By Hanish Patel and Eric Coffill

The Alabama Tax Tribunal held that a taxpayer was entitled to a refund of sales taxes paid on purchases of software that was modified for its exclusive use because it constituted nontaxable custom software. Relying on its regulation, the Alabama Department of Revenue (DOR) denied the refund, stating the “software contained canned software that was customized and the nontaxable customized portion was not separated from the taxable canned portion[.]” However, Chief Tax Tribunal Judge Bill Thompson pointed out the DOR’s regulation is contradictory because although it states modified canned software only constitutes nontaxable custom software to the extent of the modification, the regulation’s definition of custom software includes the “pre-existing program” (i.e., the canned software). See Ala. Admin. Code r. 810-6-1-.37. Therefore, since there was no statutory or judicial authority to support the regulation’s limit on modifications to canned software, the Tax Tribunal ruled the taxpayer’s modified software constituted nontaxable custom software. Russell Cty. Cmty. Hosp. v. Ala. Dep’t of Revenue, No. S 15-1683 (Ala. Tax Trib. June 13, 2016).