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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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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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