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In-depth coverage of issues surrounding state and local tax
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Does the Massachusetts Department of Revenue Still Believe SaaS is Subject to Sales Tax?

by | Jun 10, 2014 | ,

As noted in an earlier blog post, “[a] trend is developing in response to aggressive Department of Revenue/Treasury policy-making regarding cloud computing.”  This trend has not been friendly to aggressive Departments, and it appears that the Massachusetts Department of Revenue (Massachusetts Department) may be subtly moving away from its own aggressive position regarding one type of cloud computing transaction, software as a service (SaaS).

Following in the footsteps of the New York Department of Taxation and Finance, the Massachusetts Department has been one of the more aggressive departments in the current debate over the taxability of SaaS (see, e.g., Mass. Regs. Code 64H.1.3(3)(a); Mass. Letter Ruling 13-5 (June 4, 2013); Mass. Letter Ruling 12-13 (Nov. 09, 2012); Mass. Letter Ruling 12-10 (Sept. 25, 2012); Mass. Letter Ruling 12-6 (May 21, 2012)).  In its various letter rulings on the subject, the Massachusetts Department has routinely stated its position as follows:

Charges for prewritten software, whether it is electronically downloaded to the customer or accessed by the customer on the seller’s server (including the “Software as a Service” business model), are generally taxable. However, the marketing description of a product as “software -as-a-service” does not determine taxability of a product, nor does the fact that customers do not download software  or otherwise install software on their own computers or other devices.

The Massachusetts Department applies a “true object of the transaction” test to distinguish between situations where a transaction is for taxable software as opposed to a non-taxable service, noting in its guidance that “[w]here use of a software application is bundled with substantial non-taxable personal or professional services or non-taxable services such as database access or data processing, the object of the transaction may be the non-taxable service rather than a sale of software.”

Though the Massachusetts Department has continued to assert that charges for SaaS are generally subject to tax—both in its published guidance and during taxpayer audits—it has been over a year since the Massachusetts Department has published guidance finding that a specific SaaS offering was subject to tax (see Mass. Letter Ruling 13-5 (June 4, 2013)).  During that year, the Massachusetts Department has issued two new letter rulings, Mass. Letter Ruling 14-4 (May 29, 2014) and Mass. Letter Ruling 14-1 (Feb. 10, 2014), and revised one, Mass. Letter Ruling 12-8 (Revised Nov. 8, 2013), all of which have relied on the “object of the transaction” test to conclude that the offerings at issue were not taxable transfers of prewritten software.

In Mass. Letter Ruling 14-4, the Massachusetts Department considered the requestor’s SaaS offering through which it provided customers with remote access to interactive training programs hosted on its servers, seemingly a ripe fact pattern for finding that the true object of the transaction was prewritten software, especially in light of the Massachusetts Department’s position in other letter rulings (see, e.g., Mass. Letter Ruling 12-10, finding the true object of a SaaS transaction to be the underlying software, noting that “the customer must interact with the software in [...]

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Illinois Legislative Tax Policy Subcommittees Issue Joint Report on Findings

by | May 29, 2014 | , , , ,

On May 28, 2014, the Tax Policy Subcommittees of the Illinois General Assembly’s Joint Revenue and Finance and State Government Administration Committees (Subcommittees) issued their long-awaited Report on Findings regarding the State of Illinois (Report).  The Report was generated after months of hearings and solicitation of written comments from interested parties with respect to Illinois tax rates, tax incentives and tax policy issues.

The Report is chock full of facts and figures.  Unfortunately, it fails to offer much clear direction for the state, as the members of the Subcommittees were unable to agree on the majority of the issues considered.  For example, the Report provides that the state should “continue to explore” the question of whether Illinois should apply the sales tax to services, as do many surrounding states.  Similarly, the Report concludes that while most members of the Subcommittees believe that the corporate income tax rate should be reduced, they could not agree on the amount of the reduction, what corresponding cuts in state spending would offset such a reduction, or even whether the Illinois personal property replacement tax should be considered as part of the corporate income tax rate when comparing Illinois’ income tax rates to those of other states.  The Report also concludes that the Subcommittees are “strongly interested” in providing sales tax exemptions to customers who provide data centers in Illinois, but has not come to a consensus about how to move forward with that process.  The Subcommittees also failed to reach a consensus regarding any changes needed to the Economic Development for a Growing Economy credit, instead offering only the platitude that “it is imperative to ensure that Illinois remains competitive in today’s economy.”

The Report does, however, contain the following findings:

  1. In its most definitive finding, the Report recommends the elimination of the Illinois franchise tax.  No specific plan or timetable is put forward for the elimination of this tax.
  2. The Report concludes that Illinois’ eligibility criteria for the research and development (R&D) tax credit should be changed to match the federal requirements.  For instance, the federal alternative simplified R&D credit would require that R&D spending exceed 50 percent (instead of 100 percent) of the previous three year average.
  3. The Report concludes that initial filing fees for LLCs should be reduced.  No consensus was reached regarding the amount of the reduction.
  4. The Report recommends that the state streamline current processes by designating a point person to help businesses seeking the state’s help with respect to job creation, retention and relocation in Illinois.

In what appears to be an effort to boost the state’s image in the business community, the Report also references a number of favorable statements about Illinois’ business climate that the Report attributes to various business publications.  The Report touts that Illinois ranks third in corporate expansions, according to Site Selection Magazine, that Illinois was identified as among the top five states for “technology and innovation” and “infrastructure” according to CNBC Top States for Business 2013 [...]

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Michigan Appeals Court Reaffirms True Object Test for Remote Access Software

by and | May 28, 2014 | ,

In Thomson Reuters, Inc. v. Department of Treasury, No. 313825 (Mich. Ct. App. May 13, 2014) (unpublished), the Michigan Court of Appeals, reversing the ruling of the Court of Claims, held that a taxpayer’s sale of online research products was not subject to Michigan use tax.  The court held that the transaction was not taxable because it was the sale of a nontaxable service and not the sale of taxable tangible personal property.

The taxpayer sold numerous information products, including subscriptions to its research platform Checkpoint.  Checkpoint is a product of particular interest to state tax practitioners as many of us use it for research.  For the uninitiated, Checkpoint is an online tax and accounting research program that provides subscribers with access, via a web browser, to court cases, rulings and other information that is compiled, synthesized and organized by Checkpoint’s content creators from multiple up-to-date sources.

The Michigan Department of Treasury determined that the taxpayer’s sales of Checkpoint subscriptions constituted the taxable sale of “prewritten computer software” and were therefore taxable.  The taxpayer argued that the sale of subscriptions to Checkpoint constituted the nontaxable sale of an information service and, alternatively, even if tangible personal property was transferred, the sale was nonetheless “primarily” the sale of a service.  The Court of Claims granted the Department’s motion for summary judgment and held that the sales were taxable.

The taxpayer appealed and the Court of Appeals overturned the Court of Claims decision.  The Court of Appeals found that the taxpayer’s transfer of tangible personal property was incidental to the service that the taxpayer provided, and thus the transaction as a whole was not taxable.  The Court of Appeals applied the test established by the Michigan Supreme Court in Catalina Marketing Sales Corp. v. Dept. of Treasury.  678 N.W.2d 619 (Mich. 2004).  Under the Catalina test, a court must objectively analyze the entire transaction and determine whether the transaction is “principally” the transfer of tangible personal property or the transfer of services with a transfer of tangible personal property that is incidental to the service.  Applying the test in this case, the Court of Appeals found that Checkpoint subscribers were not seeking the software underlying the product, but rather were primarily seeking access to up-to-date information relevant to their research needs and benefited from the expert knowledge of Checkpoint’s content creators which rendered the customers’ research more efficient.

This is the second decision out of Michigan regarding the Catalina test.  In Auto-Owners Insurance Company v. Dept. of Treasury, Case No. 12-000082-MT (Mich.Ct.Claims Mar. 20, 2014), the Michigan Court of Claims held that certain remote software access transactions were not subject to use tax because they were nontaxable services, not the transfer of software.  The Court of Claims held that under the statute, which applied use tax to software “delivered by any means,” the taxpayer’s products were not taxable because the software was not delivered.  Although the transactions were not taxable under this interpretation, the Court of Claims went on to [...]

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Illinois Regional Transportation Authority Suffers A Setback In Its Sales Tax Sourcing Litigation

by | May 8, 2014 | , ,

Illinois’ order acceptance rule for sourcing local sales taxes has spurred litigation and endless confusion. The wide differential between local tax rates has encouraged shoppers and retailers to transact business in lower rate jurisdictions – everything from drivers heading across the county line to fill their gas tanks to huge retailers establishing order acceptance facilities in low tax rate jurisdictions. The Illinois Regional Transportation Authority (RTA) has aggressively pursued claims against municipalities and retailers it asserts have violated local sourcing rules.  Recently, the RTA suffered a serious setback in its widely publicized effort to retroactively change the rules on order acceptance.

For decades, the Illinois Department of Revenue (IDOR) administered local sales taxes so that the sole factor governing the applicable tax rate was the point at which a retailer accepted a purchase order. This “order acceptance” rule was clear and understandable, and supported by IDOR letter rulings.  Some retailers obtained IDOR approval to source their sales to a low rate local jurisdiction where a single employee physically received the buyer’s executed counterpart of the retailer’s offer to sell. In addition, a number of retailers entered into contracts with municipalities in which the municipalities agreed to rebate part of their share of the resulting local tax back to the retailers.

About 10 years ago, the IDOR began backing away from its strict order acceptance rule. Its backtracking eventually led to the Illinois Supreme Court’s recent decision in Hartney Fuel Oil.  In Hartney, the Supreme Court rejected the IDOR’s single factor order acceptance test as inconsistent with the underlying statute.  The court also held, however, that taxpayers who had relied on the old rule were not liable for transactions occurring before the court’s November 2014 ruling. The court also found that retailers had a legitimate purpose to establish offices to accept orders in low rate jurisdictions solely for the purpose of controlling the tax rate.

While the Hartney case progressed through the court system, the RTA and other local governments began both a public relations campaign and litigation challenging a number of tax sourcing arrangements. One of the leading cases is the RTA’s challenge to United Airlines’ contract to have its purchase orders for aviation fuel accepted in Sycamore, a city outside the RTA’s taxing jurisdiction. The contract called for Sycamore to rebate a portion of the local tax it received back to United.  The RTA sued both the City of Sycamore and United under the theory that the fuel sales should be relocated so that they would be subject to the RTA’s taxing power. It claimed that the Sycamore office was a “sham” and sought millions in additional tax.

On April 25, 2014, the Circuit Court of Cook County found that the Hartney ruling meant that United and its affiliates were “legally entitled to… structure their sales so that acceptance of purchase orders occurred in Sycamore and they would owe no RTA retail occupation taxes.” The court rejected the RTA’s theory that [...]

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Revise Your Tax Matrix: Remote Access of Software Exempt in Michigan and Idaho

by and | May 6, 2014 | , , , , ,

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 [...]

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Multistate Tax Commission Appoints Keith Getschel as Director of Joint Audit Program

by and | May 6, 2014 | , , ,

Beginning June 16, Keith Getschel will succeed Les Koenig as the Director of the Multistate Tax Commission (MTC) Joint Audit Program.  Les Koenig is retiring as of July 31.  Mr. Getschel comes from the Minnesota Department of Revenue, having held the position of Assistant Commissioner for Business Taxes since 2012.  Mr. Getschel has worked in the Minnesota Department of Revenue for over 30 years, holding such positions as Director of Corporate Tax and Assistant Director in the Corporate and Sales Tax Division.  He also has experience as a supervisor in the Tax Operations Division, a tax policy manager, a revenue tax specialist in the Amended Returns Unit, and an appeals officer in the Appeals and Legal Services Division.

The MTC Joint Audit Program performs audits on behalf of participating states.  The program engages in audits of taxpayers simultaneously across multiple states, conserving state funds and time.  Mr. Getschel’s reputation as a tax administrator in the Minnesota Department of Revenue makes him a great fit for this position.  He has been viewed as taxpayer friendly and willing to work cooperatively with taxpayers to resolve issues.  We hope he continues this trend at the MTC.



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U.S. Supreme Court Denies Certiorari to Review New York’s Click-Through Nexus Law

by and | Dec 5, 2013 | , ,

The U.S. Supreme Court has declined to consider the constitutionality of New York’s “Amazon” click-through sales tax nexus law, leaving it in effect and emboldening other states’ similar efforts.  Unless federal legislation is enacted, interstate retailers are facing an era of unprecedented uncertainty as states seek to apply their new laws to compel tax collection by out-of-state retailers.

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Voiding of Illinois Sales Tax Regulation Leads to Prospective Uncertainty for Sourcing Sales

by and | Nov 25, 2013 | ,

The Illinois Supreme Court recently struck down an Illinois Department of Revenue (Department) regulation sourcing sales to the location of order acceptance.  While the Supreme Court found that the Taxpayers’ Bill of Rights protected the taxpayer from retrospective liability, going forward, Illinois retailers need to closely evaluate their filing positions.  The decision will lead to a period of chaos for taxpayers, local governments and the Department.

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New Jersey Tax Court Issues Important Order on the State’s Throw Out Rule

by and | Sep 9, 2013 | , ,

The Tax Court of New Jersey recently issued an important order that may have eviscerated the impact of the Throw Out Rule on intangibles holding companies.  On its face the order does not appear to address the application of the Throw Out Rule to traditional operating businesses, however the “bottom line” of the order should be applicable to all businesses.

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