Illinois Provides Guidance on Computer Software Licensing Agreement Signature Requirement

Illinois’ state tax exemption for software licenses requires, among other things, that there be a signed written agreement between the vendor and the customer, which can be a difficult requirement to satisfy for downloadable software transactions.

By Tina M. Chunn, SALT Senior Manager

Determining the taxability of computer software continues to be one of the areas of state and local tax with wide variation of treatment among the states.  Often the question requires a more detailed review of the transaction to determine if it is a sale of computer software, a software license, software as a service (SaaS), whether the software is canned or customized, and its method of delivery to or accessibility by the customer.

For example, in Illinois, canned computer software is treated as tangible personal property (even if provided via download) and is taxable.  However, there is a specific exclusion for a license of software that meets the follow five-part test:[1]

• The license is evidenced by a written agreement signed by the licensor and the customer;
• The license restricts the customer’s duplication and use of the software
• The license bars the customer from licensing, sublicensing, or transferring the software to a third party (except a related party) without the permission and continued control of the licensor;
• The licensor has a policy of providing another copy at minimal or no charge if the customer loses or damages the software, or of permitting the licensee to make and keep an archival copy, and such policy is either stated in the license agreement, supported by the licensor’s books and records, or supported by a notarized statement made under penalties of perjury by the licensor; and
• The customer must destroy or return all copies of the software to the vendor at the end of the license period. This provision is deemed to be met, in the case of a perpetual license, without being set forth in the license agreement.

Of these five requirements, it is the first one that taxpayers have the most difficulty satisfying, as most online software transactions require a customer to read the online license agreement and them just click his or her acceptance of those terms and conditions.  Illinois has repeatedly ruled that such manner of acceptance does not satisfy the first requirement that the agreement be signed by the customer.

On Sept. 26, 2018, Illinois issued a private letter ruling specifically addressing the first condition regarding what constitutes a signed written agreement.[2]  The company requesting the private letter ruling provides digital enterprise security solutions by constantly monitoring, securing, authenticating and verifying as trusted all users and their various devices.  The company provides its software products and services electronically requiring the customer to sign a Subscription Order Form.  To sign the form the customer may either:

• Physically sign the Order Form (rarely occurs)
• Physically sign the Order Form and digitize the entire Order Form, including signature, by scanning and converting it to a Portable Document Format (“PDF”) file.
• Use DocuSign to sign the Order Form
• Use a competing software product to electronically sign the Order Form, or
• Digitally sign the Order Form by pasting a digital image of the signature of an authorized representative of the Customer onto the PDF Order Form file, then saving said file with the image of the signature embedded into the Order Form.

Therefore, digital signatures are always obtained on the Order Form and “click-through” or “check-the-box” signatures are not accepted.  However, the Order Form does not contain the full and complete terms of the software licensing agreement.  The full terms and conditions are contained in the T&C Agreement that is accessible by clicking a hyperlink contained on the Order Form and is not separately signed.  The Order Form states that the customer’s use of the software is subject to the T&C Agreement located at a particular website address, and the T&C Agreement states once the customer signs the Order Form, it is bound by the terms and conditions of the T&C Agreement.

Thus, there were two questions posed by the taxpayer: (1) whether the signature requirement is met via the five methods provided above and (2) where there are multiple documents that encompass the entire licensing agreement, which one of those must contain the written signature in order to satisfy the first requirement of a signed written agreement.

As to the first question, the state concluded that all of the signature methods listed above, except the fourth one, are acceptable for satisfying the signed written agreement requirement.  As to the fourth method, the state determined that it did not have sufficient information on the software products that compete with DocuSign to determine if this method also meets these requirements.

Regarding the second question, the state reviewed the use of the two documents to encompass the full software licensing contract.  It concluded that the Order Form is deemed to create the contract when signed by both the company and the customer and that the T&C Agreement serves merely as a supplementary document that is incorporated by reference into the Order Form (via the hyperlink).  Therefore, the signed Order Form and referenced T&C Agreement constitute a written agreement and meet the first requirement for exclusion of a software license from sales tax, and that a separate signature is not required on the T&C Agreement.

Aprio’s SALT team is experienced with reviewing software transactions to determine if they are subject to sales tax so that you maintain compliance with sales tax compliance obligations and do not incur unexpected liabilities and penalties.  We also provide guidance regarding alternative transactions structures and related requirements in order to achieve a more tax-favorable tax result.  We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Tina Chunn at tina.chunn@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the January 2019 SALT Newsletter.

[1] Ill. Admin. Code 86 § 130.1935(a)(1).

[2] Illinois Private Letter Ruling No. ST 18-0010-PLR, 09/26/2018.

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.