable services, like data processing, not to sales of tangible personal property). Because the customer redirected delivery into Texas, tax was due on the full sales price. And because a seller's use tax collection becomes a debt owed by the purchaser to the seller under § 151.103, the customer had to reimburse the Client for the tax the Client had already paid on its behalf. The letter also confirms the flip side: had the software been delivered outside Texas as originally planned, the seller wouldn't have owed Texas sales tax -- though the customer could still separately owe Texas use tax if it later brought the software into Texas for use here.

What this means for you

Software sellers and multistate customers

Where your software is physically delivered/installed determines Texas tax -- not where end users are geographically located when they later access it remotely. If a customer redirects delivery into Texas after the fact, that can create a Texas sales tax obligation even if no one ever uses the software from inside the state.

Sellers who front tax on a customer's behalf

If you (as the seller) pay use tax on a customer's behalf when the customer disputes it, this letter confirms you have a statutory right (Tax Code § 151.103) to be reimbursed by the customer -- the tax becomes the purchaser's debt to the seller, recoverable like the underlying sales price.

Accountants and tax professionals

The letter is a clean, contemporaneous illustration of two separate sourcing principles: (1) delivery location controls for sales of TPP (including software), unlike the "benefit of service" allocation rule that applies to certain enumerated taxable services; and (2) even where an out-of-state delivery avoids seller-collected sales tax, purchaser-owed use tax can still attach later if the property is brought into Texas (subject to the Rule 3.346(c)(5) exception for property used more than a year outside Texas first).

Common questions

Q: Does it matter where the software is actually used, not just delivered?
A: Not for a sale of software as tangible personal property. The Comptroller drew a sharp line: "benefit of use" sourcing applies to certain taxable services (data processing, information services, credit reporting), not to sales of tangible personal property like software.

Q: What if the software had been delivered outside Texas as originally planned?
A: The seller would not have owed Texas sales tax on that sale. But the customer could still owe Texas use tax later if it brought the software into Texas for use here (subject to a Rule 3.346(c)(5) exception for property already used more than a year elsewhere).

Q: If a seller pays disputed tax on a customer's behalf, can it get reimbursed?
A: Yes -- Tax Code § 151.103 makes the collected use tax a debt of the purchaser to the seller, recoverable the same way as the underlying sales price.

Q: Does lack of a customer's own physical presence in Texas defeat nexus?
A: The letter doesn't need to resolve the customer's nexus argument separately, since it resolves the dispute on delivery-location sourcing -- the seller (Client), which was already doing business in Texas, was responsible for collecting the tax on a Texas delivery.

Citations and references

Statutes:

• Tex. Tax Code § 151.009 (tangible personal property includes computer programs)
• Tex. Tax Code § 151.005 (definition of "sale"/"purchase")
• Tex. Tax Code § 151.051 (sales tax imposed on taxable items in Texas)
• Tex. Tax Code § 151.103 (retailer's collection of use tax; becomes purchaser's debt to seller)

Rules:

• 34 Tex. Admin. Code Rule 3.308(b)(2) (computers -- hardware, software, services, and sales)
• 34 Tex. Admin. Code Rule 3.346(b), (c)(5) (use tax; out-of-state purchase exception)

Case law cited in the original letter:

• Sterling Constr. Co. v. West Texas Equipment, 597 S.W.2d 515 (Tex. Civ. App.)
• Highway Contractors, Inc. v. West Tex. Equipment, 617 S.W.2d 515 (Tex. Civ. App.)

Prior STAR guidance referenced:

• STAR accession #9710812L (licensing of software as TPP)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/200110565L

Original ruling text

October 19, 2001

Dear **:

Thank you for your inquiry on behalf of your client ("Client"), requesting a
sales and use taxability ruling on the basis of the following set of facts:

FACTS

Client is a Delaware corporation duly authorized to do business in Texas.
Client's business includes manufacturing and selling computer software.
Client's customers include companies who maintain and operate high-speed data
networks in Texas and in other states. Client's customers frequently license
Client's software and use the software to monitor and diagnose the condition of
their networks (the "network software").

One of Client's customers ("Customer") sent Client a purchase order offering to
buy network software. The purchase order instructed Client to ship the network
software to Customer to a location outside of Texas.

Client accepted the purchaser order and began processing the request. Before
Client delivered the network software to Customer, Customer told Client to ship
the network software to facilities in CITY, Texas. Client shipped the network
software to CITY, Texas. When the network software reached CITY, Client's
employees received it and installed it on computers located in CITY, as
instructed by Customer. The computers were owned by a corporate affiliate of
Customer; not by Customer.

Customer's employees use the network software remotely from locations outside
of Texas. Customer's employees did not enter Texas to use the network
software. Customer's employees used the network software to monitor Customer's
high-speed data network (or a high-speed data network of a corporate
affiliate). The infrastructure of the high-speed data network is located in
Texas and in other states. The users who subscribe to the network are located
in all of these locations as well.

Client subsequently sent an invoice to Customer for the network software.
Client billed Customer 8.25% for Texas sales and use tax in addition to the
sales price of the network software. Customer paid Client the sales price for
the network software. Customer has refused to pay Client the Texas sales and
use tax on the network software. On Customer's behalf, Client self-accrued and
paid Texas sales or use tax of 8.25% on the network software out of its own
funds. Customer has refused to reimburse Client for the tax that Client paid
on its behalf. Customer has refused to reimburse Client thus far because
Customer believes that the transaction isn't subject to the Texas sales or use
tax and that no tax is owed.

DISCUSSION

Customer has offered various explanations of why the transaction isn't subject
to the Texas sales or use tax. First, Customer claims the transaction isn't
subject to the Texas tax because its employees weren't physically located in
Texas when they used the network software. Customer reasons that the
transaction would only be taxable if its employees had been physically present
in Texas when they used the network software. Since Customer's employees were
located outside of Texas when they used the network software, the network
software didn't benefit Customer in Texas; it benefited Customer outside of
Texas. Therefore, Customer claims that the transaction isn't subject to the
Texas sales or use tax.

Second, Customer claims the transaction isn't subject to the Texas sales or use
tax because the transaction wouldn't have been taxable in Texas if the
transaction had been executed as originally intended. If Client had delivered
the network software to Customer at a location outside of Texas, then the
network software wouldn't be taxable in Texas, even if Client subsequently sent
the network software to CITY for installation on the computers.

Finally, Customer may claim that the transaction is not subject to the Texas
sales or use tax because Client lacks nexus with Texas. Customer may claim
that since it doesn't employ any people physically located in Texas, and since
it doesn't own any property in Texas other than the network software, it isn't
subject to taxation in Texas.

Client asked us to review Customer's claims and to assess their validity.
We've reviewed Customer's claims. The claims and the facts on which they're
based are rather novel and the legal questions involved may be complex. As
such, we decided to request the Comptroller's determination on whether the
transaction is subject to the sales or use tax, as it may help to resolve any
misunderstandings by either Client or Customer. Therefore, on the basis of the
foregoing facts, we respectfully ask for answers to the following questions:

QUESTIONS

1. Is Client's charge to Customer for the network software subject to the Texas
   sales or use tax? If so, then why? If not, then why not?

Response: Tax is due on the sale, lease or license of software for use in
Texas. Texas Tax Code Section 151.009 defines tangible personal property to
mean "personal property that can be seen, weighed, measured, felt, or touched
or that is perceptible to the senses in any other manner, and, for the purposes
of this chapter, the term includes a computer program and a telephone prepaid
calling card."

In addition, Texas Tax Code Section 151.005. "Sale" or "Purchase," defines
"Sale" or "purchase" to mean any of the following when done or performed for
consideration:

(1) a transfer of title or possession of tangible personal property;

. . . .

Section 151.051. Sales Tax Imposed, provides in part:

(a) A tax is imposed on each sale of a taxable item in this state.

2. If Client's charge for the network software is not subject to the Texas
   sales or use tax, then what procedure should Client pursue to recover the tax
   it has paid in error?

Response: Tax is due on the network software licensed for use in Texas. See
subsection (b)(2) of Rule Section 3.308-Computers--Hardware, Software,
Services, and Sales.

3. If Client's charge for the network software is subject to the Texas sales or
   use tax, then should Customer reimburse Client for the taxes Client paid on
   Customer's behalf?

Response: Yes. Texas Tax Code Section 151.103. Collection by Retailer;
Purchaser's Receipt, provides:

(a) A retailer engaged in business in this state who makes a sale of a taxable
item for storage, use, or consumption in this state shall collect the use tax
that is due from the purchaser and give the purchaser a receipt for the tax
payment. When the amount of use tax is added:

(1) it becomes a part of the sales price;

(2) it is a debt of the purchaser to the seller until paid; and

(3) if unpaid, it is recoverable at law in the same manner as the original
sales price.

Emphasis added.

See also, Sterling Const. Co. v. West Texas Equipment (Tex.Civ.App., 597 S.W.2d
515) and Highway Contractors, Inc. b. West Tex. Equipment (Tex.Civ.app., 617
S.W.2d 515), that address a seller's right to recover uncollected sales tax
from a purchaser.

4. If Client had initially shipped the network software to Customer outside of
   Texas, and Customer had brought the network software into Texas for use by its
   employees remotely from outside of Texas, would that transaction have been
   subject to the Texas sales or use tax? If not, then why not? If so, then why
   and what tax rate would apply?

Response: Client would not be responsible for collecting Texas sales tax on
software delivered to a point outside Texas. However, Customer would owe Texas
use tax on the software if the software is later brought into Texas for use in
Texas.

Subsection (b) of rule 3.346 - Use Tax, provides in part:

Imposition of the use tax.

(1) Out-of-state purchases and direct payment permit purchases.

(A) If taxable items are purchased out of state for use in Texas and are
brought or shipped into Texas for storage, use, or consumption, use tax is due.
The liability may be extinguished by payment of the Texas use tax directly to
the comptroller or to a retailer authorized to collect it.

An exception to this is found in subsection (c)(5) of Rule 3.346 and is
applicable to taxable items purchased out of state and used outside Texas for a
period of more than one year, before being brought into Texas for use.

5. Would you please comment on each of Customer's three explanations of why the
   transaction is not subject to the Texas sales or use tax? Is each explanation
   consistent with Texas sales and use tax law? If so, then why? If not, then
   why not?

Response: Following are my responses to Customer's three contentions.

Customer's first contention: Texas imposes a sales tax on the purchase of
taxable items (tangible personal property or taxable service) for use in Texas.
For sales tax purposes software is treated as tangible personal property.
Therefore, the delivery of software for use in Texas is subject to Texas sales
or use tax. The fact the software is accessed by employees located outside
Texas does not control. Allocation based on benefit of use or service is
applicable to certain taxable "services" such as data processing, information
services and credit reporting services, etc. and does not apply to sales of
tangible personal property.

Customer's second contention: This contention would be valid if Customer
actually took delivery of the software at a point outside Texas. However,
because Client actually delivered the software to a point in Texas, Texas sales
or use tax is due on the charge for the software. Client, because it is
engaged in business in Texas, is required to collect and report sales or use
tax on the sale and installation of the software.

Customer's third contention: The fact that Customer is licensing software (TPP)
for use in Texas subjects that software to Texas sales and use tax. See STAR
accession #9710812L. Certainly, if legal claims arose regarding the software,
Customer would seek to avail itself to the protection of the Texas laws and
courts.

This opinion is based on the facts presented. Other facts though similar may
provide a different result.

I hope this information answers your questions. If you need additional
information, you may e-mail our tax help section at .
You may also call me toll-free at 1-800-531-5441, extension 3-4502. The
direct line is 512/463-4502. You may also write to Tax Policy Division,
Comptroller of Public Accounts.

Sincerely,

Gilbert Zamora
Tax Policy Division