Tax Tribunal Holds Modified Software Is Nontaxable Custom Software

The Alabama Tax Tribunal recently held that modified canned software is nontaxable custom software.  In Russell County Community Hospital v. Alabama Department of Revenue ( No. S 15-1683 Ala. Tax Trib. June 13, 2016), the Tribunal ruled that the taxpayer was entitled to a refund of sales tax paid on purchases of software, where the software was  modified for its exclusive use.  The Tribunal held that these modifications created custom software that is nontaxable, rather than taxable canned software.

Russell Community Hospital originally filed a joint petition for refund of sales tax paid on software that was modified to suit its particular needs.  The Alabama Department of Revenue (“ADOR”) relied on Regulation §810-6-1-.37  in denying  the refund, stating that the purchase contained canned software that was customized and that the nontaxable customized portion was not separately stated from the taxable canned portion.  However, Chief Tax Tribunal Judge Bill Thompson stated that the ADOR’s regulation contradicts itself in its definition of custom software.  Judge Thompson relied on a previous Alabama Supreme Court decision in finding that only unmodified computer software sold to nonexempt customers over the counter is subject to sales or use tax. Therefore, based on this ruling, the purchase of any software, including pre-existing, off-the-shelf programming ( i.e. “canned software”) that contains modifications to a client’s specifications is nontaxable.

Please contact our office if you have any questions or if you feel that this ruling could apply to your business.  We would be happy to discuss any refund potential with you.