In two recent General Information Letters (GILs), the Illinois Department of Revenue (Department) reaffirmed that computer software provided through a cloud-based delivery system is not subject to tax in Illinois. The Department announced that while it continues to review cloud-based arrangements and may determine they are taxable at some point, any decision to tax cloud-based services will be applied prospectively only. The GILs also recognize Quill’s physical presence requirement for Commerce Clause nexus. (more…)
The City of Chicago has announced that it will be delaying the effective date for its recent ruling under the Personal Property Lease Transaction Tax until January 1, 2016. Personal Property Lease Transaction Tax Ruling #12 takes a broad view of how the 9 percent tax applies to cloud-based services. It was scheduled to come into effect on September 1, 2015, but after an outcry from the startup community, Chicago has pushed back the date on which it expects cloud-based providers to begin collecting and remitting tax. The additional time will allow the city to further consider potential exemptions for small businesses. Providers of information services, software as a service (SaaS), platform as a service (PaaS), and some forms of infrastructure as a service (IaaS) that have nexus with the city will now have until January 1, 2016, to begin collecting the tax. (See a detailed discussion of Ruling #12 and its implications in a previous post.) The delay could backfire for the city because taxpayers will now have more time to launch challenges to the tax.
Ruling #12 is only part of Chicago’s two-pronged approach to taxing the cloud. The city had at the same time issued Amusement Tax Ruling #5, which provides that charges for video streaming, audio streaming, computer game subscriptions and other forms of online entertainment, as well as temporary download rentals, are subject to the 9 percent Amusement Tax—not the Lease Transaction Tax. That ruling also was issued with a September 1, 2015, effective date. This effective date for the Amusement Tax Ruling has not been changed, and the city has indicated that no such extension is currently under consideration.
Taxpayers providing services over the internet need to carefully consider two recent City of Chicago rulings: Lease Transaction Tax Ruling #12 and Amusement Tax Ruling #5. Issued together on June 9, 2015, the rulings extend a 9 percent tax to most services provided online. Charges for video streaming, audio streaming, computer game subscriptions, and other forms of online entertainment are subject to the 9 percent amusement tax. Charges for essentially any other kind of interactive website or online service, with only a handful of exceptions, are subject to the 9 percent lease transaction tax. The lease transaction tax is supposed to be a municipal sales and use tax on the leasing of tangible personal property, but the City is stretching the tax to encompass the deemed use of the provider’s computer in accessing a website or program over the internet. As detailed in this On the Subject, providers of information services and cloud-based services need to evaluate the applicability of the City’s guidance and consider whether to comply or challenge the imposition of tax.
The Tennessee Department of Revenue recently released Letter Ruling No. 14-05, in which it considered whether certain cloud collaboration services are subject to the state’s sales tax. At a high level, the provider’s services are provided in a typical Software as a Service (SaaS) form: (1) the provider owns the hardware and software used to provide the services; (2) the software is installed on the provider’s servers; (3) the provider’s employees monitor and maintain the hardware and software; (4) the provider charges a customer a monthly user fee; and (5) customers remotely access the software (i.e., no software is ever downloaded by a customer). Of additional note, the provider does not license any of its software to the customers.
As the Tennessee Department has done in the past, it correctly determined that the SaaS arrangement does not constitute a retail sale of computer software because the provider “does not transfer title, possession, or control of any tangible personal property or software to a customer.” Instead, the provider “ultimately uses and consumes both hardware and software as a means of providing its services.”
However, the Tennessee Department found that the cloud collaboration services are subject to the state’s sales tax as telecommunications services or ancillary services to telecommunications. The cloud collaboration services instruct a customer’s telecommunications equipment as to how to process and route calls, “augment[ing] a customer’s voice, video, messaging, presence, audio/web conferencing, and mobile capabilities.” As such, Letter Ruling No. 14-05 highlights a major concern for SaaS providers: that their services will be considered taxable telecommunications or ancillary services. While the cloud collaboration services are perhaps more clearly telecommunications or ancillary services than others, many SaaS offerings include an element of telecommunications by the very nature of remotely accessed software.
Fortunately, there are strong arguments in many states for most SaaS offerings to be excluded from the definition of telecommunications or ancillary services. Streamlined Sales and Use Tax Agreement (SSUTA) member states (Tennessee is an associate member) are required to exclude “data processing and information services that allow data to be generated, acquired, stored, processed, or retrieved and delivered by an electronic transmission to a purchaser where such purchaser’s primary purpose for the underlying transaction is the processed data or information” from the definition of “telecommunications services.” Therefore, where a provider can demonstrate that the true object of its offering is data processing or information services—and that any telecommunications services are merely incidental to those services—the offering should not constitute taxable telecommunications services. In fact, demonstrating that the telecommunications component of any SaaS offering is merely incidental to the true object of the service should be effective in almost all states, SSUTA members or not. Therefore, to adequately defend against the concern that a SaaS offering will be considered taxable telecommunications or ancillary services, providers should ensure that the true object of their offering is apparent and that it is clear that any telecommunications component is provided solely to facilitate that true object.
On June 30, 2013, the Vermont sales tax moratorium on remote access to software expired. At that time, the Vermont Department of Taxes (Department) reverted to its prior position that interpreted, without any analysis, the Vermont sales tax to apply to prewritten software that was “licensed for use and available from a remote server.” Recently, the Department released draft regulatory language relating to the taxation of remotely accessed software and is currently seeking comments on the draft (due by October 1, 2014).
The draft regulations provide a great deal of guidance, some good and some bad. On the positive side, the regulations recognize that a sale cannot occur unless “use or control [is] given [to] the purchaser with respect to the software” such that “the purchaser is able to use the software to independently perform tasks.” This language comports with established legal authorities in the state regarding when sales occur, rather than simply stating that a sale has occurred when software is remotely accessed. See, e.g., In re Merrill Theatre Corp., 415 A.2d 1327 (Vt. 1980) (finding no sale where “[the patron] never comes into possession of [the tangible property], and exerts no control over it” because the vendor was the one with “actual possession” of the property).
The draft regulations also contain a non-exhaustive list of nontaxable transactions, which provide much needed clarity in the area of cloud computing. These include: (1) a transaction whose true object is the purchase of a service (to which any transfer of software is merely incidental), (2) sales of data processing and information services, (3) a transaction where the seller processes the purchaser’s data on the seller’s software and (4) a transaction where the customer runs its own software on the seller’s hardware in a cloud computing environment (such arrangements are commonly referred to as Infrastructure as a Service (IaaS), and the draft regulations refer to them as such). This list is particularly helpful and positive because it recognizes: (1) the importance of the true object test in determining taxability rather than simply relying on licensing or other language in a contract, (2) that many cloud computing transactions are properly characterized as data processing services performed by the vendor rather than the transfer of software and (3) that IaaS is different in nature than Software as a Service (SaaS) and should be analyzed differently. The IaaS discussion is particularly significant as many states have not directly addressed the subject.
The draft regulations are less successful when they attempt to provide factors for determining whether a taxable transfer of software has occurred. These factors include whether: (1) “[t]he purchaser can use the prewritten software with little or no intervention by the seller other than ‘help desk’ assistance;” and (2) “[t]he purchaser can use an organizational tool or function that is a function of seller’s software.” The proposed factors are troublesome because of the lack of clarity regarding what it means to “use” the software or the functions of the software, which [...]
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 [...]