This morning, Indiana Governor Eric Holcomb signed a bill into law that will exempt cloud-based software transactions from State Gross Retail and Use Taxes, effective July 1, 2018. The signing took place at the headquarters of Indiana-based cloud service provider DemandJump, Inc.

Specifically, Senate Enrolled Act No. 257 (which was unanimously passed by both chambers of the General Assembly) will add a new section to the Indiana Code chapter on retail transactions that specifically provides that “[a] transaction in which an end user purchases, rents, leases, or licenses the right to remotely access prewritten computer software over the Internet, over private or public networks, or through wireless media: (1) is not considered to be a transaction in which prewritten computer software is delivered electronically; and (2) does not constitute a retail transaction.” The new law will also clarify that the sale, rental, lease or license of prewritten computer software “delivered electronically” (i.e., downloaded software) is subject to the Gross Retail and Use Taxes. Continue Reading BREAKING: Indiana Enacts Cloud Software Tax Exemption

Background

As detailed in our blog last month, MoneyGram Payment Systems, Inc. (MoneyGram) is stuck in between a rock and a hard place as states continue to duel with Delaware over the proper classification of (and priority rules applicable to) MoneyGram’s escheat liability for uncashed “official checks.”  The dispute hinges on whether the official checks are properly classified as third-party bank checks (as Delaware directed MoneyGram to remit them as) or are more similar to “money orders” (as alleged by Pennsylvania, Wisconsin and numerous other states participating in a recent audit of the official checks by third-party auditor TSG). If classified as third-party bank checks, the official checks would be subject to the federal common law priority rules set forth in Texas v. New Jersey, 379 U.S. 674 (1965) and escheat to MoneyGram’s state of incorporation (Delaware) since the company’s books and records do not indicate the apparent owner’s last known address under the first priority rule. However, if the official checks are classified as more akin to money orders under the federal Disposition of Abandoned Money Orders and Traveler’s Checks Act of 1974 (Act), as determined by TSG and demanded by Pennsylvania, Wisconsin and the other states, they would be subject to the special statutory priority rules enacted by Congress in response the Supreme Court of the United States’ Pennsylvania v. New York decision and escheat to the state where they were purchased. See 12 U.S.C. § 2503(1) (providing that where any sum is payable on a money order on which a business association is directly liable, the state in which the money order was purchased shall be entitled exclusively to escheat or take custody of the sum payable on such instrument).

In addition to the suit filed by the Pennsylvania Treasury Department seeking more than $10 million from Delaware covered in our prior blog, the Wisconsin Department of Revenue recently filed a similar complaint in federal district court in Wisconsin, alleging Delaware owes the state in excess of $13 million. Other states participating in the TSG audit (such as Arkansas, Colorado and Texas) also recently made demands to MoneyGram and Delaware.

It is interesting to note that in 2015, Minnesota (MoneyGram’s former state of incorporation) turned over in excess of $200,000 to Pennsylvania upon its demand for amounts previously remitted to Minnesota for MoneyGram official checks. Apparently not only do the states in which the transaction occurred disagree with but even a former state of incorporation took the majority path.   Continue Reading Unclaimed Property Hunger Games: States Seek Supreme Court Review in ‘Official Check’ Dispute

With many state legislatures wrapping up session within the past month or so, there has been a flurry of last-minute tax amnesty legislation passed. Nearly a half-dozen states have authorized upcoming tax amnesty periods. These tax amnesties include a waiver of interest and, in some circumstances, allow taxpayers currently under audit or with an appeal pending to participate. This blog entry highlights the various enactments that have occurred since the authors last covered the upcoming Maryland amnesty program.

Missouri

On April 27, 2015, Governor Jay Nixon signed a bill (HB 384) that creates the first Missouri tax amnesty since 2002. The bill creates a 90-day tax amnesty period scheduled to run from September 1, 2015, to November 30, 2015. The amnesty is limited in scope and applies only to income, sales and use, and corporation franchise taxes. The amnesty allows taxpayers with liabilities accrued before December 31, 2014, to pay in full between September 1, 2015, and November 30, 2015, and be relieved of all penalties and interest associated with the delinquent obligation. Before electing to participate in the amnesty program, taxpayers should be aware that participation will disqualify them from participating in any future Missouri amnesty for the same type of tax. In addition, if a taxpayer fails to comply with Missouri tax law at any time during the eight years following the agreement, the penalties and interest waived under the amnesty will be revoked and become due immediately. Finally, taxpayers who are the subject of civil or criminal state-tax-related investigations, or are currently involved in litigation over the obligation, are not eligible for the amnesty.

According to the fiscal note provided in conjunction with the bill, the state estimates that 340,000 taxpayers will be eligible for the amnesty and that the program will raise $25 million.

Oklahoma

On May 20, 2015, Governor Mary Fallin signed a bill (HB 2236) creating a two-month amnesty period from September 14, 2015, to November 13, 2015. The bill allows taxpayers that pay delinquent taxes (i.e., taxes due for any tax period ending before January 1, 2015) during the amnesty period to receive a waiver of any associated interest, penalties, fines or collection costs.

Taxes eligible for the amnesty include individual and corporate income taxes, withholding taxes, sales and use taxes, gasoline and diesel taxes, gross production and petroleum excise taxes, banking privilege taxes and mixed beverage taxes. Notably, franchise taxes are not included in this year’s amnesty (they were included in the 2008 Oklahoma amnesty).

Indiana

In May, Governor Mike Pence signed a biennial budget bill (HB 1001) that included a provision authorizing the Department of Revenue (Department) to implement an eight-week tax amnesty program before 2017. While the Department must promulgate emergency regulations that will specify exact dates and procedures, several sources have indicated that the amnesty is expected to occur sometime this fall. The upcoming amnesty will mark the second-ever amnesty offered by Indiana (the first occurred in 2005). Taxpayers that participated in the 2005 program will be disappointed to know that the authorizing legislation specifically prohibits them from participating in the upcoming amnesty.

The amnesty program is applicable to all “listed taxes” collected by the Department, including sales and use taxes, corporate and personal income taxes, financial institutions tax and gas taxes. See Indiana Code § 6-8.1-1-1 for the complete list. Unlike several of the other amnesty programs discussed that apply to more recent liabilities, the Indiana amnesty is only statutorily authorized for liabilities due before January 1, 2013 (i.e., 2012 or earlier). While the Department is not prevented from settling more recent liabilities incurred in 2013 and 2014, such an arrangement would be outside the scope of the statutory amnesty provisions.

The benefits of the upcoming program include abatement of interest, penalties, collection fees and costs that would otherwise be applicable, release of any liens and no civil or criminal prosecution. Indiana taxpayers should be aware that if an eligible liability is not paid during the amnesty period (and is subsequently discovered by the Department) penalties are doubled under the statute.

Arizona

On March 12, 2015, Governor Doug Ducey approved a budget package that included a bill (SB 1471) creating a tax recovery (amnesty) program for taxpayers with outstanding liabilities. The program is scheduled to run from September 1, 2015, through October 31, 2015, and applies to all taxes administered by the Department of Revenue, except withholding and luxury taxes. Taxpayers that come forward with tax liabilities that could have been assessed before 2014 (or before 2015 in the case of non-annual filers) will receive abatement of all civil penalties and interest. Taxpayers that were a party to a closing agreement with the Department during the liability period are not eligible for the program; however, nothing in the statute would appear to prevent a taxpayer that is currently under audit from participating in the program.

As a consequence of applying to the program, the inclusion of the outstanding debt in a taxpayer’s application is considered to be a waiver of the taxpayer’s administrative and judicial appeal rights.

South Carolina

On June 8, 2015, Governor Nikki Haley signed a bill (S. 526) giving the Department of Revenue (Department) authority to schedule and execute a three-month tax amnesty period at their discretion. The bill specifically allows the Department to waive all penalties and interest (or a portion of them at its discretion) for taxpayers that voluntarily file delinquent returns and pay all taxes owed (i.e., the Department cannot waive penalties and interest on a period-by-period basis). Taxpayers with an appeal pending may only participate in the program if they pay all the taxes owed. While payment of the liability is required to participate, it will not constitute an admission of liability or a waiver of the appeal.

Taxpayers should note that any debts not fully paid within an agreed-upon post-amnesty period will be subject to a 10 percent collection and assistance fee, in addition to the penalties and interest otherwise owed. The bill grants authority for imposition of this fee for up to one year after the close of the extended amnesty period.

Practice Note

Now is the time for taxpayers with outstanding tax obligations in any of the state’s offering amnesty (including Maryland) to consider whether the issues can and should be resolved through the amnesty program. In deciding whether to avail oneself of the amnesty offerings, taxpayers should be aware that failure to participate in many states (including Indiana and South Carolina) can lead to increased penalties and fees (the infamous “amnesty hammer”) if the delinquent obligation subsequently surfaces.

In a curious decision out of Arizona, an Administrative Law Judge (ALJ) found an out-of-state provider of online research services was properly assessed transaction privilege tax (TPT, Arizona’s substitute for a sales tax) based on the logic that the provider was renting tangible personal property to in-state customers.  The Office of Administrative Hearings (OAH) decision, No. 14C-201400197S-REV, available here, should be unsettling for all remote providers of subscription-based services with customers in Arizona.  This decision offers an example of the continued push by states to administratively expand the tax base to include nontaxable digital services.  Many states, like Arizona, do so by considering remote access to digital goods and services to be tangible personal property, as defined by statutes that are decades old.

Facts

The taxpayer was an out-of-state IT research firm offering internally-produced proprietary research and data compilation content remotely.  The taxpayer’s headquarters, offices, servers and platform were all located outside Arizona.  Customers accessed the research material via usernames and passwords received as part of a subscription.  The Arizona Department of Revenue (the Department) determined that the subscription income was subject to the TPT because it was income from the leasing of tangible personal property.  The taxpayer filed a protest with the Department, arguing that the online research services provided make it a service provider—not a lessor of tangible personal property.  The taxpayer noted “at most, [they are] providing clients with a simultaneous license to use.”

Department’s Argument

The Department argued that the taxpayer was leasing tangible personal property (research and data content) through the subscriptions they provide to customers.  Because they had exclusive access and use to the digital content (via username and password), the customers were able to perceive tangible personal property through their sense of sight. Therefore, the taxpayer’s receipts from subscriptions to its research and data content are taxable rental activities subject to the personal property rental classification.

Holding

The ALJ held the taxpayer did not meet its burden of proof of showing the Department misapplied the tax laws.  The decision dismissed all of the taxpayer’s arguments that it is not engaged in leasing tangible personal property.  At the outset, the ALJ found that the inability to control or modify the digital content was not enough to consider the customers to be lacking “exclusive control.”  This is important because the Arizona Supreme Court has made it clear that the scope and application of the personal property rental classification (and its predecessor) hinges on the degree of control over the property in question that is ceded to its putative “lessee” or “renter.” In sum, because the access and use of the proprietary research and data content was offered for a periodic subscription (consideration), such activity is the leasing of tangible personal property, and the assessment by the Department was appropriate.

Analysis

As a threshold matter, it is unclear whether the Department has authority to consider remote access to digital content to be tangible property merely because the content may be viewed on a computer or mobile device.  For purposes of this statute, the definition of tangible personal property was enacted in 1989.  See Taxation—Corrections Bill, 1989 Ariz. Legis. Serv. 132.  The Internet as we know it today did not exist, with the World Wide Web not even established until 1991.  By interpreting the definition as such, the Department is imposing a new tax—something that is the province of the legislature.  The proprietary research and data available electronically is more properly characterized as an intangible or service.  By purchasing a subscription, customers are really paying for access to the proprietary data and research, the creation of which is unquestionably a service.  This information service is the “true object” of the subscription transaction, and any tangible personal property (i.e., the ability to access it via the Internet) is a mere inconsequential element.

Second, even if the classification as tangible personal property is proper, we seriously doubt whether the exclusive use and control requirement is met in this case.  In State Tax Commission v. Peck, 106 Ariz. 394, 476 P.2d 849 (1970), the court determined that customers of a coin-operated laundry “have an exclusive use of the equipment for a fixed period of time and for payment of a fixed amount of money . . . [and] exclusively control all manual operations necessary to run the machines.” Id. at 396, 476 P.2d at 851.  Over 30 years later, the Arizona Court of Appeals found customers at a tanning salon do not “themselves exclusively control all manual operations necessary to run” the tanning beds in question. The court held that while customers could select within a five-minute window when the tanning session begins and terminate it early, the question of whether a tanning session may be commenced at all, and how long it could last, were exclusively controlled by the taxpayer’s tanning technician.  Further, the question of the appropriate tanning device was also significantly within the technician’s control. In sum, the “exclusive use and control by the customer that Peck determined to be the essence of “renting” taxing statute [was] not present” in the tanning salon context.  See Energy Squared, Inc. v. Arizona Dep’t of Revenue, 203 Ariz. 507, 510, 56 P.3d 686, 689 (Ct. App. 2002).

Here, like the tanning salon in Energy Squared, the taxpayer’s customers do not have “exclusive use or control” of the research and data.  The ability to open and access the content is limited by the subscription level, and customers are only permitted one copy (limitations that someone with exclusive use or control would not receive).  Because the information is proprietary in nature, customers are further restricted by the fact that they may not use the research as their own and may only summarize, excerpt or quote it.  Further (and perhaps most importantly), the content is at all times housed on the server of the taxpayer, who may add or subtract to the content available to customers at any time.  Because the property in question (however it may be classified) is ultimately controlled by the taxpayer, it is not exclusively used or controlled by the customer.  This common law requirement is a prerequisite to the application of the TPT personal property rental classification, upon which the Department and ALJ decision relies.

Beyond Arizona

The Arizona Department is not the first revenue department to proffer this logic to tax subscriptions to digital services.  Within the past year, the authors are aware of two other state tax agencies that have attempted to tax remote providers—both resulting in legislative action opposing the agency’s actions.

  • Alabama: On February 28, 2015, the Alabama Department of Revenue proposed an amended regulation ( Admin. Code r. 810-6-5-.09, available here) that sought to impose rental tax on remote providers of streamed music and video to in-state customers.  Similar to Arizona’s tactic here, the proposed regulation would have imposed tax by considering streamed music and movies to be tangible personal property.  After significant feedback from industry representatives, the Joint Legislative Council (composed of the state legislative leaders from both chambers) wrote the Commissioner requesting the proposed regulation be withdrawn.  The letter cited to the fact that the proposal was overly expansive and would in effect be the imposition of a new tax, a determination that rests with the legislature.
  • Idaho: In October 2014, the Idaho State Tax Commission issued a notice of proposed rulemaking for a regulation that would have taxed the sale, lease or rental of digital products (defined as tangible personal property under Idaho law) if the user had the right to stream or download them.  See Idaho State Tax Comm’n, Notice of Proposed Rulemaking Dkt. 35-0102-1401 (Oct. 2014).  In response, the legislature passed a bill in March 2015 (House Bill 209, available here) that modifies the statute to require digital products be purchased with a permanent right to use to be taxable as tangible personal property, effective April 1, 2015.  Notably, the bill states that a permanent right to use does not exist when the right to use is conditioned upon continued payment.

Practice Note:  While the OAH decision is appealable, the 30-day period to request review has run.  It is unclear whether the taxpayer in this case has requested review, appealed directly to the Board of Tax Appeals or accepted defeat.  Taxpayers providing subscriptions to digital goods and services (including streaming audio and video) should be aware of the Arizona decision and be prepared to defend their service offerings from the states apparent position.

Actually, there are really only two issues, but they are big issues.

Arizona’s Transaction Privilege Tax has always been an anomaly in the traditional state sales tax system.  Contrary to some commentators, however, the recent amendments do not, and could not, impose an origin tax on Arizona retailers for remote sales delivered out-of-state.  That is not to say that these amendments are benign.  Oddly, the amendments provide incentives for Arizona residents shipping items out-of-state to purchase these items over the internet rather than visit Arizona retailers in person.  Furthermore, these amendments create complexities for Arizona vendors shipping to foreign jurisdictions.   Finally, these amendments create additional administrative problems for retailers that are difficult to address with existing software and invite double taxation problems that should not exist in a transaction tax world.

Background: Arizona Transaction Privilege and Use Tax

For retail sales, Arizona, like most states, has two complementary transaction-based taxes, but each tax is imposed on a different entity.  The first tax, the Transaction Privilege Tax (TPT), is imposed directly on the retailer.  Ariz. Rev. Stat. § 42-5001.13.  A retailer will be subject to the TPT on the gross proceeds from a sale if “the location where the sale is made” is Arizona.  Ariz. Rev. Stat. § 42-5034.A.9.  A retailer subject to the TPT is allowed but not required to collect the amount of TPT it owes from its customers.  Ariz. Admin. Code §§ 15-5-2002, 15-5-2210.

The second tax, the Arizona Use Tax, complements and backstops the TPT.  The Use Tax is imposed on the use, storage or consumption in the State of tangible personal property purchased from an out-of-state retailer.  Ariz. Rev. Stat. § 42-5155.  Generally, the purchaser is liable for payment of Use Tax to the State, but a retailer is required to collect Use Tax from a purchaser if the retailer meets the constitutional nexus provisions.  Ariz. Rev. Stat. §§ 42-5155, 42-5160.  Use Tax is imposed only on transactions where TPT has not been imposed, i.e., a transaction is subject to either TPT or Use Tax, but not both.  Ariz. Rev. Stat. § 42-5159.A.1.

The State and its courts have been clear that, while the location of the transfer of title or possession is relevant to the inquiry as to where the sale is made, it is the totality of the retailer’s business activities that identifies the location that may tax the proceeds.  Exactly where that line is drawn, however, is not as clear.  The Arizona Department of Revenue (DOR) has taken the position that, unless an exemption applies, a seller is subject to the tax if a purchaser buys a product at a store, even if the purchaser does not take possession in the state, and the product is shipped to a location outside of the state.  The DOR is apparently taking the position either that the title transfers in the store, which cannot always be the case (a retailer could easily specify that title transfers to the customer outside the store, particularly if the retailer bears the risk of loss for the product while in transit), or that the transfer of title and possession are not the determinative factors.

The DOR has also taken the position that if a purchaser buys an item remotely, such as over the internet or by phone, the seller is subject to the TPT if it is engaged in retailing in the State and the product is delivered to Arizona.  If the seller is not engaged in retailing in Arizona but does otherwise have constructional nexus with the state, the seller must collect the Use Tax.

Arizona recognizes that its use tax operates similarly to the traditional sales/use tax imposed by other states.  As a result, Arizona allows purchasers a credit against the Use Tax for sales tax “paid in the state of purchase.”  Ariz. Rev. Stat. § 42-5159.A.2; Ariz. Admin. Code § 15-5-2305.

2015 TPT Amendments Eliminating Interstate and Foreign Commerce Exemptions

Maintains Destination Sourcing for Remote Sales

Before the 2015 amendments, Arizona did not impose TPT on certain sales purchased at an Arizona store but shipped out-of-state.  Specifically, former § 42-5061.A.14 excluded “[s]ales to nonresidents of this state for use outside this state if the vendor ships or delivers the tangible personal property out of this state” and former § 42-5061.A.35 excluded “[s]ales of tangible personal property that is shipped or delivered directly to a destination outside the United States for use in that foreign country.”  Both of these exemptions have now been removed from the statute.  H.B. 2701, 51st Leg., 2d Reg. Sess. (Ariz. 2014).  Thus, unless another exemption applies, sales to non-residents of tangible personal property (except for motor vehicles) delivered and used outside of the State are now subject to the TPT, and sales to both residents and non-residents delivered and used outside of the country are subject to the TPT.  The effect of the Amendments is that Arizona will now tax all sales of tangible personal property made at Arizona stores regardless of the delivery location.

Some commentators have suggested that these amendments make the Arizona TPT a transaction tax that uses origin sourcing.  The amendments do not do this.  First, the amendments apparently only apply to sales that take place in person at stores in Arizona.  Such sales, even of products shipped out-of-state, can hypothetically be interpreted as a destination sourced over-the-counter sale.  These amendments do not change the rule for remote sales.  The Arizona Department of Revenue’s position has always been and continues to be that sales over the internet delivered outside of Arizona are not subject to TPT, even if the retailer making the sale makes the sale in Arizona.  Thus, an Arizona vendor, with a website on Arizona servers, making a sale over that website to an Arizona resident for delivery outside of the state is not liable to TPT on that transaction.  This is classic destination sourcing.

Exacerbates Unlevel Playing Field for Brick-and-Mortar Merchants

Oddly, at a time when both states and the federal government are looking for methods to fairly and efficiently level the sales tax collection obligations between brick-and-mortar stores and remote sellers, Arizona seems to have amplified the problem.  Previously, a nonresident could visit an Arizona stores, buy something and have it shipped out-of-state without triggering application of the TPT.  After the amendments, if the nonresident does this, the TPT applies.  Thus, to the extent Arizona retailers pass the TPT through to customers, Arizona non-residents have a financial incentive to bypass buying items to be used out of state from Arizona stores.  This amendment was probably focused on trying to capture revenue associated with snowbirds that live part-time in Arizona, shop and have purchases sent to their other homes up north.  However, Arizona brick-and-mortar retailers may not be thrilled by the new incentive to avoid in-store purchases.

Aggravates Existing Administrative and Double Taxation Problems with TPT

Numerous retailers have recently experienced significant problems regarding whether the TPT or the Use Tax applies, and on what transactions tax should be applied.  By expanding the types of transactions subject to the tax, these problems are only further entrenched.  Practically, for sales shipped to another jurisdiction, many retailers do not have the systems to determine and calculate a transaction tax based on anything other than a shipping address.  The reason for this is obvious – the shipping address is the address typically used by other states.  Thus, the Arizona TPT system creates a requirement that retailers determine two different jurisdictions for tax purposes.  Similarly, there continues to be confusion regarding when Use Tax should be collected on sales made outside the State but shipped into the State.

Importantly, the Arizona TPT system creates the possibility that two states will impose a tax on the transaction, with no credit between the two.  The new amendments will make this worse by expanding the transactions on which TPT is applied.  Arizona will impose the TPT on transactions initiated in Arizona and shipped out of state, and the state of delivery will impose its use tax on the same.  Even if the TPT may be credited against the delivery state use tax, retailer systems once again just cannot practically perform this calculation, correctly bill and correctly remit. To date, the Arizona DOR has been clear that they do not care about the double taxation or the administrative problems.

Practice Note:  Complexities for Deliveries outside the United States

As noted, the amendments subject Arizona retailers to TPT on sales to all customers for which the goods are shipped out of the country.  This could create the risk of double taxation if the destination country imposes a tax on the receipt of the goods.  The foreign commerce clause prohibits states from imposing taxes that enhance the risk of double taxation.  Japan Line, Ltd. v. County of Los Angeles, 441 U.S. 434 (1979).  Arizona’s statute provides a safety valve for commerce clause problems created by the TPT by specifically exempting from the tax any products sold in transactions the Commerce Clause would prohibit § 42-5061.A.24.  Thus, retailers delivering items outside the United States must determine whether application of the TPT would enhance the risk of double taxation in violation of the foreign commerce clause, therefore creating an exemption from the TPT.