Is a software modification delivered out-of-state and brought into Texas on diskette taxable?

Subject

Software — Modifications — Delivered To Computer Storage Facility Outside Texas — Copied On Diskettes And Brought Into Texas

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9408L1311G14

Plain-English Summary

A Texas computer software company created a modification (new source code) to be appended to an existing software program that it had developed. The modification was delivered to a computer backup storage facility located outside Texas, where it was copied onto diskettes and then brought into Texas. The taxpayer asked whether those diskettes were the only taxable transaction.

The Comptroller's answer turns on who created the modification:

1. Same seller modifies its own program. If the person or company modifying the existing program was also the one who sold the original program, taxability of the modification depends on whether the original sale was itself taxable as the sale of a computer program. If the original sale was taxable, the modification is also taxable when the diskettes are brought into Texas. If the original sale was not taxable, the modification is not taxable either — only the diskettes are taxable.
2. Different party modifies the program. If the modification was performed by someone other than the seller of the original program, only the diskettes are taxable, because the modification itself is not taxable in Texas.

In short: delivering the modified code to an out-of-state storage facility first does not by itself make the diskette import the only taxable event — the answer hinges on the taxability of the underlying original program sale and on whether the same party made both the original sale and the modification.

What This Means For You

• Software vendors modifying their own products: If you sell a computer program in Texas and later create a modification to it, check whether your original sale of that program was a taxable sale of a computer program. If it was, expect the modification to be taxable too when it's brought into Texas, even if the modification work itself happened out of state.
• Third-party developers and contractors: If you modify someone else's existing software program (i.e., you didn't sell the original program to the customer), the modification itself is not taxable in Texas under this ruling — only the physical diskette (or comparable tangible medium) brought into the state is taxable.
• Businesses routing software through out-of-state storage: Routing a modification through an out-of-state backup storage facility before copying it to diskette and importing it does not change this analysis. The location of the storage facility does not control taxability — the identity of the modifier relative to the original seller, and the taxability of the original sale, do.

Q&A

Q: Are the diskettes used to bring the modified software into Texas always the only taxable transaction?
A: Not necessarily. If the same party that sold the original program also made the modification, the modification is taxable in addition to the diskettes whenever the original program sale was itself a taxable sale of a computer program.

Q: What if the original sale of the software program was not taxable?
A: Then the modification is not taxable either, and only the diskettes bringing the software into Texas are taxable.

Q: What if someone other than the original seller creates the modification?
A: In that case, only the diskettes are taxable. The modification itself is not taxable in Texas because it wasn't part of the original taxable (or non-taxable) sale transaction.

Citations

No specific statutes or administrative rules are cited in the text of this letter ruling.

Original ruling text

August 10, 1994

Dear **:

On July 28, 1994, you asked about the taxability of the purchase of a
modification of source code for an existing software program developed by a
Texas computer software company. The new source code is to be appended to the
existing computer program. The software is to be delivered to a computer
backup storage facility outside Texas. There, it will be copied on diskettes
and brought into Texas.

You asked the following question:

Are the diskettes used to bring the computer software into Texas the only
taxable transaction based on the facts as discussed above?

Answer: If the person modifying the existing program also sold the original
program, it would depend on whether the original transaction was taxable as the
sale of a computer program. If it was, the modification would also be taxable
when brought in on the diskettes. If the original program was not taxable as a
computer program, the modification would not be taxable and only the diskettes
would be taxable when brought into Texas.

On the other hand, if the modification was not done by the seller of the
original program, only the diskettes would be taxable because the modification
would not be taxable in Texas.

I hope this satisfactorily answers your question. Should you have additional
questions, please feel free to write or call me at 1-800-531-5441, extension
34004.

Sincerely,

Wade Anderson
Assistant Director, Tax Administration

NOTE: Previous Accession Number 9408508L