[CLUE-Talk] SR-7 - Special Regulation of Computer Software

[Jeffery Cann]

Finally, I found the proposed changes to SR-7.  This was written by the
Colorado Department of Revenue, a part of the Executive branch.

On this page are all of the proposed changes.  You have to scroll down to find
the text for SR-7 --
http://www.revenue.state.co.us/TPS_dir/PropRegsNotice1101.html

Incidently, this is why this proposal caught everyone off-guard.  It is
combined will all of the other proposals for all laws related to 
"INCOME, SALES AND USE TAX REGULATIONS"

Jeff

Full text follows
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SR 7 COMPUTER SOFTWARE

The internalized instruction code which controls the basic operations (i.e.,
arithmetic and logic) of the computer causing it to execute instructions
contained in system programs, is an integral part of the computer. It is not
normally accessible or modifiable by the user. Such internal code systems are
considered part of the hardware and are taxable. The fact that the vendor does
or does not charge separately for it is immaterial.

A software program is one in which instructions and routines (programs,
modules, etc.) are determined necessary to program the customer's electronic
data processing (EDP) equipment to enable the customer to accomplish specific
functions with his EDP system. For the purposes of this regulation and the
Colorado sales tax, the license of a computer program for use on a computer
leased or owned and controlled by the licensee is equivalent to the sale of a
computer program or software.

A software program used under the grant of a nonexclusive license to use the
software is tangible personal property that may be eligible for federal
investment tax credit (ITC) as ITC existed prior to 1986. Therefore, the cost
of such software is eligible for sales tax exemption when it is a necessary and
required component of manufacturing machinery, C.R.S. 39-26-114(11). (Norwest
Corporation and Subsidiaries v Commissioner, U.S. Tax Court Docket 13908-92,
April 30, 1997, 108 TC 358 No 18. Sprint Corporation and Subsidiaries, F.K.A.
United Telecommunications v. Commissioner U.S. Tax Court Docket 13159-94, April
30, 1997, 108 TC 384, No. 19; (CCH dec. 52,015 and 52,016.)

The software may be in the form of:

Systems programs (except for the instruction codes which are considered
tangible property in paragraph 1 above) - programs that control the hardware
itself and allow it to compile, assemble and process application programs. 
Applications program - programs that are created to perform business functions,
or control, or monitor processes. 
And either type of program may be:

Pre-written programs (canned) - programs that are either systems programs or
application programs and are not written specifically for the user. The
transaction for these programs is frequently labeled a license to use. The
license to use is a taxable sale. Charges for installation of such software on
to a computer owned by the licensee, or charges made for labor hours creating
user specific applications from the licensed software are services and not
subject to sales tax. If the services are performed on a computer that is sold
to the licensee, before or immediately after the installation, the services are
taxable, as the buyer’s true object is the purchase of a operational computer
and software. 

Custom programs - programs created specifically for the user. These programs
are frequently created for the user to own, in other cases they are provided to
the user under an agreement specifying an exclusive license to the user (but a
non-exclusive license would indicate a canned, generic program). The buyer is
obtaining the programming labor and the software is created as a result of the
labor and services performed. Modifications to an existing prewritten program
to meet the customer’s needs is custom programming only to the extent of the
value of the labor and services which make the modifications and changes.
Custom, user specific program labor or services are sales tax exempt when one
of the following elements is also present: 

(a) Preparation or selection of the program for the customer's use requires an
analysis of the customer's requirements by the vendor, and when separately
billed as an independent consulting charge, this charge is a service, or

(b) The program requires adaptation, by the vendor, to be used in a specific
device. For example, a software vendor offers for sale a pre-written sort
program which can be used in several computer models. The source code of the
program is standardized and not changed, and that program is tangible personal
property. Prior to operation, custom instructions unique to the customer must
be added by the vendor which optimize to the particular operating system and
the capacities of the computer model in which the program will be utilized.
Those custom changes are services. A software routine built into the program
which performs this same computer environment analysis automatically
(programatically) during installation is merely a part of a canned program’s
"custom installation" and the software routine used in the installation is
canned and tangible personal property.

Custom software is tangible property, and if resold by the original buyer is a
commodity and subject to sales tax. However the true object of a customer for
custom software programming is the programming service, the program software is
the means of transferring the ideas that the customer desires to develop.
Therefore custom software contracts are contracts where the true object is a
service of creating new, original intellectual property which is owned by the
buyer/user. Software or programs which do not meet the criteria of being
created as a service are subject to tax as acquisition of tangible personal
property.

The tangible personal property that is transferred to the customer in
connection with an exempt service is subject to payment of the tax on the
tangible personal property at the time the tangible personal property is
acquired.

A company that leases a computer with exempt custom software and does not
segregate in its billing the charge for the software lease is subject to tax on
the entire charge.

A software retailer or supplier that sells prepackaged programs for use with
computer equipment, when such programs are fully usable by the customers, is
considered to be a vendor of tangible personal property and subject to sales
tax on the purchase price of such property.

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