Was remote mainframe emulation and software-testing time taxable data processing, and could the software developer claim resale or manufacturing treatment?

Plain-English summary

A software developer dialed into a San Francisco mainframe to emulate an IBM environment, test its software, use the provider's operator and equipment, and receive consultation about discovered bugs.

The Comptroller classified the service as taxable time-sharing and data processing, which had become taxable on January 1, 1988. The developer could issue a resale certificate if the service was incorporated into or essential to tangible personal property it would resell.

The letter also allowed a manufacturing exemption certificate because the testing was performed directly on the product before distribution and made it more marketable.

Common questions

Was the remote testing service taxable? Yes, as data processing.

Could the developer use a resale certificate? Yes, under the stated essential-to-resold-property condition.

Could it use a manufacturing certificate instead? Yes, because the testing met the letter's manufacturing criteria.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9003L0997B08

Original ruling text

COMPTROLLER OF PUBLIC ACCOUNTS
STATE OF TEXAS
AUSTIN, 78774

March 28, 1990

Dear ***:

I am responding to your letter of March 19, 1990, wherein you have
inquired about the taxability of computer services. Initially I
would like to restate the facts of your letter as I understand
them.

In your situation, your company is now developing software in
"industry standard" language so that the software can be run on
IBM compatible computers. The software also runs on your hardware
through the use of an emulator. In testing your new software, you
are contracting with * who provides the emulation of the
IBM environment on their mainframe computer. You access their com-
puter by dialing up *'s mainframe which is located in San
Francisco. You are billed by the amount of time *'s computer
equipment and peripherals are used to test your software. *
provides and directs the operator of the computer equipment in the
evaluation of your software. Furthermore, *** provides consul-
tation to your company regarding "bugs" they discover during the
testing of your software.

The service that *** is providing for you is a form of time
sharing, and is considered data processing services. Data
processing services became taxable as of January 1, 1988. A
resale certificate can be issued for the taxable service if the
service is incorporated into, or is essential to the tangible
personal property which will be resold. Please see the enclosed
Rule 3.330(c)(3) regarding data processing services.

In regard to manufacturing, Rule 3.300 allows an exemption for
services performed directly on the product being manufactured
provided these services are performed prior to the product's
distribution for sale and provided the services are for the
purpose of making the product more marketable. From your facts,
it appears that you meet both of these criteria. Therefore, you
could also issue a manufacturing exemption certificate, as
opposed to a resale certificate, for ***'s services. I have
enclosed a copy of Rule 3.300 for your reference.

The above response is based on the facts provided. Changes or
additions to these facts may cause this opinion to change.

If you have any questions please contact Tax Correspondence. You
may write to the above address or call toll free 1-800-252-5555.

Sincerely,
Brad Gabbart
Tax Correspondence