Idaho: Back-and-Forth on Software Tax

Recently, the Idaho legislatures convened for a draft rule meeting to discuss the recently enacted HB598 (“Rule 027”). The goal of the meeting was to provide guidance and interpretation to assist taxpayers in complying with Rule 027. The end result will be a published administrative bulletin.

The legislatures discussed the sales tax policy and applied it to Rule 027. Fundamentally, tangible personal property (TPP) is subject to sales tax and services are not taxable. TPP includes pre-written software that is delivered in a tangible form. Pre-written software that is electronically delivered or accessed remotely is not taxable. However, entertainment software products are taxable regardless of the delivery method. In general, services are not taxable. But, if a service is delivered tangibly, it may be taxable. For example, a diagnostic service delivered on a cd maybe taxable. Not discussed, however, were several areas of taxability. These include tangible software product key, permanently loaded software with minimal function without access to provider’s services, and fee to view an entertainment product.

During the draft rule meeting, the legislatures displayed inconsistent application of the tax policy. Moreover, Idaho legislatures have difficulty reconciling that a service can be delivered via cloud or cd. In general, Idaho’s tax policy is to exclude services from sales tax.  However, the legislatures defined services by the method of delivery, not the content. For example, software that resides on a cloud is not taxable if downloaded via the internet. But, the same software content that resides on a disc/cd is taxable. In contrast, the legislatures are consistent when applying the tax policy to entertainment products. Entertainment products are taxable based on their content; not on the method of delivery (cd or internet).

Wyoming Reveals “PaaS”sive Approach to Taxing the Cloud

On July 1, 2014, the Wyoming Department of Revenue issued a bulletin to address questions concerning the sales tax treatment of current technologies. The technologies include software, cloud computing and peripheral services.

Wyoming levies a sales tax on tangible personal property. Tangible personal property includes computer software. Specifically, Wyoming taxes pre-written software regardless of delivery method. Custom software, created for a specific client, is exempt from sales tax.

In the bulletin, Wyoming reveals for the first time how it will treat cloud computing products, including SaaS, PaaS, and IaaS.  Cloud computing services will be generally treated as nontaxable purchases for purposes of Wyoming’s sales tax.  This assumes that the purchase of the cloud product is not accompanied by a transfer of tangible personal property or an enumerated service.

Access to the host site itself may or may not be taxable. If a customer is required to purchase an application to access the cloud service, the application is taxable.

The bulletin also states that data storage fees are generally not subject to Wyoming’s sales tax.  However, if host provider manipulates the data or has access to customers’ computers then the fees would be taxable.

Georgia Ruling Affirms Its Position on Electronic Delivery

Recently Georgia’s Department of Revenue (“Department”) issued Letter Ruling SUT 2014-02-20-01 regarding software and cloud service transactions. A Georgia taxpayer requested the Department to determine whether these transactions are subject to Georgia’s sales and use tax. The taxpayer sells pre-written software, software modifications delivered electronically via the taxpayer’s site. The taxpayer is also a reseller of cloud subscription services that allows a customer to access and use vendor software via the internet.

Georgia imposes a sales tax on tangible personal property which includes pre-written software delivered via tangible medium. In the Ruling, Georgia confirms its position that when pre-written software is only delivered electronically, the software is not taxable. The same rule applies to the taxpayer’s pre-written software modifications. In addition, Georgia stated that the cloud computing subscriptions did not involve the transfer of tangible personal property or an enumerated service; and were thus, nontaxable.

Massachusetts Confirms On-Line Training is Tax-Exempt

Recently a Massachusetts taxpayer requested Massachusetts’s Commissioner of Revenue (“Commissioner”) to determine the taxability of its on-line training program. Taxpayer provides an interactive training program for various industries. Taxpayer is the primary source of the on-line content. Taxpayer’s cloud services are hosted by a third party. Customers have modest to limited interaction with the on-line training. Their interaction consists of answering questions to confirm participants’ understanding.

Massachusetts imposes a sales tax on pre-written software regardless of the method of delivery. However, Massachusetts does not subject sales tax on database access. See 830 CMR 64H.1.3 (13).

In instant case, customer was purchasing the on-line training for the information provided and not for the underlying software used to deliver the information. The customer did not receive software nor did customer have the ability to control the software. The Commissioner concluded the true object of the transaction was for accessing information and not the use of software.  Accordingly, the on-line training was not taxable.

The decision may have been different if customers contributed more to the on-line interaction. The Commissioner commented that if a customer was able to produce its own training programs from the interaction, the transaction may be taxable.

Cloud Computing By Any Other Name…

Recently Missouri Department of Revenue amended their sales tax regulations on taxation of software.  Specifically, 12 CSR 10-109.050 was amended to clarify the taxation of canned (pre-written) software, customized software, software as a service, and software licenses.

In general, the new regulations do not break new ground when defining what is canned software or customized software. The new regulations provide that canned software that is delivered in a tangible medium is subject to sales tax. However, if the canned software is downloaded via online, the canned software is not taxable. The new regulations do not tax customized software.

The regulations do break new ground for Missouri by addressing software as a service is not taxable. The new regulations describe cloud computing without mentioning it by name. Missouri refers to cloud computing as software as a service, 12 CSR 10-109.050 (2)(C). The definition includes the typical attributes of what cloud computing, however the Missouri legislature carved out a piece of cloud computing that is taxable. Cloud computing services are taxable if the user/purchaser has the right to use specifically identified TPP. For example, in many cloud-computing environments, a business wants to use dedicated servers to provide efficient use of resources. However, in Missouri a business will not enjoy the tax-exempt status that other states provide.

The final part of the amendment addresses the taxation of software licenses. In general, software licenses are taxed if they are a part of the original sale agreement. However, if licenses are purchased at a subsequent time or via a third party, they are not taxable.

This new legislation may shift how enterprises conduct business by providing tax-planning opportunities. For example, a company needing a significant number of licenses can either purchase from a third party or purchase them outside of the original software agreement.  Another example, a company may choose to obtain all their software by internet delivery. In addition, this legislation will leave Missouri businesses at a competitive disadvantage when competing for businesses that require specifically dedicated resources for their needs.

In IL, It’s Location, Location, Location…..

Recently, Illinois Department of Revenue (“Department”) issued a Private Letter Ruling regarding sales apportionment for cloud services.  A non-resident taxpayer requested the Department determine the sales factor used to determine the percentage of non-resident’s business income taxable by Illinois. Taxpayer provides two types of cloud computing services. First, a dedicated cloud that provides services for specific customers with dedicated servers. Customers using the dedicated cloud are responsible for managing the admin functions.  The other cloud is the public cloud, which allows customers to use applications without downloading them on their own computers. In both cloud computing services, the taxpayer owns the servers and applications.

Illinois imposes a business income tax on sales of services; however Illinois does not have a specific definition of sales of services. The Department concluded that taxpayer’s cloud computing services are sales of services using IRC Section 7701(e). The sales factor consists of total sales in Illinois over total sales in one year. Per Illinois Income Tax Act, sales of services are sources at either a customer’s fixed place of business where services are provided; if customer’s place is not determinable, sources are sourced where services were ordered; or if place of order location is not determinable, services are sourced where services are billed.

In instant case, taxpayer’s cloud computing services are provided to customers that neither their location nor order origination is determinable. Accordingly, the Department concluded that taxpayer’s source of sales should be sourced at customers’ billing address.

Based on the Illinois’ statute, location does matter and provides tax planning opportunities to minimize taxes. A corporation can weigh the costs of creating software to have the ability to track transactions. In addition, a corporation may minimize taxes by drafting contracts with specific language. Lastly, a corporation needs to include analysis of what other states regulations are and the impact of potential amendments.

Appeals Court Says Online Research Tool Not Tangible Property

Recently, Michigan’s Court of Appeals issued an opinion concerning the taxability of electronically accessed information services, determining that an online research product was not taxable as tangible property. A Michigan taxpayer filed an appeal to Michigan’s Court of Claim’s assessment of a tax deficiency for use of prewritten software.  The taxpayer sells online tax and accounting research services. Customers subscribe to the taxpayer’s services to search and retrieve current sources, browse compiled information, and access links for their individual needs. The customers access the information via a web browser.

Michigan imposes a use tax on the sale of tangible personal property and tangible personal property includes prewritten software.

Michigan’s Court of Appeals ruled that the taxpayer’s information services are not taxable because the use of any prewritten software was incidental to the transaction as a whole. Here, the taxpayer’s primary purpose of any sale was to provide information to the customer’s needs. The Court determined that any use of prewritten software was incidental to what customers sought in purchasing the taxpayer’s product.  Notably, however, the court commented that but for the application of the incidental to service test, the product may have been taxable. The Court explained its conclusion by pointing out that this specific type of software had not been anticipated by the Legislature. Stay tuned to see if this ruling might prompt the Legislature to further delineate what prewritten software is in light of current technology.

Indiana’s Fulfillment-Center Legislation DOA

Indiana’s affiliate and click-through nexus legislation (SB269) has died before passing the Senate. We recently discussed this legislation that would have added click-through and affiliate provisions to Indiana’s sales and use tax in an attempt to target in-state fulfillment centers. The bill was introduced on January 13, 2014 by Indiana State Senator John Broden; however no vote was taken on the bill before the adjournment of the legislative session. Therefore, the bill will need to be reintroduced for consideration in a future legislative session.  Indiana commissioned two reports which estimate that the state will forgo between $ 40M and $ 217M in sales and use tax revenue without the legislation.

Maine Legislature Expands TPP Tax Base

The Maine legislature recently enacted a bill that amends the definition of tangible personal property to include any product that is electronically transferred. The bill also modifies the current affiliate nexus provisions with the rebuttable presumption used in other states’ affiliate nexus legislation.

The expanded definition of tangible personal property, which includes electronically transferred products is a further expansion of the sales tax base coming less than a year after Maine extended the tax base to digital products transferred electronically.  On June 26, 2013, the legislature expanded the tax base to include “product[s] transferred electronically,” which was defined as “digital product[s] transferred to the purchaser electronically the sale of which in non-digital physical form would be subject to tax … as a sale of tangible personal property.”  The term “digital product” was not defined in the amended laws.

Now, Maine has gone a step further by expanding the definition of tangible personal property to include any product transferred electronically, not just “digital products.”

Technology Outpaces Michigan Statute

Recently, Michigan’s Court of Claims issued an opinion in Auto-owners Ins. Co. v. Dept. of Treasury, regarding the taxability of purchases of cloud computing services (“services”). A Michigan taxpayer made a motion for summary disposition to overturn Michigan’s Department of Treasury’s decision that these purchases were taxable. The taxpayer requested that the Court determine whether these transactions are a taxable transfer of tangible personal property under Michigan’s Use Tax Act (“UTA”) or a non-taxable sale of a service.

In this case, the taxpayer is a property and casualty insurance provider that remotely accesses several third parties’ technological infrastructures which include networks, servers, data storage, and software applications. To provide these services, the taxpayer uses third parties to accomplish various business transactions ranging from marketing to billing to risk analysis.

Michigan’s UTA imposes a tax on the use of tangible personal property. Tangible personal property includes prewritten software delivered by any means. The UTA further delineates, that if the underlying transaction was merely incidental to the services rendered by a third party provider, the transaction would not be subject to the use tax.

The court focused on the legislature’s intent at the time the UTA was enacted. The court placed emphasis on the language that prewritten software includes “delivered by any means.” The court rationalized that the legislature could not have envisioned the technology that this taxpayer is using. Accordingly, the court concluded that since these remote access transactions were outside the scope of the legislature’s intent, the transactions are non-taxable services. This conclusion is consistent with Michigan’s tax statute interpretation that laws will not be extended in scope by forced construction of the statute.

The court commented that this type of transaction may be taxable in the future if the legislature expresses its intent to include such transactions. Because states are grappling with budget deficits and looking to raise revenues, it is easy to see how this may come to pass.