State Sales and Transaction Taxes of IT Products and Services: Navigating the Evolving Landscape

(1)

State Sales and Transaction Taxes of IT Products

and Services: Navigating the Evolving Landscape

Managing Multi-State Compliance Challenges for Vendors and Customers

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

THURSDAY, MARCH 5, 2015

Presenting a live 110-minute webinar with interactive Q&A

Martin Eisenstein, Managing Partner, Brann & Isaacson, Lewiston, Maine Caleb Allen, Esq., Washington State Department of Revenue, Olympia, Wash. Michael Carey, Esq., Brann & Isaacson, Lewiston, Maine

The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.

(2)

Sound Quality

If you are listening via your computer speakers, please note that the quality

of your sound will vary depending on the speed and quality of your internet connection.

If the sound quality is not satisfactory, you may listen via the phone: dial

1-888-450-9970 and enter your PIN when prompted. Otherwise, please

send us a chat or e-mail [email protected] immediately so we can address the

problem.

If you dialed in and have any difficulties during the call, press *0 for assistance.

NOTE: If you are seeking CPE credit, you must listen via your computer — phone listening is no longer permitted.

Viewing Quality

To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again.

(3)

For CLE credits, please let us know how many people are listening online by completing each of the following steps:

• Close the notification box

• In the chat box, type (1) your company name and (2) the number of

attendees at your location

• Click the SEND button beside the box

For CPE credits, attendees must listen throughout the program, including the Q & A session, and record verification codes in the corresponding spaces found on the CPE form, in order to qualify for full continuing education credits. Strafford is required to monitor attendance.

If you have not printed out the “CPE Form,” please print it now (see “Handouts” tab in “Conference Materials” box on left-hand side of your computer screen). Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926

ext. 10.

(4)

If you have not printed the conference materials for this program, please complete the following steps:

• Click on the ^ symbol next to “Conference Materials” in the middle of the left-hand column on your screen.

• Click on the tab labeled “Handouts” that appears, and there you will see a PDF of the slides for today's program.

• Double click on the PDF and a separate page will open.

• Print the slides by clicking on the printer icon.

(5)

State Sales and Transaction Taxes of

IT Products and Services:

Navigating the Evolving Landscape

March 5, 2015

Martin Eisenstein, Brann & Isaacson

Caleb Allen, Washington State Department of Revenue Michael Carey, Brann & Isaacson

Material in this webinar is for reference purposes only. This webinar is being provided with the understanding that neither the author(s) nor Strafford Publishing (and its representatives) are engaged in rendering legal, accounting, investment, or any other professional service directly through this webinar. Neither Strafford Publishing (and its representatives) nor the author(s) assume any liability for any errors or omissions, or how this webinar or its contents are used or interpreted, or for any consequences resulting directly or indirectly from the use of this webinar. For legal, financial, strategic or any other type of advice, please personally consult the appropriate professional.

Strafford 5

(6)

Today’s Program

Background Issues Regarding Sales Tax on IT Services/Products

Martin I. Eisenstein, Brann & Isaacson Slide 7 – 34

Working Through A Tax Analysis of a Sample Contract for Data Center Service, Managed Network Service, End User Service and Help Desk Service

Michael Carey, Brann & Isaacson Slide 35 – 53

Cloud Computing

Martin Eisenstein, Brann & Isaacson Slide 54 – 69

Sales and Transaction Taxes on IT Products and Services

Caleb Allen, Washington State Department of Revenue Slide 70 – 97

Hypotheticals

(7)

Background Issues Regarding Sales Tax

on IT Services/Products

By

Martin Eisenstein

(8)

Background: Issues Covered

• Distinctiveness of IT Services and Products

• 6 Questions To Determine If Product/Service Is Taxable

And Where It Is Taxable

– Question 1: What is the service or product? – Question 2: Is it a bundled service/product?

– Question 3: To what state or states is the service/product sourced?

– Question 4: Does the state tax the product or service? – Question 5: Are any exemptions available?

(9)

Background:

Distinctness of IT Services and Products

• Rapidly changing services/products

• No standard product: Services and products sold

come in many different flavors

• Statutes/rules have not kept up with the changes in

the industry

• Agency rulings and court decisions have attempted

to fit the square pegs of the IT industry in the round

hole of existing sales tax laws

• Most IT providers sell services, for which only a

minority of states tax

(10)

Background:

Distinctness of IT Services and Products

• Sourcing for tangible personal property often differs from

sourcing for services

• Sourcing for services varies among the states, particularly

when service is provided to more than one location.

• Most IT providers provide service to locations in many

states

(11)

Background: The Analysis

• Six Major Questions To Answer:

(1) What is the service or product?

(2) Is it a bundled service/product?

(3) To what state(s) is the service/product

sourced?

(4) Does the state tax the product or service?

(5) Do exemptions and/or direct pay permits

apply?

(6) Does the provider have nexus with the state where

the service is sourced?

(12)

Question 1:

What is the service or product?

• Primary Object or Primary Function Test

– Test courts applied when first addressing taxability of software before adoption of legislation characterizing software as tangible personal property. See, e.g. Sneary v. Director of Revenue, 865 S.W.2d 342 (Mo. 1993).

– Some courts continue to use test to determine taxability of software based on the mode of delivery of the software.

– Test currently used to characterize the nature of an IT service and to distinguish between taxable and non-taxable services.

• Examples of Test

– Andersen Consulting LLP v Gavin, 767 A.2d 692 (Conn. 2001): taxable computer and data processing services instead of nontaxable

(13)

Question 1:

What is the service or product?

• Examples of Application of Test

– Prodigy Services Corp., Inc., 125 S.W.3d 413(Tenn. Ct. App. 2003) ((Tenn. Ct. App. 2003): Online (Internet) service not deemed a

taxable telecommunications service but a nontaxable information service, because the primary object of the purchaser was to obtain access to the provider’s website and to obtain information from the Internet and not to obtain the transmission of its messages.

• The service provider, Prodigy, used transmission to provide its online services.

– SSOV ‘81, CCH ¶ 401-845 (1/19/95), the NY Tax Appeals Tribunal stated that primary function of taxpayer’s matching service at issue in that case was to “allow members to meet others” and thus not a taxable information service.

• The service provider, SSOV, did produce information, but that was merely a byproduct of the service.

(14)

Question 1:

What is the service or product?

• Additional Examples of Application of Test

– OH Rule 5703-9-46(B)(3)(a) True object of the transaction is the receipt of automatic data processing, computer services, or electronic

information services if such services render a significant benefit to the consumer.

• Opinion of OH Tax Commissioner CCH ¶ 404-196 (2/4/14) A cloud collaboration service offering providing the customer with hosted software applications via access to the provider’s owned computer hardware deemed a taxable automatic data processing service

because the true object is to provide customers access to equipment to process data

(15)

Question 1:

What is the service or product?

• General Principles:

− Under New York law, the tax authorities focus on the service in its entirety and do not break it down into components, even if as an ancillary matter information is provided. SSOV at p. 6

− Under law of most states, provider’s use of software or other taxable

products/ services to produce the service, does not cause the end product to be taxable.

• OH Rule 5703-9-46(B)(3)(b) provides a good explanation of test, by characterizing a service as merely incidental or supplemental and not deemed taxable data processing or computer services if

– The data processing services are merely utilized by the provider in the performance or delivery of personal or professional services; or – The benefit sought to be received by the consumer from the

services is a personal or professional service.

• SSOV (NY) : “We cannot accept the Division’s argument that the means by which a service is provided is the controlling factor in determining “taxability.”

(16)

Question 1:

What is the service or product?

• Determination of the true object

– Generally, based on what the purchaser was buying as promoted by the seller

• Sources for determination

– Marketing materials/website – Contract

– Invoices

– Accounting records (Account number to which revenue is booked)

– See, e.g., Qualcomm, Inc. v. WA Dept of Revenue, 213 P.3d 348 (WA Ct. App. 2009), determining whether data processing

(17)

Question 1:

What is the service or product?

• Troublesome characterizations in contracts/invoices

or accounts to which revenue is booked

– Warrants review and analysis

• Factors in characterization for taxability purposes:

– Ownership of equipment

• Data Processing

• Services re servers and telecommunications

equipment

– Where the service takes place in the case of data

processing and storage.

(18)

Question 1:

What is the service or product?

• Special issues as to how the property is delivered

– Some states do not tax electronically delivered

software. See, e.g., CO Stat.

§ 39-26-102(15)

amended by Ch. 299 (H.B. 1293)

– Some states treat electronically delivered

(19)

Question 1:

What is the service or product?

• Special issues whether product is tangible personal property – Customized software vs pre-written

• Some states treat pre-written as tangible personal

property but customized software as services and not

taxable. See, e.g., Colo Rev Stat §39-26-102(15)

amended by Ch. 299 (H.B. 1293), Laws 2011

• TX treats customized software as TPP. See 34

TAC3.308(b)(2)

• Special issues whether sale of certain services are part of sales price for software

– Installation: Taxable as part of the sales price in TX and other states. See, e.g., 34 TAC3.308(b)(2)

(20)

Question 1:

What is the service or product?

• Special issues whether sale of certain services are part of sales price for software

– Maintenance:

• Taxable in KS even if charge separately stated: Kan.

Stat. Ann. § 9-3603(q).

• Not taxable in some states if charges separately stated.

N.Y. Tax Law §1115(o). N.Y. Dep’t of Taxation and Finance, Taxpayer Servs. Div., Tech. Servs. Bureau, TSB-M-93 (3) S (Mar. 1, 1993).

(21)

Question 2:

Is it a bundled service/product

or separate services/products?

• “One bad apple spoils the bunch” in most cases

and states

– A price for a bundle of separate products and

services in which one product is taxable and

another product/service is not taxable means

that the entire charge is taxable

• NY cheeseboard rule. N.Y. Comp. Codes R

& Regs. Tit. 20, section 527.1(B)

– Cardinal Principle: Separately price and

invoice separate charges for different

services/products

(22)

Question 2:

Is it a bundled service/product

or separate services/products?

• NY Cheeseboard Rule followed in most states, with some exceptions even when pricing is not separately provided:

– Internet Tax Freedom Act: Combination of telecom services with Internet services may be separated into taxable and non-taxable Internet access (if state is grandfathered) if provider can reasonably identify the charges for Internet access from its books and records

kept in the regular course of business. ITFA, § 1106, 47

U.S.C. 151 note.

– Most state laws permit a provider of telecom services to separate taxable telecom charges from non-taxable

(23)

Question 2:

Is it a bundled service/product

or separate services/products?

• Exceptions to NY Cheeseboard Rule

– Section 330 of SSUTA provides for “unbundling” of

certain services (based on costs), including telecom

services, ancillary service, Internet access and

audio/video programming services.

– TX: Data Processing and Information Services Rules

permits unbundling of data processing charges when

bundled with non-taxable and taxable charges.

34 Tex. Admin. Code Section 3.330(d)(2) and

3.342(e)(2).

(24)

Question 2:

Is it a bundled service/product

or separate services/products?

• Separate pricing of products/services has limits:

– If service is auxiliary or related to main product that is taxable then the auxiliary service may be deemed taxable

• E.g. shipping and handling for software • Installation for computers and software

• Overhead items such as labor costs in providing a data processing service.

• TX rule regarding related services (data processing):

– 34TAC3.330(d)(3) (“Charges for services or expenses directly related to and incurred while providing the taxable service are taxable and may not be separated for the

purpose of excluding these charges from the tax base.

Examples would be charges for meals, telephone calls, hotel rooms, or airplane tickets.”)

– 34TAC3.330(d)(1) provides that a service is unrelated if it is commonly sold on a stand alone basis and is a distinct

(25)

Question 3:

To what state or states is the service/product sourced?

• General rule regarding sourcing of tangible personal property: • No universal rule regarding sourcing of services.

– Non-SSUTA states

• If related to tangible personal property, then generally sourced where tangible personal property is located.

• If pure service, then generally taxed where service is received, except for FL’s tax on use of a server located in FL and

Chicago’s tax on lease of personal property insofar as storage space (but not on data processing/information services.)

– The location of the terminal for access to the service

controls. See, e.g.. NYS (TSB-A-10(52)S 10/18/10); CT (ADC 12-426-27(d)); TX (Rules 3.330 and 3.342). – Issue is the proof of where the service is received and

method of allocation

(26)

Question 3:

To what state or states is the service/product sourced?

• Sourcing: SSUTA waterfall approach (OH: R.C.5739.033(C))

– If service received (i.e., first use) at the vendor’s place of business, sourced at the vendor’s place of business.

– If not received at the vendor’s place of business, sourced at the location of receipt known to the vendor.

– If neither of the above, then sourced at the address of the customer, as known from the vendor’s business records. – If none of the above, then the address given in the

transaction.

(27)

Question 3:

To what state or states is the service/product sourced?

• Receipt of service at more than one location

– NY, CT, DC rules are generally silent on multi-office access.

• In TSB-A-10(52)S (10/18/10), New York permitted apportionment based on the ratio of New York-based employees with access to the service to the number of employees located throughout the U.S. with access. • In TSB-A-03(5)S,(1/31/03), acceptance of certificate

relieved provider of liability for non-NY employees so long as provider obtains detailed information regarding address of employees of customer. Provider still liable for tax for NY-based employees.

(28)

Question 3:

To what state or states is the service/product sourced?

– TX: Rules 3.330(f)(Data Processing) and 3.342(g)(Information Services) provide a more straightforward approach.

• The general theme is for the purchaser to identify the segment of the business that the service benefits, and then issue an exemption certificate to the service provider that provides for a reasonable method of allocation. (TX exemption certificate

comparable to the certificate of multiple points of use where the provider is relieved of all liability for TX tax on these services)

• Note: Differences in burden: Provider may accept the certificate in good faith. Customer must prove by clear and convincing

evidence that the service relates to an identifiable segment of the business and then can allocate outside of TX; if not able to do so the presumption is that the 100% of the service is

provided at headquarters. See (Comptroller Decision in Hearing

(29)

Question 3:

To what state or states is the service/product sourced?

– TX: does not permit exemption certificate to exempt from tax collection by provider portion of services other than data

processing and information services, allocated to TX.

– OH approach: R.C. 5739.033(D)(Applies to purchase of software, digital goods and data processing services)

• If the purchaser does not have a direct pay permit, the

purchaser may deliver a certificate of multiple points of use and the vendor is relieved of collection responsibility for entire tax, and the purchaser may use any reasonable,

consistent and uniform method of apportioning purchases by jurisdiction.

• A purchaser who has a direct pay permit may rely on the direct pay permit in lieu of the MPU Certificate

(30)

Question 3:

To what state or states is the

service/product sourced?

• OH approach re multiple points of use

• In the absence of an exemption certificate and

direct pay permit, the vendor and customer can

work out a reasonable, consistent and uniform

method of apportionment. If the customer certifies

to the same, then this method governs and the

provider pays tax on the OH percentage.

• In the absence of any of the foregoing, the all or

nothing waterfall provisions apply.

(31)

Question 4:

Does the State Tax The Product or Service?

• Varies by state

• Most states do not tax services such as data

processing, information services and computer

consulting services

• Many states do tax services related to installation

and maintenance/repairs of computer equipment

and software.

• Many states tax telecommunications services,

although some states do not tax interstate

telecommunications services.

– Note special provisions for private line services

(32)

Question 5:

Are Any Exemptions Available?

• Resale Exemption

– In eight states resale exemptions do not apply to taxable services.

• E.g. HI and VA • Direct Pay Permit

– Not available for services in some states. See, e.g. Maine

Rule 308(4)(1)

– Not available for purchase of telecommunications services in CT. (CT Department of Revenue Services publication,

February 10, 2004.)

(33)

Question 6:

Does The Provider Have Nexus With The State

Where The Service Is Sourced?

• Quill physical presence test applies – Remote IMAC is not nexus

– On-site maintenance is nexus

• Dispatch of third parties on behalf of customer by help desk may not be nexus

– Provision of data services to other states should not create nexus

– Sale of software through downloads on the Internet

• (TX Comptroller Decision in Hearing No. 106,626, CCH

¶ 403-996 (9/19/14)) is a controversial decision

(34)

(35)

Working Through A Tax Analysis

of a Sample Contract for Data Center Service,

Managed Network Service,

End User Service and Help Desk Service

By

Michael Carey

(36)

What is the Sales and Use Tax Analysis

of an IT Services Contract?

Sample Provider Invoice to Customer

Data Center Services

Managed Network Services

End-User Services

(37)

Question 1:

What is Data Center Service?

• An IT Service Provider runs a data center that maintains and stores the customer’s data, which the customer can access at will.

• The provider may refer to its services by a specific function (e.g. hosting or data storage services), or by the nature of servers (e.g. window server or Unix virtual server).

• The tax characterization of Data Center Service may include Data Processing, Monitoring, Information Services, Hardware Repair, or IMAC (“Install, Move, Add, Change”) depending on the contract language and the nature of the service.

(38)

Question1:

What is the service? Data Processing

• Data Processing is the service of compiling information and producing records of transactions, maintaining information, and entering and retrieving information.

See e.g. D.C. Mun. Regs. Tit. 9, § 474.

• Other examples:

− Texas imposes a tax on 80% of the charges for a data processing service, which is defined to include “word processing, data entry, data retrieval, data search, information compilation, payroll and business accounting data

production … and other computerized data and information storage or manipulation … [and] the use of a computer or computer time for data processing whether the processing is performed by the provider of the computer or computer time or by the purchaser or other beneficiary of the service.” V.T.C.A. Tax Code §§ 151.0035, 151.0038, and 151.0101.

− Connecticut imposes a 1% sales tax on “computer and data processing services, “ which include “time, programming, code writing, modification of existing programs, feasibility studies and installation and implementation of software programs and systems.” Conn. Gen. Stat. Ann. §§ 12-

(39)

Question 1: What is the service?

Data Processing vs. Monitoring

• To determine the nature of the provider's services, it is important to determine the ownership of the hardware and the licensee of the software.

− Data Processing – generally, if the provider owns the computer it likely compiles and produces records.

• But in some states Data Processing is taxed whether the

provider or customer owns the equipment. See e.g., V.T.C.A., Tax Code § 151.0035.

− Monitoring - if the provider monitors the equipment and software only to determine whether there are any problems or disruptions in the service, generally, it should be classified as a monitoring

service, and not a data processing service, because any data processing is done by computers not owned by the provider. • Taxable Protective Services: If the service includes monitoring for

unauthorized access to, or use of, customer’s IT assets in New York, the charges are taxable as a protective service. N.Y. Tax Law §

1105(c)(8).

(40)

Question 1:

What is the service? Hardware Repair

• Data center equipment may break-down, so Hardware Repair will be deemed part of provider’s service unless the contract clearly states that customer has continuing responsibility for Hardware Repair.

− Many states tax hardware repair even though it is a service.

See e.g., Conn. Gen. Stat. Ann. § 12-407(a)(37)(cc); Iowa

DOR Pub. NC 78-5750 (“Iowa Sales Tax on Computers.”)

(41)

Question 1: What is the service?

IMAC (“Install, Move, Add, Change”)

• Provider may perform an IMAC on either hardware or software owned or licensed by client. Some providers refer to it as IMACD, adding “disposal” or “de-install” to the service.

− A “Hard IMAC” is one that the Provider performs in-person, whereas a “Soft IMAC” is performed remotely.

− States may tax IMACs performed on hardware, software, or both. • Some states tax:

− IMAC on either hardware or software. See e.g. D.C. municipal regulations, tit. 9 §§ 463.1, 474.4.

• Other states tax:

− IMAC performed on hardware but not software. See e.g., Iowa Code sections 423.1(10). Iowa Admin. Code r. 701-18.34(3)(e). • And, some tax

− IMAC performed on software but not hardware . See e.g., Conn. Department of Revenue Servs., Policy Statement No. 2006(8) (Mar. 23, 2007)(IMAC on owned hardware is not taxable).

(42)

Question 1: What is the service?

Information Services

• Information services is the provision of a right of access to a common database. The definition is broad enough to encompass many IT services (e.g. data

processing) but few states’ taxes information services should affect IT providers. − Many information services provisions parallel data processing. See e.g.

V.T.C.A., Tax Code 151.351, 34 TX Admin. Code §§ 3.330, 3.342.

• New Jersey does not tax data processing, and taxes the furnishing of information collected, compiled or analyzed by the seller, but has an exclusion for the provision of “personal or individual information which is not incorporated into reports furnished to other people.” N.J. Sta. Ann, § 54:32b-2(44).

(43)

Question1: What is the service?

Responsibility for Software Upgrades

• If the provider is financially responsible for patches

or other software upgrades, the taxability of the

transaction will turn on the laws of the state where

the software is installed.

• If the customer is financially responsible for

upgrades, the provider’s service will likely be treated

as IMAC for software.

(44)

Question 2:

Is The Data Center Service a Bundled Service?

Let’s compare the Data Center lines on two sample invoices:

Sample Invoice A Sample Invoice B Data Center Services Data Center Services

Mainframe: Processing Wintel Servers Mainframe: Storage Wintel Virtual Servers

IMAC Unix Servers

Break/Fix Unix Virtual Servers

Managed Network Services Managed Network Services

End-User Services End-User Services

(45)

Taxable Taxable

Question 2:

Is The Data Center Service a Bundled Service?

Sample Invoice A Sample Invoice B Data Center Services Data Center Services

Mainframe: Processing Wintel Servers Mainframe: Storage Wintel Virtual Servers

IMAC Unix Servers

Break/Fix Unix Virtual Servers

Managed Network Services Managed Network Services

End-User Services End-User Services

Help Desk Help Desk

(46)

Question 3:

To Which States is the Service Sourced?

• Where are the data centers located? If data centers are

located in more than one state, how are the costs allocated between data centers (number of servers, a measure of traffic, etc.)?

• From which states do users access the data stored at the data center? How are costs allocated among different states (number of employees, device count, offices, etc.)?

(47)

Question 3:

To Which States is the Service Sourced?

• Does the use of the data processing service or the location of a data center involve a state where most services are taxed?

− Hawaii and South Dakota tax most services performed in the state or used in it. See, Haw. Rev. Stat. § 237-13(6); S.D. Codified Laws § 10-45-4.

− New Mexico – the gross receipts tax is generally limited to services performed in New Mexico. See, N.M.Stat. Ann. § 7-9-13.1.

• Is the use of the data processing service sourced to a state that taxes data processing? See e.g., D.C. Mun. regs. tit. 9, § 474, V.T.C.A. Tax Code §§ 151.0035, 151.0038, and 151.0101.

(48)

Question 3:

To Which States is the Service Sourced?

• Will the Data Processing Service give rise to tax as a charge for terminal access?

− Chicago imposes a personal property lease transaction tax at the rate of 8% for the storage of data on servers located in the city, and also taxes database charges if the terminals for access to the data are located in Chicago and some

other conditions are satisfied. See, Chicago Municipal Code 3-32. Note that the code presumes that 50% or more of the use will occur in Chicago for contracts signed there.

(49)

Question1:

What is Help Desk Service and

End-User Service

• End-User Service (sometimes called Desktop Service) is support that the provider offers for customer’s devices, including desktop computers,

printers, peripherals, thin-clients, and hand-held devices. The service may include on-site hardware repair, on-site and remote IMAC, and monitoring. Analysis of Desktop Service follows the same major questions as earlier followed for the Data Center Services analysis.

• Help Desk Service (sometimes called Service Desk) is usually provided as a separate service to End-User Service, though the two are related. Provider’s employees answer questions posed by customer’s

employees. Questions may be posed via telephone, instant message, or email. Generally the service is sourced based on the location of the

customer’s employees. The Help Desk Service likely will be

characterized as monitoring and is taxable only in a few states, including Connecticut and New Mexico. The service will be characterized as Soft IMAC if the Statement of Work provides for provider employees to

remotely access the customer employee’s computer to diagnose and fix a problem.

(50)

Question 1:

What is Managed Network Service?

• Managed Network Service involves the management of data and voice networks, with the provider ensuring that both network machines and the network itself function well.

− A data network may be either a Local Area Network (LAN) or a Wide Area Network (WAN). A voice

network may have signals carried over wired lines, mobile signals, transmission through the Internet, or a combination of the three.

(51)

Question1:

What is the service?

Telecommunications Service (1)

• Most states tax telecommunications, though 25 states do not tax interstate telecommunications.

− Some states address the taxability of Private Line Services separately.

See e.g., Kan. Stat. Ann. § 79-3603(b)(intrastate and interstate

telecommunications services and ancillary services are taxable, but interstate private line services are exempt.)

• Most states follow definitions similar to the SSUTA which defines

telecommunications as “electronic transmission, conveyance, or routing of voice, data, audio, video or any other information or signals to a point, or between or among points.”

• Is the IT provider providing transmission? In most IT contracts we have reviewed, the IT provider provides monitoring to and possibly repair of, equipment and devices used to transmit and route calls, but is not actually providing the transmission of the data or voice communication.

(52)

Question1:

What is the service?

Telecommunications Service (2)

• Many states address the taxability of “ancillary services” separately from telecommunications services.

− Most states follow the SSUTA definition of ancillary services. SSUTA, Appendix C, Part II, p. 154 (“services that are associated with or incidental to the provision of telecommunications services, including but not limited to ‘detailed

telecommunications billing’, ‘directory assistance’, ‘vertical service,’ and ‘voice mail services.’”) See e.g., Iowa Admin. Code r. 701-18.20(7), 701-224.

− Other states tax specified services. See, e.g., N.H. Code Admin. R. Ann. Rev 1602.04(d) (gross charge subject to tax includes the following: operator

assistance, directory information, call-waiting, and call-forwarding.)

(53)

(54)

Cloud Computing

By

(55)

Cloud Computing: What Is it?

• Amalgam of computer services

– Provider of services owns or leases equipment and

software from third parties and sells to customers access to software and/or equipment.

• Normally maintained in a data center

– Cloud computing customer contracts to access host equipment and/or software, and/or to obtain related services from the provider, on demand or on a

usage/subscription fee basis.

– Access is usually over the Internet through any of a number of platforms (mobile devices, laptops, tablets, desktops).

(56)

Cloud Computing: What Is It? (Cont.)

• Types of service

– IaaS: Infrastructure as a service

• Access to data storage and computing resources

• E.g., Amazon Web services (“elastic compute cloud … elastic block storage”)

– SaaS: Software as a service (e.g., Salesforce.com) • Access to software and/or applications

• Similar to application services

(57)

Cloud Computing: What Is It? (Cont.)

• PaaS: Platform as a service

− Use by customer of customer’s created or owned

applications on provider’s software (languages, libraries, tools)

− E.g., Google app. engine

− May be a hybrid of SaaS and IaaS, but is treated most often as SaaS as true object

• Hosting and managing e-mail

• Miscellaneous services such as privacy protection, or hosting Web page or virtual private network within the cloud

(58)

DRIVERS OF TAXABILITY

DETERMINATION: THE FRAMEWORK

• Characterization of the Service

– Is it tangible personal property or a taxable service? • True object test governs: MA Letter Ruling 12-8

(11/8/13)(true object was access to equipment to use software and not software itself and, therefore, not taxable.)

– Statutory/rule treatment: e.g., prewritten software • Sourcing

– Where is the host located?

– Where is the service used and what documentation must be provided to provider?

» PA Form Rev – 1220 (see attached in Appendix)

(59)

DRIVERS OF TAXABILITY DETERMINATION:

THE FRAMEWORK (cont’d.)

• Other Taxation Factors:

– State statutes regarding whether taxable sale or

lease takes place

– State statutes exempting or taxing cloud services

– Bundled charge or separate charge by service

(60)

Taxability Test by Service: IaaS

• Characterization:

– Data processing or computer service

• TX, DC, CT, and OH.

– Texas Comptroller of Public Accounts, Letter

No. 201207533L (7/31/2012)

– Some states may be treated as a lease or rental of

computer space if provider’s computer located there

• FL;

(61)

Taxability Test by Service: IaaS

• Not subject to tax as a lease of property

− TN Letter Ruling 1414 (charges for cloud infrastructure services and co-location services not taxable, because possession, title and control of tangible personal

property or computer software is never transferred to the user. Charges for use of dedicated computer

equipment are subject to tax)

• Subject to tax under general services statute: NM, SD, HI.

(62)

Taxability Test by Service: IaaS

• Sourcing

– Where benefit received

• TX, WA, OH, CT

• Chicago re data processing terminals

– Where service provided

• FL, Chicago (storage), UT

– Where first use occurs

(63)

Taxability Test by Service: SaaS/PaaS

• Characterization

– 14 states do not tax pre-written software delivered electronically, so they don’t tax SaaS.

– Increasing number of states have dealt with taxability of SaaS and App Service Provider Services

• Generally treated under a true object test as pre-written software delivered electronically but exceptions in

certain states for taxation of SaaS when electronic downloaded software is otherwise taxable

– CT treats it as a computer service subject to 1% tax. – SC treats it as a communications service

(64)

Taxability Test by Service: SaaS/PaaS

• Sourcing

– To state where used/accessed

• Increasing number of states PA, UT, NY, TX, OH, DC, WA, NM, and HI.

– PA Letter Ruling No. SUT-12-001: Reverses prior ruling so taxable if used in PA

– Presumption used in PA if billed to PA unless submit PA certificate REV-1220

– UT – Letter Ruling No. 10-001 reverses course like PA. Also see Utah PLR 13-003 (12/4/2013),

(65)

Taxability Test by Service: SaaS/PaaS

– Not taxable in certain states

• (e.g. VA and ID, by statute, VA Code Sec. 58.1-609.5(1), IC §63-3616(b))(treated like electronically downloaded software).

• GA: LR SUT-2014-05 (cloud-based services including hosting customer-provided software applications were non-taxable services). Treated like electronic downloaded software, which is not taxable because not deemed tangible personal property. Ga. Comp. R. & Regs. r. 560-12-2-.111(4)(a), (b)

• RI and WI : Electronically delivered software is taxable but SaaS and data processing services, delivered by a Software as a Service platform, are not taxable.

• TN: Letter Rulings 12-11 and 13-12: Both SaaS and remote storage not subject to tax where servers are located outside of Tennessee.

• SC taxes only intrastate communications.

(66)

Taxability Test by Service: SaaS/PaaS

• Has a sale taken place of SaaS (when treated as tangible personal property)?

– Expansive Definition

• NY: sale is “any transfer of title or possession or both and any lease or license to use” and a right to use constitutes a license to use. 20 N.Y. Comp. Codes R and Regs.

Section 526.7(e)(4)(iii). – Narrow Definition

• AZ (Ariz. Reg. 15-5-154.B), and IL 86 IL Admin. Code Sec. 130.1935(a)(1).

(67)

Taxability Test by Service: Web Hosting

• True object test governs?

– Is the object tangible personal property?

• Treated similarly to IaaS if object is service, unless pure management services.

• Treated as SaaS if object is software program. • Is there an exemption under the ITFA?

– ITFA (Section 1105 definition of Internet access)

• Services packaged with access to the Internet, such as a home page, electronic mail and instant messaging, video clips, and personal electronic storage capacity.

• Services described in bullet above that are not packaged with Internet access.

• Any other products and services even if they utilize Internet protocol are not exempt Internet access.

(68)

Other Issues Regarding Taxability

• Billing

– Should there be a bundled fee or a fee by type of service? • SSUTA may not permit unbundling as relates to cloud

computing

• Some state statutes may permit

– 34 Texas Admin. Code section 3.330(d)(2) • Ideal is to break up fee into separate charges by

service.

(69)

(70)

Sales and Transaction Taxes

on IT Products and Services

March 5, 2015

Caleb Allen, Washington State Department of Revenue

(71)

Caveat

• Discussion does not necessarily reflect

position of the DOR.

– My opinion does not always carry the day 

• Letter ruling is a good option for complex fact

patterns.

71

Strafford

(72)

A Tax Administrator’s Approach

– What is the product or service supplied?

– What tax categories might apply?

• Some unique Washington categories.

– How is the transaction structured?

• Determining how bundling may effect the taxability, etc

– How is it sourced?

(73)

What is It?

73

Strafford

(74)

What is the Product or Service

• Fact intensive process:

– Taxpayers can influence the outcome with

detailed and accurate descriptions.

– Best to avoid vague terminology from marketing

material:

• “we provide a broad range of information technology

consulting”

• “our service optimizes user experience”

(75)

Sources of Information

• Letter ruling request descriptions

• Contract descriptions

• Additional information may add “color”

– Website

– Invoices

– 10K and other available financial information

– Press releases

– Third party review of products

75

Strafford

(76)

Take-Aways

• Clear technical descriptions in communications

with Department help.

• Website messaging matters. Communicate with

marketing guys.

• Contract language matters. Communicate with

legal department.

• Consistency between sources helps build

confidence in descriptions.

(77)

What Tax Categories

May Apply?

77

Strafford

(78)

Overview of Categories in WA

• Prewritten software (common)

– Upgrades, updates, fixes, patches, etc

• Remote access to prewritten software (WA)

• Custom software or customization services (common)

• Digital automated services (WA)

• Telecommunications (common)

• Professional/technical services (common)

– help desk, consulting, engineering, support, etc

• Services in respect to tangible personal property (WA)

(79)

Remotely Accessed Software

• Definition: the right to access and use

prewritten software where possession is

maintained by the seller or a third party

regardless of how charged.

– Hosted by seller or third party.

– No need for “delivery;” access is sufficient.

– Avoids discussion of “delivery” or “possession” as

that may relate to the definition of a “sale.”

– RCW 82.04.050(6)(b).

79

Strafford

(80)

Digital Automated Service

• Definition: “…any service transferred

electronically that uses one or more software

applications”

– Examples: online searchable databases, information

services, Internet crawler, etc.

– Exclusions: hosting, storage, data processing,

advertising etc

• More than just prewritten software:

– Data, information, digital goods?

– Functionality: email blasts, multiplayer environment?

(81)

How it Fits Together

Digital Automated Service

Remote Access

Software Digital Good

Books, music, video,

data, facts, information Software Service that use software

81

Cloud

Computing Exclusions

Strafford

(82)

Services Rendered with Respect to TPP

• Services with respect to TPP (i.e. prewritten

software and hardware).

– Routine installation of prewritten software

• E.g. click through.

– uninstalling prewritten software.

– Repair or installation of hardware or equipment.

• Contrast: separately stated charges for

customization of prewritten software generally

not subject to sales tax

(83)

Take-Aways

• Check state law for unique tax categories.

83

Strafford

(84)

(85)

Time Out

• Where are we in the analysis?

– We have an idea of what the product or service is

– We have an idea of what tax categories may apply

– We have a tentative conclusion regarding

taxability on a standalone basis

• Where are we going?

– Examine whether the form of the transaction

alters our tax conclusions

– What are the forms?

85

Strafford

(86)

Overview of Transaction Structure

• How is the transaction structured?

– Multiple items for a single price

– Multiple items for multiple prices

• Form and context influences taxability

• Bundling discussion is simplified.

(87)

Multiple Items for a Single Price

• Bundled transaction means two or more products where:

– Products are distinct and identifiable; and

• Analysis/tests

– The products are sold for one non-itemized price

• Analysis/tests

• A bundle is generally taxable.

– Telecom can be unbundled.

• Exceptions (NT):

– The taxable component is essential AND exclusively provided together with the nontaxable component and the true object of the transaction is the nontaxable component.

– The taxable component is 10% or less of the value of the bundled transaction

87

Strafford

(88)

Bundle Example

• In-person product training sold with digital

training materials (electronically supplied

digital good) for a single price.

(89)

Bundled Example (Cont)

• Two or more products (yes)

• Distinct and identifiable (maybe)

• Sold for one non itemized price (yes)

• Tentative conclusion, taxable?

• Exceptions:

– Essential to each other AND sold exclusively

together (yes)

• True object is in person training (yes)

– Not taxable.

89

Strafford

(90)

Multiple Items for Multiple Prices

• Generally separate tax treatment for itemized

prices.

• Are the separately itemized products part of a

single retail activity?

– Definition of “selling price”

• “…Services necessary to complete the sale…”? • RCW 82.08.010

– “Functionally Integrated” (Chicago Bridge 659 P2d

463) and determinations.

(91)

Take-Aways

• Consider how the transaction is structured

and how it may affect tax conclusions.

91

Strafford

(92)

(93)

Sourcing Hierarchy (SSUTA)

• General Rule (based on Streamline Agreement)

– Business location (received over the counter)

– Place of receipt (actual place of receipt-e.g.

shipping address)

– Address in books and records (contracts,

accounting)

– Address obtained during sale (credit card

billing address)

– Origin (shipping warehouse or server)

• RCW 82.32.730

93

Strafford

(94)

Sourcing and Place of Receipt

• Place of receipt

– "Receive" and "receipt" mean:

• taking possession of TPP

• making first use of digital automated services or other

services, or

• taking possession or making first use of digital goods or

digital codes, whichever comes first.

(95)

Multiple Points of Use (“MPU”)

Exemption

• Seller does not collect sales tax, but buyer pays use tax.

• Exemption certificate required.

• Use limited to:

– Digital goods, digital codes, digital automated services,

remote access software, and prewritten software.

• Only businesses (not personal use).

• Product sold must be concurrently available inside and

outside WA.

• Apportionment based on user location.

• RCW 82.08.02088.

95

Strafford

(96)

(97)

Nexus

• Safe harbor:

– The department may not consider a person’s

ownership of, or rights in, computer software,

including computer software used to provide a

digital automated service, master copies of

software, digital goods, digital codes residing on a

server in the state in determining nexus.

• Distinguish the ownership of other tangible

personal property like servers etc.

• RCW 82.32.532.

97

Strafford

(98)

Hypothetical #1

(From Brann & Isaacson)

• Cloud service provider with data centers in Texas but with offices in New Jersey

• Cloud service provider provides the following services:

– Bundled service including storing customer’s data, processing data, use of provider’s SAS accounting software, hosting e-mail

– Separate service of hosting Web site and taking orders – Separate service of storage of data for customers

• Customer 1, situated in New York City but with offices in Ohio and

Illinois, has contracted for the bundled service to which it is billed at its NYC headquarters. Where, if anywhere, is the service taxable?

(99)

Hypothetical #2

(From Brann & Isaacson)

• IT Service Provider operates a data center in Chicago, where it offers the following services to Customer 2, which has offices in TX, CA, NY, and OH:

– Data storage – Data Processing

– Desktop support done remotely – Onsite service of desktops

– Management of telecom bills

• Price is bundled price for the on-site and remote service but the other services are separately priced

• Company gives a certificate of multiple points of use and a TX exemption certificate

(100)

Hypothetical #3

(From Brann & Isaacson

• IT Provider located in NY provides the following services (Smart Loan and Lending Pit services) to its customers located in OH, WA and NY

– Smart Loan Service

• Smart Loan is a system that supports and automates securities lending and borrowing, bank loans, short sale authorizations and profit/loss analysis. The main function of the Smart Loan service is to process and maintain ancillary accounting ledgers regarding

taxpayer’s customers’ securities lending and borrowing

transactions, including monitoring credit limits on a real time basis. • The Smart Loan service commences with taxpayer’s receipt of data

from a customer with respect to that customer’s securities lending and borrowing transactions; the customer uses ancillary software provided by taxpayer free of charge to input the data. Transactions can only take place during certain hours of the day when

Petitioner’s employees are present.

(101)

Hypothetical #3 (cont’d)

(From Brann & Isaacson)

• The Smart Loan system incorporates software that taxpayer uses to deliver processed data to its customers. This software is furnished to taxpayer’s customers for the exclusive purpose of providing a convenient means for petitioner’s customers to view processed data. The main purpose of such software is to facilitate a secure connection between petitioner and its customers. This software cannot function independently of the Smart Loan system, is provided to customers free of charge, cannot be altered or

manipulated by taxpayer’s customers, and has no value apart from its relationship to the Smart Loan service.

• Questions:

– Is this a license of software in NY, where the client is located? – Is this an information service taxable in NY?

– How is sourcing to NY determined?

– Is this service taxable in WA and/or OH?

(102)

Hypothetical #3 (cont’d)

(From Brann & Isaacson)

– Lending Pit Service

• The Lending Pit service is delivered pursuant to a Subscription Order and

Terms of Use Agreement. The service involves obtaining, compiling, analyzing, processing and maintaining pre-trade and post-trade data for customers to view over a secure internet connection using petitioner’s proprietary web-based

application. Using Lending Pit allows customers to view their own current lending data in comparison to their own historical lending data, as well as to view their own current and/or historical lending data in comparison with

benchmarks formulated by petitioner using raw data from all of its customers. Lending Pit customers have the option of viewing their data in comparison to the benchmarks or in isolation. Taxpayer uses its proprietary software to gather, store and process the data.

• Questions:

– Is this a license of software in NY, where the client is located? – Is this an information service taxable in NY?

(103)

Hypothetical

(Washington State

Department of Revenue)

10 3 Strafford

(104)

Hypothetical

• ABC sells the following to EFG:

– Business tracking system (“System”) that uses prewritten

software hosted by ABC and accessed by EFG.

– Non routine customization and implementation of the

System.

– Optional training involving digital materials and in-person

training.

– Non-optional Testing to make sure the “System” works.

(105)

What is it (break it down)?

• The “System.”

– Note: “tracking system” is a vague term. – Prewritten software.

– Accessed not delivered.

• Customization and implementation

– Customizing prewritten software. – Note: implementation is a vague term

• Training

– In person training.

– Digital training material. – Looks like bundle.

– Optional service.

• Testing

– Testing accessed software (RAS is a service not TPP). – Non-optional service.