Tax Type
Retail Sales and Use Tax
Description
Computers, services, and software; Computer software license agreements.
Topic
Taxability of Persons and Transactions
Date Issued
03-05-1998
March 5, 1998
Dear**********
In your letter, you seek correction of the sales and use tax assessment issued to your client, ***** (the Taxpayer). I apologize for the delay in responding to your letter.
FACTS
The Taxpayer markets and distributes information technology products and services to government and commercial clients. An audit for the period January 1993 through November 1995 resulted in an assessment of use tax on untaxed purchases and sales tax on nontaxed sales of tangible personal property.
The Taxpayer takes exception to the use tax assessed on computer software license agreements. In the license agreement with ***** (Licensor), the Taxpayer is granted the right to reproduce the Licensor's computer software products on any medium and distribute it by sublicense to distributors and end users. The Licensor issues master copies of its products to the Taxpayer who uses them to reproduce copies for distribution to sublicensees obtained by the Taxpayer. Title to and ownership of all reproduced copies remains with the Licensor. Royalties accrue to the Licensor with respect to each sublicense sold by the Taxpayer to an end user. As required by the license agreement, the Taxpayer prepaid a lump-sum royalty to the Licensor. For each dollar of the royalty due upon a sublicense, one dollar is credited against the prepaid amount. When the prepaid amount is exhausted, the Taxpayer is required to remit a specific royalty to the Licensor for each sublicense granted during a given month.
The Taxpayer maintains that no payment is associated with such reproductions, nor is the Taxpayer allowed to use such reproductions. As such, the Taxpayer maintains that the royalties prepaid or subsequently paid cannot be characterized as payments made for the reproduction and use of tangible personal property. An amendment to the license agreement grants the Taxpayer the right to use the Licensor's products for internal purposes. However, the Taxpayer maintains that no specific payment was ever required for such use.
The Taxpayer also maintains that the sublicenses constitute exempt transactions as the reproduced copies are transferred to the customer electronically via modem. The Taxpayer further maintains that the sublicense royalties clearly relate to the reproduced copies of the software, not to the master copies originally provided to the Taxpayer. Even if a tangible transfer occurs, the Taxpayer maintains that the resale exemption applies to the Taxpayer's purchases and that no tax is due on the sales price since the customers are federal government agencies who qualify for an exemption on their purchases of goods.
The Taxpayer also protests the tax assessed on three other license agreements (purchased from another vendor in March 1995) in which the facts are similar to the license agreement provisions provided above. If these other license agreements are held taxable, the Taxpayer requests they be removed from the audit sample and taxed separately as was done with the license agreement with Licensor. In addition, the Taxpayer requests waiver of the penalty assessed on the use tax.
DETERMINATION
Computer Software License Agreements
Code of Virginia Sec. 58.1-602 defines ``sale' to mean ``any transfer of title or possession, or both, exchange, barter, lease or rental, conditional or otherwise, in any manner or by any means whatsoever, of tangible personal property . . . for a consideration . . . .' (Emphasis added.) Accordingly, all that is needed to constitute the ``sale' of tangible personal property is the transfer of possession of the tangible personal property to another person. Transfer of title to the tangible personal property is not required to create a sale as long as possession of the property is transferred to another person for a consideration.
In addition, a taxpayer may not make a taxable use of goods purchased for resale purposes if the resale exemption is to be maintained. See Code of Virginia Sec. 58.1-623(C), copy enclosed. When the prepayment was made by the Taxpayer, the Licensor provided the Taxpayer with master copies of all of its software products as stipulated in the license agreement. In this transaction, it is clear that these master copies were not resold but used by the Taxpayer to reproduce copies or to electronically transfer the software to its customer. Accordingly, such use was not an exempt use or retention, demonstration or display while the property was held by the Taxpayer. Rather, the Taxpayer made a taxable use of the master copies.
I would also note that the facts of this case are similar to the facts in a previous case, i.e., P.D. 93-157 (7/23/93, copy enclosed). In that case, the department held that:
Based on a review of the license agreements provided, I must conclude that the royalty prepayment obligates the Licensor to provide the master copies to the Taxpayer. Without these master copies, it is clear that the sublicense agreements cannot be consummated. As the licensing agreements at issue convey not only the right to use the master copies of the Licensor's software products, but also the tangible software itself, it is apparent that tangible master copies are critical to, and thus are the main objective of, the overall transaction.
Accordingly, I must also conclude that the transaction between the Taxpayer and the Licensor constitutes a ``retail sale' as defined under Code of Virginia Sec. 58.1-602, copy enclosed. This ruling is based on the fact that: (1) possession of the master copies transfers to the ultimate consumer, i.e., the Taxpayer, and (2) consideration passes in the form of the lump sum prepayment and subsequent payments. Based on all of the foregoing, all of the computer software license agreements at issue are taxable.
Sample
As the license agreement with Licensor was taxed separately, and for purposes of consistent treatment, I will agree to remove the three license agreements included in the audit sample and tax them separately.
Penalty
The department generally waives penalty on audit deficiencies occurring in new areas not covered by a prior audit. It appears that license agreements were not covered in the prior audit of the Taxpayer. Accordingly, I will agree to waive the penalty assessed on all license agreements included in the audit.
In addition, audit deficiencies in new areas are not included in compliance ratio computations. As the license agreements constitute a new issue, the use tax compliance ratio will be recomputed without the license agreements. If the recomputed compliance ratio meets or exceeds the minimum level of acceptable compliance, the penalty on use tax will be abated in full.
Conclusion
The audit will be revised in accordance with this determination. Upon revision, a revised audit report and a revised assessment with interest updated will be sent to the Taxpayer for the outstanding liabilities.
If you have any questions about the audit revision, please contact *****, Audit Supervisor of the department's ***** District Office, at *****, extension *****. If you have any questions regarding policy issues, please contact ***** at *****.
Dear**********
In your letter, you seek correction of the sales and use tax assessment issued to your client, ***** (the Taxpayer). I apologize for the delay in responding to your letter.
FACTS
The Taxpayer markets and distributes information technology products and services to government and commercial clients. An audit for the period January 1993 through November 1995 resulted in an assessment of use tax on untaxed purchases and sales tax on nontaxed sales of tangible personal property.
The Taxpayer takes exception to the use tax assessed on computer software license agreements. In the license agreement with ***** (Licensor), the Taxpayer is granted the right to reproduce the Licensor's computer software products on any medium and distribute it by sublicense to distributors and end users. The Licensor issues master copies of its products to the Taxpayer who uses them to reproduce copies for distribution to sublicensees obtained by the Taxpayer. Title to and ownership of all reproduced copies remains with the Licensor. Royalties accrue to the Licensor with respect to each sublicense sold by the Taxpayer to an end user. As required by the license agreement, the Taxpayer prepaid a lump-sum royalty to the Licensor. For each dollar of the royalty due upon a sublicense, one dollar is credited against the prepaid amount. When the prepaid amount is exhausted, the Taxpayer is required to remit a specific royalty to the Licensor for each sublicense granted during a given month.
The Taxpayer maintains that no payment is associated with such reproductions, nor is the Taxpayer allowed to use such reproductions. As such, the Taxpayer maintains that the royalties prepaid or subsequently paid cannot be characterized as payments made for the reproduction and use of tangible personal property. An amendment to the license agreement grants the Taxpayer the right to use the Licensor's products for internal purposes. However, the Taxpayer maintains that no specific payment was ever required for such use.
The Taxpayer also maintains that the sublicenses constitute exempt transactions as the reproduced copies are transferred to the customer electronically via modem. The Taxpayer further maintains that the sublicense royalties clearly relate to the reproduced copies of the software, not to the master copies originally provided to the Taxpayer. Even if a tangible transfer occurs, the Taxpayer maintains that the resale exemption applies to the Taxpayer's purchases and that no tax is due on the sales price since the customers are federal government agencies who qualify for an exemption on their purchases of goods.
The Taxpayer also protests the tax assessed on three other license agreements (purchased from another vendor in March 1995) in which the facts are similar to the license agreement provisions provided above. If these other license agreements are held taxable, the Taxpayer requests they be removed from the audit sample and taxed separately as was done with the license agreement with Licensor. In addition, the Taxpayer requests waiver of the penalty assessed on the use tax.
DETERMINATION
Computer Software License Agreements
Code of Virginia Sec. 58.1-602 defines ``sale' to mean ``any transfer of title or possession, or both, exchange, barter, lease or rental, conditional or otherwise, in any manner or by any means whatsoever, of tangible personal property . . . for a consideration . . . .' (Emphasis added.) Accordingly, all that is needed to constitute the ``sale' of tangible personal property is the transfer of possession of the tangible personal property to another person. Transfer of title to the tangible personal property is not required to create a sale as long as possession of the property is transferred to another person for a consideration.
In addition, a taxpayer may not make a taxable use of goods purchased for resale purposes if the resale exemption is to be maintained. See Code of Virginia Sec. 58.1-623(C), copy enclosed. When the prepayment was made by the Taxpayer, the Licensor provided the Taxpayer with master copies of all of its software products as stipulated in the license agreement. In this transaction, it is clear that these master copies were not resold but used by the Taxpayer to reproduce copies or to electronically transfer the software to its customer. Accordingly, such use was not an exempt use or retention, demonstration or display while the property was held by the Taxpayer. Rather, the Taxpayer made a taxable use of the master copies.
I would also note that the facts of this case are similar to the facts in a previous case, i.e., P.D. 93-157 (7/23/93, copy enclosed). In that case, the department held that:
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The resale exemption is inapplicable since the licensed software does not pass directly to the sublicensee; rather, it is being used by the Taxpayer to make copies. Such a transaction is analogous to a situation in which a dealer purchases photographs and makes duplicate copies of such for resale to others. In the Taxpayer's case and the example provided, both the original purchase and subsequent sales of copies are taxable. Accordingly, the license agreement was properly included in the assessment.
Based on a review of the license agreements provided, I must conclude that the royalty prepayment obligates the Licensor to provide the master copies to the Taxpayer. Without these master copies, it is clear that the sublicense agreements cannot be consummated. As the licensing agreements at issue convey not only the right to use the master copies of the Licensor's software products, but also the tangible software itself, it is apparent that tangible master copies are critical to, and thus are the main objective of, the overall transaction.
Accordingly, I must also conclude that the transaction between the Taxpayer and the Licensor constitutes a ``retail sale' as defined under Code of Virginia Sec. 58.1-602, copy enclosed. This ruling is based on the fact that: (1) possession of the master copies transfers to the ultimate consumer, i.e., the Taxpayer, and (2) consideration passes in the form of the lump sum prepayment and subsequent payments. Based on all of the foregoing, all of the computer software license agreements at issue are taxable.
Sample
As the license agreement with Licensor was taxed separately, and for purposes of consistent treatment, I will agree to remove the three license agreements included in the audit sample and tax them separately.
Penalty
The department generally waives penalty on audit deficiencies occurring in new areas not covered by a prior audit. It appears that license agreements were not covered in the prior audit of the Taxpayer. Accordingly, I will agree to waive the penalty assessed on all license agreements included in the audit.
In addition, audit deficiencies in new areas are not included in compliance ratio computations. As the license agreements constitute a new issue, the use tax compliance ratio will be recomputed without the license agreements. If the recomputed compliance ratio meets or exceeds the minimum level of acceptable compliance, the penalty on use tax will be abated in full.
Conclusion
The audit will be revised in accordance with this determination. Upon revision, a revised audit report and a revised assessment with interest updated will be sent to the Taxpayer for the outstanding liabilities.
If you have any questions about the audit revision, please contact *****, Audit Supervisor of the department's ***** District Office, at *****, extension *****. If you have any questions regarding policy issues, please contact ***** at *****.
Rulings of the Tax Commissioner