When shareware software is downloaded for free but the user later pays a registration fee to unlock it, is that a taxable sale in Texas, and does it matter which server the customer downloaded the software from?

Plain-English summary

A developer of clinical software for medical professionals distributed it as "shareware" -- a free try-before-you-buy download available from multiple servers (the developer's own Texas-hosted site, a university server, and others), with users encouraged to redistribute it freely to friends and colleagues. The software is functionally limited or time-limited until the user pays a registration fee and receives a key that unlocks it. Because the developer often can't tell where a paying customer originally got their copy (a friend, the Texas web server, the university server, or elsewhere), he asked the Comptroller when, if ever, sales tax applies. The answer: downloading the free trial copy is NOT a taxable sale, because "sale" under Tax Code § 151.005 requires a transfer of tangible property for consideration, and nothing is paid at download time. The taxable event is REGISTRATION -- when the customer pays the fee and gets the unlock key. Texas tax is due on that registration payment if the purchaser is in Texas at the time of registration, or if the software will be used on a machine located in Texas. Critically, this means it does NOT matter which server the customer downloaded the free trial from -- a Texas server, an out-of-state server, or a friend's copy -- because the download itself was never the sale. The developer must keep records reflecting the purchaser's location (or where the software is used) at the time of registration to support the tax treatment claimed.

What this means for you

Shareware, freemium, and try-before-you-buy software vendors

The taxable event is the payment/registration, not the download. Track and document where your customer is located (or where the software will be used) at the time they pay to register/unlock the software -- that's what determines whether Texas tax is due, not which server hosted the free trial download.

Vendors distributing free trials from multiple servers (including out-of-state mirrors)

You don't need to track exactly which server a customer downloaded a free copy from to determine Texas tax liability. What matters is the buyer's location (or where the software runs) when they actually pay.

Accountants and tax professionals

This letter is a clean, general application of Tax Code § 151.005's consideration-based definition of "sale" to the shareware/freemium software model -- useful for any modern free-trial-then-pay software distribution question, adjusted for how sourcing rules have evolved since 1997.

Common questions

Q: Is downloading free shareware a taxable sale in Texas?
A: No, per this letter -- there's no consideration exchanged at download time, so it isn't a "sale" under Tax Code § 151.005.

Q: When does the taxable sale actually happen?
A: Per this letter, at registration -- when the customer pays the fee and receives the software key that unlocks full functionality.

Q: Does it matter which server (Texas or otherwise) the customer downloaded the free copy from?
A: No, per this letter -- what matters is whether the purchaser is in Texas at the time of registration, or whether the software is used on a machine in Texas, not the download source.

Q: What records does the vendor need to keep?
A: Per this letter, records reflecting the purchaser's location (or where the software is used) at the time of registration.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.005 (definition of "sale")

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9704161L

Original ruling text

April 7, 1997

Dear ***:

Thank you for your recent letter which is restated in part with response below.

My business is writing clinical software for medical users - physicians,
nurses, clinical pharmacists and the like. This software is distributed as
shareware. Shareware is not a type of software but a software distribution
method. It involves the following:

1. The software is made available to potential customers on a "try before you
   buy" basis. The potential customer who downloads or otherwise receives the
   software does not "pay to download."

2. The software is usually made available at multiple sites (one or more
   Internet or bulletin board servers including shareware archives in multiple
   states and/or countries).

3. Anyone who downloads the software is encouraged to redistribute it to
   friends or colleagues. This redistribution may take several forms: passing the
   software as email message attachments between friends, copying the software to
   floppy diskettes or posting the software to a bulletin board or another web
   site.

Shareware products are typically encumbered in some manner so that the
potential customer either has unrestricted program function for a limited
amount of time (time limiting) or restricted program function for unlimited
time (function limiting). Both types of encumbrances are intended as
incentives for users to register the software. Registering shareware usually
involves the following:

1. Customer payment for a license to use the software.

2. Payment to either the shareware author or an agent (sometimes an electronic
   agent) representing the author's interests.

3. Giving the customer a software key that removes the software's encumbrance.
   The software key is sent in either an email message or a postal letter. In
   either case, the customer's payment is for a license to use the software. The
   software key brands his copy of the software with a unique identifier while
   also removing the encumbrances.

I maintain a copy of my products on a web site on an Internet server here in
CITY A. The purpose of my web site is to explain my products to potential
customers and to let them download the most recent versions of those products.
Remember, downloading is "free." My software products are also available on
the XYZ LIBRARY, UNIVERSITY W, server as well as other servers. When a
customer sends me a check for the software, I have no way of knowing whether
the software was obtained from a friend, from my web site, from the UNIVERSITY
W web site or from another country. How the customer came to receive the
software is, to all intents and purposes, impossible to tell.

My specific questions are:

1. Does the registration of shareware ever incur a sales tax?
2. If it does, under exactly what circumstances does it do so?
3. Does the email transmission of a software key from a point in Texas to a
   point outside of Texas constitute a sale? If so, why is it that a like
   transaction handled by the U.S. Postal Service is not a sale?

Response: Software that is sold in Texas is subject to sales tax. Tax Code
Section 151.005 defines the term to include a transfer of title or possession
of tangible property for a consideration. I would like to point out that
consideration includes a promise to pay in the future. Shareware is not
normally considered to be sold at the time it is transferred to a user because
there is no consideration given at that time. Registration of shareware and
payment of a fee for the registration constitutes a sale of the software.
Texas tax is due if the purchaser is in Texas at the time of registration or
the software is used on a machine in Texas. Your records must reflect this
information.

This opinion is rendered based on the facts presented. If there are additional
or different facts, the opinion may change.

You may call me toll free at 1-800-531-5441, ext. 3-4680. The direct line is
512/463-4680. You may also write to Tax Policy, Comptroller of Public
Accounts. My Internet address is .

Sincerely,
Al Van Allen
Tax Policy Division