Sales tax on the purchase of computer hardware, software and maintenance agreementsThe definition of custom computer software for purposes of the State sales and use tax was changed by the 1997 session of the General Assembly. This change was made effective for purchases made or after October 1, 1997. The effect of this law was to make it more difficult to exempt software purchases from sales tax thereby making it more expensive to acquire the product.
The sale of computer hardware is taxable as a sale of tangible personal property. This term includes computer software delivered on a storage medium such as a CD-ROM, disk or tape. Basic operating programs are subject to the sales and use tax.
Custom computer software is exempt from sales and use tax. "Custom software" means software written in accordance with the specifications of a specific customer, including a user manual or other documentation that accompanies the sale of the software. Canned software that has its source code modified will meet the definition of custom software, depending on the timing of the transaction.
The sales and use tax is a transaction tax and any modification to the software?s source code must occur prior to the sale or exchange in order to be exempt from sales and use tax. There is no percentage amount specified in the law for the amount of source code that must be changed in order to be exempt from tax. Therefore, any change to source code prior to the sale or exchange will exempt the transaction from the sales and use tax. The term source code does not include changes to configure hardware.
There is no prohibition in the law that prevents a transaction from being structured to avoid sales and use tax. If the vendor is engaged to modify the software after the sale, he could also be engaged to modify prior to the sale, thus exempting the sale from sales tax.
Canned Computer software is prewritten software that can be installed and executed with no changes to the software?s source code other than changes made to configure hardware or software. Canned computer software is subject to the sales and use tax.
Access Charges are separately stated charges for access to a computer program or database and are exempt from the sales and use tax.
Sale or Lease of Computer Hardware:
Optional computer maintenance agreement is one that the purchaser is not required to purchase from the seller or lessor and he is free to contract with whomever he chooses. Optional computer maintenance agreements providing for the furnishing of parts, labor, and materials to maintain hardware are not subject to sale and use tax. The repairer and not the customer must pay tax on the parts used to repair the hardware. If the repairer bills the customer for parts not included in the maintenance agreement, then the repairer must collect the tax from the customer and remit to Revenue.
Mandatory computer maintenance agreement is one the purchaser is required to buy as a condition of the sale or lease of the hardware. Mandatory computer maintenance agreements are subject to the sales and use tax. It does not matter if the maintenance agreement is a separate agreement or part of sale or lease of the hardware.
Sale or Lease of Computer Software:
Optional software maintenance agreement that provides only for the maintenance of the software being sold, leased or licensed is a sale of service and is not subject to the sales and use tax. The agreement may include support services such as consultants. The seller is liable for sales tax on the price of any software enhancement or update used in fulfilling the maintenance agreement.
Mandatory software maintenance agreements are subject to sales and use tax, even if the charge for the maintenance agreement is separately stated on the invoice.
Manufacturer's Warranty is an explicit warranty the manufacturer extends to the purchaser as part of the purchase price of the new property. If the manufacturer uses a part to make a repair under a manufacturer?s warranty contract and the customer is not charged for the part, then the customer is not liable for the sales and use tax. Warranty deductibles also are not subject to the sales and use tax.
Dealer's Warranty (a contract that extends beyond the manufacturer?s warranty period) is not subject to tax, but the dealer must pay sales and use tax on parts used in fulfilling the warranty contract. When the part is given without cost to the customer, the dealer must pay tax when it is withdrawn from inventory.