Chicago Lease Transaction Tax Expanded to Include Perpetual Software Licenses

Sept. 26, 2013

The city of Chicago announced changes to its taxation of software licenses under the lease transaction tax (LTT). Chicago imposes an 8 percent LTT (essentially a sales tax on leases) on certain software licenses that are exempt from Illinois sales and use tax. Historically the tax was imposed only on nonperpetual licenses of software. On Aug. 6, the city issued a ruling that expands application of the LTT to perpetual software licenses. The change is effective for perpetual software licenses that meet the requirements listed here for the Illinois exemption and that have payments due on or after Sept. 1, 2013, even if the software was acquired prior to that date.

Under Illinois sales tax rules, a software license is considered exempt if it satisfies all of the following conditions:

  • It is evidenced by a written agreement signed by the licensor and the customer.
  • It restricts the customer’s duplication and use of the software.
  • It restricts sublicensing (except to a related party) without the permission and continued control of the licensor.
  • The licensor agrees to provide a backup copy at no cost or for a nominal charge.
  • The customer must destroy or return all copies of the software to the licensor at the end of the license period. (This provision is deemed to be met, in the case of a perpetual license, without being set forth in the license agreement.)

A perpetual license provides a user with perpetual use of the software for a fee. A nonperpetual license gives the user the right to use the software only for a specified period of time and requires return or destruction of the software at the end of the license term.

Remotely accessed software and databases, which are not currently subject to Illinois sales tax, continue to be subject to the LTT.

Software vendors doing business in Chicago will need to begin collecting the tax for perpetual licenses with payments due on or after Sept. 1, 2013. Companies that are perpetual licensees of software must self-assess the 8 percent tax if their vendor does not collect it.

Taxpayers have raised questions about the city of Chicago’s statutory authority to expand the LTT to perpetual leases, but taxpayers need to comply until the position is successfully challenged in court.

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