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Alabama DOR to Update Software Regs After Court Decision

Posted on June 26, 2019

The Alabama Department of Revenue is reviewing its administrative rules to ensure that they are consistent with a recent state supreme court decision regarding the taxability of software.

The Alabama Supreme Court ruled May 17 in Ex parte Russell County Community Hospital LLC that all computer software is tangible personal property and subject to sales tax, finding that there was no distinction between pre-written (“canned”) computer software and customized software. But the court also held that some services that accompany software may be nontaxable if separately stated.

In a June 19 release, the DOR said it is reviewing and will update its administrative rules “to ensure that the terminology used to demonstrate” the distinction between software transactions and separately stated or invoiced services that accompany software is consistent with the court’s decision.

The DOR said the court’s decision “is consistent with the department’s long-stated administrative stance that software transactions are taxable, but separately stated or invoiced services that may attend the conveyance of software are not subject to the state’s sales or use tax.”

The hospital in the case filed a refund request for sales tax it paid for computer software and accompanying equipment, arguing that the software was exempt custom software programming under Ala. Admin. Code Reg. 810-6-1-.37(5), but the DOR denied the request.

Though the Alabama Tax Tribunal found in favor of the hospital, both the circuit court and the Alabama Court of Civil Appeals agreed with the DOR that the software at issue was taxable.

The state high court said in its main opinion that nontaxable services such as designing and programming new software for a particular user can accompany the transfer of software if the costs of the services are separately stated and invoiced, but that “charges for the software itself trigger the imposition of sales tax at the time the sale closes and the software is transferred to the purchaser.”

Blake Madison of Rosen Harwood LLP told Tax Notes June 24 that the majority of justices concurred in the holding that the hospital was not entitled to the refund of sales taxes on the purchase of computer software, but only two actually participated in the main opinion that all software is subject to Alabama’s sales tax. The court also made it clear that charges for certain services are nontaxable if separately stated and invoiced, Madison said.

Madison continued that exactly how the DOR will alter its longstanding regulation on the issue in light of the court’s decision remains to be see, adding that people should “stay tuned for more on this in the coming months.”

Bruce Ely of Bradley Arant Boult Cummings LLP told Tax Notes June 20 that “the notice attempts to downplay the significance of the Supreme Court ruling and it seems to imply that the department will apply the ruling retroactively.” Ely represented Medhost, the seller of the computer software in the case, which was voluntarily dismissed from the case before the trial in the circuit court.

Ely said he has urged the commissioner’s office to issue a notice confirming that the ruling will be applied prospectively only, calling it “only fair.”

Ely continued that taxpayers need guidance on how to allocate the contract price between the software and related nontaxable services.

“Although four justices remarked that the Alabama Legislature is in a better position [to clarify the taxability of software], I think the department can fill in most of those gaps,” Ely added. “And they need to do that very soon.”

DOR spokesman Frank Miles told Tax Notes June 21 that the DOR would be “making technical updates to its rule number 810-6-1-.37.”

“Taxpayers will be able to engage with the department in the course of the rulemaking process," Miles continued. He added that taxpayers with questions about the process or the impact of the court’s decision should contact Kelley Gillikin in the Tax Policy and Governmental Affairs Division.

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