SaaS Sales and Use Tax: Reconciling Varying State Rules to Avoid Unforeseen Tax Traps

Transcription

1 FOR LIVE PROGRAM ONLY SaaS Sales and Use Tax: Reconciling Varying State Rules to Avoid Unforeseen Tax Traps TUESDAY, JUNE 7, 2016, 1:00-2:50 pm Eastern IMPORTANT INFORMATION FOR THE LIVE PROGRAM This program is approved for 2 CPE credit hours. To earn credit you must: Participate in the program on your own computer connection (no sharing) if you need to register additional people, please call customer service at x10 (or x10). Strafford accepts American Express, Visa, MasterCard, Discover. Listen on-line via your computer speakers. Respond to five prompts during the program plus a single verification code. You will have to write down only the final verification code on the attestation form, which will be ed to registered attendees. To earn full credit, you must remain connected for the entire program. WHO TO CONTACT DURING THE LIVE EVENT For Additional Registrations: -Call Strafford Customer Service x10 (or x10) For Assistance During the Live Program: -On the web, use the chat box at the bottom left of the screen If you get disconnected during the program, you can simply log in using your original instructions and PIN.

2 Tips for Optimal Quality FOR LIVE PROGRAM ONLY Sound Quality When listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection. If the sound quality is not satisfactory, please immediately so we can address the problem.

3 SaaS Sales and Use Tax June 7, 2016 Gerald J. Donnini, II, Esq., Partner Moffa Gainor & Sutton, Ft. Lauderdale, Fla. Martin Eisenstein, Managing Partner Brann & Isaacson, Lewiston, Maine Nicole R. Ford, Esq. McDermott Will & Emery, Dallas Kelley C. Miller, Attorney Reed Smith, Washington, D.C.

4 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

5 Essential Characteristics of Cloud Computing Remote Access Accessed over the Internet or other network. Broad access The cloud can typically be accessed by a number of devices, software, or platforms. No Fixed Payments Pay as you go. Resource Sharing Shared resources amongst many different customers. Scaling Resources can be scaled up or down based on per-moment demand. Self-Service Customers may typically access services whenever they want, without needing anything other than a web interface. 5

6 What is the Cloud? Cloud offerings are electronic versions of traditional commercial transactions ASPs: Software hosting. Software as a Service (SaaS): Software accessed over the Internet, with either no, or de minimis downloads. Platform as a Service (PaaS): Platform for developers to develop, test, and distribute applications. Infrastructure as a Service (IaaS): Purchase of remote computing resources. 6

7 What is NOT Cloud Computing? Downloaded Software Specified Digital Products (electronic music, books, video) Digital Automated Services Information Services Data Processing Services Cloud-facilitated professional services 7

8 Application Service Providers (ASPs) An entity retains custody over (or hosts ) software for use by third parties. Users of the software hosted by the ASP typically will access the software via the Internet. The ASP may or may not own or license the software, but generally will own or maintain the hardware and networking equipment required for the user to access the software. The ASP may charge the user a license fee for the software (in instances where the ASP owns the software) and/or a fee for maintaining the software/hardware used by its customer. 8

9 Software as a Service ( SaaS ) The SaaS model allows the consumer to use the provider s software applications running on a cloud infrastructure. The applications are accessible from various client devices through a client interface such as a web browser (e.g., web-based ). The consumer does not manage or control the underlying cloud infrastructure including network, servers, operating systems, storage, or application capabilities. Under the SaaS model a service agreement is almost always executed (vs. a software license agreement or services agreement for an ASP). SaaS model is familiar to most Internet users, and includes such offerings as web-based , calendars, word processing, and digital photo applications. 9

10 Platform as a Service ( PaaS ) The PaaS model allows the consumer to run consumer-created or acquired applications on the cloud provider s platform. The consumer does not manage or control the underlying cloud infrastructure including network, servers, operating systems, or storage, but has control over the deployed applications and possibly the application hosting environment configurations. 10

11 Infrastructure as a Service ( IaaS ) The IaaS model provides the consumer with processing, storage, network capabilities, and other fundamental computing resources where the consumer is able to deploy and run software, which can include operating systems and applications. The consumer does not manage or control the underlying cloud infrastructure but has control over operating systems, storage, deployed applications, and possibly limited control of select networking components (e.g., host firewall). An example of an IaaS model includes web hosting and managed services. 11

12 Service Provider Customer Division of Ownership IaaS PaaS SaaS Users Users Users Applications Applications Applications Tools Tools Tools OS OS OS Hardware Hardware Hardware Network Network Network Physical Physical Physical Indicates separation between Provider and Customer 12

13 Pizza as a Service 13

14 SaaS Sales and Use Tax: Reconciling Varying State Rules to Avoid Unforeseen Tax Traps How the States Got Their Positions on Cloud Computing Kelley C. Miller

15 What is cloud computing? 15 *

16 Who is using cloud computing? Why do the states care? Cloud Computing Providers Cloud computing providers are those companies within the tech sector that provide cloud services Cloud Computing Consumers Consumers of cloud computing services fall across all business sectors, with varying types/levels of cloud service usage What is the cloud provider selling? Software, remote access to software, hosting, on-demand. And, where is it being developed, delivered, and used? Who is buying and using cloud services? Where are the services purchased and used? 16 *

17 How did the states develop their cloud computing guidance? 17 *

18 How did the states develop their cloud computing guidance? Example: Washington State Remote Access Software Digital Automated Service Digital Good Software The Cloud Services that use software Books, music, video, data, facts, information 18 *

19 Arizona Arizona was one of the first states to issue a ruling that specifically referenced cloud computing. Cloud services treated as the taxable license of TPP. TIR No. LR (Mar. 24, 2010). Gross receipts derived from hosting software were subject to the transaction privilege tax. Letter Ruling (Jun. 22, 2011). The Arizona Department of Revenue has stated its position that it will treat software licenses as the equivalent of tangible personal property, including licenses of hosted software. Consequently, the Arizona Department of Revenue has taken the position that a software license is to be taxed as a retail sale of tangible personal property if it is for a perpetual or indefinite period. LR (Ariz. Dep t of Revenue April 29, 2013). If the software license only allows a customer to access or use the software for a limited time then the software license is taxed as a rental of tangible personal property. Because hosted software is usually limited in duration, Arizona generally treats such software as a rental of tangible personal property *

20 Idaho Idaho s 1965 definition of tangible property is that which a person could feel, touch, lift. However, in 1986, Idaho included software in the definition of tangible property, regardless of the delivery method. In this manner, Idaho s statutory construct was deemed open-ended and seemed archaic as applied to the cloud computing products flooding the market. For years, the Commission viewed sales of cloud computing products as a sale of tangible personal property and notified taxpayers of millions due under audit. Technology industry leaders fought back against the Commission s view. The Idaho Tech Council submitted a position paper urging the Commission and legislators to work together on reform efforts, and suggested adopting the approach taken by states such as Kansas, which find cloud computing services non-taxable because they lack a transfer of tangible personal property. On April 3, 2013, Idaho s legislature enacted an exemption, effective immediately, for cloud computing products. L. 2013, H243 (c. 271); codified as Id. Code (b). Idaho Summary New statute: Remotely accessed software is not TPP. Idaho Code (b). Previous ruling: Department gave narrow interpretation to prior statutory exemption *

21 Michigan The Michigan Department of Treasury recently issued guidance related to Auto-Owners, a case regarding the taxability of prewritten computer software delivered or accessed through the Internet. In Auto-Owners, the Michigan Court of Appeals determined that the majority of software contracts between an insurance provider and third party companies were not subject to taxation under Michigan's Use Tax Act (UTA) because they did not involve the delivery of prewritten computer software. The Court of Appeals also determined that prewritten computer software was only an incidental component of the professional services purchased by the insurance provider and did not subject the charges to tax. As a result of this and other similar cases, the Department of the Treasury indicated that it will apply the guidance in Auto-Owners retroactively to all open tax years, despite contrary guidance issued by the Department prior to the date of the decision. Notice to Taxpayers Regarding Auto-Owners Insurance Company v. Michigan Department of Treasury (1/6/2016) 21 *

22 New York Sales tax is on receipts from transfers of title or possession to items of tangible personal property. NY Definition of TPP includes prewritten software. There is no legislative guidance as to when a license to use exists regarding software. ( Rentals, leases, and licenses to use includes all transactions in which there is a transfer for a consideration of possession of tangible personal property without a transfer of title. NY Position: Cloud computing sales made by ASPs are taxable licenses to remotely use prewritten software. Online services constitute sale of pre-written software. See Adobe Systems Inc., TSB-A-08(62)S; TSB-A-09(19)S (May 21, 2009); TSB-A-10(2)S (January 20, 2010); TSB-A-10(44)S (Sept. 22, 2010); TSB-A-11(17)S (June 1, 2011), TSB-A- 13(22)S (July 25, 2013). Remote access to canned software is taxable. Taxpayer deemed to have constructive possession of the software via "right to use or control or direct the use" of the software. The situs of the sale was the location associated with the license to use (i.e., the location of the taxpayer s employees that use the software). TSB-A-09(37)S, New York Commissioner of Taxation and Finance, Aug. 25, 2009); TSB-A-13(22)S (July 25, 2013) *

23 Tennessee Charges for data storage and retrieval were not taxable. Let. Rul. No (July 27, 2011). Fee for access to software housed outside of TN not taxable because there was no transfer of possession or control. Let. Rul. No (Oct. 10, 2011). Fee for access to online databases of applications was not subject to tax because there was no transfer of possession of the applications. Tenn. Rev. Rul. No (Jan. 14, 2013). Then 23 *

24 Tennessee Charges for affiliate-hosted software, vendor-hosted software, and internally-hosted software are all subject to sales and use tax in Tennessee. Both the affiliate-hosted and vendor-hosted software remain on a server located outside of Tennessee at all times, and no sale or transfer of tangible personal property or electronic delivery of the software occurs in Tennessee. Instead, the taxpayer is purchasing, remote access to the software. Effective July 1, 2015, software accessed remotely is subject to tax in Tennessee. Internally hosted software is subject to Tennessee sales and use tax insofar as the purchased software is physically or electronically transferred to the taxpayer in Tennessee. However, charges incurred for software that is purchased and downloaded or installed in locations outside of Tennessee, and remotely accessed by the taxpayer in Tennessee, are not subject to tax. Letter Ruling No , Tennessee Department of Revenue (12/17/2015, released 1/20/2016) 24 *

25 Chicago On June 9, 2015, the Chicago Department of Finance adopted Personal Property Lease Transaction Tax Ruling #12 to provide guidance on the taxability of cloud computing, software, and related products. The ruling clarifies that the Chicago personal property lease transaction tax applies to the use of personal property, including a non-possessory computer leases, unless the charges are exempt. The Department noted that if a customer pays a provider for the ability to use the provider's computer to input, modify or retrieve data or information then the charge is for the customer's use of the computer, and is taxable. Originally, the effective date of the ruling was July 1, However, on August 7, 2015, the Chicago Department of Chicago Department of Finance announced it would delay the effective date until January 1, 2016, in response to concerns from the city s technology sector. Chicago Dept. of Revenue Personal Property Lease Transaction Tax Ruling No. 12 (6/9/2015); Chicago Dept. of Revenue Informational Bulletin (11/19/2015) 25 *

26 Income Tax - Sourcing the Cloud Is it a sale of TPP or of a service? Or, both? TPP Sourced to the customer; Services sourced to where the service is performed Why does this matter? Single-factor sourcing; market v. COP Colorado Sale of TPP, source to delivery location. PLR (Oct. 2, 2013). But what is the delivery location? The server? The end user s address? Illinois, Massachusetts, Pennsylvania Sale of a service, sourced to customer location. But how do you determine customer location? 26 *

27 Income Tax - Sourcing the Cloud What if customer location is unclear? States default rules vary: Illinois PLR (1) Customer order location; (2) billing address. Massachusetts (Jan. 2, 2015 final 830 CMR ) These are the general rules, but there are many exceptions: Rules of reasonable approximation apply if delivery state cannot be determined. Otherwise, For individuals, use billing address. For businesses, use (1) contract management location; (2) customer order location; (3) billing address. Billing address safe harbor rules may apply. Pennsylvania (Info Notice ; Eff. 2015) Market- based sourcing guidance: (1) Customer s street address; (2) IP address records or other network data if it corresponds reasonably well to the estimated locations of customers. Tennessee 27 *

28 Cloud Computing Trends G E R A L D J. D O N N I N I I I, E S Q. L AW O F F I C E S O F M O F FA, S U T T O N, & D O N N I N I, P. A. J E R R Y D O N N I N F L O R I D A S A L E S TA X. C O M O F F I C E P H O N E : ( )

29 Gerald J. Donnini II, Esq. Gerald "Jerry" Donnini II is an associate who joined the Law Offices of Moffa, Gainor, & Sutton, P.A., as a law clerk in Mr. Donnini concentrates in the area of Florida and Federal tax matters, with a heavy emphasis on the tobacco, convenience stores and petroleum industries. He also handles a myriad of multi-state state and local tax issues. Mr. Donnini is a co-author for CCH s Expert Treatise Library: State Sales and Us Tax and writes extensively on multi-state tax issues for SalesTaxSupport.com. Mr. Donnini also regularly represents cigarette, beverage, and tobacco distributors against the Division of Alcohol and Tobacco in connection with refund claims and audit defense. While at Nova Southeastern University, Shepard Broad Law Center, Mr. Donnini was the Notes and Comments Editor of Nova Law Review and Vice President of the Sports and Entertainment Law Society. Prior to attending law school at Nova in 2008, Jerry was an accountant for National Retail Properties, Inc. Mr. Donnini earned his LL.M. in Taxation at New York University. Education: New York University School of Law, L.L.M., Taxation (2014) Nova Southeastern University, J.D., magna cum laude (2011) University of Central Florida, B.B.A, Accounting (2007) Bar Admissions: Florida US Tax Court Gerald J Donnini II, Esq., Shareholder Moffa, Sutton, & Donnini, P.A. Office: Fax: JerryDonnini@FloridaSalesTax.com Website: One Financial Plaza, Suite S.E. Third Avenue Fort Lauderdale, FL 33394

30 Step 1: Apply Test True Object Cloud Computing Step 2: Is the product software or a service? If software, which category? 1. Tangible Personal Property 2. Canned vs. Custom 3. Delivery If service, is it taxable? Taxable Nontaxable 30

31 True Object Dominant Purpose Essence of the Transaction Traditional Tests See Dunhill Int l List Co., Inc., Case No (Fla. Div. Admin. Hrgs. 2003). 31

32 Massachusetts Treats ALL canned software as Tangible Personal Property Regulation Taxes Use of Software Object to Obtain Database Access Nontaxable Ltr. Rul. 11-4, Mass. Dep't of Revenue (Apr. 12, 2011) Object of Workflow Add-Ons Taxable Ltr. Rul. 11-2, Mass. Dep't of Revenue (Mar. 4, 2011). Object of Subscriptions Taxable Accord Ltr. Rule 14-1 Mass. Dep't of Revenue (Feb. 10, 2014). But see automated communications are taxable Ltr. Rul , Mass. Dep't of Revenue (Nov. 9, 2012). 32

33 Tangible Personal Property Taxable Washington The term "sale at retail" or "retail sale" also includes the sale of prewritten computer software to a consumer, regardless of the method of delivery to the end user. Wash. Rev. Code (6)(a) Nontaxable Florida Tangible personal property means and includes personal property which may be seen, weighed, measured, or touched or is in any manner perceptible to the senses. Section (19), Florida Statutes. 33

34 Canned vs. Custom Software Canned A software product or solution, usually purchased from a software company, which cannot be modified or altered beyond the original functionality. Connecticut Tangible personal property means personal property which may be seen, weighed, measured, felt or touched or which is in any other manner perceptible to the senses including canned or prewritten computer software. Conn. Gen. Stat (a)(19). Custom Software created to meet the needs of a particular customer. West Virginia "Sale" means any transaction resulting in the purchase or lease of tangible personal property, custom software or a taxable service from a retailer. W. Va. Code, 11-15A-1(9). 34

35 Canned vs. Custom Software Four General Categories 1. Prewritten, tangible medium 2. Customized, tangible medium 3. Prewritten, delivered electronically 4. Customized, delivered electronically 35

36 Canned vs. Custom Software Tangible Personal Property Digital Automated Services Washington Lack of analysis Arizona Priv. Taxpayer Rul , Ariz. Dep't of Revenue (Mar. 25, 2013). Massachusetts Ltr. Rul. 12-6, Mass. Dep't of Revenue (May 21, 2012). Non-Tangible Personal Property Form of Delivery Florida 36

37 Electronic Delivery Generally non-taxable, but sometimes explicitly taxable Non-taxable Missouri Taxable only if sold in a tangible form Iowa Not taxable if substance of the transactions is delivered in electronic means Colorado Taxable only if delivered in a tangible medium Florida Not taxable if not delivered in tangible form 37

38 Electronic Delivery Taxable License of an Intangible New Mexico Receipts from the licensing of an intangible are taxable gross receipts. Rul , NM Tax'n & Revenue Dep't (Jan. 31, 2013). 38

39 Service Treatment Taxable South Carolina Priv. Ltr. Rul. 10-2, SC Dep't of Revenue (July 29, 2010). Connecticut Legal Rul , Conn. Dep't of Revenue Servs. (July 28, 1993). Ohio Opinion of the Tax Comm'r, No , Ohio Dep't of Tax'n (Feb. 4, 2014). 39

40 Non-taxable Wisconsin Service Treatment Priv. Ltr. Rul. W , Wis. Dep't of Revenue (Mar. 24, 2010). Priv. Ltr. Rul. W , Wis. Dep't of Revenue (Mar. 6, 2009). Georgia Ltr. Rul. LR SUT No , Ga. Dep't of Revenue (June 9, 2014). Massachusetts Ltr. Rul. 08-6, Mass. Dep't of Revenue (Mar. 26, 2008). 40

41 SaaS Sales and Use Tax: Reconciling Varying State Rules to Avoid Unforeseen Tax Traps June 7, 2016 Martin Eisenstein, Brann & Isaacson 41

42 SOURCING ISSUES AND NEXUS 42

43 Outline of Topics Preliminary Sourcing Questions Location of User or Users Location of Server Where Software Is Housed Sourcing: Single location of Users Both Server and User Located in State Multiple Locations of Users Use of Certificates of Multiple Points of Use Certificates Nexus Provider User 43

44 Sourcing Issues: Single Location User Within Same State As Server Delivery within the state by cloud computing provider situated in the state All states treat this as an intra-state sale and subject to tax in the state of service if the state taxes cloud computing services. No other state has nexus with the transaction and could tax the sale under the Commerce Clause. See Goldberg v. Sweet, 488 U.S. 252 (1989). 44

45 Sourcing Issues: Single Location User Within Same State As Server Some states tax SaaS if purely intrastate access but not if it is interstate service. E.g: In SC SaaS would be taxable as a communications service. See SC DOR Ruling # SC does not tax interstate communications services. Code ; 2120(11)(a)(exempts toll charges for the transmission of voice or messages between telephone exchanges. ) E.g. In MS SaaS is not taxable if servers located outside of Mississippi, but taxable if servers where software resides located in MS. Miss. Admin. Code 35-IV-5.06 (300). 45

46 Single Location of User But Different States of Server and User Second situation: Customer uses SaaS in state where software is not housed All but a few jurisdictions that tax SaaS source SaaS where the user is located. New York Department of Taxation and Finance TSB-A-11(17)S, June 1, ("We conclude that the hosted marketing service constitutes the sale of prewritten software and its charges for that service are subject to sales and use tax.") Id. ("If the client s employees who use the software are located both in and outside of New York State, Petitioner should collect tax based on the portion of the receipt attributable to the client s employee users located in New York.") AZ Department of Revenue Private Taxpayer Ruling , April 29, ("For remote access software arrangements, the server location where the software and files are physically stored makes no difference for Arizona TPT purposes. The location where the lessee uses the leased property on a non-temporary basis is what is determinative.") Chicago personal property lease transaction tax: Transaction Tax Ruling No

47 Single Location of User But Different States of Server and User The following jurisdictions impose transaction taxes based on the location of the server, irrespective of the location of the user. NM gross receipts (sales) tax: tax is imposed on IaaS or data processing (but not SaaS) only if servers are located in NM N. M. Stat. Ann ("Gross Receipts" include "the total amount of money or the value of other consideration received from selling...services performed outside New Mexico, the product of which is initially used in New Mexico, or from performing services in New Mexico.") FL sales tax: Florida taxes the rental of a computer and its related components which is physically located in this state, but [w]hen the computer is located outside this state, the rental of the computer is not taxable. Fla. Admin. Code Ann. r. 12A-1.032(2), (3). 47

48 Sourcing Issues: Users Located in Multiple States Customer uses SaaS in several states where software is not housed NY approach: Provider responsible for tax based on users in NY: Provider must receive customer s confirmation of the ratio of New York-based employees with access to the service (including detailed information as to their location) to the number of employees with access. Provider relieved of liability for non-ny employees but still liable for tax for NY-based employees. TSB-A-10(52)S (10/18/10); TSB-A-03(5)S,(1/31/03) Chicago Approach in Transaction Tax Ruling No. 12: Similar to but not the same as New York (based on location of users within city limits) 48

49 Sourcing Issues: Users Located in Multiple States OH approach (Provider not responsible for any tax collection): R.C (D) If the purchaser provides a certificate of multiple points of use or a direct pay permit, the vendor is relieved of collection responsibility, and the purchaser may use any reasonable, consistent and uniform method of apportioning purchases by jurisdiction. In the absence of an exemption certificate, the vendor and customer can work out a reasonable, consistent and uniform method of apportionment and the customer certifies to the same. 49

50 Users Located In Multiple States: Certificate of Multiple Points of Use At one time the SSUTA provided for a certificate of Multiple Points of Use to eliminate or reduce the provider s requirement to collect tax on its sales to multiple states. This provision of the SSUTA was repealed. Many states (including SSUTA members) but not all states permit a retailer to accept a certificate of multiple points of use, despite the SSUTA deletion of that form. Some states require the retailer to collect tax only with regard to the proportion of users in the state. NY (attached form); NC (Form E-595E) 50

51 Users Located In Multiple States: Certificate of Multiple Points of Use Other states do not require the seller to collect the state's sales tax, but place the obligation on the purchaser to remit tax to the state and every other state where the users are located. See attached KS and OH MPU Sourcing Certificates; attached MI Sales and Use Tax Exemption Certificate; and VT Regulation Section (8)-4; MA, SD, TN, WA additionally do not require seller to collect sales tax. TX does not require provider to pay any tax, but relies on purchaser to pay tax if purchaser has provided an exemption certificate comparable to the certificate of multiple points of use used in other states. 51

52 Special Sourcing Issues A common issue that many providers face is that they do not know the address of the users of the service SSUTA Twenty-four member states: AR, GA, IN, IA, KS, KY, MI, MN, NE, NV, NJ, NC, ND, OH, OK, RH, SD, TN, UT, VT, WA, WV, WI, and WY apply the waterfall approach SSUTA Waterfall Approach (Only if a higher priority tier is not satisfied will the next tier be used) First Tier: If received (i.e., first use) at the vendor s place of business, sourced at the vendor s place of business In turn defined for service as where purchaser makes first use. 52

53 Sourcing Issues: SSUTA Waterfall Approach First Tier: Where is first use of service made? WA approach: Wash. Rev. Code (6)(f). ("With respect to a service defined as a retail sale in RCW (6)(b), [use means] the first act within this state by which the taxpayer, as a consumer, accesses the prewritten computer software...") OH approach similar to WA approach: Opinion of the OH Tax Commissioner, February 4, ("However, the service is sourced to Ohio only if the benefit of the service is received in Ohio (i.e., customer is located in Ohio and accesses the service from a location in Ohio). Other states have not spoken to issue 53

54 Sourcing Issues: SSUTA Waterfall Approach The common approach is to deem the first use not to be made at the location of the server (i.e. to follow the WA and OH rule) and then proceed down the waterfall to: Second Tier: If not received at the vendor s place of business, location of receipt known to the vendor Third: If neither of the above, then at the address of the customer known from the vendor s business records Fourth: Then, the address given in the transaction Fifth: If none of the above, from where the service was provided Approach followed by Chicago: Transaction Tax Ruling No

55 Special Sourcing Issues: TX Approach and Best Practices Where benefit is received if identified by buyer: SaaS is taxed as data processing, which is taxable where the benefit of the service is received. Rule 3.330(f) presumes that the benefit is at the location of the customer s principal place of business if the customer cannot (or does not) assign the use of the service to an identifiable segment of its business and then issues an exemption certificate for users located outside of TX. See (Comptroller Decision in Hearing No. 106,058 (5/31/2013)(CCH ) Best practice for providers: Obtain certificate on MPU format or state-specific format such as TX exemption certificate as to line of business in which service is used and number of users by state. 55

56 Threshold Questions: Nexus-Related Issues Does the purchaser have nexus in the state where the server is located? Is the vendor required to collect tax, if applicable, of the state where the server is located? Is the vendor required to collect tax where its customer and customer s users are located? 56

57 Nexus-Related Issues: General Quill Corp. v. North Dakota, 504 U.S. 298 (1992), sets the constitutional standard. Quill states (quoting Bellas Hess): There is a sharp distinction between mail-order sellers with retail outlets, solicitors, or property within a state and those who do more than communicate with customers in the state by and or common carrier as a part of general interstate business. (505 U.S. at 307) (emphasis added). Quill requires a physical presence. Through retailers own employees, properties or facilities. Attribution nexus: Agent/representative. 57

58 Nexus-Related Issues: General Some commentators have suggested that Quill may be overturned, citing Justice Kennedy's concurring opinion in Direct Marketing Association v. Brohl, 135 S. Ct. 1124, 1131 (2015) (Quill was "questionable even when decided.") Several states are currently taking up arms against Quill: Alabama and South Dakota are the most noteworthy examples Ala. Admin. Code r : Requires annual sales to Alabama of $250,000 and satisfaction of one of the ten categories of the statute, Section The AL DOR has issued a number of assessments, which are wending their way through the administrative channels 58

59 Nexus-Related Issues: Quill South Dakota SB No. 106, provides that nexus is established by annual SD sales of more than $100,000 or 200 or more deliveries into SD Statute provides that law is not retroactive (unlike the AL Rule) SD has already filed suit for a declaratory judgment against Wayfair, Newegg, Overstock, and Systemax seeking a declaration in its favor [that] will require abrogation of the United States Supreme Court s decision in Quill VT Legislature had adopted HB 873 (but Governor has yet to sign) that provides that nexus is established based on SD economic presence standard, but law is not in effect until after a controlling court decision or federal legislation abrogates the physical presence requirement of Quill. 59

60 Quill is still good law Nexus-Related Issues: General Note that Justice White s dissent in Quill is very similar to Justice Kennedy s concurrence in DMA v. Brohl. In Comptroller of the Treasury of Maryland v. Wynne, 575 U.S. (5/18/15), the majority opinion written by Justice Alito and the dissenting opinion of Justice Ginsburg cited Quill with approval as providing that the Due Process standard is different than the Commerce Clause standard. 60

61 Nexus-Related Issues: General Quill held that while the Commerce Clause requires a physical presence, due process is satisfied without a physical presence if the out of state retailer had sufficient contacts with the state and purposefully directed its activities at the state. 504 U.S. 298, 308 The test advocated by the states to replace Quill is in effect the Due Process test of a company purposefully directing its activities to the state. Stare decisis is an important consideration for the Supreme Court, especially in cases where Congress can act. See Justice Scalia s dissenting opinion in Wynne and concurring opinion in Quill itself. 61

62 Nexus Implications To Purchaser Basic principle: Remote Access to Software located on a server in another state should not create nexus of purchaser in state where server is located. While software may be deemed tangible personal property in the state where the server is located, the purchaser has no ownership rights and should not be deemed the owner of tangible personal property where the server is located. The right of access to the software is no different than the ownership by Quill of floppy diskettes in North Dakota, which was deemed by the U.S. Supreme Court to create nexus. See Texas Tax Code Sec (nexus safe haven for use of software that is owned, licensed, or leased by the user or provider. ) 62

63 Lack Of Nexus Of Purchaser: Is Sales Tax Due In State Where Server is located? Is sales tax due if state where the server is located assesses a tax on SaaS? First prong of Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977) test requires substantial nexus with the transaction. Arguably if the state taxes SaaS and the fifth tier of the waterfall is implicated, the state has substantial nexus with the transaction because of the location of the server there. Oklahoma Tax Com'n v. Jefferson Lines, Inc., 514 U.S. 175 (1995). But under the waterfall approach, when the state where the user is located imposes tax on SaaS if customers use it in the state, the internal consistency test (i.e. if every state were to impose the tax there would be double taxation and discrimination against interstate commerce) is satisfied. See the U.S. Supreme Court's recent decision in Wynne. 63

64 Nexus: Does the Provider Have Nexus Over the Service Where Used? Absent another connection with the state where users are located, merely permitting access by persons located in the state should not establish a physical presence of the provider in the user s state. See the discussion on prior slides. But in TX Comptroller Decision, Hearing No. 106,626, CCH (9/19/14), an administrative law judge held that a company that sold software electronically downloaded by TX customers established nexus with TX, because it retained ownership of the software, which is deemed tangible personal property. Decision is contrary to Quill, but SaaS, since it remains in the server state, should not be deemed tangible personal property at the user s location. 64

65 How Do We Characterize? Customer s true object, primary purpose? Which of these various elements of the service was predominant? What ownership rights (to what is being purchased) are transferred? What does the purchase agreement say? What do the marketing materials say? Is there a software license agreement? 65

66 Animal, Vegetable or Mineral? States struggle to characterize transactions in the cloud: Is it taxable software? All Internet-based platforms necessarily utilize software But that doesn t mean software is the true object of the transaction Is it a taxable information service? Internet-based services may draw upon a database of information But that doesn t mean the true object of the transaction is the information Is it a taxable communications service? When, if ever, does a cloud based service that routes messages or information constitute a communications service itself? Who supplies the telecommunications transport? 66

67 True Object: Examples Thomson Reuters Inc. v. Dep t of Treasury, Dkt. No (Mich. App. May 13, 2014) In the instant case, any transfer of tangible personal property was incidental to the service provided. Checkpoint subscribers primarily sought access to up-to-date information relevant to their needs.... Customers sought the expert knowledge of Checkpoint's content creators in synthesizing, compiling, and organizing the materials, thereby rendering research more efficient. There is no evidence that any de minimus amount of software transferred was the object of the transaction, or that customers sought to own or otherwise have responsibility for the prewritten computer software. Further, considering the transaction as a whole, the fact that the license agreement entitles users to access and use the Checkpoint program does not establish that users primarily sought the physical software.... Any transfer of prewritten computer software was an insignificant part of the overall transaction aimed at providing a service. Comptroller v. CheckFree Services Corp., Dkt. No CV (Tex. App. Apr. 19, 2016) [T]he trial court s findings and conclusions properly focused on the essence of the transaction at issue, rather than simply the involvement of a computer, to determine the nature of the services CheckFree provided.... [T]he trial court was required to determine whether CheckFree does something more than compiling and producing records of transactions, maintaining information, and entering and retrieving information, such as providing physical science, legal, or accounting services based on the information i.e., providing professional services that are facilitated by the use of a computer. Mass. Letter Ruling 14-4 (May 29, 2014); Mass. Letter Ruling 14-1 (Feb. 10, 2014); Mass. Letter Ruling 12-8 (Revised Nov. 8, 2013) 67

68 True Object: Examples New York Department of Taxation and Finance TSB-A-15(2)S (April 14, 2015) The product described in the opinion allowed customers to access computing power provided by the requestor, not just software. The Department determined that although the requestor transferred a license of an operating system to the customer as part of the transaction, the entire product was not taxable. The Department determined that the customer was purchasing the right to use computing power, and not prewritten software. Although not directly using the term, the Department appears to have applied the true object test. As such, the Department distinguished this service from the products described in other advisory opinions addressing remote access to prewritten software where the customer primarily wants specific software, as opposed to a computing power product. 68