Are digital certificates (Digital IDs) sold and delivered over the Internet subject to Texas sales tax as software, data processing, information services, or telecommunications services?

Plain-English summary

A company provides "Digital ID" certificate solutions for secure e-commerce and communications over the Internet -- customers register online, the company authenticates their identity (via a third party like Equifax), and delivers the Digital ID electronically. The company had already established Texas nexus through physical contacts and asked the Comptroller to walk through four separate theories under which its charges might be taxable.

The Comptroller rejected all four: (1) Not a taxable computer program -- the Digital ID is a cryptographic key used within a client's existing software, not sold as or with a software program itself. (2) Not a taxable data processing service -- the company isn't encrypting data on behalf of its clients. (3) Not a taxable information service -- the company doesn't charge for access to public Digital IDs (which anyone can use), and issuing a private certificate for a fee isn't itself a taxable information service. (4) Not a taxable telecommunications service. The one catch: the company still owes tax on its own purchases of taxable items -- including telecommunications services -- that it buys to provide this nontaxable service.

What this means for you

Digital certificate and authentication service providers

Selling authentication credentials (keys, certificates) delivered electronically isn't automatically taxed as software, data processing, information services, or telecom just because it's Internet-delivered -- each category has its own test, and this letter shows a service can clear all four.

Companies buying taxable inputs to provide a nontaxable service

Even if your end product is nontaxable, you still owe sales tax on your own taxable purchases (equipment, telecommunications services, etc.) used to produce it -- a nontaxable output doesn't create an exemption on your inputs.

Accountants and tax professionals

This letter is useful as an early (1999) example of how Texas analyzed internet-delivered digital products/services against each of the state's enumerated taxable service categories individually, rather than applying one blanket "digital products" rule.

Common questions

Q: Is selling a digital certificate/authentication key over the Internet taxable in Texas?
A: Not per this letter, when the certificate is a key used within existing client software (not sold as a software program) and the company isn't encrypting data or charging for information access.

Q: Does the company owe any Texas tax at all in this scenario?
A: Yes -- on its own purchases of taxable items (including telecommunications services) it buys to provide the nontaxable service, even though the service itself isn't taxed.

Citations and references

This letter does not cite a specific Tax Code section or Comptroller rule number in its text -- the analysis walks through four service categories (computer program, data processing, information services, telecommunications services) based on the Comptroller's stated reasoning in the letter itself.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9911887L

Original ruling text

November 18, 1999

Dear **:

Thank you for letter relative to Texas' Sales Tax as applied to sales of
digital ID's transferred through the Internet. You have supplied additional
information as requested by our response of July 16, 1999.

ORIGINAL FACTS (presented in June 2, 1999 request) COMPANY A, is a provider
of digital certificate solutions for businesses and individuals wanting to
perform secure electronic commerce and communications over the Internet.

Internet IDs are delivered through COMPANY A's Digital ID Center, an on-line
service which is open 24 hours a day, 7 days a week. COMPANY A markets Digital
IDs for servers, browsers, email applications and software content. End users
apply for an Internet ID by first accessing COMPANY A's website and then
completing an on-line registration form. Once COMPANY A authenticates the
identity of an applicant (via a third party such as Equifax), the applicant can
only receive the Digital ID electronically over the Internet. A Digital ID
typically contains the following: (1) Owner's public key; (2) Owner's name; (3)
Expiration date of the public key; (4) Name of the issuer (the certification
authority, otherwise known as the "CA", that issued the Digital ID); (5) Serial
number of the Digital ID; and (6) Digital signature of the issuer.

Based on the physical contacts with Texas, COMPANY A has established nexus for
sales and use tax purposes.

ISSUES

I. Is a Digital ID a computer program subject to Texas sales tax?

Response. No. Per the documentation presented and our phone conversation of
November 17, 1999, the Digital ID is a key produced by an algorithm that is
used within a client's existing software and not a program including a key or
algorithm that is used to encrypt data. The key is not sold with or as a part
of a software program.

II. Are the transfer of Digital ID's through the Internet subject to Texas
sales tax as Data Processing Services?

Response. The transfer of the Digital ID is not a data processing service.
Per our conversation, the client is not encrypting data for their clients.

III. Is the transfer of a Digital ID through the Internet subject to Texas
sales tax as information services?

Response. Your client does not charge for access to public Digital IDs. The
private ID is proprietary, as you pointed out, the public key is designed to be
used by anyone. Your client is not performing a taxable information service
when charging a customer for a certificate (digital id) for a period of time.

IV. Are the transfer of Digital ID's through the Internet subject to Texas
sales tax as telecommunications services?

Response. No. However, your client must pay tax on the purchase of taxable
items used in the provision of the non taxable service including
telecommunication services subject to Texas tax.

This opinion is 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. 5-0613. The direct line is
512/475-0613. You may also write to Tax Policy Division, Comptroller of Public
Accounts.

Sincerely,

Kevin Koller
Tax Policy Division