Appeal from the Circuit Court of Sangamon County, the Hon.
Richard J. Cadagan, Judge, presiding.
MR. JUSTICE CLARK DELIVERED THE OPINION OF THE COURT:
Rehearing denied June 4, 1981.
After an audit was conducted by defendant, the Department of Revenue, a deficiency tax assessment was asserted against the plaintiff, the First National Bank of Springfield. Liability for the deficiencies was alleged to be due under the Use Tax Act (Ill. Rev. Stat. 1977, ch. 120, pars. 439.1 to 439.22), the Retailers' Occupation Tax Act (Ill. Rev. Stat. 1977, ch. 120, pars. 440 to 453), and the Municipal Retailers' Occupation Tax Act (Ill. Rev. Stat. 1977, ch. 24, par. 8-11-1). The plaintiff protested the assessment and, after a hearing, the Department issued a final deficiency assessment in the amount of $12,131.10, including penalty and interest. The final assessment constituted a final administrative decision. The plaintiff filed a complaint for review of the Department's final assessment in the circuit court of Sangamon County. Subsequently, the parties agreed to reduce the final assessment by the amount of taxes attributable to the sales by plaintiff of repossessed machinery. As a result, the only remaining dispute concerned the taxability under the Use Tax Act of five computer software programs purchased by plaintiff for use in Illinois. The circuit court decided, as a matter of law, that the plaintiff's purchase of computer software programs from out-of-State, nonresident suppliers were purchases of intangible personal property and therefore not subject to the use tax. The court set aside the Department's final assessment and entered judgment for the plaintiff. The Department moved for a direct appeal to this court under Rule 302(b) (73 Ill.2d R. 302(b)). We allowed the Department's motion. We affirm.
In the computer industry, computer hardware is the tangible part of the machinery itself. Software denotes the information loaded into the machine and the directions given to the machine (usually through the media of punch cards, discs or magnetic tapes) as to what it is to do and upon what command. Software also may include counseling and expert engineering assistance furnished by the seller of software, as well as flow charts and instruction manuals. (See Honeywell, Inc. v. Lithonia Lighting, Inc. (N.D. Ga. 1970), 317 F. Supp. 406, 408.) The record in this case indicates that only magnetic tapes were delivered to the bank. There is no mention of any other materials accompanying the tapes.
There are two basic types of software programs. An operational program controls the hardware and actually makes the machine operate. It is fundamental and necessary to the functioning of the hardware. An applicational program is designed to perform specific functions once the programming information is fed into the computer. See Commerce Union Bank v. Tidwell (Tenn. 1976), 538 S.W.2d 405, 406.
In the instant case, the programs involved were applicational. Larry Thomson, an assistant vice president and manager of data processing at the plaintiff bank, testified that the bank purchased five applicational programs from five different sources. The programs purchased were a customer information file from the National City Bank of Cleveland which would enable the bank to compile information from all of the bank's accounting ledgers and make it available at one source. Another program computed installment-loan payments, while a third program computed commercial-loan payments. A fourth program, a programmer's information and index program, is, according to Thomson, "commonly known as a librarian system whereby [the bank] could take other programs, such as the National City program, place it on that library and use that as a method of keeping track of the program, making changes to it." The last program, an audit program, contained a set of instructions used to accumulate requested information from all other programs. Thomson also testified that the programs were delivered on magnetic tapes. The programs were then taken off the magnetic tapes and put into a library, where necessary modifications were made to the programs to accommodate the bank's particular needs. After the information was removed from the tapes and stored elsewhere, the tapes could either be used again or discarded. Thomson stated further that those instructions could have been conveyed to the bank through discs, punch cards or over the telephone.
Section 3 of the Use Tax Act provides:
"A tax is imposed upon the privilege of using in this State tangible personal property * * * purchased at retail from a retailer." (Ill. Rev. Stat. 1977, ch. 120, par. 439.3.)
Thus, the issue in this case is whether computer software is tangible personal property and is therefore taxable under the Use Tax Act.
The plaintiff contends that the magnetic tapes in question here constituted intangible personal property, because they were, in essence, merely a means of conveying programming instructions. The plaintiff argues that software primarily represents intangible services and not tangible goods. The Department, on the contrary, contends that the physical qualities of the tapes predominate over the information contained on them. The Department compares the tapes to films, phonograph records and books. All three examples, the Department argues, represent the physical manifestation of intangible ideas and artistic achievement, yet all three are taxable as tangible personal property.
Taxing statutes are to be strictly construed, and their language is not to be extended or enlarged by implication beyond its clear import, but in cases of doubt such laws are construed most strongly against the government and in favor of the taxpayer. Ingersoll Milling Machine Co. v. Department of Revenue (1950), 405 Ill. 367, 373; Mahon v. Nudelman (1941), 377 Ill. 331, 335.
In our opinion, computer software, such as the instant magnetic tapes, is more properly characterized as intangible, than tangible, personal property. The Use Tax Act does not define the word "tangible," but this court abided by the following definition in Farrand Coal Co. v. Halpin (1957), 10 Ill.2d 507, 511:
"An examination of the statute in question and the objectives intended to be accomplished thereby clearly indicates that the General Assembly when using the word tangible in referring to personal property had in mind the ordinary and popularly understood meaning of such term as indicated in Webster's first definition thereof, which is `Capable of being touched; also, perceptible to the ...