Does licensing software to Texas customers to access an out-of-state database service create Texas franchise tax nexus, even with no salespeople in the state?
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This page answers the general question as of 1993. Ezel answers yours, under current Texas tax law, with citations.
Plain-English summary
A company provided its customers with access to third-party databases through a "gateway." To make that work, the company licensed software (which it continued to own) to its Texas customers, who used it to reach the gateway and were billed monthly fees for the service. At the time of the request, the company was also considering sending traveling salespeople into Texas, but had not yet done so.
The Comptroller ruled that the presence of this licensed software in Texas customers' hands, by itself, creates substantial nexus with Texas for franchise (income) tax purposes — even with zero traveling salespeople in the state. The ruling distinguishes this from the U.S. Supreme Court's Quill case, where four floppy discs used by a mail-order seller were not enough to create nexus. Here, the software was "necessary for the delivery of the service" and had "widespread use" among the company's Texas customers, which the Comptroller found sufficient to establish nexus.
Because nexus exists either way, having traveling salespeople in Texas would not change the nexus answer (it would just make nexus unquestionable on its own). The Comptroller also classified the company as a service provider, not a seller of canned software, since its revenue came primarily from database access/maintenance fees rather than software sales — meaning it owes franchise tax under both the capital component and the earned surplus component, apportioned using Texas's single gross receipts factor.
What this means for you
Software/database/SaaS-style businesses
If you license software to Texas customers as the means by which they access your core service (a database, a platform, a gateway, etc.), the Comptroller treats that licensed software as enough by itself to create Texas franchise tax nexus — you do not need boots-on-the-ground salespeople in the state. The key factors called out here are that the software is (1) necessary to deliver the service and (2) used widely by customers, not just an incidental convenience.
Businesses deciding whether to send sales staff into Texas
This ruling suggests that adding traveling salespeople doesn't hurt (or help) if nexus is already established through the software — it would simply put nexus beyond question. It only matters here as an alternate, independently-sufficient basis for nexus.
Businesses questioning whether they're a "software seller" or a "service provider" for franchise tax
If your primary revenue stream is fees for use of a database, platform, or maintenance/access service — not licensing or selling the software itself — the Comptroller will likely treat you as a service provider. That determines which franchise tax components apply (capital plus earned surplus) and the required apportionment method (single gross receipts factor).
Common questions
Q: Does a company need physical presence (like employees or salespeople) in Texas to owe franchise tax?
A: Not necessarily. This ruling found that Texas customers' possession and use of the company's licensed software — needed to access its service — was itself enough to create substantial nexus, without any traveling salespeople in the state.
Q: How is this different from the Quill case, where mailing floppy discs wasn't enough for nexus?
A: The ruling distinguishes Quill by pointing out that in this case the software was "necessary for the delivery of the service" and had "widespread use" by the company's customers — unlike the four floppy discs in Quill, which apparently were not integral to ongoing service delivery in the same way.
Q: Is the company treated as selling software (tangible personal property) or providing a service?
A: A service provider. Because its revenue came mainly from the database/maintenance fees rather than from software sales, the Comptroller concluded it was providing a service, not selling canned software.
Q: What franchise tax components and apportionment method apply?
A: Both the capital and earned surplus components of the Texas franchise tax apply, and the company must apportion using a single gross receipts factor (not a three-factor formula).
Q: Does the company need to separately register/qualify to do business in Texas if there's no other nexus basis?
A: The ruling didn't reach that question — the Comptroller answered it "not applicable," since nexus (and by extension the related question) was already resolved based on the software's presence in the state.
Source
- STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
- Opinion: https://star.comptroller.texas.gov/view/9301L1217E07
Original ruling text
January 27, 1993
Dear **:
Thank you for inquiring as to the taxability of your client which provides
access to third party databases. Your client will provide software to its
customers in Texas, which software will allow them to access your client's
gateway and, consequently, the third party databases. The software will remain
your client's property. The customer will use ** to access the
gateway and will be charged fees on a monthly basis for the services provided.
At this time, the client is considering having traveling sales people enter
Texas.
Your questions, based on these facts, are as follows:
- If the Taxpayer does not have any traveling sales people in your state are
they subject to income (franchise) tax based on the presence of the licensed
software in the state?
Answer: Yes. Unlike the four floppy discs involved in the Quill case, this
software is necessary for the delivery of the service and will have a
widespread use by your client's customers. Under these facts, we have concluded
that the software creates substantial nexus with Texas.
- Would the answer to (1) above be different if they did have traveling sales
people in your state?
Answer: No. However, there would be no question that the Taxpayer would have
substantial nexus if they utilized traveling sales people in Texas.
- If the Taxpayer is subject to income (franchise) tax, are they considered a
seller of tangible personal property (sale of canned software) or a service
business, since the primary revenue is from the use of the database or
maintenance agreements and not the sale of the software?
Answer: The Taxpayer would be considered the provider of a service rather than
the seller of tangible personal property and would be subject to both the
capital and earned surplus sections of the franchise tax.
(4) If the Taxpayer is subject to income (franchise) tax, what apportionment
methodology, should be used (i.e. three factor, single gross receipts factor,
or another method).
Answer: The Texas franchise tax requires the use of a single gross receipts
factor.
(5) If the Taxpayer is not subject to income (franchise) tax and does not have
traveling sales people in your state, is the presence of licensed software in
your state sufficient nexus to require the Taxpayer to qualify to do business
in your state?
Answer: Not applicable. See answer to question (1)
(6) Would the answer to (5) above be different if they did have traveling sales
people in your state?
Answer: No. See answer to question (2)
Again, thank you for inquiring about the tax liabilities of your client.
Should you have further questions, please do not hesitate to call me at
l-800-252-5555 ext. 3-4783.
Sincerely,
Mike Doyle
Director of Tax Administration
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