If the Department of Treasury (Treasury) was hoping that the Michigan courts would simply overlook the previous two cloud computing losses this year in Thomson Reuters (previously covered here) and Auto-Owners (discussed here), they appear to have been mistaken. Last Wednesday’s Court of Claims opinion in Rehmann Robson & Co. v. Department of Treasury marked the third Michigan decision this year to rule that cloud-based services are not subject to use tax in the state. In Rehmann Robson, the Court of Claims found that the use of Checkpoint (a web-based tax and accounting research tool) by a large accounting firm was properly characterized as a non-taxable information service, despite Treasury’s continued effort to impose use tax and litigate similar cloud-based transactions. This taxpayer victory comes just six months after the Michigan Court of Appeals in Thomson Reuters found that a subscription to Checkpoint was primarily the sale of a service under the Catalina Marketing test, Michigan’s version of the “true object” test, which looks to whether the use of tangible personal property was incidental to the provision of services when both are provided in the same transaction. The Thomson Reuters decision reversed a 2013 Court of Claims opinion that granted summary disposition in favor of Treasury’s ability to tax the cloud-based service as “prewritten computer software.”
While all three Michigan decisions issued this year reach the same conclusion, the most recent decision makes an explicit effort to affirmatively block any potential avenue Treasury may use to impose the use tax on cloud-based transactions. For what it’s worth, the Rehmann Robson opinion was written by the same judge who wrote the Auto-Owners opinion released in March 2014, and contained an identical analysis. Unlike the Thomson Reuters decision that found use of prewritten computer software in the state, but simply found it to be incidental to the nontaxable information services provided under Catalina Marketing, Auto-Owners (and now Rehmann Robson) both undercut the Treasury’s argument before it begins.
First, the court held that there was no tangible personal property transferred because the definition of “prewritten computer software” was not satisfied. Like many other states, Michigan defines this term as software “delivered by any means.” The court reasoned that because the accounting firm simply accessed information via the web that was processed via BNA and Thomson Reuter’s own software, hardware and infrastructure, there was no “delivery” under a conventional understanding of the word. Absent delivery, there was no prewritten computer software for Treasury to impose tax upon.
Second, the Court of Claims went on to note that even if prewritten computer software was delivered, the accounting firm did not sufficiently “use” the software to impose the tax. Because the accounting firm did not exercise a right or power over the software incident to ownership (other than the ability to control research outcomes by inputting research terms), there was no use. The court explicitly turned down Treasury’s argument that mere “access” to Checkpoint’s computer servers equates to use.
Finally, the court noted that even if prewritten computer software was delivered and used within the meaning of the use tax statute, the use of the software was merely incidental to the services rendered under the Catalina Marketing test. The court objectively considered the six Catalina factors and determined that as a whole, any prewritten computer software was an incidental component of the principal transaction (the provision of information services).
The Rehmann Robson opinion, when paired with Auto Owners and Thomson Reuters, provides three cases that set strong precedents that Treasury has to overcome before subjecting cloud-based services to use tax in Michigan. It remains to be seen whether Treasury will ignore the Michigan judiciary and continue to litigate cloud-based cases. With three strikes against them, Michigan taxpayers can only hope that Treasury will take a seat on the bench when it comes to litigating alleged use tax obligations for cloud-based transactions.
Last Wednesday’s opinion should spark discussion in Michigan over a pair of bills (SB 0142 and SB 0143) introduced in 2013 and carried over into 2014 that would amend the definition of prewritten computer software to explicitly exclude granting the right to use prewritten software installed on another person’s server for sales and use tax purposes. While these bills will not be carried over into 2015, they certainly appear to be prime candidates to be reintroduced if Treasury continues to assess and litigate the issue. While no pre-filing of bills is allowed in Michigan, the 2015 session is set to begin January 14, 2015.
Practice Note: The Rehmann Robson opinion would appear to settle any debate that cloud-based transactions are subject to use tax in Michigan. At the same time, Michigan has been plagued by a long history of economic difficulties that have put serious pressure on Treasury to raise revenue. Any party interested in legislatively fixing this ongoing dilemma in Michigan is encouraged to contact the authors as soon as possible to discuss.