United States

Alabama: Customized Canned Software Not Subject to Sales and Use Tax

Jun 27, 2016
From KPMG TaxWatch

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The Alabama Tax Tribunal recently addressed whether software programs customized for the specific needs of a customer constituted custom software. The Department argued that the transactions were taxable because the software contained canned software and the charges for customization were not separately stated on the invoices. In 1996, the Alabama Supreme Court held that canned software is a sale of tangible personal property subject to Alabama sales and use tax. Shortly thereafter, the Alabama Department of Revenue amended its regulation on computer software to recognize the difference between taxable canned software and nontaxable custom software. The Administrative Law Judge (ALJ) determined that the Department’s regulation was contradictory.  One portion of the regulation stated that canned software integrated or customized in a unique way to the specifications of a particular customer constituted custom software. Another section of the regulation, however, provided that modifications to canned software constituted custom software only to the extent of the modification. The ALJ found nothing in Alabama statutes or case law to support the interpretation that custom software is only custom to the extent of the modification. Therefore, because the software at issue had been modified to fit the specific needs of the client, the ALJ determined that it constituted nontaxable custom software. Interestingly, in a very long footnote the ALJ discussed the difficulties in attempting to distinguish between custom and canned software and stated that he agreed with the principle that both canned and customized software should be taxable. Please contact Scott Jackson at 404-618-8688 with questions on Russell Cty. Cmty. Hosp. v. Dep't of Revenue. 

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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.