In Calavista, L.P. v. Hegar, a Texas district court ruled that Calavista’s charges for software-related services were not subject to the Texas sales and use tax. The Court signed a final judgment granting Calavista’s Motion for Summary Judgment in full.
Calavista offers a variety of software-related products and services to companies nationwide. This includes software development services, software consulting services, and quality assurance testing. When performing software development services, Calavista may either create custom programs or modify existing software owned by its clients.
Texas Sales & Use Tax
While the sale or licensing of software is subject to the Texas sales tax, creating a custom software program or modifying a client’s existing software program is not, as long as the client has exclusive rights to the software program. Calavista used internally-developed software to run tests to ensure that the programmer’s coding produced the intended result. Calavista shared this internally-developed software with its clients to run their own tests. In simple terms, this internally-developed software functioned much like a “spell-check” program for software developers.
The Comptroller had argued that this internally-developed software, by its use, became integrated with the software sold to its clients. Moreover, Calavista’s contracts with clients included language stating that Calavista retained rights to its “underlying technology,” which included its internally-developed software. Because Calavista retained rights to this internally-developed software, the Comptroller argued that the client did not hold exclusive rights to the software created and sold by Calavista. Therefore, the Comptroller argued that Calavista’s services did not qualify as nontaxable software development services.
Calavista established that the internally-developed software is analogous to a mechanic’s wrench, rather than a component of a car. Just as it would not make sense for a mechanic to leave his wrench inside of a car once he had finished his repairs, the internally-developed software did not become a component of Calavista’s final product. Rather, it was simply used to assist Calavista and its clients throughout the development process.