TAXATION RULING NO. ST 2305

ST 2305

SALES TAX : COMPUTER SOFTWARE

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FOI status:

May be releasedFOI number: I 1206732

PREAMBLE

The purpose of this Ruling is to clarify a number of issues that have been raised in relation to the interpretation and operation of the provisions contained in the Sales Tax Laws Amendment Act 1986 - Act No. 99 of 1986 - which deal with sales tax payable in respect of goods containing computer software. The amendments made by that Act to the various Sales Tax Assessment Acts operate on and from 20 August 1986.

RULING

2. Before considering particular issues in detail, it is worthwhile to remind officers administering the new provisions that there must always be a taxable transaction in goods - the carrying medium - (including a deemed sale by reason of sub-section 3(3A) of the Sales Tax Assessment Act (No. 1)) connected with the supply of computer software before the amendments apply. The changes do not impose sales tax on computer services alone. Where a taxable transaction in goods is not involved, for example, the electronic transfer of software by satellite, no sales tax liability arises.

3. In order to determine a liability to sales tax, two questions are therefore paramount -

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is the process of producing the computer software "manufacture" for sales tax purposes; and

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are there any goods connected with the computer software that reach a taxing point, e.g., sale, deemed sale or entry for home consumption, concerned in the transaction?

4. This Ruling has been prepared with these comments in mind.

"Manufacture"

5. The definition of "Manufacture" in sub-section 3(1) of the Sales Tax Assessment Act (No.1) 1930 (Assessment Act (No.1)) has been amended to include -

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the copying or reproduction of a computer program, with or without related information and whether in the same or a different material form; or

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the conversion of a computer program to another language, code or notation, so as to embody the computer program in goods.

6. Both of the above processes are now "manufacture" for sales tax purposes. To the extent that machinery is used exclusively or principally in either of these processes of manufacture, such machinery would qualify for exemption from sales tax as "aids to manufacture". In this regard, the view is taken that the specific amendment of the definition of "Manufacture" to include certain specific processes as manufacture does not exclude by inference any process which was within the scope of the definition prior to its amendment. Nor does it treat as manufacture processes such as the writing of a computer program.

7. It may often be the case that the owner of a program, e.g., a master program, does not personally copy the program onto another medium or into another computer. The owner may simply supply the master program to another person who will provide the required numbers of copies of the program embodied on goods. In these circumstances, new sub-section 3(1A) of Assessment Act (No.1) will be called into play.

8. The result will be that the person who supplies the computer program to another for the purpose of copying the program onto goods will be the "Manufacturer", while the real manufacturer will be a wholesale merchant by virtue of sub-paragraph (a)(ii) of the definition of that expression.

"In-house Manufacture"

9. The copying of a computer program from a carrying medium into a computer or onto another carrying medium for a person's own use is technically within the amended definition of "Manufacture". No sales tax liability arises, however, in respect of this "manufacturing" process. New sub-section 17(1A) of Assessment Act (No.1) operates to ensure the development "in-house" of computer programs, that are applied to the developer's own use, is free of sales tax. There are two important issues in relation to "in-house" development of computer programs. These are -

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the meaning of "in-house"; and

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how the goods are applied to own use.

10. The most common "in-house" software development will arise in relation to the development of a computer program by an employee of the developer/employer. In these circumstances, the author of the computer program (the employee) has no interest in the copyright in the program. Under sub-section 35(6) of the Copyright Act 1968, the employer is the owner of the copyright subsisting in the program written by the author in pursuance of the terms of his employment under a "contract of service".

11. The other situation which is accepted as being "in-house" development of a computer program is where section 197 of the Copyright Act is applicable. Generally speaking, the author of a computer program is the owner of any copyright subsisting in it : sub-section 35(2) of the Copyright Act. Section 197 of that Act deals with prospective ownership of copyright and overrides sub-section 35(2). Under section 197, an agreement may be entered into, in writing, between a person who would be the owner of the copyright in a computer program on its coming into existence and another person, whereby the future copyright may be assigned on its coming into existence to that other person. For example, a person may need some specialist or custom made software to be developed for use in carrying on his or her own business and engages a consultant to carry out the work. If a section 197 agreement is entered into between the person and the consultant in relation to the development of the software, i.e., the copyright in the computer program will vest in the person who engaged the consultant by force of that provision, the development of that software will, subject to the comments in paragraph 12, be accepted as "in-house" and free of any sales tax liability. Such an agreement must be in writing and entered into before the software is written.

12. This rule will not apply, however, where it is clear that there is an intention to avoid sales tax payable on the transaction between the statutory owner of the copyright and the consultant, e.g., a collateral agreement is entered into between the parties whereby the section 197 statutory owner agrees to return to the consultant any rights the consultant would have retained under an ordinary or commercial licence agreement. Put another way, the statutory assignment of the copyright in the work, that is the software, must be absolute and unfettered before it will be accepted as "in-house".

13. So far as goods applied to own use is concerned, it is a relatively common practice in the marketing of computer software for the goods, i.e., the carrying medium, to be given free of charge to the user. Goods that are given away are generally treated, for sales tax purposes, as having been applied to own use. New sub-section 3(3A) of Assessment Act (No.1) ensures, however, that where goods that contain a computer program are given, e.g., a gift, on short-term hire, rent or loan, to a person and valuable consideration passes in respect of the right to use, or for the supply of, that program, a sale of goods will be deemed to have occurred. A deemed sale of goods will adopt the characteristic of being a wholesale or retail sale depending on the stage it occurs in the marketing chain.

Goods Embodying a Computer Program

14. The new provisions do not deem a computer program to be goods. Nor is any valuable consideration payable for the right to use a program contained on goods deemed to be a sale under those provisions. Both of these aspects have given rise to some confusion. Simply stated, the law now provides that where goods, in which a computer program has been embodied, are dealt with in a taxable manner, the sale value of the goods for sales tax purposes includes the value of any consideration paid for the right to use, or the supply of the program.

15. Where a computer program has been embodied in goods before 20 August 1986 and the goods have passed the taxing point before 20 August 1986, e.g., the program has been licensed to the user before that time, any licence fees paid on or after 20 August by that user for that program would not be taxable. If the licence agreement is renewed for the same program (not an updated or modified version) with the same client, any licence fees payable under the agreement would also not be subject to sales tax.

Electronic Transfer of Software

16. When introducing the amending legislation in the Parliament on 19 August 1986, the Minister Assisting the Treasurer, the Hon. Chris Hurford, MP, said that the legislation did not seek to tax the electronic transfer of software by means of the domestic telephone system or satellite communications. The reason for this is not because there is any specific exclusion of electronic transfers of software in the amending legislation, but because generally such transfers do not amount to the manufacture of goods, nor involve any taxable transaction in goods.

Sale Value of Computer Software

17. Where a computer program is made available to a user in taxable circumstances, questions have been raised about the liability to tax of any service elements provided as part of the contract "price".

18. Where a single contract is entered into in relation to the supply of, or the right to use, a computer program and that contract includes services, such as training, consultancy advice, etc, the entire consideration payable is part of the taxable sale value of the carrying medium. If, on the other hand, genuine service contracts are available from the supplier to the user at arm's length cost and the contracts are genuinely non-obligatory, the consideration paid by the user for the service contracts is not taxable. This is consistent with the application of the sales tax law in relation to other "service contracts".

19. An example would be where a person desiring to obtain a pay-roll program for business use obtains a quote of $10,000 for the supply of (including installation) and the right to use the program, $1,500 for a separate contract to train two operators for one week and $2,000 for a separate contract for a telephone "hot-line" service for 12 months. Provided the training and "hot-line" are optional, only the $10,000 for the software is subject to sales tax. Attempts to inflate service contracts beyond arm's length values should be carefully scrutinized and, if appropriate, subject to adjustment with full penalties or prosecution action.

20. The treatment of maintenance and installation contracts has been closely examined in this office. In relation to the latter, it has been decided that consideration paid for software installation is part of the taxable sale value of the goods containing the software. Separate contracts for installation will, therefore, not relieve a supplier of any liability to tax in respect of consideration received under that separate contract. This is because the view is taken that installation is not a genuine option however the contracts may be dressed-up. Similarly, the supply of operating manuals is regarded as an essential part of the supply of the software, although the separate purchase of additional manuals at the option of the purchaser would not be.

21. Maintenance contracts often cover a bundle of services, including updating the original program with a new disc, etc, containing a new program, but for a single fee. Provided a maintenance contract is non-obligatory its cost would not form part of the taxable sale value of the original software. However, to the extent that a maintenance contract provides for the supply of new (updated or modified) software by means of replacement discs, etc, otherwise than as part of ordinary warranty arrangements, it would give rise to a separate taxable transaction.

Timing

22. The taxable consideration payable in respect of a computer program may not always be paid in a lump sum at the time physical possession in the "goods" passes. An example of trading terms, in relation to a taxable payment, could be as follows :

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30% - 14 days after invoice;

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30% - on installation; and

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40% - on implementation.

In this case, sales tax would become payable 21 days after the month during which the payment in relation to installation becomes due, i.e., sales tax would be first payable at that time on 60% of the fee. When the final 40% payment became due and payable, sales tax would be payable on that payment 21 days after the end of the month in which it became due and payable.

Master Programs

23. Many businesses will have had on hand at 20 August 1986 master programs from which further copies are made for sale or gift to the user with a licence fee payable in relation to the program. The copying of those programs is manufacture and the transaction (consisting of the sale or gift of a copy with an accompanying licence agreement to a user) is subject to sales tax, notwithstanding that the master program passed the taxing point before 20 August 1986.

24. If, for example, a person imports a master program for the purpose of copying that program for the use of other persons by licence, that person will be a manufacturer for sales tax purposes. The imported master program will be an aid to manufacture and should be entered for home consumption sales tax free.

COMMISSIONER OF TAXATION
24 November 1986

References

ATO references:
NO L86/6180-4

Date of effect:
Immediate

Date original memo issued:
17 September 1986

Subject References:
COMPUTER PROGRAM

Legislative References:
SALES TAX ASSESSMENT ACT (NO.1) 1930; SUB-SECTION 3(1) AND
18B