Illinois Considers Taxing Custom Software

Foobar_Zen writes "Illinois Governor Rod Blagojevich is proposing to tax custom software; he is hoping to generate $64 million. You can read the story at burrwolff.com. I am wondering if there any other states that currently tax for custom software? How is this going to affect Illinois? What does this do to independent application and software developers?" And what about software that adds value but itself is available without charge?

What exactly does "custom" mean...

[Black Rabbit]

...and who gets to define it?

this one is easy

[dhuv]

Just sell a license for a lifetime. You can just sell them licenses each time you charge for changes.

How about custom duty on software from India?

[d2k297]

I think the fed should levy custom duty on software from India

Not as bad as some proposals... taxing open-source

[shoppa]

Some proposals that have circulated in the US congress could have limited the flow of open source software across international borders and/or taxed the open-source software at some arbitrary value supposedly related to commercial packages. These proposals never got out of the press release stage, at least as far as I can see. And it was probably never worthwhile to worry about them, as very press-release level laws get any more than the most minimal attention. (OTOH RIAA press releases seem to be closely scrutinized here... and they aren't even a lawmaker or lawmaking body!)

At least the proposed Illinois tax only appears to only tax the cash that changes hands. But again, it's only at the press release level and there's no real wording that I've seen.

Consider other proposals first?

[mrtrumbe]

Yesterday, Blagojevich dismissed out of hand a casino proposal the mayor of Chicago had proposed, threatening to veto any legislation the mayor was able to get passed. He did so in part because it would "prevents us from making the hard decisions that are necessary to continue to reform the system here in Springfield and get our fiscal house in order." Basically the message was, no quick fix until the budget comes under control. Read more about it here [chicagotribune.com] ("free" registration required).

Now today, we get his quick fix plan to tax custom software! And I'm sure we'd all agree this is much better than a casino in Chicago, right? Right??

Bah! Me no like politicians.

Taft

Re:What exactly does "custom" mean...

[JJ]

...and who gets to define it?

The 'custom software' loophole has been around for years. For basics, any software which required substantial modification or creation was seen as good for programmer's jobs and as an extra expense to business, so it was given this loophole.

In short, Gov. Blag*&%$ is raising the cost of employing programmers in Illinois and making outsourcing much more profitable. Hope you didn't vote for the idiot.

tax? why?

[Anonymous Coward]

Interesting to notice that most posters are talking semantics. Have you ever considered that it is basically an illegal action to simply tax something because the government runs out of budget? Who are they anyway to tax this randomly? I think this is a more important question than simply looking at the exact definition of the word 'custom'.

Bye bye Illinois software industry

[AtariAmarok]

These people forget that if you tax an activity, it serves to discourage the activity. What this does is discourage software programming in Illinois.

Easy way out...

[alispguru]

The software is free, and copyrighted, and useless without a dongle.

The dongle costs $$$. The only "custom" software in it is the authentication key, and if they're going to tax that, they'll have to tax RFID chips too.

Any other problems?

Re:Yeah right.

[Roger Keith Barrett]

I did RTFA, and I still agree that "custom software" is too vague and might be an undefinable concept.

The problem here, once again, is that the creation of software is being defined as a corporate-only or business-only activity.

Since government can't usually see beyond their corporate buddies. This could screw up all types of non-srinkwrapped software, not just OSS but freeware and shareware as well.

Tech Support

[bigattichouse]

Well I will just have to give them the software for free, but charge them a monthly fee for potential support calls. I'll probably get a much better revenue stream that way.

Re:How about custom duty on software from India?

[WIAKywbfatw]

And this would be called free trade? Just like the free trade in steel, lumber, etc that the US repects?

Even setting aside the hypocrisy of preaching free trade then not practicing it, your custom duty may be impractical: you're forgetting that a great deal of software code written in India is written by programmers employed by American companies, so how you'd levy a custom duty on, say, a product that was coded by Indian employees of a company based in California would be interesting.

Microsoft will make sure this doesn't happen

[gozar]

Read the section:

The governor estimates a business tax increase of $64 million by eliminating the distinction between canned software sold at retail (subject to sales tax), custom software (subject to service occupation tax on the value of tangible personal property transferred with the software) and software licensed or leased by the developer (currently not taxed).

The relevant section is that software licensed or leased by the developer will now be taxed. Since Microsoft essentially leases their software under the Software Assurance plan, that means there will now be an extra tax burden on companies using Microsoft products. Microsoft will make sure that doesn't happen, because that will just be one more reason to switch to an OSS solution.

Re:Yeah right.

[cbr2702]

I think part of the idea is that currently custom software is both defined and exempt from tax (unlike prepackaged retail software) and one possibility here is that they would eliminate the distinction and take their 6.25%.

Re:Article text

[n1ywb]

I think you hit the nail on the head. This is like hammering another nail in the coffin of American computer engineering. It's the LAST thing our ailing computer industry needs right now. Even if it will indirectly benefit open source, I'd hate to see any contract programmer put out of business.

Maine Sales tax on custom software

[jimcooncat]

Maine imposes 5% tax on custom software.

From Maine Statues, Title 36, Section 1752 - Definitions

1-E. Custom computer software program. "Custom computer software program" means any computer software that is written or prepared exclusively for a particular customer. "Custom computer software program" does not include a "canned" or prewritten program that is held or exists for a general or repeated sale, lease or license, even if the program was initially developed on a custom basis or for in-house use. An existing prewritten program that has been modified to meet a particular customer's needs is a "custom computer software program" to the extent of the modification, and to the extent that the amount charged for the modification is separately stated.

------
I called the Maine Revenue Service a while back and asked them how they determined the difference between a custom computer program, writing a maintenance script, making an application macro, spreadsheet formula or adding a Windows shortcut to a client's desktop -- at what point does this become taxable?

They replied: there's no one here that can tell you, and there's no one that will be here that can call you back with the answer.

So I stopped putting "custom programming" on my invoices, and all labor is now charged as "computer maintenance". IANAL, just a tech guy trying to comply, but there's just no way to.

This just makes custom and shrink wrap the same!

[Shadowhawk]

Relax!

I RTFA'd and all it says is that they want to eliminate the difference between custom software (currently hit by a some odd tax which is probably a lower % and may be 0% in some cases) and shring wrap software (which is hit with normal sales tax).

Also, licensed or leased software (ala software as a service type things becoming common) will also have sales tax (currently is not taxed). I expect that latter change will spread quickly as "software service" business plan becomes more common.

Re:Yeah right.

[astar]

This is a state tax issue, since a Governor was proposing it.

Currently, in the state of Washington, shrink wrap software gets a sales tax, but custom does not. My old employee, TOM Software [tom-software.com] makes a complicated full-featured multi-user accounting package which pretty much requires a reseller to install it. The software is typically customized by the reseller for the end user client. TOM Software did not figure they were selling shrinkwrap, but started being taxed. They went to court, and they lost.

The court case was probably ten years ago. As I recall, they took it up to appeals court, so in this state, it is all very official. I have not read the court decision. If you are going to look it up, TOM Software was know as Northwest Source Group at the time.

Re:Article text

[Rupert]

Since almost all software sold at retail is, according to the software developers concerned, licenced or leased rather than sold, does this mean that I don't have to pay sales tax on, say, Windows XP Pro if I buy it in Illinois?

Alternatively, if I *do* pay sales tax on it, does that mean I retain all my first sale rights, including the right to transfer it? Can I stop eBay from taking down my auction when I want sell my copy of XP? Can I force Microsoft to reactivate the product key when I do sell it?

Re:Yeah right.

[JGski]

In the US, you do pay sales tax on the lease payment itself (you're buying 1 month of service or use of the vehicle).

The cashflow implications of this tax are one of the pro's of leasing: "buying" you pay all sales tax on the entire purchase price at time 0, while "leasing" you pay k/N sales tax of the entire purchase price spread over time 0 to N, where k is the ratio of residual to purchase price (typ. 0.5-0.8) and N is the number of payments, typically 36-60. The NPV of the sales tax is far less on a lease. This and other factors determine the total NPV of lease vs. buy though.