Illinois has clarified that software delivered via a cloud-based system is exempt from the state’s sales tax.
This was clarified in the General Information Letter, prepared on 9 October 2024 and published by the Illinois Department of Revenue on 6 November 2024. The Department stated that “canned” software” (prewritten and standard software packages) is typically taxable when sold directly, but cloud-based software accessed solely online is not subject to the same tax.
Generally, “canned” computer software sales are taxable retail sales in Illinois. Canned computer software is considered tangible personal property regardless of the form in which it is transferred or transmitted, including tape, disc, card, electronic means, or other media. However, if the computer software consists of custom computer programmes, then the sales of such software may not be taxable retail sales. Custom computer programmes or software are prepared to the special order of the customer.
The selection of pre-written or canned programmes assembled by vendors into software packages does not constitute custom software unless real and substantial changes are made to the programmes or creation of programme interfacing logic. Computer software that is not custom software is considered to be canned computer software.
Software as a service is generally defined as a cloud computing service model where the provider licenses the use of computer software to a client and manages all needed physical and software resources. The possession and ownership of software remains with the provider, and the client accesses the software on web-enabled devices over the internet. The software is often provided on a subscription basis.
A provider of software as a service is acting as a serviceman. As a serviceman, the seller does not incur Retailers’ Occupation Tax. Service Occupation Tax is imposed upon all persons engaged in the business of making sales of service on all tangible personal property transferred incident to a sale of service, including computer software.
Computer software is defined broadly in the Retailers’ Occupation Tax Act. However, computer software accessed through a cloud-based delivery system – a system in which computer software is never downloaded onto a client’s computer and is only accessed remotely – is not subject to tax. If a provider of such a service provides to the subscriber an API, applet, desktop agent, or a remote access agent to enable the subscriber to access the provider’s network and services, the subscriber is receiving computer software.
A serviceman may provide such software along with a subscription for software as a service in a single transaction. Although there may not be a separate charge to the subscriber for the computer software, it is nonetheless subject to tax, unless the transfer qualifies as a non-taxable license of computer software. If an Illinois customer downloads computer software for free from an out-of-State retailer’s or serviceman’s web site or server that is also located out of State, the retailer or serviceman, even though it is donating tangible personal property to the customer, has exercised no power or control over the property in Illinois.
In this instance, the donor would not have made any taxable use of the property in Illinois. The customer, the donee, would incur no Use Tax liability for the retailer or Service Use Tax liability for the serviceman to collect and remit to Illinois.
The Department does not consider the viewing, downloading or electronically transmitting of video, text, and other data over the internet to be the transfer of tangible personal property. However, if a company provides services that are accompanied with the transfer of tangible personal property, including computer software, such service transactions are generally subject to tax liability under the Service Occupation Tax Act.
If a transaction does not involve the transfer of any tangible personal property to the customer, then it generally would not be subject to Retailers’ Occupation Tax, Use Tax, Service Occupation Tax, or Service Use Tax. Information or data that is electronically transferred or downloaded is not considered the transfer of tangible personal property in this State.
Illinois does not tax subscriptions of software as a service.
Claim for credit
The Department’s regulation describes the procedures used to obtain a credit for sales tax that is erroneously paid. Please note that only persons who have actually paid tax to the Department can file a claim for credit. Since retailers usually pay the tax to the Department, usually only retailers can file a claim for credit.
To file this claim, however, if a seller has collected tax from a purchaser, it must first prove to the Department that it has unconditionally repaid the taxes to the purchaser. The taxpayers must apply for the credit in the manner described in the rule.
Under Illinois sales tax laws, retailers are not required to file claims for credit. Please note that the Department has no authority to compel the seller to file a claim for credit. As this regulation explains, this procedure is a matter of business between the purchaser and the retailer – the retailer is not required by the tax laws to file a claim for credit.