In a 5-3-1 decision, the Alabama Supreme Court ruled on Friday that the sale of computer software in Alabama is subject to sales or use tax, even if it’s customized in whole or in part for a particular user (see Ex parte Russell County Community Hospital, LLC, Ala. S. Ct., Case No. 1180204 (May 17, 2019)). This ruling was despite the long-standing Alabama Department of Revenue (ADOR) guideline providing that charges for “custom software programming” are not subject to Alabama sales/use tax. Former tax attorney Justice William B. Sellers, one of the major proponents of legislation that eventually established the independent Alabama Tax Tribunal, authored the majority opinion.
The taxpayer, Russell County Community Hospital, paid sales tax to its software vendor/consulting firm, Medhost of Tennessee, Inc. (our firm’s client), of approximately $18,000 and later sought a refund arguing that the software in question qualified under the ADOR regulation cited above as “custom software.” Instead, the Court affirmed the lower court’s denial of the refund and then announced that “all software, including custom software created for a particular user, is ‘tangible personal property’” subject to sales and use tax in Alabama. Readers may recall when the Court ruled that canned software would be subject to sales/use tax, on a prospective basis, in Wal-Mart Stores Inc. v. City of Mobile in 1996.
The majority opinion reaffirmed, however, that certain related services wouldn’t be taxable if the vendor invoices them separately from the charge for the software. Four justices wrote in either concurring or dissenting opinions that they felt the Alabama Legislature was in a better position to dictate the parameters of the taxation of computer software, or at the very least, to address the issue of what Justice Greg Shaw termed potential “artful invoicing.”
The decision is expected to have broad implications; practitioners have already requested clarification from the ADOR that the new standard will be applied prospectively only. Indeed, the ADOR’s long-standing dichotomy between canned and customized software remains in its 20+ year old regulation. Thankfully, initial indications are that the state’s largest private auditing firm, which represents the majority of cities and counties in the state, will not apply the ruling retroactively.