Texas Sales and Use Tax: “Tangible Personal Property”

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July 05, 2018

Tangible personal property is “personal property” contrasted with “real property” (i.e., “real estate”). Texas Tax Code § 151.009 defines “tangible personal property” as “personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to the senses in any other manner… .” For the purposes of the sales and use tax, the term “tangible personal property” includes a computer program and a telephone prepaid calling card.

Computer Program

The Tax Code defines a “computer program” as “a series of instructions that are coded for acceptance or use by a computer system and that are designed to permit the computer system to process data and provide results or information.” The computer program may be presented on a variety of media, both tangible and intangible:

  • Magnetic tapes
  • Punched cards
  • Printed instructions
  • Other tangible or electronic media
  • Internet download of software for use in Texas8

Before 1987 there was a distinction between the taxability of custom computer programs and other computer programs. Since 1987, there has been no such distinction. The Court in Verizon North, Inc. v. Comptroller,9 considered whether Verizon North, Inc. owed tax on its purchase of computer software for use by an affiliate. The software, at the time of purchase, was not ready for its final use, because it needed to be modified and customized for the end user.

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Verizon challenged the Comptroller’s imposition of tax because it contended the purchased computer software did not fit the statutory definition of a “computer program.” While Texas Tax Code § 151.0031 defines a “computer program” as “a series of instructions that are coded for acceptance or use by a computer system and that are designed to permit the computer system to process data and provide results and information,” Comptroller Rule 3.308(b)(1) further defines a “computer program” as “a series of instructions sold as a completed program which are coded for acceptance or use by a computer system … .” (emphasis added).

The decision focused on the phrase “sold as a completed computer program.” Since the software required further modification before Verizon’s affiliate could put it to use, Verizon argued it didn’t meet the statutory definition. However, the Court determined it did meet the statutory definition, since the computer program could have been run, albeit not at its most optimal capacity, at the time Verizon received delivery of the product. The Court determined the software was “a completed program as sold, regardless of what modifications, extension, and customizations that the purchaser deems necessary for its intended use … .”10

2013 Update. The more recent case of Verizon Business Network Services, Inc. v. Combs,11 considered whether “feature enhancements” constituted the sale of a taxable “computer program” in Texas when shipped to the communications company’s Richardson, Texas, laboratory for testing before it was used in providing services, which were headquartered in Washington DC and used throughout the United States. The court held the testing of feature enhancements in Richardson constituted a taxable use in Texas and contrasted the creation of “feature enhancements” with the maintenance of tangible personal property, which is a service. Since the “feature enhancements” did more than maintain the existing software operating system functionality at is existing levels before the changes, they were determined to be computer programs, subject to sales and use tax.12

The case of 7-Eleven, Inc. v. Combs,13 also considered an aspect of the definition of a “computer program.” Specifically the Court considered whether 7-Eleven was entitled to a refund of sales taxes paid on software transferred to two categories of stores located outside Texas: (1) those owned by third party franchisees and (2) company stores owned by 7-Eleven.

During the audit period, 7-Eleven purchased a nonexclusive, perpetual license to “use, reproduce, and possess” custom computer software designed to manage and automate 7-Eleven’s stores.14

First, the vendor installed “host software” on 7-Eleven’s corporate mainframe. Then the vendor installed “store software” on the in-store computers. The vendor delivered separate “gold masters” of the host software and the store software to 7-Eleven. The “gold masters” allowed the corporate mainframe to communicate directly with the store computers. This formed the “backbone” of the financial system and captured data necessary to conduct and monitor sales and other store functions. 7-Eleven used the software to perform data processing services for the stores.15

Then, the vendor installed software to automate the store’s scanning point of sale (POS) cash registers, which 7-Eleven rented to the stores. This POS software was installed only in the stores. In the original administrative proceeding, the Comptroller found that this software, which was installed in the out-of-state stores was not taxable in Texas. However, the Tax Division filed a motion for rehearing on the grounds that the software was not purchased solely for resale and that it was incidental to the rental of tangible personal property (i.e., the point of sale registers), which disqualified the transaction from exemption. The Comptroller granted the Tax Division’s motion for rehearing and ultimately denied the refund. 7-Eleven paid the resulting tax under protest.16

7-Eleven claimed the resale exemption both as a sale for resale of tangible personal property (software) and as resale of tangible personal property transferred as an integral part of a data processing service. For the franchise stores, the Court of Appeals agreed with 7-Eleven that it had purchased the software for resale to its franchisees and had transferred the software as an integral part of a taxable data processing service. Even though the franchisees were not required to pay tax on the data processing services, because the service benefit location was outside the State of Texas, the transfer had occurred and the exemption applied.17

For the company stores, the Court of Appeals held that 7-Eleven had not established its burden of proving that the store software purchased for the out-of-state company stores was not used in Texas before it was transferred out-of-state and remanded the case to the District Court for further consideration of that issue.18 In its motion for rehearing, the Comptroller argued for the first time that the software-development charges could not be allocated in the manner urged by 7-Eleven because the license agreement for the software “provides for a single charge for a single license,” rather than a price per copy. While the court was troubled that this issue was

raised on rehearing, it remanded the case back to trial to determine whether 7-Eleven made any “use” of the store software before and after removing it from its tax-free inventory.

2018 Update. The Comptroller revised Rule 3.308, to change the definition of a computer program. The rule revisions were adopted on January 19, 2018. The revised definition no longer requires the program to be sold as “completed program.”19 Within the next year, the Austin Third Court of Appeals may decide how the previous definition applies to the manufacturing exemption under Texas Tax Code § 151.318. Silicon Laboratories, Inc. v. Hegar, No. 03–17–00061–CV, (Tex. App.—Austin, pending decision). This case is currently scheduled for oral hearing on February 28, 2018.

Prepaid Phone Cards

Effective September 1, 1997 sales tax is due on the sale of all telephone prepaid calling cards unless a resale or exemption certificate is given at the time of purchase. Taxpayers purchasing prepaid phone cards for resale may issue a resale certificate to purchase the cards tax free, but must collect and remit sales tax on the selling price of the card.20

Digital Products

In 2001, the Texas Legislature revised Tax Code § 151.010 to state that, “… the sale or use of a taxable item in electronic form instead of on physical media does not alter the item’s tax status.”21 Digital products include such things as photographs and music. Downloaded music and pictures cause a physical change to the medium on which they are stored; therefore, they can be measured and are considered tangible personal property.22 E-books are also taxable.23

Software as a Service

The Comptroller treats the sale of software, canned or custom, as the taxable sale of tangible personal property. “Software as a service” (SaaS) providers allow use of software via the Internet or other digital means without the customer actually taking possession of the software itself. In the context of SaaS, customers may use online applications to enter, store, manipulate and monitor data. The Comptroller generally considers the SaaS transaction to be the sale of taxable data processing services.24

Example 1. SaaSY, a California corporation with sales personnel in Texas, makes sales to Texas customers. SaaSY’s manufacturing customers use its online business application to record and manage their business transactions. The business application software resides on servers at the manufacturer’s data center. Data and information entered by the customers are also stored on SaaSY’s servers in California. The customers access the software through the Internet. No special hardware or software is needed to access the software; only Internet access, for which the customers are required to supply their own hardware and software.

The manufacturer’s employees generate and enter the business information, which serves as the basic platform for business operations, allowing them to manage inventory, record sales, fulfill orders, process payroll, execute accounting functions, manage employees and create financial statements. The online software holds all customer data in a single database, allowing access to all performance metrics in a customizable, real-time dashboard.

The application’s comprehensiveness is illustrated by the payroll component, which allows a manufacturer to enter data once and manage all of its payroll functions, including paying employees and calculating earnings, deductions, taxes and company contributions. This component can also prepare, print and file IRS forms such as the W-2 and 1099-MISC and tax returns for federal, state and local jurisdictions.

Customers obtain a non-exclusive, non-transferable license to use the service and to display content solely for the customer’s internal business operations during the term of the agreement. The license agreement is not a concurrent user license, and the customer may not copy, modify, reverse engineer, disassemble, attempt to discover any source code, or otherwise modify the software. Under the license agreements, customers give SaaSY a license to copy, store, record, transmit, maintain, display, view, print, or otherwise use customer data to the extent necessary to provide the service to customers.

The Comptroller determined that SaaSY was providing taxable data processing services to the customers. The customers transmit the data directly to SaaSY’s servers in California, which manipulate and process the data to prepare a tax return. SaaSY’s service goes so far as to actually file the tax return for its customers and guarantee the accuracy of the information and the timeliness of the filing. It also stores the data for future payroll use and so that it can be retrieved in the event of an audit. The fact that the customers themselves were entering the data had no effect on the service’s taxability.25


The Comptroller has interpreted the Tax Code definition of “tangible personal property” to also include “electricity.”26 

But Not Telecommunications

Although the Comptroller considers electricity to be tangible personal property, the same is not true for telephone signals, which are similarly generated. GTE Southwest v. Combs27 considered whether the manufacturing applied to equipment a local exchange carrier used to provide telecommunications products to its customers. The manufacturing exemption applies to “tangible personal property” used in “manufacturing, processing, or fabrication of tangible personal property for ultimate sale.” GTE contended that its telecommunications product consisted of “voice and data transmissions in the form of electronic signals, dial tones, busy signals, ring tone signals, digital addresses, and electricity to power the system, all of which are ‘measured,’ ‘felt,’ and ‘perceptible.’”28

Telecommunications, unlike electricity, is taxed as a service under Texas Tax Code § 151.0101. The equipment itself did not necessarily transfer to the customers as part of the taxable service. The Comptroller therefore denied GTE’s claim for a refund of sales and use tax it had paid on the equipment it used to manufacture the telephone signals.29 The district court granted summary judgment in favor of the Comptroller and the Court of Appeals affirmed its decision.30


2016 Update. The Texas legislature repealed the 2% fireworks tax effective September 1, 2015. In Texas, fireworks may be legally sold in applicable locations only during certain holiday periods: Texas Independence Day (February 25-March 2), San Jacinto Day (April 16-21), Cinco de Mayo (May 1-5 and only within 100 miles from the Texas-Mexico Border), Memorial Day (May 25-30), Independence Day (June 24-July 4 – not requiring county approval), and New Years Eve (December 20-January 1 – not requiring county approval). Even though the fireworks tax has been repealed, sellers of fireworks are still selling tangible personal property, so they must be permitted for, collect, and remit, sales and use tax.31

Tangible Personal Property with Real Property

2016 Update. Furniture leased as a lump sum charge with real property (e.g., a furnished apartment lease) is not subject to sales or use tax. However, food provided to residents and staff under a service agreement is not tangible personal property leased with real property and is taxable.32


7 See Comptroller Rule 3.323(C)(3) (dealing with exports).

8 See e.g., Comptroller Letter No. 200105276L (Al Van Allen, May 29, 2001) (stating that “charges for computer programs downloaded from Texas servers to a location outside Texas are exempt under Tax Code § 151.330.”).

9 308 S.W.3d 1, Tex. App.—Austin (May 22, 2009, pet. denied).

10 Id at *4.

11 ____S.W.3d.____ , Cause No. 07-11-0025-CV (Tex.App.—Amarillo 2013, pet. filed June 19, 2013).

12 The court granted a partial refund for sales tax paid on software purchased for exclusive use outside

Texas, but did not grant interest, as it was not an issue raised in the motion for rehearing.

13 7-Eleven, Inc. v. Combs, 311 S.W.3d 676 (Tex. App.—Austin 2010, pet. denied) (original opinion dated August 31, 2009 withdrawn).

14 Id.

15 Id.

16 Id.

17 Id.

18 Id.

19 34 Tex. Admin. Code § 3.308.

20 See, e.g., Comptroller Letter No. 9710828L (Lindey Osborne, October 7, 1997).

21 This change was made by the 77th Legislature.

22 See, e.g., Comptroller Letter No. 200005359L (Barbara Truesdale, May 30, 2000).

23 See, e.g., Comptroller Letter No. 200209444L (Nolan Ward, September 23, 2002).

24 See, e.g., Comptroller Letter No. 200812241L (December 16, 2008).

25 See Comptroller Letter No. 200805095L (From Lia Edwards to Nancy Prosser, May 28, 2008).

26 Comptroller Rule 3.295(b). See, e.g. Comptroller Letter No. 200204996L (Al Van Allen, April 19, 2002).

27 ___ S.W.3d ___, 2010 WL 2218662, Cause No. 03-08-00561-CV (Tex. App.—Austin 2010, pet. denied

Oct. 1, 2010, reh’g denied Jan. 14, 2011).

28 Id. at *4.

29 Id. at *1.

30 Id. at *1.

31 See April 2016 Tax Policy News.

32 Comptroller Letter NO. 2015111615L (PLR #143360028) (November 20, 2015).

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