saas sales and use tax: reconciling varying state rules...

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SaaS Sales and Use Tax: Reconciling Varying State Rules

To Avoid Unforeseen Tax TrapsTHURSDAY, JULY 18, 2019, 1:00-2:50 pm Eastern

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July 18, 2019

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

Gerald J. Donnini, II, Esq., Partner

Moffa Sutton & Donnini

[email protected]

DeAndré R. Morrow, Attorney

Reed Smith

[email protected]

Jamie E. T. Szal, Attorney

Brann & Isaacson

[email protected]

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.

BACKGROUND

GERALD J. DONNIN I I I , ESQ.

LAW OFF ICES OF MOFFA, SUTTON, & DONNIN I , P.A.

JERRYDONNIN [email protected]

OFF ICE PHONE: (954) 642 -9390


Gerald J. Donnini II, Esq. [email protected]

Gerald "Jerry" Donnini II is a shareholder who joined the Law Offices of Moffa, Sutton, & Donnini, P.A., as a law clerk in 2010. 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

6

Gerald J Donnini II, Esq., Shareholder

Moffa, Sutton, & Donnini, P.A.

Office: 954-642-9390

Fax: 954-761-1004

Email: [email protected]

Website: http://www.FloridaSalesTax.com

100 West Cypress Creek Road, Suite 930

Fort Lauderdale, FL 33309


http://www.cchgroup.com/opencms/opencms/web/TAA/PDFs/all/expert-treatise-library-state-sales-use-taxation.pdf

http://www.salestaxsupport.com/blogs/sales-use-tax/author/jerrydonnini/


http://www.floridasalestax.com/

ESSENTIAL CHARACTERISTICS OF CLOUD

COMPUTING

o Remote Access – Accessed via Internet or other network

o Broad Access – Cloud may be accessed by a number ofdevices, 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

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Office: 954-642-9390

Fax: 954-761-1004







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 minimisdownloads

• 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

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Office: 954-642-9390

Fax: 954-761-1004







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

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Office: 954-642-9390

Fax: 954-761-1004







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.

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Office: 954-642-9390

Fax: 954-761-1004







SOFTWARE AS A SERVICE (“SAAS”)o The SaaS model allows consumers to use the provider’s

software application that runs on a cloud infrastructure.

o The applications are accessible from various client devices through interfaces such as a web-browser (e.g., web-based email).

o The consumer does not manage or control the underlying cloud infrastructure including network, servers, operating systems, storage, or application capabilities.

o A service agreement is usually executed under the SaaS model, unlike an ASP (may be a software license agreement or a service agreement).

o SaaS model is familiar to most Internet users, and includes offerings such as web-based email, calendars, word processing, and digital photo applications (e.g., Google docs or Gmail).

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Office: 954-642-9390

Fax: 954-761-1004







PLATFORM AS A SERVICE (“PAAS”)o PaaS model allows the consumer to run consumer-created or

acquired applications on the cloud provider’s platform.

o 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.

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Office: 954-642-9390

Fax: 954-761-1004







INFRASTRUCTURE AS A SERVICE (“IAAS”)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.

o 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).

o Examples of IaaS models include web hosting and managed services (e.g., Amazon Web Services (“AWS”) or Microsoft Azure).

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Office: 954-642-9390

Fax: 954-761-1004







DIVISION OF OWNERSHIP

SER

VIC

E

PR

OV

IDER

CU

STO

MER

IAAS

USERS

APPLICATIONS

TOOLS

OPERATING

SYSTEM

HARDWARE

NETWORK

PHYSICAL

PAAS

USERS

APPLICATIONS

TOOLS

OPERATING

SYSTEM

HARDWARE

NETWORK

PHYSICAL

SAAS

USERS

APPLICATIONS

TOOLS

OPERATING

SYSTEM

HARDWARE

NETWORK

PHYSICAL

Indicates separation between

Provider and Customer

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Office: 954-642-9390

Fax: 954-761-1004







15

EXAMPLE – CAR AS A SERVICE (CAAS)

CAR

FINANCE

DEPRECIATION

SERVICING

RENEWABLES

INSURANCE

ROAD TAX

GARAGE

FUEL

ROAD TOLLS

DRIVER

CAR

FINANCE

DEPRECIATION

SERVICING

RENEWABLES

INSURANCE

ROAD TAX

GARAGE

FUEL

ROAD TOLLS

DRIVER

CAR

FINANCE

DEPRECIATION

SERVICING

RENEWABLES

INSURANCE

ROAD TAX

GARAGE

FUEL

ROAD TOLLS

DRIVER

CAR

FINANCE

DEPRECIATION

SERVICING

RENEWABLES

INSURANCE

ROAD TAX

GARAGE

FUEL

ROAD TOLLS

DRIVER

On PremiseInfrastructure as a Service (IaaS)

Platform as a Service (PaaS)

Managed by Client

Managed by Service Provider

CAR OWNED CAR LEASED CAR HIRED TAXI

CLOUD COMPUTING

TRENDSG 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 RY D O N N I N I @ 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 : ( 9 5 4 ) 6 4 2 - 9 3 9 0



Office: 954-642-9390

Fax: 954-761-1004








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

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Fax: 954-761-1004







TRADITIONAL TESTS

o True Object

o Dominant Purpose

o Essence of the Transaction

See Dunhill Int’l List Co., Inc., Case No. 02-3614 (Fla. Div. Admin. Hrgs. 2003).

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Office: 954-642-9390

Fax: 954-761-1004







MASSACHUSETTS

Treats ALL canned software as Tangible Personal Propertyo 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 email communications are taxable • Ltr. Rul. 12-13, Mass. Dep't of Revenue (Nov. 9, 2012).

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Office: 954-642-9390

Fax: 954-761-1004







TANGIBLE PERSONAL PROPERTY

Taxable

oWashington

• 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 userCode § 82.04.050(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 212.02(19), Florida Statutes.

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Fax: 954-761-1004







CANNED VS. CUSTOM SOFTWARECannedo 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. § 12-407(a)(13).

Customo 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).

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Fax: 954-761-1004







CANNED VS. CUSTOM SOFTWARE

Four General Categories

1. Prewritten, tangible medium

2. Customized, tangible medium

3. Prewritten, delivered electronically

4. Customized, delivered electronically

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Office: 954-642-9390

Fax: 954-761-1004







CANNED VS. CUSTOM SOFTWARE

Tangible Personal Property

o Digital Automated Services

• Washington

o Lack of analysis

• Arizona

◦ Priv. Taxpayer Rul. 13-002, 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

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Fax: 954-761-1004







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

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Office: 954-642-9390

Fax: 954-761-1004







ELECTRONIC DELIVERY

Taxable License of an Intangible

o New Mexico

• Receipts from the licensing of an intangible are taxable gross receipts.

◦ Rul. 401-13-1, NM Tax'n & Revenue Dep't (Jan. 31, 2013).

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Office: 954-642-9390

Fax: 954-761-1004







SERVICE TREATMENT

Taxable

o South Carolina

• Priv. Ltr. Rul. 10-2, SC Dep't of Revenue (July 29, 2010).

o Connecticut

• Legal Rul. 93-15, Conn. Dep't of Revenue Servs. (July 28, 1993).

o Ohio

• Opinion of the Tax Comm'r, No. 14-0001, Ohio Dep't of Tax'n (Feb. 4, 2014).

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Office: 954-642-9390

Fax: 954-761-1004







SERVICE TREATMENT

Non-taxable

oWisconsin

• Priv. Ltr. Rul. W1025002, Wis. Dep't of Revenue (Mar. 24, 2010).

• Priv. Ltr. Rul. W0921002, Wis. Dep't of Revenue (Mar. 6, 2009).

o Georgia

• Ltr. Rul. LR SUT No. 2014-05, Ga. Dep't of Revenue (June 9, 2014).

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Office: 954-642-9390

Fax: 954-761-1004








DeAndré R. Morrow

[email protected]

How the States Got Their

Positions on Cloud Computing

*

www.reedsmith.com/statetax

What is cloud computing?IaaS

Infrastructure as a

Service

PaaS

Platform as a Service

SaaS

Software as a Service

On-demand server,

storage, and network

resources:

Hosted application

environment for

building and

deploying cloud

applications:

Applications, typically

available via the

browser:

Store your data online

with a third party cloud

vendor, or utilize their

compute power to

process data.

Create a customer

service application

online, test it online, and

deliver it to your

employees via that same

online platform.

Access your email

online, use customer

relationship

management tools

online, etc. Many typical

desktop apps now

accessed via web

browser.

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*


Remotely Accessed Software/SaaS

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https://www.google.com/url?sa=i&rct=j&q=&esrc=s&source=images&cd=&cad=rja&uact=8&ved=0ahUKEwjZ6v6Oz47WAhUB54MKHYODDj8QjRwIBw&url=https://pixabay.com/en/coding-computer-computer-user-pc-1294361/&psig=AFQjCNG9vFsNCyVkvC8dzjP61hyRAk-3mw&ust=1504720571224473

http://www.google.com/url?sa=i&rct=j&q=&esrc=s&source=images&cd=&cad=rja&uact=8&ved=0ahUKEwjC3aL00I7WAhXn6YMKHVR0B60QjRwIBw&url=http://www.save9.com/is-it-ok-to-backup-nhs-patient-data-in-the-cloud/&psig=AFQjCNFVQ7mnmbSkLhpIo7YrjG6Cgonv7A&ust=1504721052577877

https://www.google.com/url?sa=i&rct=j&q=&esrc=s&source=images&cd=&ved=0ahUKEwjLoYyo0Y7WAhWG2YMKHVi8AdEQjRwIBw&url=https://www.fws.gov/northeast/pafo/&psig=AFQjCNFQYII9H5efO5iGkvyos7wZjTSeCA&ust=1504721164542993

https://www.google.com/url?sa=i&rct=j&q=&esrc=s&source=images&cd=&cad=rja&uact=8&ved=0ahUKEwjwhOWN0Y7WAhUI6IMKHV6lAzQQjRwIBw&url=https://apexminecrafthosting.com/pricing/&psig=AFQjCNG9y9VLp7ik0EVi5jZtsdVJCwbaKw&ust=1504721106499497

*


Who is using cloud computing? Why do the states care?

Cloud Computing Providers

Cloud Computing Consumers

Cloud computing providers are those companies within the tech sector

that provide cloud services

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?

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*


How did the states develop their cloud computing guidance?

Custom software Prewritten software Computer servers

Installation Digital storage Access to software

32

*


How did the states develop their cloud computing guidance? Example: Washington State

Remote Access

Software

Digital Automated

Service

Digital Good

SoftwareServices that use software

Books, music,

video, data, facts,

information

33

*


Cloud computing / software / data

processing?

▪ Taxability of cloud computing varies by state.

▪ Not taxable because:

▪ The customer does not have physical possession of the item; therefore, it is not a sale or lease of software or tangible personal property.

▪ The vendor’s server is not in the state.

▪ The product is not canned or prewritten software and is not an enumerated taxable service.

▪ Taxable because:

▪ The customer has “constructive possession” of the item; therefore, it represents a taxable sale or lease of software despite no physical transfer of the item.

▪ The server is a single-tenant server; therefore, it is a taxable lease of tangible personal property despite no physical possession.

▪ It is within the meaning of an enumerated taxable service.

▪ Customer receives benefit of a taxable service such as data processing or information service in the state.

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*


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. LR10-007 (Mar. 24, 2010). Gross receipts derived from hosting software were subject to the transaction privilege tax. Letter Ruling 11-011 (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. LR13-005 (Ariz. Dep’t of Revenue April 29, 2013).

▪ Liability for sales tax on the gross receipts from hosting software for Arizona customers, pursuant to the Ariz. Rev. Stat. Ann. §42-5071. If the software license only allows a customer to access or use the software for a limited timethen the software license is taxed as a rental of tangible personal property.

▪ Arizona Department of Revenue issued a decision, determining that subscription income from online database was subject to transaction privilege tax. Arizona DOR Director's Decision No. 201400197-S, 10/27/2015

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*


Rhode Island

▪ Advisory 2018-38, Rhode Island Division of Taxation, September 4, 2018

▪ Advisory issued as a reminder that as of October 1, 2018, SaaS will be subject to sales and use tax.

▪ Tax will apply regardless of whether access to or use of the software is permanent or temporary, and regardless of whether it is downloaded.

▪ Applies to everything from cloud based Excel to online dating and job-search programs.

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*


Illinois

▪ General Information Letters issued taking the position that a SaaS provider is a serviceman and therefore subject to the Service Occupation Tax (SOT) rather than the Retailer’s Occupation Tax (ROT). General Information Letter ST 16-0035-GIL, Illinois Department of Revenue, August 17, 2016; General Information Letter ST 16-0034-GIL, Illinois Department of Revenue, August 17, 2016.

▪ If the SaaS Provider does not require or provide for any download of any software including an API, applet, desktop agent or a remote access agent, then no tax should apply.

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*


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, 2015.

▪ 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)

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*


Chicago

▪ 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 17-0007-GIL (Mar. 2, 2017).

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*


Iowa

▪ Effective January 1, 2019, Iowa expanded its taxable enumerated services to include Software as a Service (“SaaS”) and over fifty other new services.

▪ Additionally, Iowa imposes sales tax on specified digital products. Taxable digital products include digital audio works, digital books, digital movies, and electronic games.

▪ Exemption for the purchase of SaaS and specified digital products used exclusively by commercial enterprises.

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*


Idaho

▪ Idaho’s 1965 definition of tangible property is that which a person could “feel, touch, lift.”

▪ 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.

▪ 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.

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*


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 § 63-3616(b).

▪ Idaho – Summary

▪ statute: Remotely accessed software is not TPP. Idaho Code 63-3616(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. In this context, 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.

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*


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. 321505 (Mi. Ct. App. 10/27/2015)

▪ Taxable prewritten computer software delivered by any means requires that set of coded instructions be conveyed or handed over by any means and that the customer exercise control over the software conveyed

▪ Mere transfer of information and data via customer accessing the software does not constitute “delivery” by any means of prewritten computer software

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*


Michigan

▪ 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-Ownersretroactively 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)

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*


▪ Sales tax is on receipts from transfers of ‘‘title or possession’’ to items of tangible personal property.” NY Position: Cloud computing sales made by ASPs are taxable licenses to remotely use prewritten software.

▪ 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.”

▪ 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).

New York

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*


Tennessee

▪Charges for data storage and retrieval were not taxable. Let. Rul. No. 11-38 (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. 11-58 (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. 13-03 (Jan. 14, 2013).

Then…

47

*


Tennessee

▪Charges for affiliate-hosted software, vendor-hosted software, and internally-hosted software are all subject to sales and use tax in Tennessee.

▪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. 15-09, Tennessee Department of Revenue (12/17/2015, released 1/20/2016)

48

*


Washington

▪ Charges made to consumers 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 also 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 §82.04.050(6)(b) ; Wash. Admin. Code §458-20-15502(10)(b) ; Washington State Department of Revenue, Digital Products Bills (ESHB 2075 & SHB 2620), 05/03/2010.

▪ Charges for the right to access and use prewritten computer software, where possession of the software is maintained by the seller or a third party, are subject to tax, regardless of whether the charge for the service is on a per use, per user, per license, subscription, or other basis. See discussion above. [Wash. Rev. Code §82.04.050(6)(b) .] Data processing does not include the service described in Wash. Rev. Code §82.04.050(6)(b) . [Wash. Rev. Code §82.04.192(3)(b)(xv) .]

▪ Certain B-2-B 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 §458-20-15502(11)(a) .]

49

*


Washington ▪ The taxpayer, a provider of cloud based fax, messaging and email

services, argued that its services should be considered data processing services taxable under the service and activities B&O classification.

▪ Department of Revenue has classified the taxpayer's fax and messaging services as telecommunications services and its email 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 email 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 emails. The taxpayer's email services were deemed to be digital automated services.

▪ The taxpayer did not qualify for exemption under the ITFA because the taxpayer was not an email provider (the taxpayer only provided a service applicable to emails provided by other parties) and did not provided personal storage. Washington Tax Determination No. 14-0307, 09/23/2014, 35 WTD 51.

50

*


Broader Effects of Wayfair

• Wayfair addressed the sales/use tax collection responsibility of a retail seller of tangible personal property, but the case will have broader import.

• Potentially affected companies include:

• Providers of hosted software and digital goods.

• Inbound foreign sellers.

• Service providers.

• Wayfair impacts extend beyond just sales/use tax

• Potentially affected taxes may include:

• Income/franchise taxes.

• Gross receipts taxes.

• Taxes based on paid in capital or net worth.

51

*


Broader Effects of Wayfair

• Businesses selling SaaS, cloud computing, and digital goods/services to end users, which lack a large nexus footprint, may now be subject to additional sales/use tax collection responsibilities.

• How are sales sourced in determining whether Wayfair thresholds are met?

52


Jamie Szal, Brann & Isaacson

[email protected]

July 18, 2019

SOURCING, NEXUS

AND IDENTIFYING

THE SERVICE

54

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

55

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).

56

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 #05-13.

• SC does not tax interstate communications services. Code 1976 §§ 12-36-1920; 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).

57

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, 2011. ("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 16-011, 9/23/16; LR 15-005 5/14/2015. (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. 12, 6/9/15.

58

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. §7-9-3.5. ("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. 401-13-1 (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).

59

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)

60

Sourcing Issues: Users Located In Multiple States

• OH approach (Provider not responsible for collecting any

tax): R.C. 5739.033(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.

61

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.

• Despite the repeal, many states (including SSUTA members),

but not all states, permit a retailer to accept a certificate of

multiple points of use.

• Some states require the retailer to collect tax only with

regard to the proportion of users in the state.

• NY; NC (Form E-595E)

62

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 KS and OH

MPU Sourcing Certificates; MI Sales and Use Tax Exemption

Certificate; and VT Regulation Section 1.9701 (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.

63

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.

64

Sourcing Issues: SSUTA Waterfall Approach

• First Tier: Where is first use of service made?

• WA approach: Wash. Rev. Code. § 82.12.010(6)(f). ("With

respect to a service defined as a retail sale in RCW

82.04.050(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, 2014. ("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

65

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. 12

66

Special Sourcing Issues: TX Approach and Best Practices

• Where benefit is received if use tax:

• SaaS is taxed as data processing,

• SaaS 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 No. 106,058 (5/31/2013)(CCH ¶ 403-

909).

• 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

67

Special Sourcing Issues: TX Approach and Best Practices

• 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. § 151.005(3)( “Sale” . . .

means . . . “the performance of a taxable

service”), 151.010 (“ ‘Taxable item’ means tangible

personal property and taxable services.”);

151.051(a) (“A tax is imposed on each sale of a

taxable item in this state.”).

68

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.

• Many states take the position that the right of access to the software is

no different than the ownership by Quill of floppy diskettes in North

Dakota, which was deemed nexus creating physical presence by the

U.S. Supreme Court.

• See Texas Tax Code Sec. 151.108 (nexus safe haven for use of “software

that is owned, licensed, or leased by the user or provider.”)

69

Nexus: Does the Provider Have Nexus Where The

Service Is 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 ¶ 403-

996 (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.

• Since SaaS remains in the server state, it should not be deemed

tangible personal property at the user’s location.

70

Identifying the Service: The True Object

• Primary Object or Primary Function Test

• Test courts applied when first addressing taxability of software

before adoption of legislation characterizing software as tangible

personal property. See, e.g. Sneary v. Director of Revenue, 865

S.W.2d 342 (Mo. 1993).

• Examples of Application of Primary Object Test

• Prodigy Services Corp., Inc., 125 S.W.3d 413(Tenn. Ct. App. 2003)

((Tenn. Ct. App. 2003): Online (Internet) service not deemed a

taxable telecommunications service but a nontaxable information

service, because the primary object of the purchaser was to obtain

access to the provider’s website and not to obtain the transmission

of its messages.

71

Identifying the Service: The True Object

• Application of Primary Object Test

• SSOV ‘81, CCH ¶ 401-845 (1/19/95), the NY Tax Appeals Tribunal

stated that primary function of taxpayer’s matching service at issue

in that case was to “allow members to meet others” and thus not a

taxable information service. The service provider, SSOV, did

produce information, but that was merely a byproduct of the

service.

• OH Rule 5703-9-46(B)(3)(b) service is incidental or supplemental

and not deemed taxable data processing or computer services if

• The data processing services are merely utilized by the

provider in the performance or delivery of services; or

• The benefit sought to be received by the consumer from

the services is a personal or professional service.

72

Is the Service SaaS?

• Application of Primary Object Test: Software is Merely Incidental

• Tennessee Dep’t. of Rev., Letter Ruling 16-12 (December 16, 2016).

• Charges for access to cloud-based storage databases and

associated software-based services are not subject to tax.

• True object was the provision of nontaxable data storage

services, and the software add-on would be useless without the

data storage services.

• NY Department of Taxation and Finance TSB-A-15(2)S (4/14/15)

• Provider licensed software , which allowed customers to access

computing power of provider, but customer’s purpose to

purchase computing power

73

Is the Service SaaS?

• Application of Primary Object Test: Software is Merely Incidental

• MA Department of Revenue Letter Ruling 14-1

• Subscription service where customers can obtain information

about businesses, and recent shipments they have made and

about suppliers and manufacturers.

• Company’s software organizes data, extracts relevant

information from the data, combines data with other data, and

identifies patterns in data, resulting in a database that is easily

accessible and customer friendly.

• Based on true object test, Commissioner ruled that true object

was access to a data base and not to use of software; therefore

not taxable.

74

Determination of Whether the Service is SaaS?

• Determination of the true object

• Generally, based on what the purchaser was buying as promoted by

the seller

• Sources for determination

• Marketing materials/website

• Contract

• Invoices

• Accounting records (Account number to which revenue is booked)

• See, e.g., Qualcomm, Inc. v. WA Dept of Revenue, 213 P.3d 348 (WA

Ct. App. 2009), Determination of taxable service based on

marketing materials and invoices.

75

Nexus Questions

I. Dormant Commerce Clause

A. Sales Tax

B. Corporate Income Tax

II. Due Process Clause

A. Sales Tax, Corporate Income Tax

III. Type of tax

A. Sales tax.

B. Corporate income tax.

C. Local Taxes.

D. Gross receipts taxes.

IV. Conceptual Framework

76

Nexus-Related Issues

• Threshold Questions:

• 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?

77

Nexus-Related Issues: Quill is Dead

• For 25 years Quill Corp. v. North Dakota, 504 U.S. 298 (1992), set the constitutional standard.

• Quill states (quoting Bellas Hess):

• Quill required a physical presence.

1. Click-through/affiliate nexus

a. Amazon/Overstock (New York)

b. Pennsylvania SUT Bulletin 2011-01

2. Cookie nexus (Massachusetts Reg. 830 CMR 64H.1.7)

3. Nexus regulation (Alabama Reg. 810-6-2-.90.03)

4. Notice and reporting regimes (Colorado)

• Now what?

78

Direct Marketing Assoc. (2015)

I. Trade association sought to enjoin Colorado’s notice and reporting requirements for non-reporting sellers

II. Justice Kennedy’s concurrence triggers immediate state responses

III. After Justice Kennedy’s concurrence, South Dakota enacts “kill Quill” bill (SB 106)

IV. Requires remote sellers to collect taxes if:

A. More than $100,000 of sales or 200 separate transactions to in-state residents per year

B. No retroactivity

C. Protection for sellers that voluntarily comply

D. Expedited appeal process; enforcement stayed during any appeal process

V. By mid-2017, at least 20 other states had enacted similar legislation

80

Supreme Court Holding

I. Quill and National Bellas Hess overruled; physical presence standard “unsound and incorrect”

II. Case remanded but Court provides framework for analyzing whether undue burdens:

A. Transactional safe harbor—200 sales or $100,000 in sales was sufficient

B. Not retroactive

C. South Dakota is member of Streamlined Sales and Use Tax Agreement (SSUTA), reducing compliance costs

81

How Low Can You Go?

I. Minimum nexus threshold:

A. 200 is the consensus number of transactions

B. $100,000 in annual sales is the majority receipts threshold, but some

states use $250,000 or $500,000

II. Gross sales vs. taxable sales

III. Does state size matter?

A. Wayfair accepts $100,000 sales threshold

B. But South Dakota has less than 1 million residents

C. Should same standard apply to all states?

82

Does Wayfair Apply to Non-SSUTA States?

I. Court noted that SSUTA reduces compliance burden:

A. Single state-level administration

B. Uniform definitions of products and services

C. Simplified tax rate structures

D. Access to sales tax software paid for by the state

E. Immunity from audit liability

II. Other benefits include simplified tax returns, remittance, and

registration

III. But adopted in only 24 states

83

Dormant Commerce Clause (“DCC”)

I. Court on physical presence:

A. No longer makes sense in today’s economy.

B. Distorts location decisions.

C. Artificial (single employee or warehouse

overrides “pervasive modern technology”).

II. The Court’s alternative:

A. Pike balancing.

B. Weigh the administrative burden against the

state interests.

84

DCC - Pike Balancing

I. Test

A. Weigh the administrative burden for the

business in complying with the state rule

against the government interest and benefits.

B. Derives from Pike v. Bruce Church, Inc., 397

U.S. 137 (1970).

II. United States amicus brief:

A. Argued for Pike balancing.

III. Considerations:

(1) What law requires (how burdensome that is);

(2) Burden for individual business.

85

DCC Burdens – Online Service Providers

I. Online service providers.

A. Many exceed the SD thresholds.

B. May only collect in home state or not at all.

C. Have to collect everywhere now if thresholds

exceeded?

D. Unduly burdensome?

II. In weighing burdens on the online service provider, should

the following be considered?

A. Sourcing difficulties.

B. Time and administrative expense spent on taxability

analysis.

86

DCC - Other Contexts

I. What about other contexts?

A. Challenges to state fees and licenses and similar

requirements more likely covered by Pike. See,

e.g., Targa Resources Partners, LP v. Director,

Div of Tax’n (NJ Tax Court 2018).

B. Corporate income taxes likely under Complete

Auto framework.

C. Strategic question of whether to argue

unconstitutionally burdensome under: (1) Pike;

(2) Complete Auto; or (3) both.

87

Due Process Clause

I. Due Process Clause

A. Minimum contacts.

B. Reasonably anticipate being haled into court.

C. “Purposeful direction.”

II. Big question

A. If a company sells services online, and does not

ship TPP into any states, how strong is the

argument that the online seller has

“purposefully directed” its online services at any

particular state?”

88

Constitutional Challenges to Gross Receipts Taxes

I. Overview

A. OH, TX, WA, NV impose a gross receipts

tax in lieu of an income tax.

B. OR recently enacted a gross receipts tax,

effective 1/1/20, though the legislation is

under file from citizens initiatives.

C. States take position that PL 86-272

protections do not apply.

II. Practical considerations.

A. Filing thresholds.

B. Lower rates for certain kinds of companies

(service providers may not qualify, but

could).

89

Conceptual Framework

I. When considering a constitutional challenge, ask:

A. What is being imposed (tax or fee or something

else)?

B. Who is imposing it (state or a locality)?

C. Is there anything about the regime that makes

it particularly burdensome?

D. Anything about your company’s unique facts

that makes the regime burdensome?

E. Argument that no purposeful direction at

jurisdiction?

90

Limitations on a State’s Power to Tax

• Limitations

• Commerce Clause

• Economic nexus standard: “Taxpayer ‘avails itself of

the substantial privilege of carrying on business’ in

that jurisdiction.”

• Discrimination

• Undue Burden-Retroactivity

• External consistency-fair apportionment prong of

Complete Auto

91

State Tax Statute Must Authorize

• It is more common that the underlying state statute limits

the tax to those companies engaged in business activities in

the states

• Exceptions (MTC Factor presence states)(Sales alone):

• Income Tax: Alabama; California; Colorado;

Connecticut; New Hampshire; Michigan; New York;

Tennessee; Wisconsin; and Virginia

• Gross Receipts Tax: WA, OH, TN, and NV but not TX

• Franchise Taxes: 13 states require payment of tax if

“doing business in the state” or company obtains

certificate of authority

92

The Wayfair Effect: Physical Presence Is Not a Commerce Clause Requirement

• Effect One:

• Removes the Commerce Clause Physical Presence requirement for all taxes

The Court confirmed the Complete Auto four part test applies to all state taxes

The Court reinterpreted the substantial nexus prong to make clear that physical

presence is not required

First time that the U.S. Supreme Court ruled that physical presence not required for any

tax

• Prior to Wayfair, the states argued (and largely prevailed) that physical

presence test of nexus only applied to sales taxes.

• Income taxes: Geoffrey v. 437 S.E.2d 13 (S.C. 1993). KFC Corp. v. Iowa Dep’t of Revenue, 792

N.W.2d 308 (Iowa 2010), cert. denied, 565 U.S. 817 (2011)

• Gross Receipts taxes: MTC Factor Presence test adopted in 2002. Crutchfield Corp. v. Testa,, 2016-

Ohio-7760

93

States: Because of Wayfair They Are Free to Impose Taxes Based on Sales Alone

• Effect Two: Local jurisdictions have sought to impose taxes on

companies without a physical presence.

• Portland Oregon referendum adopted on 11/6/18: 1% gross

receipts tax on sales in Portland on a “large retailer,”

• San Francisco referendum adopted on 11/6/18: 1% gross receipts

tax if more than $500,000 of SF gross receipts

• Amendment to Philadelphia BIRT (Business Income and

Receipts Tax): $100,000 of receipts may create nexus

• However, regulation continues to recognize PL 86-272 for

income taxes.

94

Will States Seek to Extend Wayfair Beyond Sales Taxes?

• By interpretation of broad doing business language in statute:

• Franchise Tax on Paid In Capital or Net Worth

• AL Stat Sec. 40-14A-22 on privilege of doing business

• 805 ILCS 5/15.65 IL franchise tax on the privilege of exercising the

authority to do business in the state

• New legislation enacted phase-out repeal process. Franchise tax will be repealed as of 1/1/2024.

• Franchise and income taxes:

• Capital One Auto Finance, Inc. v. OR Dept. Rev., 22 OTR 326 (2016), affirmed on

other grounds 423 P.3d 80 (2018)

• MA – economic nexus applies to income tax; P.L. 86-272 will no longer apply to

corporate excise tax.

• Idaho, Kentucky, Oklahoma automatic response to sales tax

registration per Wayfair was to register the companies for income tax.

95

What protections are provided by P.L. 86-272?

• P.L. 86-272 provides that a state (or political subdivision) may not “impose . . . a net

income tax on the income derived within such State by any person from interstate

commerce if the only business activities within such State by or on behalf of such

person” are as follows: the solicitation of orders in such State for sales of tangible

personal property if orders are sent outside the state for approval and are fulfilled

from outside of the State

• Protected activities also include:

• The maintenance in the state by an independent contractor of an office in the

state so long as the independent contract is engaged in mere solicitation of the

sale of tangible personal property.

• An independent contractor is defined as an agent that does work for more

than one principal.

96

Does Wayfair affect P.L. 86-272 protection?

• The short answer to the question is no.

• Wayfair is a dormant commerce clause case that

relates to the restrictions on a state power’s to

impose tax on interstate commerce in the absence

of federal legislation.

• P.L. 86-272 preempts state tax laws under the

supremacy clause of the Constitution.

97

What companies and activities are not protected by P.L. 86-272?

• Protection is not provided to companies incorporated in

the taxing state.

• Protection is not provided for taxes other than taxes

based on net income.

• Protection is not provided if the activities in the state

exceed mere solicitation. Wisconsin Dep’t of Revenue v.

William Wrigley, Jr., 505 U.S. 214 (1992); See Statement of

Information Concerning Practices of MTC and Signatory

States.

98

Is a company that sells services protected by PL 86-272?

• No protection if it engages in any activity in the state

with regard to the provision of services.

• Protection under the statute is limited to solicitation

of sales of tangible personal property

• A provider of cloud services likely does not engage in

activities in a state but a party that installs networks

would not be protected

99

Is a company that sells services automatically denied PL 86-272 protection?

• The majority of commentators assert that the protection does not extend to

companies that sell services even if they don’t engage in activities in the state.

Richard Cram, “No Shade for Cloud Computing Income Under P.L. 86-272”

State Tax Notes, Sept. 24, 2018.

• Wis. Admin. Code Tax § 2.82(3)(b)(2)(a) - PL 86-272 does not apply to

those businesses that sell services, intangibles or real estate.

• The presenter thinks that the majority opinion is wrong. See, Eisenstein and

Bessey, "Wayfair and P.L. 86-272 in a Services Economy," State Tax Notes,

November 5, 2018

• Note the Multistate Tax Commission Uniformity Committee formed a

working group on January 17, 2019 to update its Policy Statement of

Signatory States on PL 86-272.

• Among the issues being considered is whether PL 86-272 extends to

service providers

100

The argument that service providers are protected by P.L. 86-272

• The starting point for the argument is that the protection in P.L. 86-272 is not

limited to income derived from the sales of tangible personal property, but extends

to a state’s tax on “income derived within such State by any person from interstate

commerce.”

• The reference regarding sales of tangible personal property relates only to the

in-state activities

• PL 86-272 does not limit the categories of income from interstate commerce

that are immune from taxation.

• Under the Supremacy Clause the intent of Congress is critical—the language of

the statute is essential to determining intent.

• The legislative history supports the presenter’s view.

• PL 86-272 sets the lower limit of a state’s power to tax. Heublein Inc. v. SC Tax

Commission, 409 U.S. 275 (1972)

101

Does doing business on the Internet void the P.L. 86-272 protection?

• Wayfair concluded that the virtual contacts with a

state of an Internet site and economic contacts

created nexus.

• Some have argued that such virtual and economic

contacts are activities in the state that exceed the P.L.

86-272 protection so a service provider that does

business on the Internet is subject to PL 86-272

protection.

• Standard under the Commerce Clause is not same under P.L. 86-272 because

different basis for limitations on state powers. The question is one of

legislative intent.

102

Does doing business on the Internet void the P.L. 86-272 protection?

• Many states consider software to be tangible personal property. In these

states, solicitation of sales of software in interstate commerce should

qualify as protected activities under P.L. 86-272. Out-of-state sellers of

software should be immune from taxation under P.L. 86-272 so long as

their in-state activities do not exceed solicitation.

• State treatment not uniform. How, if at all, does P.L. 86-272 apply to

income derived from sales of these products?

• SaaS - either services or sales of software;

• IaaS - either a data processing service or as a lease of computer equipment,

to the extent the customer is being provided with storage and server space;

• Remote monitoring - a service.

103

Takeaways

• Wayfair’s effect highlights the importance of good tax

planning

• P.L. 86-272 limits should not be inadvertently tripped

• Adopt guidelines

• Carefully consider registration to do business in a state.

• May be a concession that company is doing business.

See Louisiana Private Letter Ruling No. 08-007

104

How should a service provider approach Wayfair issues?

• The problem:

• The state and local laws are changing almost on a daily basis

• The laws vary by states

• Sourcing of services for purposes of sales taxes is difficult at best

• The Commerce Clause and Due Process Clause tests require a case-by-case analysis

• Relevant Factors:

• State Laws: What do they provide?

• State Enforcement

• Burdens Imposed by States

• Company Features

105105

State Laws

• How does the state statute/regulation define a company

required to collect the state sales tax?

• 3 Types:

• Sales threshold

• Most states include sales of services in addition to tangible personal property.

• AL/KY limited to tangible personal property

• To full extent of the U.S. Constitution

• Physical presence

106106

State Laws

• Does the state impose a sale tax on the Company’s services

and if so at what?

• Characterization of the service provided is important

• Only a few states tax services per se

• But a number of states tax data processing (e.g. TX;

OH; DC; CT) at varying rates.

• A larger number of states tax cloud services

107107

State Laws

• Determine sourcing of services in the states

• No universal rule for sourcing of services

• Determine how state addresses when service used by multiple users

in different states

• Many states but not all states permit a retailer to accept a

certificate of multiple points of use

• Some states require the retailer to collect tax only with regard to

the proportion of users in the state. e.g. MA ; NY

• Other states: Provider not required to collect any tax, but

purchaser is required to remit tax to the state and other states.

E.g. TX

108108

The Questions

• State Enforcement:

• Announced Date for collection

• Is it retroactive, in fact or in effect?

• MA is retroactive back to 10/1/17

• HI, ME and VT with start dates of 7/1/18 and NY

with a start date of 6/21/18 are in effect

retroactive.

• Other states have varying dates.

109109

The Questions

• Determination of the Economic Threshold:

• On a rolling basis: See CA and MD

• Determination of jurisdictions to collect

• CA-district taxes

• CO-local jurisdictions, both state administered and

home rule jurisdictions

• Determination of impact on other taxes in states: e.g.

gross receipts taxes/income taxes/franchise taxes

110110

Additional Questions

• State Burdens/Discrimination

• Is it one of the 24 SSUTA states?

•Does the state have local tax rates

•Does the state provide for different exemptions at

the state and local level

•NY; LA; CO

•Does the state compensate retailers for

collection?

111111

Facts Regarding The Company

• Sales nationally and by state

• Nature of company’s business, including whether

services are taxable in the various states

• Is the Company able to determine the destination of

the services?

• Does the company obtain information from

customers as to where the users are located?

• How does the Company market its services?

112112

Facts Regarding The Company

• Order system and platform

• Are the operating systems customized

• Does the company collect sales tax in any states?

• When can the company realistically collect?

• What are the complications of collecting?

• Integration with order/return systems

113113

Key Considerations

• Is registration in a state on a special form?

• Special Remote seller registration (SC, OK and IN)

• AL: Simplified Sellers Use Tax

• LA: Application to File Direct Marketer Sales Tax

Return, Form R-1031A

• TX: flat local rate

• Should registration be done electronically?

• AL, CA, GA, MA, NY, and SD require electronic

registration.

114114

Key Considerations

• Should the Company consider registration in the

SSUTA states rather than each state individually?

• Advantages: Payment of Certified Service Provider

(“CSP”) for lookup service and filing of returns;

also provides some immunity

• Disadvantages: Required to register in all states

• Who should register the company?

• CSP? Outside professional? Company itself?

115115

Key Considerations

• Effect on other State taxes:

• OH, WA, and OR: Gross receipts taxes

• KY and OK position

• Does the state give the seller the option to collect or to comply with

notice and reporting?

• PA (until 6/1/19); OK; RI; GA

• Any potential liabilities for past activities

• Consider VDA or other negotiated solution

116116

Putting It All Together

• Compile findings in a matrix on a state by state basis:

• List company sales (dollars and transactions)

• Describe state law and enforcement

• Determine sourcing methodology based on the type

of services provided and information to obtain from

customers

• Identify possible exposures and defenses

• Determine a proposed plan of action per state

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saas sales and use tax: reconciling varying state rules...

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