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

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1 FOR LIVE PROGRAM ONLY SaaS Sales and Use Tax: Reconciling Varying State Rules to Avoid Unforeseen Tax Traps TUESDAY, JUNE 20, 2017, 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 20, 2017 Gerald J. Donnini, II, Esq., Partner Moffa Sutton & Donnini, Ft. Lauderdale, Fla. Martin Eisenstein, Managing Partner Brann & Isaacson, Lewiston, Maine 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 BACKGROUND G E RALD J. DONNINI II, ESQ. L AW OFFICES OF MOFFA, S U T TO N, & D O N N I N I, P. A. JERRY D O N N I N O F F I C E P H O N E : ( )

6 Gerald J. Donnini II, Esq. Gerald "Jerry" Donnini II is a shareholder who joined the Law Offices of Moffa, Sutton, & Donnini, 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 L.L.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

7 ESSENTIAL CHARACTERISTICS OF CLOUD COMPUTING o Remote Access Accessed via Internet or other network o Broad Access Cloud may be accessed by a number of devices, software, or platforms o No Fixed Payments Pay as you go o Resource Sharing Resources shared amongst many different customers o Scaling Resources can be scaled up or down based on per-moment demand o Self-Service Customers may access services at their own leisure, only needing a web interface 7

8 WHAT IS CONSIDERED THE CLOUD? o 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, used to develop, test, and distribute applications Infrastructure as a Service (IaaS) Purchase of remote computing resources 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

9 WHAT IS NOT CONSIDERED CLOUD COMPUTING? o Downloaded Software o Specified Digital Products (electronic music, books & video) o Digital Automated Services o Information Services o Data Processing Services o Cloud-facilitated Professional Services 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

10 APPLICATION SERVICE PROVIDERS (ASPS) o Entity that retains custody over (or hosts ) software for use by third parties. o Software users typically use the Internet to access software hosted by an ASP. o ASP may or may not own or license the software, but generally owns or maintains the hardware and networking equipment required for the user to access the software. When the ASP owns the license for the software, they may charge the user a license fee and/or a maintenance fee for the software/hardware used by the user. 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

11 SOFTWARE AS A SERVICE ( SAAS ) o o o o o The SaaS model allows consumers to use the provider s software application that runs on a cloud infrastructure. The applications are accessible from various client devices through interfaces 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. A service agreement is usually executed under the SaaS model, unlike an ASP (may be a software license agreement or a service agreement). SaaS model is familiar to most Internet users, and includes offerings such as web-based , calendars, word processing, and digital photo applications (e.g., Google docs or Gmail). 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

12 PLATFORM AS A SERVICE ( PAAS ) o o PaaS model allows the consumer to run consumer-created or acquired applications on the cloud provider s platform. Consumer does not manage or control the underlying cloud infrastructure, including the network, servers, operating systems, or storage; but they have control over the deployment of applications and possibly the application s hosting environment configuration. 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

13 INFRASTRUCTURE AS A SERVICE ( IAAS ) o o o The IaaS model provides the consumer with processing, storage, network capabilities, and other fundamental computing resources in which the consumer may deploy and run software. While the consumer does not manage or control the underlying cloud infrastructure, they do have control over operating systems, storage, deployed applications, and possibly limited control of specific networking components (e.g., host firewalls). Examples of IaaS models include web hosting and managed services (e.g., Amazon Web Services ( AWS ) or Microsoft Azure). 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

14 SERVICE PROVIDER CUSTOMER DIVISION OF OWNERSHIP IAAS PAAS SAAS USERS APPLICATIONS TOOLS USERS APPLICATIONS TOOLS USERS APPLICATIONS TOOLS Indicates separation between Provider and Customer OPERATING OPERATING OPERATING SYSTEM SYSTEM SYSTEM HARDWARE HARDWARE HARDWARE NETWORK PHYSICAL NETWORK PHYSICAL NETWORK PHYSICAL 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

15 EXAMPLE CAR AS A SERVICE (CAAS) On Premise Infrastructure as a Service (IaaS) Platform as a Service (PaaS) CAR FINANCE CAR FINANCE CAR FINANCE CAR FINANCE Managed by Client DEPRECIATION SERVICING DEPRECIATION SERVICING DEPRECIATION SERVICING DEPRECIATION SERVICING Managed by Service Provider RENEWABLES RENEWABLES RENEWABLES RENEWABLES INSURANCE INSURANCE INSURANCE INSURANCE ROAD TAX ROAD TAX ROAD TAX ROAD TAX GARAGE GARAGE GARAGE GARAGE FUEL FUEL FUEL FUEL ROAD TOLLS ROAD TOLLS ROAD TOLLS ROAD TOLLS DRIVER DRIVER DRIVER DRIVER CAR OWNED CAR LEASED CAR HIRED TAXI 15

16 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 TO N, & D O N N I N I, P. A. J E R R Y D O N N I N F LO 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 : ( )

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

18 TRADITIONAL TESTS o True Object o Dominant Purpose o Essence of the Transaction See Dunhill Int l List Co., Inc., Case No (Fla. Div. Admin. Hrgs. 2003). 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

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

20 TANGIBLE PERSONAL PROPERTY Taxable o Washington The term "sale. Wash. Rev. 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 Code (6)(a) Nontaxable o 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. 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

21 CANNED VS. CUSTOM SOFTWARE Canned o 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)(13). Custom o 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). 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

22 CANNED VS. CUSTOM SOFTWARE Four General Categories 1. Prewritten, tangible medium 2. Customized, tangible medium 3. Prewritten, delivered electronically 4. Customized, delivered electronically 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

23 CANNED VS. CUSTOM SOFTWARE Tangible Personal Property o Digital Automated Services Washington o 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 o Form of Delivery Florida 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

24 ELECTRONIC DELIVERY Generally non-taxable, but sometimes explicitly taxable o 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 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

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

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

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

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29 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

30 What is cloud computing? IaaS Infrastructure as a Service On-demand server, storage, and network resources: Store your data online with a third party cloud vendor, or utilize their compute power to process data. PaaS Platform as a Service Hosted application environment for building and deploying cloud applications: Create a customer service application online, test it online, and deliver it to your employees via that same online platform. SaaS Software as a Service Applications, typically available via the browser: Access your online, use customer relationship management tools online, etc. Many typical desktop apps now accessed via web browser. * 30

31 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? * 31

32 How did the states develop their cloud computing guidance? Custom software Prewritten software Computer servers Installation Digital storage Access to software * 32

33 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 * 33

34 Washington Charges made to purchasers for the right to access and use prewritten computer software, where possession of the software is maintained by the seller or a third party, is subject to sales and use tax, regardless of whether the charge for the service is on a per use, per user, per license, subscription, or other basis. Wash. Rev. Code (6)(b); Wash. Admin. Code (10)(b); Washington State Department of Revenue, Digital Products Bills (ESHB 2075 & SHB 2620), 05/03/2010. Certain business-to-business exceptions apply. Sales tax does not apply to the sale of prewritten computer software or remote access prewritten software if the buyer provides the seller with an exemption certificate claiming multiple points of use (MPU). Wash. Admin. Code (11)(a). * 34

35 Washington Washington Tax Determination No , 09/23/2014, 35 WTD 51. The taxpayer, a provider of cloud-based fax, messaging and services, argued that its services should be considered data processing services taxable under the service and activities B&O classification. The Department of Revenue has classified the taxpayer's fax and messaging services as telecommunications services and its services as digital automated services. The Appeals division stated, with regard to the taxpayer's faxing and messaging services, that the services were provided, in part, through third party communications providers and that faxing services have long been held to constitute telecommunications. The taxpayer's faxing and messaging services were not data processing services because the taxpayer's customers contracted with the taxpayer to send transmissions to their own customers, not to extract or process data. Similarly, the taxpayer's services were not considered data processing services because the taxpayer was not engaged for the primary purpose of reformatting or extracting its customers' data, but, rather for the customization and personalization of s. The taxpayer's services were deemed to be digital automated services. Sales of digital automated services are taxable retail sales, unless an exemption applies. * 35

36 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. Arizona DOR Director's Decision No S, 10/27/ * 36

37 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. * 37

38 Idaho 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. For Idaho tax purposes, there is an exclusion from the definition of taxable tangible personal property for the following: computer software that is delivered electronically; remotely accessed computer software; and computer software that is delivered by the load and leave method where the vendor or its agent loads the software at the user's location but does not transfer any tangible personal property containing the software to the user. The term remotely accessed computer software means computer software that a user accesses over the Internet, over private or public networks, or through wireless media, where the user has only the right to use or access the software by means of a license, lease, subscription, service, or other agreement. * 38

39 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. Auto-Owners Insurance Company v. Department of Treasury, Dkt. No (Mi. Ct. App. 10/27/2015) At issue in Auto-Owners was whether certain products were subject to the imposition of use tax on prewritten computer software delivered in any manner under Mich. Comp. Laws Ann b(o). The Court of Appeals found in favor of the taxpayers. Essentially, the court found that there were two different categories of products at issue in the case. One category consisted of products that did not include the delivery of code that enabled the vendor's system to operate. The court found these products did not satisfy the requirement that prewritten computer software must be delivered, in any manner, because there was no proof that code was electronically delivered to the taxpayer, or that the taxpayer exercised any incidence of ownership over the vendor's code. The second category consisted of products where the court found that some prewritten computer software was electronically delivered to the taxpayers. The court found that the electronic delivery of a local client or desktop agent was sufficient to constitute an ownership-type right over the product. * 39

40 Michigan However, even though the court found that some software had been delivered, the court determined that under the incidental to service test under Catalina Marketing Sales Corp. v. Department of Treasury, 470 Mich 13, 678 NW2d 619 (2004), the software was merely incidental to the vendor's rendering of professional services. 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) * 40

41 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). * 41

42 New York Cloud Computing Rulings: New York Advisory Opinion No. TSB-A-15(2)S, 04/14/2015 The Department determined that while customers received rights to use prewritten computer software, that software was merely a portal, and, therefore, incidental to the services provided by the petitioner. Customers use the operating system for the computing power necessary to run applications of their choosing, such as for managing applications, performing searches, and other administrative functions. The Department determined that the primary purpose of the product was the sale of computing power and, conversely, that the right to use the petitioner s prewritten software is only an incidental part of providing this service. Therefore, the Department concluded that the product was not subject to sales and use tax. New York Advisory Opinion No. TSB-A-15(36)S, 09/18/2015 Taxpayer sought an Advisory Opinion from the Office of Counsel for the Department, as to the application of New York sales tax to its provision of a cloudbased software platform service delivered through four key offerings: (1) Line-Item IT billing, (2) budgeting and financial reporting, (3) service costing, and (4) business unit planning. The IT billing was an information service. With regard to Taxpayer s other three services, the Department concluded that these services provided the customer with additional software tools to analyze on Taxpayer s platform the information produced as part of Petitioner's Line-Item IT-Billing service. Thus, while Petitioner's Line-Item IT Billing service was a nontaxable information service, these additional optional products were taxable prewritten software. * 42

43 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 * 43

44 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) * 44

45 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) * 45

46 Currently, computer software provided through a cloud-based delivery system is not subject to tax. The Department continues to review cloud-based arrangements. If, after review, the Department determines that these transactions are subject to tax, it will only apply this determination prospectively. A provider of software as a service is acting as a serviceman. If the provider does not transfer any tangible personal property to the customer then the transaction generally would not be subject to Retailer s Occupation Tax, Use Tax, Service Occupation Tax, or Service Use Tax. If a provider of a service provides to the subscriber an API, applet, desktop agent, or a remote access agent to enable the subscriber to access the provider s network and services, it appears the subscriber is receiving the computer software. Although there may not be a separate charge to the subscriber for the computer software, it is nonetheless subject to tax, unless the transfer qualifies as a non-taxable license of computer software. If the provider is not otherwise required to be registered under Section 2a of the Retailer s Occupation Tax Act and qualifies as a de minimis serviceman, the provider could elect to pay Use Tax on its cost price of the computer software. See Ill. Dept. of Rev., Illinois General Information Letter ST GIL (Mar. 2, 2017). * 46

47 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? * 47

48 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 * 48

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50 SaaS Sales and Use Tax: Reconciling Varying State Rules to Avoid Unforeseen Tax Traps June 20, 2017 Martin Eisenstein, Brann & Isaacson 50

51 SOURCING, NEXUS AND IDENTIFYING THE SERVICE 51

52 Outline of Topics Preliminary Sourcing Questions Location of User or Users Location of Server Where Software Is Housed Sourcing: Single location of Users Multiple Locations of Users Use of Certificates of Multiple Points of Use Certificates Nexus Provider User Identifying the Service: Primary Object 52

53 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). 53

54 Sourcing Issues: Single Location User Within Same State As User 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. See MS Admin. Code 35-IV-5.06 (300). 54

55 Single Location of User But Different States of Server and User Customer uses SaaS in one state but not where software is 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."); Also see TSB A-16(8)S (3/15/16) AZ Dept. of Rev., LR , 9/23/16; LR /14/2015. (The location where the lessee uses the leased property on a nontemporary basis is what is determinative.) Chicago personal property lease transaction tax: Transaction Tax Ruling No. 12, 6/9/15. 55

56 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."). As to SaaS, however, taxed based on where users are located. NM Taxation and Revenue Dept. Ruling No (January 2013). 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). 56

57 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-11(17)S (6/1/11); TSB-A-10(52)S (10/18/10). Chicago Approach in Transaction Tax Ruling No. 12: Similar to New York (based on location of users within City limits) 57

58 Sourcing Issues: Users Located In Multiple States OH approach (Provider not responsible for collecting any tax): 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. 58

59 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) 59

60 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 collect the sales/use 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. 60

61 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 (associate state), 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. 61

62 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 62

63 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

64 Special Sourcing Issues: TX Approach and Best Practices Where benefit is received if use tax: SaaS is taxed as data processing, which is taxable where the benefit of the service is received if subject to use tax. 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 ) 64

65 Special Sourcing Issues: TX Approach and Best Practices Best practice for providers: Obtain certificate of exemption from customers and/or a certificate as to the line of business for use and the location of the users If server is located in TX is SaaS subject to sales tax? Sales tax is based on location of where service is performed. Tex. Tax Code Ann., (3)( Sale... means... the performance of a taxable service ), ( Taxable item means tangible personal property and taxable services. ); (a) ( A tax is imposed on each sale of a taxable item in this state. ). 65

66 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? 66

67 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. 67

68 Nexus-Related Issues: Is Quill Still Good Law? Some commentators suggest that Quill may be overturned, citing Justice Kennedy's concurring opinion in DMA v. Brohl, 135 S. Ct. 1124, 1131 (2015) (Quill was "questionable even when decided.") Alabama, South Dakota, Tennessee, Wyoming, Massachusetts and Indiana are the most noteworthy examples of states seeking to overturn Quill Ala. Admin. Code Rule : The Rule applies to out-of-state sellers who lack an Alabama physical presence but who are making retail sales of tangible personal property into the state. Under the Rule, an out-of-state seller is subject to Alabama sales and use tax collection obligations if the seller: makes at least $250,000 in sales to Alabama customers and engages in one of the ten categories of activities in the statute, Section

69 Nexus-Related Issues: Is Quill Still Good Law? Under former Commissioner Magee, the AL DOR issued a number of assessments in March 2016 based on Rule Most cases settled but in June 2016, Newegg filed an appeal with the Alabama Tax Tribunal Newegg contends that it is not subject to Alabama sales tax because it lacks a physical presence and Rule is inconsistent with both the U.S. Constitution and Alabama law. The Department admits that the Rule is at odds with Quill but argues that the Quill physical presence standard has become unworkable. Discovery complete and decision to be rendered by end of

70 Nexus-Related Issues: Is Quill Still Good Law? 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 filed suit for a declaratory judgment against internet retailers, Wayfair, Newegg, and Overstock, seeking a declaration in its favor [that] will require abrogation of the United States Supreme Court s decision in Quill On March 6, 2017 the South Dakota Circuit Court declared that the SD economic presence statute is unconstitutional based on Quill and granted the summary judgment motion for retailers. The State has appealed the decision to the South Dakota Supreme Court. Decision anticipated by that Court by the end of the calendar year. 70

71 Nexus-Related Issues: Is Quill Still Good Law? Tennessee Rule (2) ( Rule 129 ) Adopted by the TN Department of Revenue and approved by the Tennessee Attorney General on October 3, 2016 Rule 129 requires out-of-state sellers who make at least $500,000 in annual sales to Tennessee customers to register for and collect Tennessee use tax by July 1, 2017, regardless of whether the seller has a physical presence 4/12/2017 TN Chancery Court issued an injunction barring enforcement of Rule, pending consideration of the merits of the suit under Quill. 5/9/2017 TN Legislature (SB 53-HB261) requires legislative approval of economic presence standard in Rule 129 if a final court decision rules in favor of Department. 71

72 Nexus-Related Issues: Is Quill Still Good Law? Other States Adopt Similar Legislation to SD statute 3/3/17 WY and 5/2/17 Indiana adopt economic presence based on SD model, effective on 7/1/17: annual WY/IN sales of more than $100,000 or 200 or more deliveries into WY/IN Economic presence standard effective only on a prospective basis MA Department of Revenue Directive 17-1: (4/3/17) Enforcement as of 7/1/17 that doing business on the Internet creates nexus Tracking software and cookies on customers computers and use ;ofcontent delivery networks. 72

73 Nexus-Related Issues: General Quill is still applicable standard No court has ruled otherwise Pushback from state courts and legislatures Note that Justice White s dissent in Quill is very similar to Justice Kennedy s concurrence in DMA v. Brohl. 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. 73

74 Nexus-Related Issues: Quill 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. 74

75 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. ) But note MA Directive