Illinois – Taxability of Licensed Software

SALT Report 2730 – The Illinois Department of Revenue issued a general information letter regarding the application of Retailers’ Occupation Tax to sales of canned software. In this case, the Taxpayer states that its software sales are on a license basis only, and therefore are governed by the terms of Illinois Department of Revenue Code 130.1935.

Specifically, the Taxpayer states that the software it sells is licensed between the software publisher and the Taxpayer’s customers.  Therefore, because the Taxpayer is not a party to the agreement it charges its customers sales tax.  However, several customers have indicated that they believe they should not be charged sales tax because they have a licensing agreement with the software publishing company.

Because of this, the Taxpayer requested a ruling to clarify whether “sales by a reseller of software who is not the licensor are exempt from sales tax; or whether it is obligated to charge sales tax.”

In its response, the Department stated that in Illinois sales of canned computer software are taxable retail sales.  Additionally, canned computer software is considered tangible personal property regardless of whether it is transferred by tape, disc, card, electronic means, or other media.

However, in some cases computer software may not be a taxable retail sale under 86 Ill. Adm. Code 130.1935.  For example, under subsection (a)(1) of Section 130.1935 neither the transfer, update, or license of software is taxable if it meets the following requirements:

  • There is a written agreement signed by the licensor and the customer,
  • The agreement restricts the customer’s duplication and use of the software,
  • The agreement prohibits the customer from licensing, sublicensing or transferring the software to an unrelated third party without the permission and continued control of the licensor,
  • The licensor will provide another copy at minimal or no charge if the customer loses or damages the software, or allows the licensee to make an archival copy.  This provision must be stated in the license agreement, and supported by the licensor’s books and records, or supported by a notarized statement, and
  • The customer is required to destroy or return all copies of the software to the licensor at the end of the licensing period. In the case of a perpetual license, this provision is not required to be in the license agreement.

Based on the criteria above, the Department stated that because the licensing agreement between the software publishing company and the Taxpayer’s customers meet the requirements of Section 130.1935(a)(1), neither the transfer of software by the Taxpayer to its customers nor the subsequent software updates are subject to Retailers’ Occupation Tax. However, the Taxpayer must obtain a copy of the signed licensing agreement from each of its customers to document the exempt sales.

For Further Information

Illinois Department of Revenue – General Information Letter ST 13-0032-GIL