New Software Exclusions

software exclusions

NC Senate Bill 490 modified G.S. 105-275(40) to exclude custom software from the property tax base. The additional wordage now reads as follows:

“The foregoing does not include development of software or any modifications to software, whether done internally by the taxpayer or externally by a third party, to meet the customer’s specified needs.”

What Does This Mean?

Beginning in January of 2014, customized software will be viewed as a service. Thus, custom software services rendered will be transactions that are exempt from state sales tax – effectively changing the way that software is taxed in your jurisdiction.

Software that is purchased before customization will still be subject to taxation, but significantly enhanced additions to a commercial piece will not.

The revenue impact of this new exclusion is unknown at this time. However, NC legislators believe that relieving the broad levy on computer software will make North Carolina a more attractive business environment.

Know the Distinction

What classifies as a “customized” software piece will be highly debated, so it is important to understand the distinction between commercial and custom software and the language generally used to describe both:

  • Commercial/Taxable: Off-the-shelf software that is readily available for purchase by the general public and often sold in retail stores (e.g. Microsoft Office, Windows).
    • Prewritten software
    • Canned software
    • Mass marketed consumer software products (e.g. video games)
  • Customized/Not Taxable: Made-from-scratch software & customized software that has substantially modified existing software; often developed for use by a single user or business.

To further distinguish these differences, “…modifications to a prewritten program are treated as custom software and not taxed if the modification costs are separately stated from the canned program cost. If modifications are not separately stated, the total amount is taxed. However, if the modifications are so extensive that the end result is not a modification to a canned program, but rather is a custom program, then the program as a whole is not taxed” (Wei-Ching Kuo 7-8).

It’s possible that the lessened burden on taxpayers will increase growth and decrease transaction costs for software companies in NC, making business use of software less costly. Going forward, be sure to pay close attention to any changes to the computer section of your tax base to develop a more clear understanding of the effect the new exclusion may have on the tax revenue in your jurisdiction.


Wei-Ching Kuo, John. “SALES/USE TAXATION OF SOFTWARE: AN ISSUE OF TANGIBILITY.”High Technology Law Journal. 1987:  7-8. Web. 5 Dec. 2013. 

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