Alabama: Canned and Custom Software is Taxable Tangible Personal Property

The Alabama Supreme Court recently held that Alabama sales and use tax law does not distinguish between canned and custom software for purposes of taxability. The taxpayer, an operator of hospitals, purchased computer software and equipment from a third-party vendor. After the purchase, the software provider performed a custom implementation and configuration for the taxpayer. The taxpayer later petitioned the Alabama Department of Revenue for a refund of the sales tax paid, arguing that the purchase constituted nontaxable custom software. Under the Department’s regulations, custom software programming is not taxable regardless of the manner in which output is transferred to customers. After the Department denied the taxpayer’s refund, the matter eventually made its way to the state’s highest court.

Affirming the court of appeals decision in favor of the Department, the court held that “all software, including custom software created for a particular user, is ‘tangible personal property’ for purposes of Alabama sales tax.”  However, the court noted that transactions involving sales of software may also include the provision of nontaxable services, such as modifying or configuring existing software to meet a particular user’s needs. If the costs of these related services are separately stated and invoiced, they will be nontaxable. “The pertinent distinction is how the transaction is documented and invoiced, and that is left strictly in the hands of the seller and purchaser.” With respect to the transaction at issue, when the third-party vendor “implemented” the software so that it would operate effectively in the hospitals, it was providing nontaxable services and appropriately no sales tax was collected on the separately stated implementation services. However, in the court’s view, the taxpayer was not entitled to a refund of the sales tax paid on the software itself.

Please contact Scott Jackson at (404) 614-8688 with questions on Ex Parte Russell County Community Hospital, LLC d/b/a Jack Hughston Memorial Hospital v. State Department of Revenue.