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Alabama Appellate Court Finds Photos Merely Incidental to Nontaxable Photography Services

Last Friday, the Alabama Court of Civil Appeals handed the Department of Revenue (Department) a significant loss in their continued attempt to tax non-enumerated services and tangible property provided in conjunction with those services under the sales tax.  See State Dep’t of Revenue v. Omni Studio, LLC, No. 2140889 (Ala. Civ. App. Apr. 29, 2016).  Specifically, the appellate court affirmed the taxpayer’s motion for summary judgment granted by the trial court, which set aside the Department’s assessment on the basis that photographs provided by a photography studio are merely incidental to the nontaxable photography services provided by the studio.  While the prospective effect of the holding in the photography context is unclear due to recent amendments to the photography regulation (effective January 4, 2016), the case is significant in that it strengthens the “incidental to service” (or “true object”) precedent in Alabama and should be seen as a rebuke to the Department for ignoring judicial precedent in favor of their own administrative practices and guidance.

This decision is important in analyzing the taxability of mixed/bundled sales to Alabamans (i.e., where services and some degree of tangible personal property are provided as part of the same transaction).  As with any decision, taxpayers should consider potential refund claims. (more…)




Alabama Legislature Rejects (Yet Another) Attempted Digital Tax Expansion

Last month, a much-anticipated bill drafted by the Alabama Department of Revenue (Department) was introduced in the Alabama Senate that would have expanded the definition of tangible personal property to include “digital goods.”  See Senate Bill 242 (introduced February 16, 2016).  Fortunately, the Senate Finance and Taxation Education Committee (Committee) rejected the bill on March 9, 2016, after hearing testimony from Assistant Department Counsel Christy Edwards and extensively questioning her on the bill’s content and motives.  Notably, the Department continues to take aggressive positions in an effort to tax digital goods and services, without the requisite statutory or legislative approval to back it up.

Background

On February 28 2015, the Department proposed an amendment to Regulation 810-6-5-.09, which would have amended the rental tax on tangible personal property to include “digital transmissions” (broadly defined to include digital content such as streamed audio and video).  After significant opposition from industry representatives, the Joint Legislative Council (composed of leadership from both chambers) wrote a letter to Commissioner Julie Magee in April 2015 requesting that the proposed regulation be withdrawn.  It 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.  See our prior coverage here.  With hesitation and only after continued pushback from the Legislative Council, the Department withdrew the rental tax regulation amendment on July 7, 2015.

In response to the rejection of the proposed regulation, the Department went through its historic revenue rulings and revoked a number of technology rulings in January 2016, noting they will continue attempting to apply the rental tax to streaming services.  Commissioner Magee cited the revocations as a mere “clarification” that did not change the law.  In her comments to the revocations, Commissioner Magee noted that all taxpayers will be collecting and remitting tax in the future “[e]ither legislatively through a digital goods bill or through audits and assessments.”

Senate Bill 242

The digital goods bill arrived just a few weeks later, sponsored by Senator Trip Pittman.  As introduced, the bill would define “tangible personal property” to include “digital goods.”  For these purposes, digital goods include “[s]ounds, images, data, facts, or information, or any combination thereof, transferred electronically, including, but not limited to, specified digital products and any other service transferred electronically that uses one or more software applications.”  As is readily apparent, this language is extremely broad and arguably includes every service delivered over the internet.  The definition also raised concerns because it borrows from Streamlined language (“transferred electronically”; “specified digital products”), but Alabama is not a Streamlined state and does not define those terms elsewhere in the legislation or Code.  As drafted, the bill would have become effective immediately upon passage.

After cancelling a scheduled Committee hearing earlier this month, citing the need for revisions, the sponsor and Department entered the March 9 public hearing with a substitute bill.  Instead of defining “digital [...]

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California Supreme Court Denies BOE Petition for Review in Lucent Technologies

Last week, the California Supreme Court denied the State Board of Equalization’s (BOE’s) petition for review in Lucent Technologies, Inc. v. State Bd. of Equalization, No. S230657 (petition for review denied Jan. 20, 2016). This comes just months after the California Court of Appeals held against the BOE and ordered it to pay Lucent’s $25 million sales tax refund. As explained in more detail below, the denial finalizes the favorable precedent of the Court of Appeals in Nortel Networks Inc. v. State Bd. of Equalization, 191 Cal. App. 4th 1259, 119 Cal. Rptr. 3d 905 (2011)—representing a monumental victory for a broad range of taxpayers in California and opening the door for significant refund opportunities. Moreover, the California Supreme Court’s denial affirms the Court of Appeals decision that the BOE’s position was not substantially justified and the taxpayer was entitled to reasonable litigation costs of over $2.6 million.

Background

Lucent and AT&T (collectively Lucent) are and were global suppliers of products and services supporting, among other things, landline and wireless telephone services, the internet, and other public and private data, voice and multimedia communications networks using terrestrial and wireless technologies. Lucent manufactured and sold switching equipment (switches) to their telephone customers, which allowed the customers to provide telephone calling and other services to the end customers. The switches required software, provided on storage media, to operate. Lucent designed the software (both switch-specific and generic) that runs the switches they sell, which was copyrighted because it is an original work of authorship that has been fixed onto tapes. The software also embodies, implements and enables at least one of 18 different patents held by Lucent.

Between January 1, 1995, and September 30, 2000, Lucent entered into contracts with nine different telephone companies to: (1) sell them one or more switches; (2) provide the instructions on how to install and run those switches; (3) develop and produce a copy of the software necessary to operate those switches; and (4) grant the companies the right to copy the software onto their switch’s hard drive and thereafter to use the software (which necessarily results in the software being copied into the switch’s operating memory). Lucent gave the telephone companies the software by sending them magnetic tapes or CDs containing the software. Lucent’s placement of the software onto the tapes or discs, like the addition of any data to such physical media, physically altered those media. The telephone companies paid Lucent over $300 million for a copy of the software and for the licenses to copy and use that software on their switches.

The BOE assessed sales tax on the full amount of the licensing fees paid under the contracts between Lucent and its telephone company customers. Lucent paid the assessment and sued the BOE for a sales tax refund attributable to the software and licenses to copy and use that software at the trial court. The parties filed cross-motions for summary judgment on Lucent’s refund claims, and the Los Angeles [...]

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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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