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Michigan Appeals Court Reaffirms True Object Test for Remote Access Software

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 May 13, 2014) (unpublished), the Michigan Court of Appeals, reversing the ruling of the Court of Claims, held that a taxpayer’s sale of online research products was not subject to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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Revise Your Tax Matrix: Remote Access of Software Exempt in Michigan and Idaho

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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