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Tax Insights
from State and Local Tax Services
Texas comptroller finds software
licensed to Texas customers created
nexus for sales and use tax purposes
November 18, 2014
In brief
In a September 19, 2014 decision released on November 5, 2014, the Texas Comptroller of Public
Accounts determined that electronically downloaded software licensed by a Utah corporation to Texas
customers constituted physical presence in Texas sufficient to establish sales and use tax nexus.
According to the decision, nexus was established because the software was characterized as tangible
personal property and the Utah corporation retained all property rights in the software, which was
physically present and generating revenue in Texas.
The Comptroller upheld an ALJ determination that the corporation had an obligation to charge and
collect use tax from customers, and denied refund claims of sales tax paid and an interest waiver.
[201409970H; SOAH Docket No. 304-13-5657.26; CPA Hearing No. 106,632, Texas Comptroller of
Public Accounts (9/19/2014)]
In detail
A Utah corporation (Petitioner)
licensed computer programs
and digital content that was
downloaded through the
internet to Texas customers.
The license agreements
provided that the licensed
products were property of and
proprietary to Petitioner.
Petitioner otherwise had no
significant contacts with Texas.
The Business Activity Research
Team (BART), part of the Tax
Division (Staff) of the Texas
Comptroller of Public Accounts
(Comptroller), conducted an
examination of Petitioner's
activities to determine whether
it had nexus with Texas and
should have collected and
reported sales and use tax on its
sales to Texas customers.
BART concluded the licensing of
software downloaded over the
internet to Texas customers
established substantial nexus
for sales and use tax purposes
because the software was
tangible personal property and
Petitioner retained title to the
software, which was physically
present and generating revenue
in Texas. During the
examination, Petitioner
submitted a Petition for
Redetermination and Statement
of Grounds requesting
redetermination and began
collecting sales tax from
customers. Petitioner then filed
refund claims that were later
denied by an administrative law
judge (ALJ). Petitioner
challenged the ALJ’s decision by
requesting a refund hearing
with the Comptroller.
Quill’s physical presence
requirement for substantial
nexus
Nexus is defined in 34 Texas
Administrative Code Section
3.286(a)(5) as meaning
"sufficient contact with or
activity within this state, as
determined by state and federal
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law, to require a person to collect and
remit sales and use tax." In Quill
Corp. v. North Dakota, 504 U.S. 298
(1992), the Supreme Court held that a
physical presence in the state is
required in order to establish
substantial nexus with the state.
purposes of applying the Supreme
Court’s bright-line test requiring
substantial physical presence.
Notably, in a footnote of the Quill
decision the Supreme Court dismissed
the existence of a few floppy diskettes
located in the state containing
software Quill licensed to its
customers as insufficient to satisfy the
substantial nexus requirement. The
Supreme Court stated that although
Quill’s title to this tangible personal
property located in Texas “might
constitute some minimal nexus, we
expressly rejected a ‘slightest
presence’ standard of constitutional
nexus. We therefore conclude that
Quill’s licensing of software in this
case does not meet the ‘substantial
nexus’ requirement of the Commerce
Clause.”
The ALJ noted that “nexus is not
automatically conferred by the
statutory characterization of a
computer program as taxable tangible
personal property. The substantial
physical presence requirement is
determined by the character of the
rights and interest Petitioner retained
in the software and digital images
downloaded by users located in
Texas.” The ALJ stated that, unlike
the floppy disks considered in Quill, it
is unclear the nature or extent of the
rights Petitioner retained or could
exercise over its software once it had
been downloaded into an electric form
by the Texas customer. Nevertheless,
the ALJ concluded that the record
established Petitioner had retained all
property rights in tangible personal
property, and “it is this reservation of
all property rights that ultimately
militates against Petitioner’s claim
that it lacks the requisite physical
presence in Texas.”
Electronically delivered software
is characterized as tangible
personal property in Texas
The ALJ analyzed whether the
licensed software and digital images
constituted tangible personal property
for sales and use tax purposes. In
Texas, electronically downloaded
software is statutorily categorized as
tangible personal property under
Texas Tax Code Sections 151.009 and
151.010. The ALJ noted that while this
characterization is not in and of itself
determinative that there is the
requisite physical presence in Texas,
what was ultimately determinative
was that Petitioner did not challenge
this characterization. Consequently,
Petitioner’s software was treated as
tangible personal property for the
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Petitioner retained property
rights in the licensed software
constituting substantial physical
presence
According to the ALJ, it was evident
from the evidence that Petitioner’s
licensed software exceeded the
‘slightest presence’ of the floppy disks
analyzed in Quill because the software
licenses “generated fees that exceeded
$***…. [that] cannot be dismissed as
not establishing a substantial physical
presence in Texas…” Consequently,
the ALJ determined that Petitioner
had established requisite substantial
nexus with Texas. The Comptroller
upheld the ALJ’s sales and use tax
determination and interest
assessment, denied the refund claims,
but waived the penalty imposed. The
Comptroller also denied that the sales
and use tax imposition would create
an undue burden.
The takeaway
In recent years, Texas has adopted
increasingly assertive positions on
software and computer servers for
sales and use tax nexus purposes.
Under 34 TAC Sec. 3.286(a)(2)(E), a
retailer that owns or uses tangible
personal property located in the state,
including a computer server or
software, is considered engaged in
business within Texas and hence may
be responsible for collecting and
remitting Texas sales and use taxes.
The Comptroller’s decision expands
the scope of Texas sales and use tax
nexus to specifically include taxpayers
retaining property rights over
software electronically delivered to
Texas customers.
The ALJ assumes that electronic
software statutorily defined as
tangible personal property for sales
tax purposes also necessarily
constitutes a ‘physical presence’ for
constitutional nexus purposes.
Further, the ALJ concluded
Petitioner’s physical presence was
substantial based on the (undisclosed)
amount of revenue generated from the
licensing agreements. Although this is
an administrative level decision and
likely subject to further proceedings,
Texas may consider companies
licensing software in any form to
Texas customers to have established
Texas sales and use tax nexus.
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Let’s talk
If you have any questions regarding this ruling please contact:
State and Local Tax Services
John M. Cooney
Partner, Houston
(713) 356-8080
[email protected]
William P. Waltman
Partner, Houston
(713) 306-9015
[email protected]
Rob Morse
Manager, New York
(646) 471-0157
[email protected]
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