In 2016, former Chief Judge Bill Thompson of the Alabama Tax Tribunal held that the taxpayer-hospital (Russell County Community Hospital, LLC) was entitled to a refund of the sales tax paid on the purchase of software that it contended was customized for its particular functions. The hospital contracted with a well-known healthcare management company to provide the hospital with various computer software programs. The vendor started with canned software, and then arguably customized it to meet the specific needs of the hospital. The hospital paid sales tax to the company on the software, and the hospital and the company later jointly petitioned for a refund, which was denied by the Department.
In ruling for the taxpayer, the Tax
Tribunal relied heavily on the Alabama Supreme Court’s decision in Wal-Mart
Stores, Inc. v. City of Mobile and County of Mobile, 696 So 2d 290 (Ala.
1996), which held that unmodified, “canned” computer software sold to nonexempt
customers was subject to Alabama and local sales or use tax. Following that ruling, the Department issued Regulation
810-6-1-.37 (the “Regulation”), which the Department cited in support of its
refund denial. Judge Thompson found the
Regulation to be internally inconsistent.
Paragraph (5) of the Regulation
states that software is entirely exempt from sales tax if it is customized, but
the same paragraph also states that only the itemized charges for customizing
the software are exempt from sales tax. The
Department had denied the joint petition in issue because the charges to the
hospital were not itemized between the canned software and the customized
portion. Judge Thompson added a footnote
explaining that it is extremely difficult to determine whether software is
custom or canned and that he would support the imposition of sales tax on all
Apparently relying on Judge
Thompson’s footnote, the Department argued on appeal to the Russell County
Circuit Court that sales tax should apply to the purchase of all software,
whether canned or customized. This position,
if it had been adopted, would not only have removed the court‑mandated
exemption for custom software, but would have also meant that the Department
was disavowing its own regulation, which specifies that custom software is not
subject to sales tax.
On January 26, 2018, the Circuit
Court affirmed the Department’s denial of the refund request and thus reversed
the Tax Tribunal. The Circuit Court
ruled that it was not custom software programming because the CEO of Medhost
testified that none of the software was custom, rather the software was
prefabricated and could be configured to a particular customer’s needs at their
location, and the configurations did not require the dispatching of programmers
to the hospital. Importantly, the
Circuit Court did not address Judge Thompson’s footnote or the Department’s new
argument in support of imposing sales tax on all software.
The Alabama Court of Civil Appeals has now weighed in and its decision, found here, affirms the decision of the trial court. Readers should carefully watch to see if this case is taken by the Alabama Supreme Court to further clarify its past rulings on the taxability of sales of computer software.