Recently, I presented at a webinar hosted by Strafford Publishing on the subject of sales and use tax on digital products and services. It almost goes without saying that the interstate sale of digital products—whether books or software—is complicated, if for no other reason than it requires analyzing the sales and use tax consequences of such transactions based upon forty-five states’ (and the District of Columbia’s) sales tax laws, which were adopted long before the advent of the digital age. For example, the starting point for sales tax analysis in most states is whether the transaction involves the sale of “tangible personal property.” Is a digital product such as a digital book that is downloaded by the customer tangible personal property?
The states do not provide for uniform treatment of the taxability of digital products from state to state, nor are all digital products taxed similarly within a given state. Colorado, for example, taxes digital books and music, but does not tax digital software. Twenty-five states tax digital books, music and videos, while thirty states tax prewritten software.
What makes analysis in this field even trickier are the different methods of delivery of digital products and the various pricing plans under which such products are sold. For example, under one delivery method, the seller provides the buyer an electronic access code to permit the buyer to download the digital product at the buyer’s convenience. For a sale such as this, in addition to analyzing whether the underlying product is taxable, the seller must also determine whether the sale of the access code is taxable at the time of such sale. The SSUTA, of which there are 24 member states, treats the sale of a “digital code” that entitles the purchaser to download a taxable digital product as a taxable transaction. See Section 332(G). But not every state, of course, is a member of the SSUTA and non-member states do not always follow this principle. For instance, the non-member states of Texas, New York, and Illinois treat the sale of such access codes as tantamount to selling a gift card. These states treat the sale of a gift card or access code as the sale of an intangible. It is only when the gift card is redeemed that a taxable sale of tangible personal property has occurred. See, for example, Ill. General Information Letter ST 10-0052-GIL (June 4, 2010).
The law is even cloudier if the seller sells for one price a “bundle” of rights to access not only a taxable product but also a non-taxable product. For example, in Tennessee Department of Revenue, Revenue Ruling No. 12-11 (July 24, 2012), the Department of Revenue considered whether a bundled service that provided access to both reference books and computer simulation programs at a single price was taxable. The Department noted that access to digital books is taxable, while access to the software is not taxable. Nevertheless, because the provider charged one price for these products, the Department held that the entire “bundled” product was taxable. This ruling falls in line with New York’s so-called “Cheeseboard Rule,” in which tax was due on the entire purchase price where a seller was selling for one price tax exempt cheeses together with a taxable cheese board. See 20 NYCRR 527.1(b).
The conclusions that can be drawn are that a retailer of digital products should determine the taxability of the products it sells based on the nature of the products sold and the method of access or delivery of the products. In addition, a seller should consider whether to sell its products for a “bundled price,” or to price its products separately, when selling distinctly taxable or nontaxable items such as software and other digital products. If one price is charged, the seller is likely liable for tax on the entire price.
Showing posts with label Tennessee. Show all posts
Showing posts with label Tennessee. Show all posts
Friday, February 15, 2013
Friday, November 2, 2012
Tennessee Ruling Provides Another Wrinkle for Cloud Computing Services
A recent ruling by the Tennessee Department of Revenue (Ruling #12-11) illustrates some of the anomalies and pitfalls in properly taxing cloud computing services. The request for ruling concerned a service that provided Tennessee users access to software maintained on remote servers located outside of Tennessee. This is otherwise known as an SaaS service. In addition, the charge for the service permitted users access to certain databases, including certain reference materials such as dictionaries and encyclopedias. It would appear that the users did not download the references to their computers.
One of the anomalies in the ruling is that the Department stated that the SaaS portion of the service was not taxable, but access to the databases was taxable because the Department deemed the access to include the right to license and use digital books. As of January 1, 2009, the right to license and use digital books is taxable pursuant to an amendment to the Tennessee sales and use tax statute adopting the Streamlined Sales and Use Tax Agreement (“SSUTA”).
The Department’s basis for this distinction in taxability appears to be that access to software is not taxable because “title, possession, and control” of the software always resides outside of Tennessee. On the other hand, the taxability of digital books is predicated on the following underscored clause from Tenn. Code Ann § 67-6-233(a), which provides for the taxation of digital books when there has been the “retail sale, lease, licensing, or use of specified digital products transferred to or accessed by subscribers or consumers in this state.” (emphasis added). Section 67-6-231(a), providing for the taxation of software, includes only “software transferred by tangible storage media or delivered electronically,” but does not include access to the software. The difference between the two statutory provisions is subtle. On the one hand, digital books are taxable if the consumer in Tennessee has “access” to the books, without being required to download them. On the other hand, computer software is not taxable, even if the consumer has access to the software, so long as the consumer does not download the software to his or her computer in Tennessee.
Another anomaly pointed out in the ruling is the distinction between information services and digital books. The Department conceded in its ruling that data processing and information services are not taxable in Tennessee, and defined such nontaxable services as allowing “data to be generated, acquired, stored, processed or retrieved or delivered by electronic transmission.” Because the service at issue in the ruling included access not only to information maintained in a database by the service provider, but also access to reference materials such as a dictionary or encyclopedia, the non-taxable information service was transformed into access to digital books.
Finally, the “pitfall” is, as the Department ruled, because the charge was for the combined service of access to the software as well as access to the databases and the digital books, the entire transaction was taxable. This was the case even though the transaction fit within the definition of a “bundled” transaction (i.e., the sale of two or more services for one price), and some of the services were not taxable. The ruling is in line with the old New York “cheeseboard” rule* and the proverbial expression that “one rotten apple spoils the bunch.” The lesson for a cloud service provider is that it should itemize charges for separate services; otherwise it stands the risk of taxation of the entire transaction. This is so, even in the SSUTA states, which only provide for “unbundling” services (i.e., permitting the showing of the portion of a bundled transaction that is not taxable) where the services consist of a bundled transaction of “telecommunications services, ancillary services, Internet access services, or audio or video programming services.” Most cloud computer service providers do not provide such components as part of their service offerings and so itemizing the services they actually provide is a constructive way to limit the tax hit.
* Under 20 NYCRR § 527.1(b), “Taxable and exempt items sold as a single unit. When tangible personal property, composed of taxable and exempt items is sold as a single unit, the tax shall be collected on the total price. Example: A vendor sells a package containing assorted cheeses, a cheese board and a knife for $15. He is required to collect tax on $15.”
One of the anomalies in the ruling is that the Department stated that the SaaS portion of the service was not taxable, but access to the databases was taxable because the Department deemed the access to include the right to license and use digital books. As of January 1, 2009, the right to license and use digital books is taxable pursuant to an amendment to the Tennessee sales and use tax statute adopting the Streamlined Sales and Use Tax Agreement (“SSUTA”).
The Department’s basis for this distinction in taxability appears to be that access to software is not taxable because “title, possession, and control” of the software always resides outside of Tennessee. On the other hand, the taxability of digital books is predicated on the following underscored clause from Tenn. Code Ann § 67-6-233(a), which provides for the taxation of digital books when there has been the “retail sale, lease, licensing, or use of specified digital products transferred to or accessed by subscribers or consumers in this state.” (emphasis added). Section 67-6-231(a), providing for the taxation of software, includes only “software transferred by tangible storage media or delivered electronically,” but does not include access to the software. The difference between the two statutory provisions is subtle. On the one hand, digital books are taxable if the consumer in Tennessee has “access” to the books, without being required to download them. On the other hand, computer software is not taxable, even if the consumer has access to the software, so long as the consumer does not download the software to his or her computer in Tennessee.
Another anomaly pointed out in the ruling is the distinction between information services and digital books. The Department conceded in its ruling that data processing and information services are not taxable in Tennessee, and defined such nontaxable services as allowing “data to be generated, acquired, stored, processed or retrieved or delivered by electronic transmission.” Because the service at issue in the ruling included access not only to information maintained in a database by the service provider, but also access to reference materials such as a dictionary or encyclopedia, the non-taxable information service was transformed into access to digital books.
Finally, the “pitfall” is, as the Department ruled, because the charge was for the combined service of access to the software as well as access to the databases and the digital books, the entire transaction was taxable. This was the case even though the transaction fit within the definition of a “bundled” transaction (i.e., the sale of two or more services for one price), and some of the services were not taxable. The ruling is in line with the old New York “cheeseboard” rule* and the proverbial expression that “one rotten apple spoils the bunch.” The lesson for a cloud service provider is that it should itemize charges for separate services; otherwise it stands the risk of taxation of the entire transaction. This is so, even in the SSUTA states, which only provide for “unbundling” services (i.e., permitting the showing of the portion of a bundled transaction that is not taxable) where the services consist of a bundled transaction of “telecommunications services, ancillary services, Internet access services, or audio or video programming services.” Most cloud computer service providers do not provide such components as part of their service offerings and so itemizing the services they actually provide is a constructive way to limit the tax hit.
* Under 20 NYCRR § 527.1(b), “Taxable and exempt items sold as a single unit. When tangible personal property, composed of taxable and exempt items is sold as a single unit, the tax shall be collected on the total price. Example: A vendor sells a package containing assorted cheeses, a cheese board and a knife for $15. He is required to collect tax on $15.”
Monday, March 7, 2011
Additional States Introduce Affiliate-Nexus Legislation
On March 2, an Internet-affiliate nexus bill was introduced in the Arkansas State Senate (SB 738). Arkansas joins Arizona, California, Connecticut, Hawaii, Illinois, Massachusetts, Minnesota, Mississippi, New Mexico, Tennessee, Texas, and Vermont, as the thirteenth state this legislative season to consider such a measure. Nearly all of the bills -- with the exception of Illinois’s HB 3659, which was passed by the Illinois legislature and is now awaiting signature or veto by Governor Quinn, and Connecticut’s SB 5545 -- are patterned directly upon the New York affiliate nexus law enacted in 2008 and challenged in court, so far unsuccessfully, by Amazon.com. In other words, 11 of the 13 proposed laws create a rebuttable presumption that an out-of-state Internet retailer is obligated to collect and remit the state’s sales and use taxes if the retailer enters into an agreement with an in-state resident (an “affiliate”) pursuant to which the affiliate places a link from the affiliate’s website to the retailer’s site, and the retailer realizes at least $10,000 in sales to customers referred to it by the affiliate’s links. The presumption can be negated by proof that the in-state affiliates did not engage in any in-state solicitation on behalf of the retailer.
In its November 2010 ruling, the Appellate Division of the New York Supreme Court found that the ability of a retailer to rebut the presumption of solicitation was an important factor in determining that the New York law is not unconstitutional on its face. The Court, however, remanded the case for further proceedings on the issue of whether the law violates the Commerce Clause and Due Process Clause as applied to specifically to Amazon. As the ongoing proceedings in the New York case make clear, the constitutionality of such “New York-style” affiliate-nexus legislation is far from resolved.
At the same time, it is worth noting that the Illinois and Connecticut bills differ from the New York law in that neither bill provides that the presumption that a retailer must collect sales and use tax as a result of having in-state Internet affiliates may be rebutted. Imposing an irrebuttable presumption of nexus is highly suspect under both the Commerce Clause and Due Process Clause. Without a rebuttable presumption in place to protect retailers, Illinois and Connecticut would subject Internet retailers to burdensome state tax collection obligations when the retailers are effectively doing nothing more than advertising. For that reason, the progress of each of these bills bears watching. Stay tuned.
In its November 2010 ruling, the Appellate Division of the New York Supreme Court found that the ability of a retailer to rebut the presumption of solicitation was an important factor in determining that the New York law is not unconstitutional on its face. The Court, however, remanded the case for further proceedings on the issue of whether the law violates the Commerce Clause and Due Process Clause as applied to specifically to Amazon. As the ongoing proceedings in the New York case make clear, the constitutionality of such “New York-style” affiliate-nexus legislation is far from resolved.
At the same time, it is worth noting that the Illinois and Connecticut bills differ from the New York law in that neither bill provides that the presumption that a retailer must collect sales and use tax as a result of having in-state Internet affiliates may be rebutted. Imposing an irrebuttable presumption of nexus is highly suspect under both the Commerce Clause and Due Process Clause. Without a rebuttable presumption in place to protect retailers, Illinois and Connecticut would subject Internet retailers to burdensome state tax collection obligations when the retailers are effectively doing nothing more than advertising. For that reason, the progress of each of these bills bears watching. Stay tuned.
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