A trend is developing in response to aggressive Department of Revenue/Treasury policymaking regarding cloud computing. The courts and legislatures are addressing the issue and concluding that the remote access to software should not be taxed. Here are two recent developments that illustrate the trend:
Michigan – Auto-Owners Insurance Company v. Department of Treasury
On March 20, 2014, the Michigan Court of Claims held in Auto-Owners Insurance Company v. Department of Treasury that certain cloud transactions were not subject to use tax because the transactions were nontaxable services. The State has appealed this decision.
Auto-Owners engaged in transactions with numerous vendors to provide services and products that Auto-Owners used to conduct its business. The court grouped Auto-Owners’ transactions into transactions with six categories of providers: (1) Insurance industry providers; (2) Marketing and advertising providers; (3) Technology and communications providers; (4) Information providers; (5) Payment remittance and processing support providers; and (6) Technology providers. The transactions all involved, on some level, Auto-Owners accessing software through the Internet. No software was downloaded by Auto-Owners.
The Michigan use tax is imposed on the privilege of using tangible personal property in the state. Tangible personal property includes prewritten, non-custom, software that is “delivered by any means.” Mich. Comp. Laws § 205.92b(o). The court held that the transactions were not subject to use tax under the plain language of Michigan’s statute.
First, the court held that use tax did not apply because the court interpreted the “delivered by any means” language from Michigan’s statute to apply to the electronic and physical delivery of software, not the remote access of a third-party provider’s technology infrastructure. Second, the court held that the software was not “used” by Auto-Owners. Auto-Owners did not have control over the software as it only had the “ability to control outcomes by inputting certain data to be analyzed.” Third, the court held that even if prewritten computer software was delivered and used, the use was “merely incidental to the services rendered by the third-party providers and would not subject the overall transactions to use tax.” Michigan case law provides that if a transaction includes the transfer of tangible personal property and non-taxable services, the transaction is not taxable if the transfer of property is incidental to the services.
Practice Note: This decision is encouraging in that the court said that the Department was ignoring the plain meaning of the statute and overreaching, and determined that the legislature must provide specific language extending the sales and use tax for such transactions to be taxable. It is important to note that the Michigan statute uses the phrase “delivered by any means,” and the court focused on the definition of deliver in reaching its decision. This decision will likely have implications for other streamlined sales tax (SST) member states. Auto-Owners Ins. Co. v. Dep’t of Treas., No. 12-000082-MT (Mich. Ct. Cl. Mar. 20, 2014).
Idaho – H.B. 598
On April 4, 2014, Governor Butch Otter signed into law Idaho H.B. 598. Idaho subjects sales of tangible personal property to sales tax. Idaho Code Ann. § 63-3616. H.B. 598 excludes from the definition of “tangible personal property” “computer software that is delivered electronically; remotely accessed computer software; and computer software that is delivered by the load and leave method where the vendor or its agent loads the software at the user’s location but does not transfer any tangible personal property containing the software to the user.” However, the bill does not exempt “computer software that constitutes digital music, digital books, digital videos and digital games” – leaving them subject to tax as tangible personal property. This language was pushed by the Idaho State Tax Commission to codify its existing administrative position that such items are already taxable.
Practice Note: The legislation takes effect on July 1, 2014, though an argument exists that some cloud based software was previously exempt by legislation that passed in 2013. We expect rulemaking on H.B. 598 to happen quickly.