Does Texas charge sales or use tax when a company licenses its programming-language source code and specifications to other developers?

Plain-English summary

A software company had developed a high-level programming language (called "OpenGL" in the letter, used for three-dimensional-graphics applications) with a graphics application programming interface (API). It released the formal specifications and source code of the API to licensees under a limited, nonexclusive, non-transferable, royalty-bearing license, letting the licensee use and modify that information to build its own "derived programs." The company earned a royalty on each copy of a derived program the licensee sold, and it also offered support, maintenance, and interim updates to licensees.

The Comptroller's answer turned on one distinction: whether what was being transferred was a completed computer program — "a series of instructions sold as a completed program that are coded for acceptance or use by a computer system and which are designed to permit the computer system to process data and provide results ... or information." If the source code and specifications being licensed did NOT rise to that level (i.e., the licensee still had to do real development work to turn it into a working program), the license was not taxable, no exemption certificate was needed, and neither the per-copy royalty nor the maintenance/support/update charges were taxable. But if the source code and specifications DID meet the "completed program" definition, the opposite was true across the board: the company had to collect tax (or take a resale certificate from the licensee), the royalties riding on top of the derived-program sales were taxable as part of the sales price, and maintenance/support/updates were taxable whether billed separately or not.

What this means for software companies and licensors

If you license source code, specifications, an API, or a programming language/toolkit to other developers so they can build their own end product, the sale generally is not subject to Texas sales or use tax — as long as what you're handing over is not itself a "completed computer program" ready for a computer to run and produce results. Once your deliverable crosses into a working, ready-to-run program, the whole economic package built on it (the license itself, per-unit royalties from downstream sales, and separately billed maintenance/support/updates) becomes taxable, and you're on the hook to collect tax or get a resale certificate.

What this means for accountants and tax professionals

The letter applies Rule 3.308's "completed computer program" test and treats it as the single gating question for every related revenue stream — license fees, royalties, and maintenance. Note that the ruling doesn't draw a bright line for where "source code/specifications" stops and "completed program" starts; it explicitly defers to the facts of each case ("If there are any additional or different facts, the opinion may change"), so this letter is useful for the framework, not a numeric or technical test you can apply mechanically to a different product.

Common questions

Q: Is licensing source code to another developer automatically tax-free in Texas?
A: Not automatically. It's tax-free only if the source code/specifications being transferred don't themselves qualify as a "completed computer program." If they do, the license is taxable.

Q: If the license is non-taxable, do I still need to keep an exemption or resale certificate from the licensee?
A: No. The Comptroller told this taxpayer that if the source code and specifications don't meet the definition of a completed program, no exemption certificate is required from the licensee because the transaction is simply nontaxable.

Q: Are the ongoing royalties I collect from a licensee taxable?
A: It depends on the same "completed program" test. If the source code is a completed program, royalties the licensee pays you (as part of what it charges for its own derived program) are part of the taxable sales price, and the licensee may issue you a resale certificate. If the source code is not a completed program, the royalties are not taxable.

Q: What about charges for support, maintenance, and interim updates to the source code?
A: Under Rule 3.308(b)(3), if the underlying source code is a completed computer program, maintenance charges are taxable when performed by the seller of the program — whether or not they're separately stated in the contract. If the source code isn't a computer program, tax isn't due on maintenance either.

Q: Can I rely on this letter for my own software licensing situation?
A: Only if your facts match. This is a private STAR letter ruling redacted for one taxpayer; it can only support a detrimental-reliance claim for the taxpayer it was issued to, and the Comptroller says explicitly that a different or additional fact pattern could change the answer.

Citations and references

Rules cited:

• 34 Tex. Admin. Code Rule 3.308 (Computers — hardware, software, services), including Rule 3.308(b)(3) on taxability of maintenance charges

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9212718L

Original ruling text

December 29, 1992

Dear ***:

Thank you for your recent letter inquiring about the taxability of licensing a
high level programming language. As I understand it, ***
(*****) has developed a high level programming language for
applications using three dimensional graphics. The language is called "OpenGL"
and features a graphics application programming interface (API).

*** releases the formal specifications and source code of API to
licensees. In addition, the licensee receives a limited, nonexclusive,
non-transferable, royalty-bearing license and the right to use and modify the
information and data contained in the specifications and source code to create
derived programs. ** receives a royalty on each copy of the derived
program sold by the licensee. Support, maintenance, and interim updates for
source codes and specifications are available to licensees from ****.

Your questions with response are as follows:

(1) Is the transfer of *** source code and specifications, to the
licensee, under the situations described above subject to sales or use tax in
your state?

Response: The licensing of source code and specifications for a programming
language is not taxable unless it is sold as a completed computer program. A
computer program is defined as a series of instructions sold as a completed
program that are coded for acceptance or use by a computer system and which are
designed to permit the computer system to process data and provide results
(e.g. graphics) or information. Your letter seems to indicate that a completed
program is not being licensed. If this is the case, no tax is due on the
licensing of the language to create a derived program. On the other hand, if
the source code and specifications meets the definition of a completed program,
*** would be required to collect tax or accept a properly completed
resale certificate in lieu of tax.

(2) If the answer to Question 1 is "No", what documents must ***
keep for its records to substantiate the non-taxable nature of the transaction?

Response: If the source code and specifications do not definition of a
completed computer program, not be required to keep any type of exemption
certificate from the licensee because this is nontaxable transaction.

(3) If the answer to Question 1 is "Yes", what is the code section/authority
for such determination.

Response: Rule 3.308, Computers, defines computer software details the
responsibilities for collecting tax computer programs.

(4) Is the royalty paid to *** subject to sales tax in Texas.

Response: If the source code and specifications are a completed program, the
royalties paid by programmers creating and selling derived programs are a part
of the sales price of the derived programs. The programmers may issue resale
certificates to *** in lieu of tax. If the source code and
specifications are not a completed program, tax is not due on the royalties
paid to *****.

(5) Are the charges for support and maintenance of the source code, which
includes interim updates to the source code, subject to sales tax in Texas?
Will the taxability change if the charges for updates are separately stated in
the contract?

Response: If the source code is a completed computer program, maintenance is
taxable when done by the person who sold the program whether separately stated
or not. Rule 3.308 (b)(3). Tax is not due if the source code is not a computer
program. This opinion is based on the facts presented. If there are any
additional or different facts, the opinion may change.

If you have any questions or need additional information, you may call toll
free 1-800-531-5441, ext. 50037 or the regular Austin number is 512-475-0037.
You also may write to Tax Administration Division.

Sincerely,

Lindey Osborne
Tax Administration Division