Laws, Regulations & Annotations
Business Taxes Law Guide – Revision 2017
Sales and Use Tax Annotations
120.0000 AUTOMATIC DATA PROCESSING SERVICES AND EQUIPMENT—Regulation 1502
(a) IN GENERAL
120.0350 Optional Maintenance Contract—Equipment and Software. A taxpayer is a manufacturer of industrial equipment used in the production of tangible personal property. One of the component parts of the equipment is a computer that provides necessary automation for the equipment. The computer is integrated into the overall system and is not used for any other purpose. The software controls the computer that in turn controls the equipment. The software was developed specifically for use with the system (equipment) and is not useful on any other equipment. The computer and related software are not major components of the equipment and account for less than 10% of the equipment's cost.
After the expiration of the standard equipment warranty provided to customers at the time of purchase, customers have the option to enter into a lump-sum service agreement with the taxpayer. Under the agreement, the taxpayer is required to perform various preventative and remedial maintenance procedures on the equipment. Required materials are provided on a no-charge basis. In addition, the taxpayer will furnish and install software updates as they are released by the taxpayer for equipment covered by a service agreement at no additional charge to the customer.
The taxpayer has been accruing use tax on the cost of materials furnished under the optional service agreements. At issue is the application of tax to the portions of the service agreement attributable to the software.
Regulation 1502(f)(1)(C) provides that an optional maintenance agreement that contemplates the providing of program updates on storage media is regarded as a contract for the sale of tangible personal property. Tax applies to the sale or use of such maintenance agreements inside this state. Under these facts, the service agreement is regarded as both an optional maintenance agreement of the equipment as well as an optional maintenance agreement for the software. As such, tax applies to the portion of the lump-sum service agreement that represents the charge for the optional software maintenance. The taxpayer should report and pay tax to the Board measured by the amount allocated to the software maintenance portion of the lump-sum charge for the service agreement. 5/29/96. (Am. 2004–2).
(Note: Regulation 1502 was amended so that beginning January 1, 2003, 50 percent of the charge for optional software maintenance agreements is subject to tax. Prior to that date, generally 100 percent of the charge was subject to tax.)