State and Local Tax Services
California Sales & Use Tax: How to Minimize Sales Tax on Computer Software and Related Products & Services
By Christina Edson and Alex Tran, State and Local Tax Group
The application of sales & use tax to sales of computer software and related products and services (e.g. installation, training, maintenance agreements) is complex in many states including California. If you are a seller or purchaser of software products and related services you should be aware that California has intricate laws regarding their taxability, some of which are discussed below.
In California, the sale of canned (prewritten) computer software is subject to sales tax. However, California does not tax software if it is not delivered in a tangible medium (i.e. via electronic/digital download, or where a seller does a “load and leave” by installing the software but not giving the purchaser a CD or any other tangible items to retain (e.g. training manuals). Therefore, buyers and sellers of computer software could avoid California sales and use tax simply by downloading electronically the original software and all subsequent software updates, training manuals, etc.
While the taxation of software in California is fairly straight forward, taxpayers frequently misconstrue how to apply sales and use taxes to the related products and services (i.e. maintenance agreements, upgrades/updates, support, training, and manuals) that are delivered after the original sale of software. The taxability of these products and services depends on how the original software was delivered as well as whether or not they were a mandatory part of the original sale or was otherwise included without any additional charge.
For example, if the original software is sold in a CD-ROM format and all ensuing software updates and manuals are delivered only via the internet, the charges for the updates and manuals would all be taxable despite the digitized method of delivery because the original software was delivered in a taxable manner. However, under the same scenario, if the original software is instead delivered via the internet only, all ensuing updates and manuals would be exempt (providing they are delivered electronically and not in a tangible form).
However, unlike California, most states do not link the taxability of the original sale of software with the ensuing updates and other related services. For example, a purchaser of software in another state that exempts downloaded software would typically not pay sales or use tax on the software updates even though the original software purchased was delivered via a CD-ROM.
Under California law, optional maintenance contracts, assuming they are separately purchased from original software sale, are taxed based on the method of delivery. If no tangible personal property is delivered with the sale of these products and services, then no sales tax applies. If tangible personal property is provided with the transaction, then only 50% of the maintenance contract is subject to sales tax.
Companies should evaluate whether or not they are correctly applying these California laws in their sales/purchases of computer software and related products and services. Often times, sellers of these products will apply sales tax across all of their products and services due to a misunderstanding of the intricacies of California’s complex sales and use tax laws. Companies should investigate whether or not it is feasible to restructure their sales invoices and/or their method of delivery to mitigate California sales and use tax.
For questions, please contact Christina Edson at 858-627-1475.
