Ex parte Russell County Community Hospital, LLC

          PETITION FOR WRIT OF CERTIORARI TO THE COURT OF CIVIL APPEALS Russell Circuit Court, CV-16-900160; Court of Civil Appeals, 2170527

          SELLERS, JUSTICE.

         This Court granted a petition for a writ of certiorari seeking review of the Alabama Court of Civil Appeals' decision affirming a judgment of the Russell Circuit Court ("the trial court"), which ruled that a series of transactions involving the sale of computer software and accompanying equipment was subject to sales tax. See Russell Cty. Cmty. Hosp., LLC v. State Dep't of Revenue, [Ms. 2170527, November 16, 2018] ___So. 3d ___(Ala. Civ. App. 2018). We affirm the Court of Civil Appeals' judgment.

         Between February 2012 and October 2014, Medhost of Tennessee, Inc. ("Medhost"), sold Russell County Community Hospital, LLC, d/b/a Jack Hughston Memorial Hospital ("the taxpayer"), computer software and accompanying equipment, which Medhost contracted to install in a hospital operated by the taxpayer. The software and equipment assists the taxpayer in operating various aspects of its hospital. Medhost collected a little less than $18, 000 in sales tax in connection with the transactions, which it remitted to the Alabama Department of Revenue ("the Department").

         Later, the taxpayer petitioned the Department for a refund of the sales tax it had paid on the transactions with Medhost. The Department denied that request, and the taxpayer appealed to the Alabama Tax Tribunal ("the tax tribunal"), which reversed the Department's decision and directed the Department to grant the taxpayer's request for a refund. The Department then filed an action in the trial court requesting de novo review of the tax tribunal's decision. After a hearing, during which testimony was presented ore tenus, the trial court overturned the tax tribunal's decision and affirmed the Department's denial of the taxpayer's refund petition.^[1] The taxpayer appealed to the Court of Civil Appeals, which affirmed the trial court's judgment. We granted the taxpayer's petition for a writ of certiorari.

         In Alabama, sales tax is levied on the sale of tangible personal property. State Dep't of Revenue v. Wells Fargo Fin. Acceptance Alabama, Inc., 19 So.3d 892, 894 (Ala. Civ. App. 2008) (citing § 40-23-2(1), Ala. Code 1975). This Court has defined "tangible personal property" as "'something that can be seen, felt, handled, sold commercially ... and has physical substance.'" State v. Advertiser Co., 257 Ala. 423, 429, 59 So.2d 576, 580 (1952) (quoting a trial court's order with approval). See also Black's Law Dictionary 1412 (10th ed. 2014) (defining "tangible personal property" as "[c]orporeal personal property of any kind; personal property that can be seen, weighed, measured, felt, touched, or in any other way perceived by the senses").

         The Court has decided two appeals involving taxation in connection with the sale of computer software. The first, decided in 1977, was State v. Central Computer Services, Inc., 349 So.2d 1160 (Ala. 1977). The issue in that case was stated broadly as "whether computer 'software' constitutes tangible personal property for purposes of the state use tax." 349 So.2d at 1161.^[2] The software in Central Computer Services had been conveyed to the software user via magnetic tapes or punched cards that were "used to program [the user's] computer which provide[d] data processing services for banks." Id. Upon receiving the tapes or cards, the user would transfer the "information" contained thereon to the user's own magnetic discs and would then return or discard the tapes and cards. This Court held that the software user had not purchased tangible property. Rather, "the essence of [the] transaction was the purchase of nontaxable intangible information." 349 So.2d at 1162. The Court determined that the physical media that had been used to transfer that "information" was incidental to the sale of the information. In support of that reasoning, the Court noted that "this information can also be telephoned to the computer or brought into Alabama in the mind of an employee of [the software seller]." Id.

         Approximately 20 years later, in Wal-Mart Stores, Inc. v. City of Mobile, 696 So.2d 290 (Ala. 1996), this Court considered the type of software that was being sold in Wal-Mart retail discount stores in the mid 1990s, although the Court broadly stated the issue as "whether computer software is intangible personal property." 696 So.2d at 290. The Court acknowledged that the reasoning underlying Central Computer Services was that the purchaser of software was really purchasing intangible information. The Court noted, however, that, since that case was decided in 1977, "there ha[d] been a shift in the view of many courts." 696 So.2d at 291.

"One of the changes that has occurred in this state and elsewhere, which was perhaps not reasonably to be anticipated in 1977, is the proliferation of 'canned' computer software, such as is sold by stores like Wal-Mart. As a practical matter, the marketing of such 'canned' software presumes that the information sought will be conveyed by way of a tangible medium. In this sense, the merchandiser is making a sale of tangible property, like the sale of a book."

696 So.2d at 291 (emphasis omitted). The Court thus relied on an assumption that the "information" making up canned software would necessarily be conveyed by way of a tangible medium. The Court, however, appeared to go further and to suggest that the "information" itself is tangible once it is recorded somewhere:

"'The software itself, i.e., the physical copy, is not merely a right or an idea to be comprehended by the understanding. The purchaser of the computer software neither desires nor receives mere knowledge, but rather receives a certain arrangement of matter that will make his or her computer perform a desired function. This arrangement of matter, physically recorded on some tangible medium, constitutes a corporeal body.'"

669 So.2d at 291 (quoting South Cent. Bell Tel. Co. v. Barthelemy, 643 So.2d 1240, 1246 (La. 1994) (emphasis added)).

         The taxpayer argues that this case, unlike Wal-Mart, does not involve canned software. Rather, the taxpayer asserts that it purchased nontaxable services in the form of "custom software programming." The taxpayer points to an administrative regulation promulgated by the Department, which provides, in part, that

"[c]ustom software programming is not subject to tax regardless of the manner or medium of transfer to the customer since the charge for the custom software programming is a charge for professional services and the manner or medium of transfer is considered incidental to the sale of the service."

Ala. Admin. Code (Dep't of Revenue), Reg. 810-6-1-.37(5) ("the Regulation").^[3] The Regulation defines "custom software programming" as "software programs created specifically for one user and prepared to the special order of that user." Id. The term includes "programs that contain pre-existing routines, utilities, or other program components that are integrated in a unique way to the specifications of a specific purchaser." Id. Custom software programming also includes "modifications to a canned computer software program when such modifications are prepared to the special order of the customer," although "only to the extent of the modification[s]" and only to the extent the modifications are separately invoiced to the purchaser. Id. The Department concedes in its brief to this Court that "there is no doubt that paying someone to customize your software (or to write new software from scratch) is exempt from sales tax as a service."^[4]

         Consistent with the Court's statements in Wal-Mart, we hold that all software, including custom software created for a particular user, is "tangible personal property" for purposes of Alabama sales tax. There are, however, nontaxable services that can accompany the conveyance of software. Those services include, but are not limited to, determining a particular software user's needs, designing and programming new software for a particular user, ^[5] modifying or configuring existing software programs to meet a particular user's needs, installing software, and training users to operate software. If the costs of such services are separately stated and invoiced, they are nontaxable. Charges for the software itself trigger the imposition of sales tax at the time the sale closes and the software is transferred to the purchaser.

         Thus, there is no distinction for Alabama sales-tax purposes between canned or custom software. All software is tangible personal property and thus subject to sales tax. The pertinent distinction is how the transaction is documented and invoiced, and that is left strictly in the hands of the seller and purchaser. To the extent a seller tenders an invoice for computer software, the gross amount allocated to that software is subject to sales tax. However, a seller's invoice for services such as those identified above, when separately stated, is not subject to sales tax.

         In the present case, the testimony presented to the trial court included that of Medhost's chairman and chief executive officer, Bill Anderson. Anderson's testimony supports a conclusion that Medhost sold the taxpayer preexisting software and equipment, which was available for purchase by any hospital, and that Medhost thereafter "implemented" the software and equipment at the taxpayer's hospital so that hospital personnel could operate it efficiently. Implementation of the software consisted of a determination of how the taxpayer's hospital functions; setting up hardware and similar equipment; data entry and selection of "configuration options" that exist within Medhost ...