Illinois Sales Tax on Software and Maintenance Agreements
Software and Maintenance Agreements
Sales of “canned” computer software are taxable as retail sales in Illinois. Sales of custom software, which is prepared to the special order of the customer, are not taxable. Computer software that is not custom software is considered to be canned software. Selection of canned programs into a software package does not constitute custom software unless substantial changes are made to the programs. Licenses of software are not considered to be taxable retail sales in certain circumstances.
Whether or not a maintenance agreement for tangible personal property is taxable depends on whether the charges for the maintenance agreement are included in the sale price of the tangible personal property. If the charges are included in the sale price, they are subject to tax but no tax is incurred on the maintenance services or parts when the repair or servicing is performed. If the maintenance agreement is sold separately, the sale of the agreement is not taxable, though maintenance or repair services or parts provided under those agreements will be deemed under the Service Occupation Tax Act to incur use tax based on the cost price of tangible personal property transferred to customers incident to the service provided.
If the terms of a maintenance agreement include a “patch” or “bug fix” in order to correct an error or defect in software or hardware, the tangible personal property transferred in order to provide this service is taxed based upon the above analysis. If the maintenance agreement includes charges for updates of canned software for new releases or improvements, charges for updates of canned software are fully taxable as sales.16 If the charges related to software updates are instead for custom software, they may not be taxable.
Labor Charges
In calculating the Retailers’ Occupation Tax, labor or service costs are not deductible from gross receipts. These costs of doing business are an element of gross receipts and are subject to tax even if separately stated on an invoice.
Transportation and Delivery Charges
In Kean v. Wal-Mart Stores, Inc., the Illinois Supreme Court addressed whether shipping charges for Internet purchases of tangible personal property were subject to sales tax in Illinois. The Court held that there was an “inseparable link” between the sale of the merchandise and its delivery.21 The Court determined that outgoing transportation and delivery charges to the customer were part of the gross receipts subject to the Retailers’ Occupation Tax.
An “inseparable link” exists, the Court said, when the transportation and delivery charges are not separately stated to the customer on the contract or invoice, or if the charges are separately identified but there is no other option for the customer to receive the property other than via delivery by the seller.23 An “inseparable link” does not exist if the personal property can be sold to the customer without the retailer providing the delivery service, and the delivery charges would therefore not be included in the selling price of the property.
The Department expanded on the Court’s decision, clarifying that when charges for transportation and delivery are stated separately, and the customer has the option to pick up the property rather than have it delivered, transportation and delivery is considered a separate service from the sale and is excluded from the gross receipts subject to the Retailers’ Occupation Tax. The Department also provided that if the customer has the option to pick up the property, the seller must maintain documentation demonstrating that option.
Illinois Sales Tax on Software and Maintenance Agreements