​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​Taxability of Canned Computer Software, Digital Goods, and Related Services​​

Background​

Softw​are vendors often sell canned computer software directly to the consumer, which is delivered on tangible media, electronically, digitally, streamed, or accessed through a software-as-a-service agreement (SaaS). A vendor may offer services in conjunction with the sale of canned computer software, such ​as:

• software or hardware system design; 
• architecture or project management; 
• configuration services; 
• data conversion or processing; 
• modification to the canned software; 
• testing; 
• installation or implementation; 
• programming needed to make the canned software functional for the purchaser; 
• preparing manuals; 
• providing training.
  

Statement of Law

​The Tax Reform Code of 1971 provides that a sale at retail includes:

Any transfer, for a consideration, of the ownership, custody or possession of tangible personal property, including the grant of a license to use or consume whether such transfer be absolute or conditional and by whatsoever means the same shall have been effected.

72 P.S. § 7201(k)(1). In addition, the definition includes:

The rendition for a consideration of the service of repairing, altering, mending, pressing, fitting, dyeing, laundering, drycleaning or cleaning tangible personal property other than wearing apparel or shoes, or applying or installing tangible personal property as a repair or replacement part of other tangible personal property except wearing apparel or shoes for a consideration, whether or not the services are performed directly or by any means other than by coin-operated self-service laundry equipment for wearing apparel or household goods and whether or not any tangible personal property is transferred in conjunction therewith, except such services as are rendered in the construction, reconstruction, remodeling, repair or maintenance of real estate: Provided, however, That this subclause shall not be deemed to impose tax upon such services in the preparation for sale of new items which are excluded from the tax under clause (26) of section 204, or upon diaper service.

72 P.S. § 7201(k)(4). The Tax Reform Code defines purchase price to include:

The total value of anything paid or delivered, or promised to be paid or delivered, whether it be money or otherwise, in complete performance of a sale at retail or purchase at retail as herein defined, without any deduction on account of the cost or value of the property sold, cost or value of transportation, cost or value of labor or service, interest or discount paid or allowed after the sale is consummated, any other taxes imposed by the Commonwealth of Pennsylvania or any other expense, except that there shall be excluded any gratuity or any separately stated deposit charge for returnable containers.

​72 ​P.S. §​ 720​​1(g)(1) (emphasis added). Further, the Tax Reform Code defines, use to ​be:

The exercise of any right or power incidental to the ownership, custody or possession of tangible personal property and shall include, but not be limited to transportation, storage or consumption.

72 P.S. § 7201(o)(1)

Act 84 of 2016 amended the Tax Reform Code to include the following in the definition of tangible personal property at 72 P.S. § 7201(m)(2)(i-x):

The term shall include the following, whether electronically or digitally delivered, streamed or accessed and whether purchased singly, by subscription or in any other manner, including maintenance and updates:

• video;
• photographs;
• books;
• any other otherwise taxable printed matter;
• applications, commonly known as apps;
• games;
• music;
• any other audio, including satellite radio service;
• canned software, notwithstanding the function performed, including support, except separately invoiced help desk or call center support; or
• any other otherwise taxable tangible personal property electronically or digitally delivered, streamed, or accessed.

Id. The Department of Revenue’s regulations state the following services performed on tangible personal property are taxable whether tangible personal property is transferred or not:

1. Repairing, altering, mending, pressing, fitting, dyeing, laundering, drycleaning or cleaning tangible personal property other than clothing or footwear. Effective July 1, 1971, charges for repairing, altering, mending, pressing, fitting, dyeing, laundering, drycleaning or cleaning clothing or footwear are exempt from tax. For example, if a bookcase is taken to a carpenter to have a defective shelf repaired, the charge for the repair is subject to tax. However, if a shoe is taken to a shoe repairperson to have a heel fixed, the charge for the repair is not subject to tax.
2. Applying or installing tangible personal property as a repair or replacement part of other tangible personal property. For example, if a garage employee replaces a tire on an automobile with a new one, the installation charge plus the price of the new tire is subject to tax. If the garage employee merely replaces the old tire with a spare belonging to the car owner, the installation charge is nevertheless subject to tax.
3. Labor or services billed by the vendor for delivering, installing or applying tangible personal property sold by the vendor even if the services are contracted for separately.  

61 Pa. Code § 31.5(a)​

Conclusion

Canned computer software, by definition and long-standing case law, is tangible personal property. 72 P.S. §7201(m); Dechert LLP v. Commonwealth, 998 A.2d 575 (Pa. 2010); Graham Packaging Company, LP v. Commonwealth, 882 A.2d 1076 (Pa. Cmwlth. 2005). The taxable portion of purchase price includes the total paid in complete performance of the sale at retail. A vendor is not allowed to exclude the cost of labor or service from the purchase price of a sale at retail of tangible personal property. 72 P.S. § 7201(k); 61 Pa. Code § 33.2. For example, if the labor or service is necessary for the tangible personal property to function as required, then it is included in the taxable purchase price as it is required to complete the sale at retail. See Downs Racing, LP v. Commonwealth, 196 A.3d 603 (Pa. 2018).

As the Tax Reform Code taxes repairing, altering, mending, pressing, fitting, dyeing, laundering, drycleaning or cleaning tangible personal property, any charges for modifying or configuring canned computer software is taxable as the alteration of tangible personal property regardless of whether such modification or configuration is performed in conjunction with the sale of canned computer software or not.

The sale of custom software and any related services to custom software is not subject to sales tax. Custom software is designed, created and developed for and to the specifications of an original purchaser. The original purchaser is the first person for whom the custom software was designed, created, and developed, and to whom it was transferred in a sale at retail.

​Examples

The following are examples that apply the principles and concepts explained above. However, please note that they are examples. Each sale at retail must be evaluated to determine the taxable purchase price for each separately stated item. A sale at retail does not become taxable or not taxable because a certain word or phrase is used or because it is artificially structured, e.g., a sale at retail of canned software is not nontaxable just because it is labeled as a service. The form of the transaction does not override the substance nor reality. “[T]ax law deals in economic realities, not legal abstractions.” Greenwood Gaming & Entertainment, Inc. v. Commonwealth, 263 A.3d 611, 623 (Pa. 2021) (Saylor, J., concurring) (quoting PPL Corp. v. Comm’r of Internal Revenue, 569 U.S. 329, 340 (2013)). See also Golden Triangle Broadcasting, Inc. v. City of Pittsburgh, 397 A.2d 1147, 1151 (Pa. 1979) (economic realities should not be ignored when determining tax liability) (citing Commonwealth v. Arrot Mills Co., 22 A. 243, 243 (Pa. 1891)) (“the corporation must be measured not by what it calls itself, but what it does”).

When evaluating a sale at retail, the Department of Revenue will consider the details of the transaction. In addition to reviewing the invoice, other documents such as a contract, purchase order, and statements of work may be consulted for relevant information. If a purchase contains taxable and nontaxable components, the records must be sufficiently detailed to reflect which portions are nontaxable. 72 P.S. § 7271; Downs Racing, 196 A.3d at 611. In determining whether a charge is part of the otherwise taxable purchase price, among other things, consideration is given to whether there are separate agreements, the timing of the various agreements, whether the charge is for an item that is necessary for the tangible personal property to function, and whether the decision to incur the charge was dependent upon events occurring after the initial purchase. Id. at 612-13. That determination will be made in consideration of the broad definitions of “purchase price” and “sale at retail.” 72 P.S. § 7201.​