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BREAKING: Indiana Enacts Cloud Software Tax Exemption

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. (more…)




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Michigan Backs Off Cloud Tax, Refund Opportunities Available

After refusing to back down on the issue for years, the Michigan Department of Treasury (Department) issued guidance last week to taxpayers announcing a change in its policy on the sales and use taxation of remotely accessed prewritten computer software.  This comes after years of litigating the issue in the Michigan courts, most recently with the precedential taxpayer victory in Auto-Owners Ins. Co. v. Dep’t of Treasury, No. 321505 (Mich. Ct. App. Oct. 27, 2015), in which the Michigan Court of Appeals held that remote access to software did not constitute delivery of tangible personal property.  See our prior coverage here.  The Department has announced it will apply Auto-Owners (and the numerous other favorable decisions) retroactively and thus allow for refunds for all open tax years.  This is a huge victory for taxpayers; however, those that paid the tax (both purchasers and providers alike) must act promptly to coordinate and request a refund prior to the period of limitations expiring.

Implications

In issuing this guidance, the Department specifically adopts the Michigan Court of Appeals interpretation of “delivered by any means” (as required to be considered taxable prewritten computer software).  Going forward, the “mere transfer of information and data that was processed using the software of the third-party businesses does not constitute ‘delivery by any means’” and is not prewritten software subject to sales and use tax.  See Auto-Owners, at 7.  Not only has the Department admitted defeat with respect to the delivery definition, but it also appears to have acquiesced to taxpayers’ arguments with respect to the true object test (or “incidental to services” test in Michigan).  This test was first announced by the Michigan Supreme Court in Catalina Marketing, and provides that a court must objectively analyze the entire transaction using six factors 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.[1]  In last week’s guidance, the Department states that if only a portion of a software program is electronically delivered to a customer, the “incidental to service” test will be applied to determine whether the transaction constitutes the rendition of a nontaxable service rather than the sale of tangible personal property.  However, if a software program is electronically downloaded in its entirety, it remains taxable.  This guidance comes in the wake of Department and the taxpayer in Thomson Reuters, Inc. v. Dep’t of Treasury stipulating to the dismissal of a Supreme Court case involving the same issues that had been appealed by the Department.  In light of these developments, it appears that the Department has given up all ongoing litigation over cloud services.

Immediate Action Required for Refunds

Taxpayers who paid sales or use tax on cloud based services are entitled to receive a refund for all open periods.  In Michigan, the period of limitations for filing a refund [...]

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Precedential Cloud Victory in Michigan Court of Appeals

On Tuesday, a three-judge panel sitting for the Michigan Court of Appeals unanimously affirmed a lower court decision finding that the use of cloud-based services in Michigan is not subject to use tax in Auto-Owners Ins. Co. v. Dep’t of Treasury, No. 321505 (Mich. Ct. App. Oct. 27, 2015). While there have been a number of cloud-based use tax victories in the Michigan courts over the past year and a half, this decision marks the first published Court of Appeals opinion (i.e., it has precedential effect under the rule of stare decisis). See Mich. Ct. R. 7.215(C)(2). Therefore, the trial courts and Michigan Court of Appeals are obligated to follow the holdings in this case when presented with similar facts, until the Michigan Supreme Court or Court of Appeals say otherwise. While the ultimate outcome (i.e., not taxable) of the lower court decision was affirmed, the analysis used by the Court of Appeals to get there was slightly different and the court took the time to analyze over a dozen different contracts, as discussed below. Given the fact that a petition for review is currently pending in another Court of Appeals case (Thomson Reuters) decided on similar issues in 2014, it will be interesting to see if this development increases the Michigan Supreme Court’s appetite to hear a use tax case on cloud-based services. The Department of Treasury (Department) has approximately 40 days to request that the Auto-Owners decision be reviewed by the Michigan Supreme Court.

Facts

Auto-Owners is an insurance company based out of Michigan that entered into a variety of contracts with third-parties to provide cloud-based services. These contracts were grouped into six basic categories for purposes of this case: (1) insurance industry specific contracts, (2) technology and communications contracts, (3) online research contracts, (4) payment remittance and processing support contracts, (5) equipment maintenance and software customer support contracts and (6) marketing and advertising contracts.  The contracts all involved, at some level, software accessed through the internet. Michigan audited Auto-Owners and ultimately issued a use tax deficiency assessment based on the cloud-based service contracts it utilized.  In doing so, the Department cited the Michigan use tax statute, which like many states, provides that tax is imposed on the privilege of using tangible personal property in the state. See generally Mich. Comp. Laws Ann. § 205.93. The Department took the position that the software used in Michigan by Auto-Owners was “tangible personal property,” which is defined to include prewritten, non-custom, software that is “delivered by any means” under Michigan law. See Mich. Comp. Laws Ann. § 205.92b(o). The taxpayer paid the tax under protest and filed a refund claim, which was the focus of the Court of Claims decision being appealed.

Procedural History

At the trial court level, the Court of Claims determined that the application of use tax to the software used in Michigan by Auto-Owners would be improper. In doing so, the court issued three separate holdings—all in favor of the taxpayer. First, the court held that use tax [...]

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Three Strikes…Tax on Cloud Computing Out in Michigan?

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.”

Analysis

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 [...]

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