The Texas Comptroller affirmed that a software company had nexus in Texas through software licenses, requiring it to collect sales tax. The Comptroller found that licensed software constituted tangible personal property physically present in Texas. Though the amounts were redacted, the judge determined nexus was substantial based on fees generated from Texas licenses. This sets a precedent that licensing software in Texas creates a tax collection obligation, but the threshold for "substantial" nexus remains unclear.

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State & Local Tax Alert
Breaking state and local tax developments from Grant Thornton LLP
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Texas Comptroller Finds Sales Tax Nexus Through Software
Licenses
The Texas Comptroller has affirmed an Administrative Law Judge (ALJ) decision that a
software company is required to collect and remit sales and use tax on its sales of software
licenses to Texas customers.1 The ALJ found that the presence of software in Texas
constituted nexus because the company owned tangible personal property in Texas
(although the software was licensed to other entities in Texas). The ALJ then determined
that the nexus was substantial because of the amount of fees generated by the tangible
personal property in the state.
Background
The taxpayer, a Utah corporation that sold computer programs and digital content
primarily through the Internet, also delivered products via common carrier, such as the
U.S. Postal Service. During the relevant period, the taxpayer sold multiple software
products to customers in Texas, but did not have employees or an office in the state. The
taxpayer’s employees had been in the state twice since 2002 for educational conferences,
but they did not solicit orders while in Texas.
Computer programs generally were not purchased by customers, but were licensed to the
customers so that they had a limited right to use the program or content on a limited
number of computers. Thus, the purchase and use of the taxpayer’s products were
governed by license agreements. All of the agreements provided that the licensed
products remained the property of and proprietary to the taxpayer. Also, most of the
agreements explicitly provided that the taxpayer retained all rights in, title to, and
ownership of the licensed products.
Under Texas law, an out-of-state retailer who is engaged in business in Texas and who
makes a sale of a taxable item for storage, use, or consumption in Texas is required to
collect use tax from the purchaser.2 The scope of being engaged in business in Texas is
1 Decision, Hearing Nos. 106,632, 108,626, Texas Comptroller of Public Accounts, Sept. 19, 2014
(released Nov. 2014). Note that Texas has a unique system for contested tax cases. The Texas
Comptroller can refer a contested case to the State Office of Administrative Hearings (SOAH).
ALJs from the SOAH conduct administrative hearings and then prepare a Proposal for Decision
(PFD) regarding the contested case. The Comptroller then decides whether to accept or reject (in
whole or in part) the PFD. If the taxpayer disagrees with the Comptroller’s decision, the case may
be appealed to the state district court.
2 TEX. TAX CODE ANN. § 151.103(a).
Release date
February 18, 2015
States
Texas
Issue/Topic
Sales and Use Tax
Contact details
John LaBorde
Houston
T 832.476.3605
E john.laborde@us.gt.com
Pat McCown
Dallas
T 214.561.2350
E pat.mccown@us.gt.com
Terry Gaul
Houston
T 832.476.5088
E terry.gaul@us.gt.com
David Somerville
Houston
T 832.476.3601
E david.somerville@us.gt.com
Annie Kuntz
Houston
T 832.487.1418
E annie.kuntz@us.gt.com
Jamie C. Yesnowitz
Washington, DC
T 202.521.1504
E jamie.yesnowitz@us.gt.com
Lori Stolly
Cincinnati
T 513.345.4540
E lori.stolly@us.gt.com
www.GrantThornton.com/SALT

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fairly broad and includes the following catchall phrase: “otherwise [doing] business in this
state.”3
The Comptroller reasoned that because the software is tangible personal property under
Texas law,4 the taxpayer’s tangible personal property was physically present in the state,
and the taxpayer had derived receipts from the property, that the taxpayer had substantial
nexus with Texas.5 Because of the substantial nexus, the taxpayer had the obligation to
collect use tax from its Texas customers. Subsequently, the Comptroller found that the
taxpayer had failed to collect tax on its sales in Texas and assessed taxes, penalties and
accrued interest for the period from January 1, 2002 through June 30, 2010. After this
assessment, the taxpayer began collecting tax. The taxpayer brought this action seeking a
waiver of the penalties and a refund for taxes remitted after June 30, 2010. According to
the taxpayer, it was not required to collect tax because it did not have substantial nexus
with Texas.
Taxpayer Had Substantial Nexus
The ALJ used the Complete Auto test to determine the validity of the Comptroller’s
assessment.6 Under this test, a tax will be sustained against a Commerce Clause challenge
so long as the tax “is applied to an activity with a substantial nexus with the taxing state, is
fairly apportioned, does not discriminate against interstate commerce, and is fairly related
to the services provided by the state.”7 The ALJ quickly dismissed the last three prongs of
the test by explaining that “it is well settled that the Texas use tax is fairly apportioned,
does not discriminate against interstate commerce, and is fairly related to the services
provided by the state.” Therefore, the remaining issue in the case was whether the
taxpayer had substantial nexus with Texas.
The ALJ did not find that the employees’ conference attendance was a possible source of
nexus because they were present in Texas only to learn about developments in the
industry. However, the ALJ found that the taxpayer did have nexus with Texas because it
had tangible personal property in the state. Software is tangible personal property for sales
tax purposes in Texas.8 The software still belonged to the taxpayer because the license
agreements explicitly provided that the software remained the taxpayer’s property after sale
and download.
3 TEX. TAX CODE ANN. § 151.107(a).
4 TEX. TAX CODE ANN. § 151.009. The statute provides that “‘[t]angible personal property’ means
personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to the
senses in any other manner, and, for the purposes of this chapter, the term includes a computer program and a
telephone prepaid calling card.” (Emphasis added.)
5 This reasoning is further bolstered by 34 TEX. ADMIN. CODE § 3.286(a)(2), which provides “a
person is engaged in business in Texas if the person has nexus with the state as evidenced by …
[deriving] receipts from a rental or lease of tangible personal property that is located in this state or
[owning] or [using] tangible personal property that is located in this state, including a computer
server or software.”
6 Complete Auto Transit v. Brady, 430 U.S. 274 (1977).
7 Id.
8 TEX. TAX CODE ANN. § 151.009.

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Nexus must be substantial for the state to have the authority to impose a tax. The ALJ
looked to Quill Corp. v. North Dakota in the nexus analysis.9 In Quill, the taxpayer had title
to floppy diskettes in the state, but there were so few that the U.S. Supreme Court refused
to find substantial nexus. The ALJ in this case found that the fees generated from Texas
licenses were large enough to establish substantial nexus. The decision redacted the fee
amounts, so it is unknown what dollar amount the ALJ (and by affirming the decision, the
Comptroller) believes constitutes “substantial.”
The ALJ agreed with the Comptroller except for the Comptroller’s characterization of the
licensing of software as a lease. The ALJ explained that in order to be a lease for tax
purposes, a party must have exclusive possession and control, but not title to, the
property.10 However, the fact that the taxpayer’s customers had non-exclusive licenses to
use the property meant that they were not leasing the property. The ALJ did not re-
categorize the property – it only noted that the software would be classified as tangible
personal property. There was no subsequent discussion, for example, if the transactions
remained subject to sales/use tax as “a transfer of title or possession of tangible personal
property”11 rather than as “the exchange, barter, lease, or rental of tangible personal
property.”12 The ALJ focused his analysis solely on the nexus issue at hand.
Apparently, the taxpayer did not challenge the statutory characterization of software as
tangible personal property, and such statute does not make any distinction in
characterization between software downloaded electronically or delivered in a physical
media form (e.g., disk).13
In summary, the ALJ found that the taxpayer had physical presence in Texas to a degree
that constituted substantial nexus. Following a finding that the taxpayer was not entitled
to insolvency relief or an interest waiver, the ALJ recommended that the assessments be
affirmed and no refund be issued. The Texas Comptroller agreed with the ALJ, making
this hearing decision consistent with long-standing Comptroller policy.14
Commentary
This decision has potentially far-reaching consequences assuming that it is not appealed
and reversed in the judicial process. To be in line with the Comptroller’s policy, out-of-
state companies who license software in Texas must collect use tax. As it is common to
use licenses instead of selling the software outright, many companies are required to
collect use tax.
One problem with relying on this decision in the future is that the amount of fees
generated by the licenses was not disclosed by the ALJ, just that nexus was substantial in
this instance. Based on Quill, it is clear that some presence does not automatically mean
9 504 U.S. 298 (1992).
10 34 TEX. ADMIN CODE § 3.294.
11 TEX. TAX CODE ANN. § 151.005(1).
12 TEX. TAX CODE ANN. § 151.005(2).
13 TEX. TAX CODE ANN. § 151.009.
14 There are numerous prior hearing decisions holding that licensing tangible personal property and
deriving receipts from the licenses creates nexus in Texas. For example, see Decision, Hearing No.
36,237, Texas Comptroller of Public Accounts, July 21, 1998.

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the presence is substantial. However, after this decision, it is unclear what amount of
receipts the Comptroller deems to be substantial prior to a finding of substantial nexus.
Importantly, this decision is not binding on Texas courts. While this decision represents
the Comptroller’s current policy going back at least to a prior hearing decision from
1998,15 this issue of software licenses creating nexus does not appear to have been
challenged in court. Perhaps the taxpayer in this case or other similarly situated software
company will choose to take this matter to the state district court.
Finally, while computer software is considered to be tangible personal property for sales
tax purposes in Texas, such classification does not necessarily carry over for other Texas
taxes.16 Computer software may be treated, for example, as tangible personal property for
Revised Texas Franchise Tax (RTFT) cost of goods sold deduction purposes,17 as an
intangible asset for RTFT apportionment purposes18 and as intangible personal property
for Texas property tax purposes.19 Each of these classifications presents potential
opportunities to taxpayers as well as traps for the unwary.
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addressed.
15 Decision, Hearing No. 36,237, Texas Comptroller of Public Accounts, July 21, 1998.
16 TEX. TAX CODE ANN. § 151.009.
17 TEX. TAX CODE ANN. § 171.1012(a)(3)(A)(iii).
18 34 TEX. ADMIN. CODE § 3.591(e)(3).
19 TEX. TAX CODE ANN. § 1.04(6).