United States: Texas Comptroller Finds Sales Tax Nexus Through Software Licenses

The Texas Comptroller has affirmed an Administrative Law Judge (ALJ) decision that a software company is required to collect and remit sales and use tax on its sales of software licenses to Texas customers.1 The ALJ found that the presence of software in Texas constituted nexus because the company owned tangible personal property in Texas (although the software was licensed to other entities in Texas). The ALJ then determined that the nexus was substantial because of the amount of fees generated by the tangible personal property in the state.


The taxpayer, a Utah corporation that sold computer programs and digital content primarily through the Internet, also delivered products via common carrier, such as the U.S. Postal Service. During the relevant period, the taxpayer sold multiple software products to customers in Texas, but did not have employees or an office in the state. The taxpayer's employees had been in the state twice since 2002 for educational conferences, but they did not solicit orders while in Texas.

Computer programs generally were not purchased by customers, but were licensed to the customers so that they had a limited right to use the program or content on a limited number of computers. Thus, the purchase and use of the taxpayer's products were governed by license agreements. All of the agreements provided that the licensed products remained the property of and proprietary to the taxpayer. Also, most of the agreements explicitly provided that the taxpayer retained all rights in, title to, and ownership of the licensed products.

Under Texas law, an out-of-state retailer who is engaged in business in Texas and who makes a sale of a taxable item for storage, use, or consumption in Texas is required to collect use tax from the purchaser.2 The scope of being engaged in business in Texas is fairly broad and includes the following catchall phrase: "otherwise [doing] business in this state."3

The Comptroller reasoned that because the software is tangible personal property under Texas law,4 the taxpayer's tangible personal property was physically present in the state, and the taxpayer had derived receipts from the property, that the taxpayer had substantial nexus with Texas.5 Because of the substantial nexus, the taxpayer had the obligation to collect use tax from its Texas customers. Subsequently, the Comptroller found that the taxpayer had failed to collect tax on its sales in Texas and assessed taxes, penalties and accrued interest for the period from January 1, 2002 through June 30, 2010. After this assessment, the taxpayer began collecting tax. The taxpayer brought this action seeking a waiver of the penalties and a refund for taxes remitted after June 30, 2010. According to the taxpayer, it was not required to collect tax because it did not have substantial nexus with Texas.

Taxpayer Had Substantial Nexus

The ALJ used the Complete Auto test to determine the validity of the Comptroller's assessment.6 Under this test, a tax will be sustained against a Commerce Clause challenge so long as the tax "is applied to an activity with a substantial nexus with the taxing state, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the state."7 The ALJ quickly dismissed the last three prongs of the test by explaining that "it is well settled that the Texas use tax is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the state." Therefore, the remaining issue in the case was whether the taxpayer had substantial nexus with Texas.

The ALJ did not find that the employees' conference attendance was a possible source of nexus because they were present in Texas only to learn about developments in the industry. However, the ALJ found that the taxpayer did have nexus with Texas because it had tangible personal property in the state. Software is tangible personal property for sales tax purposes in Texas.8 The software still belonged to the taxpayer because the license agreements explicitly provided that the software remained the taxpayer's property after sale and download.

Nexus must be substantial for the state to have the authority to impose a tax. The ALJ looked to Quill Corp. v. North Dakota in the nexus analysis.9 In Quill, the taxpayer had title to floppy diskettes in the state, but there were so few that the U.S. Supreme Court refused to find substantial nexus. The ALJ in this case found that the fees generated from Texas licenses were large enough to establish substantial nexus. The decision redacted the fee amounts, so it is unknown what dollar amount the ALJ (and by affirming the decision, the Comptroller) believes constitutes "substantial."

The ALJ agreed with the Comptroller except for the Comptroller's characterization of the licensing of software as a lease. The ALJ explained that in order to be a lease for tax purposes, a party must have exclusive possession and control, but not title to, the property.10 However, the fact that the taxpayer's customers had non-exclusive licenses to use the property meant that they were not leasing the property. The ALJ did not recategorize the property – it only noted that the software would be classified as tangible personal property. There was no subsequent discussion, for example, if the transactions remained subject to sales/use tax as "a transfer of title or possession of tangible personal property"11 rather than as "the exchange, barter, lease, or rental of tangible personal property."12 The ALJ focused his analysis solely on the nexus issue at hand.

Apparently, the taxpayer did not challenge the statutory characterization of software as tangible personal property, and such statute does not make any distinction in characterization between software downloaded electronically or delivered in a physical media form (e.g., disk).13

In summary, the ALJ found that the taxpayer had physical presence in Texas to a degree that constituted substantial nexus. Following a finding that the taxpayer was not entitled to insolvency relief or an interest waiver, the ALJ recommended that the assessments be affirmed and no refund be issued. The Texas Comptroller agreed with the ALJ, making this hearing decision consistent with long-standing Comptroller policy.14


This decision has potentially far-reaching consequences assuming that it is not appealed and reversed in the judicial process. To be in line with the Comptroller's policy, out-ofstate companies who license software in Texas must collect use tax. As it is common to use licenses instead of selling the software outright, many companies are required to collect use tax.

One problem with relying on this decision in the future is that the amount of fees generated by the licenses was not disclosed by the ALJ, just that nexus was substantial in this instance. Based on Quill, it is clear that some presence does not automatically mean the presence is substantial. However, after this decision, it is unclear what amount of receipts the Comptroller deems to be substantial prior to a finding of substantial nexus.

Importantly, this decision is not binding on Texas courts. While this decision represents the Comptroller's current policy going back at least to a prior hearing decision from 1998,15 this issue of software licenses creating nexus does not appear to have been challenged in court. Perhaps the taxpayer in this case or other similarly situated software company will choose to take this matter to the state district court.

Finally, while computer software is considered to be tangible personal property for sales tax purposes in Texas, such classification does not necessarily carry over for other Texas taxes.16 Computer software may be treated, for example, as tangible personal property for Revised Texas Franchise Tax (RTFT) cost of goods sold deduction purposes,17 as an intangible asset for RTFT apportionment purposes18 and as intangible personal property for Texas property tax purposes.19 Each of these classifications presents potential opportunities to taxpayers as well as traps for the unwary.


1 Decision, Hearing Nos. 106,632, 108,626, Texas Comptroller of Public Accounts, Sept. 19, 2014 (released Nov. 2014). Note that Texas has a unique system for contested tax cases. The Texas Comptroller can refer a contested case to the State Office of Administrative Hearings (SOAH). ALJs from the SOAH conduct administrative hearings and then prepare a Proposal for Decision (PFD) regarding the contested case. The Comptroller then decides whether to accept or reject (in whole or in part) the PFD. If the taxpayer disagrees with the Comptroller's decision, the case may be appealed to the state district court.

2 TEX. TAX CODE ANN. § 151.103(a).

3 TEX. TAX CODE ANN. § 151.107(a).

4 TEX. TAX CODE ANN. § 151.009. The statute provides that "'[t]angible personal property' means personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to the senses in any other manner, and, for the purposes of this chapter, the term includes a computer program and a telephone prepaid calling card." (Emphasis added.)

5 This reasoning is further bolstered by 34 TEX. ADMIN. CODE § 3.286(a)(2), which provides "a person is engaged in business in Texas if the person has nexus with the state as evidenced by ... [deriving] receipts from a rental or lease of tangible personal property that is located in this state or [owning] or [using] tangible personal property that is located in this state, including a computer server or software."

6 Complete Auto Transit v. Brady, 430 U.S. 274 (1977).

7 Id.

8 TEX. TAX CODE ANN. § 151.009.

9 504 U.S. 298 (1992).

10 34 TEX. ADMIN CODE § 3.294.

11 TEX. TAX CODE ANN. § 151.005(1).

12 TEX. TAX CODE ANN. § 151.005(2).

13 TEX. TAX CODE ANN. § 151.009.

14 There are numerous prior hearing decisions holding that licensing tangible personal property and deriving receipts from the licenses creates nexus in Texas. For example, see Decision, Hearing No. 36,237, Texas Comptroller of Public Accounts, July 21, 1998.

15 Decision, Hearing No. 36,237, Texas Comptroller of Public Accounts, July 21, 1998.

16 TEX. TAX CODE ANN. § 151.009.

17 TEX. TAX CODE ANN. § 171.1012(a)(3)(A)(iii).

18 34 TEX. ADMIN. CODE § 3.591(e)(3).

19 TEX. TAX CODE ANN. § 1.04(6).

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