State Sales Tax in the Digital Economy: Navigating...

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State Sales Tax in the Digital Economy: Navigating

Electronic Taxability and the Factor Presence Rule

WEDNESDAY, FEBRUARY 10, 2016, 1:00-2:50 pm Eastern

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mailto:[email protected]

February 10, 2016

State Sales Tax in the Digital Economy

David W. Bertoni, Partner

Brann & Isaacson

[email protected]

Martin Eisenstein, Managing Partner

Brann & Isaacson

[email protected]

Michael E. Carey, Esq.

Brann & Isaacson

[email protected]




Notice

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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.

STATE SALES TAX IN THE DIGITAL ECONOMY:

NAVIGATING ELECTRONIC TAXABILITY AND

THE FACTOR PRESENCE RULE

February 10, 2016

Martin Eisenstein, Managing Partner

David Bertoni, Partner

Michael Carey, Associate

BRANN & ISAACSON

Material in this webinar is for reference purposes only. This webinar is being provided with the understanding that

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5

Background Issues Regarding Sales Tax

on IT Services/Products

By

Martin Eisenstein

6 Strafford

Background:

IT Outsourcing Levels

Data Processing / Storage

Networks / Desktop Support

Help Desk / IMAC / Repair)

Networks / Desktop

Help Desk / Remote IMAC

Software

On Site IMAC / Repair

7 Strafford 7

Categories of IT Products

• Software: – Custom

• A few states (e.g. CT (1%), HI, NM, TX (most but not all situations)) tax custom software

– Taxation of prewritten software based on method of delivery

– Tangible medium: most states tax

– Load and leave: Generally same as tangible medium (NV exception)

– Electronically delivered: Fewer states tax (FL is not TPP)

– Software as a Service (SaaS)(to be discussed)

8 Strafford 8

Categories of IT Products:

Detecting Problems and Fixing Them

• Does It Work And Fixing It: Monitoring/Help Desk, IMAC

(“Install, Move, Add and Change”) and Repairs

– Sourced to where asset is located, which may not be

location where service is performed

• E.g. Monitoring, Help Desk and Remote IMAC

– Monitoring/Help Desk

• Generally taxable only where services are taxable but also

taxable in CT (1%) and MS

• Note: NM principle re performance of services

• TX: taxable if monitoring for repairs but not for performance

• NY: taxable if monitoring for security issues

9 Strafford 9


Monitoring, IMAC and Repair Services

• IMAC/Repairs

– First question: Is the service performed on software, whether remotely or not?

• Taxable in certain states where help desk is not taxable: e.g. KS, MS, NM (services deemed performed in state of user).

• Taxable in TX only if vendor supplied the software

• Taxable in NJ only if performed on pre-written software

• Not taxable in FL if software is electronically delivered

– Second question: Is the service performed on hardware?

• Taxable in many states: CT (full rate), FL, NY, TX

– Third question: does the vendor supply the parts?

• CA – 10% rule; IL and VA (50% of charge taxable)

1

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Data Processing

• Data Processing Services: Compiling/processing information, manipulating data and maintaining and storing customer information

• Threshold question: Who owns the servers and software?

– If provider, then treated as data processing and taxable in 7 states (CT (1%), DC, HI, NM, OH, TX (80% of charge), SD).

• Chicago Personal Property Lease Transaction Tax (5.25% or 9%)

– If customer, then still may be taxable as data processing in DC and TX but not in other states

• If Customer owns the equipment/data center, then need to consider nature of services supplied by Provider

– Is it help supply to manage the data center? Taxable in OH, PA if performed there

– Are they IMAC/repair services?

1

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Information Services

• Right to access content contained in a common data base vs.

access to software of provider or information of customer

• Taxable in 15 states and generally in large States – NY, NJ,

TX (but not CA)

– Distinction from data processing

• Stock quotes vs. stock trades

• Westlaw/CCH but note Chicago personal property lease transaction

tax

• Broad interpretation (NY)(electronic plus individual report if

common data base) vs. Narrow Interpretation (FL)

1

2 Strafford 12

Background: The Analysis

• Six Major Questions To Answer:

(1) What is the service or product?

(2) Is it a bundled service/product?

(3) To what state(s) is the service/product

sourced?

(4) Does the state tax the product or service?

(5) Do exemptions and/or direct pay permits

apply?

(6) Does the provider have nexus with the state where

the service is sourced?

1

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Question 1: What is the service or product?

• 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).

– Some courts continue to use test to determine taxability of software

based on the mode of delivery of the software.

– Test currently used by many states to characterize the nature of an

IT service.

• Examples of Test

– Andersen Consulting LLP v Gavin, 767 A.2d 692 (Conn. 2001):

taxable computer and data processing services instead of

nontaxable professional services provided by consulting firm.

14 Strafford 14


• 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.

• The service provider, Prodigy, used transmission to provide its

online services.

– 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.

15 Strafford 15


• General Principles Re True Object:

− Under law of most states, provider’s use of software or other taxable

products / services to produce the service, does not cause the end

product to be taxable.

• OH Rule 5703-9-46(B)(3)(b) provides a good explanation of test, by

characterizing a service as merely 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.

• SSOV (NY) : “We cannot accept the Division’s argument that the

means by which a service is provided is the controlling factor in

determining “taxability.”

16 Strafford 16


• Determination of the true object

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

• Sources for determination: To be reviewed by practitioners

– 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), determining whether data processing service or telecommunications service based on the primary purpose or true object, as determined from marketing materials and invoices.

17 Strafford 17

Question 1:

What is the service or product?

• The De Minimis Rule

– SSUTA

• Less than 10% of the provider’s cost or price

– TX

• Less than 5%

– Chicago

• Less than 50%

• What is the basis for measurement of the percentage?

18 Strafford 18

Question 2: Is it a bundled service/product

or separate services/products?

• “One bad apple spoils the bunch” in most cases and states

– A price for a bundle of separate products and services in which one product is taxable and another product/service is not taxable means that the entire charge is taxable

• NY cheeseboard rule. N.Y. Comp. Codes R & Regs. Tit. 20, section 527.1(B)

– Cardinal Principle: Separately price and invoice separate charges for different services/products

19 Strafford 19



• “Unbundling” from books and records :

– Internet Tax Freedom Act: Combination of telecom services

with Internet services. ITFA, § 1106, 47 U.S.C. 151 note.

– Many state laws permit a provider of telecom services to

separate taxable telecom charges from non-taxable telecom

charges based on its books and records.

– SSUTA Section 330 permits unbundling” of telecom services,

ancillary service, Internet access and audio/video programming

services

– TX: Data Processing and Information Services. Rules

3.330(d)(2) and 3.342(e)(2).

– NC permits unbundling based on a reasonable allocation. N.C.

Gen. Stat. Ann. § 105-164.4D

20

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• Separate pricing of products/services has limits:

– If service is auxiliary or related to main product that is taxable then the auxiliary service may be deemed taxable

• E.g. shipping and handling for software

• Installation for computers and software

• Overhead items such as labor costs

• TX rule regarding related services (data processing):

– 34TAC3.330(d)(3) (Charges for services/expenses related to and incurred while providing the taxable service are taxable and may not be separated from taxable charges.. Examples would be charges for meals, telephone calls.)

– 34TAC3.330(d)(1) provides that a service is unrelated if it is commonly sold on a stand alone basis and is a distinct service from the data processing service.

21 Strafford 21

Question 3: To What State or States is

the Service or Product Sourced?

• General rule regarding sourcing of tangible personal

property: Delivery State

• No universal rule regarding sourcing of services.

– Non-SSUTA states

• If related to tangible personal property, then generally sourced

where tangible personal property is located

• If pure service, then generally sourced where service is

received, except for FL’s tax on use of a server located in FL

and Chicago’s tax on lease of personal property insofar as

storage

• Location of the terminal for access. See, e.g.. NYS (TSB-A-

10(52)S 10/18/10); CT (ADC 12-426-27(d)); TX (Rules 3.330

and 3.342); Chicago (Transactional Tax Ruling 12).

22

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Question 3: To What State or States is

the Service or Product Sourced?

• TX: Where benefit received

– Data Processing: Presumption 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

• SSUTA Waterfall approach: The Tiers

– First: Received at vendor’s place of business?

– Second: 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: Address given in the transaction

– Fifth: Where the service was provided

Strafford

23 23

Sourcing Issues:

Users Located in Multiple States

• Customer uses software or services in several states

where software is not housed

– NY approach: Provider responsible for tax based on

users in NY: Provider must receive customer’s

confirmation of the ratio of New York-based employees

with access to the service (including detailed

information as to their location) to the number of

employees with access. Provider relieved of liability for

non-NY employees but still liable for tax for NY-based

employees. TSB-A-10(52)S (10/18/10); TSB-A-

03(5)S,(1/31/03)

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24

Sourcing Issues:

Users Located in Multiple States

• OH approach (Provider not responsible for any tax collection):

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

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25

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

• 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. E.g. MA (Form ST-12);

NY ; NC (Form E-595E)

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

purchaser to remit tax to the state and other states. See KS

and OH MPU Sourcing Certificates; MI Sales and Use Tax

Exemption Certificate; VT Regulation Section 1.9701 (8)-4; TX

Rule 3.330

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26

Question 4: Does the State Tax The

Product or Service? The Cloud

• See Background and Cloud Computing Discussion on slides (slides

52 thru 68)

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27

Question 5: Are There Any Exemptions

Available Under State Laws?

• Resale Exemption

– In eight states resale exemptions do not apply to taxable

services

• E.g. HI and VA

• Direct Pay Permit

– Not available for services in some states. See, e.g. Maine

Rule 308(4)(1); IN

– Not available for purchase of telecommunications services

in CT. (CT Department of Revenue Services publication,

February 10, 2004.)

– Make sure that direct pay permit covers the services in

question

Strafford

28 28

Tax Jurisdiction Rules

Under Assault

By

David Bertoni

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29

Limits On Reach Of State and Local

Taxes To Non-Residents

• The extraterritorial reach of state and local taxes is limited by

the United States Constitution, as well as by state and local

laws that describe the scope and reach of such taxes.

– State statutes and local ordinances should be reviewed carefully

• There can be technical defenses to jurisdiction under these

laws, but is becoming less true as states move to a “factor

presence” approach based upon gross receipts alone

• You should also carefully examine tax department

publications and administrative opinion letters and rulings for

helpful nuances

– The U.S. Constitution trumps state and local law

• The Commerce Clause requirement of a “substantial nexus”

• The Due Process Clause, into which new life has been

breathed

30 Strafford 30

The Pitched Battle To Reach Non-

Resident Businesses • Factor presence, or “sales only” nexus

– Inconsistent with “substantial nexus” test and due process

– Traditionally part of the income tax apportionment process

– Can raise serious “external consistency” questions

– Examples include Ohio Commercial Activity Tax (“CAT”) Washington Business & Occupation Tax (“B&O Tax”).

• Theories of “virtual presence,” ”economic nexus,” and “equivalent of physical presence”

• Shift to ”business privilege” taxes measured by gross receipts

– Threading the needle between income tax and sales and use taxes?

– Public Law 86-272

• Taxation Of In-state Customers

– Chicago’s expanded taxation of non-possessory leases and amusements

– Sidesteps the jurisdictional issue

– Likely the initial salvo in a battle to ramp up pressure on service providers

31 Strafford 31

The Commerce Clause: The Thin Blue

Line Against Unlawful Taxation?

• Substantial nexus: The bright-line physical presence test

– Complete Auto Transit Inc. v. Brady (1977)

– Quill Corp. v. North Dakota (1992)

• Protects a zone of interstate commerce

• Contrasts physical presence with with interstate interaction

– Tyler Pipe Industries, Inc. v. Washington Dep’t of Revenue (1987)

• Is this test limited to sales and use taxes?

– Argument based on language in Quill

– Sidestepped in income tax cases?

• Geoffrey, Inc. v. South Carolina Tax Comm’n (1993)

– Ohio’s CAT and the Washington B&O Tax vs. Tyler Pipe

• Seminal “physical presence” case involved the Washington B&O

Tax which is materially identical to Ohio’s CAT

32

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The Due Process Clause: New Life For

Cloud Service Providers?

• Different jurisdictional test than Commerce Clause

– Quill Corp. v. North Dakota (1992)

– Comptroller of Treasury v. Wynne (2015)

• New constitutional protections for geographically agnostic interstate businesses?

– J. McIntyre Ltd. v. Nicastro (2011)

– Daimler AG v. Bauman (2014)

• “At no time did petitioner engage in any activities in New Jersey that reveal an intent to invoke or benefit from the protection of its laws.”

– Selling nationally via the “stream of commerce” is not enough

– “These facts may reveal an intent to serve the U.S. market, but they do not show that J. McIntyre purposefully availed itself of the New Jersey market.”

33

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Factor Presence

• “Factor Presence Nexus Standard for Business Activity Taxes”

– Approved by the Multistate Tax Commission October 17, 2002

– No analysis of its constitutional legitimacy

• Tax jurisdiction based based sales alone -- $500,000 per year

• Adopted by an increasing number of states with differing sales

levels

– Ohio CAT

– Washington B&O Tax

– Tennessee Business Tax

– Nevada Commerce Tax

• Major test cases now pending before the Ohio Supreme Court

34

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“Virtual Presence”

• Raised by the Ohio Tax Commissioner in defense of the CAT

– Mere communication over the Internet sufficient to create nexus based upon a variety of ubiquitous activities, including

• The use of “cookies”

• Search term advertising arrangements with national search engines

• Use of caching services such as Akamai or other reliance on instate servers

• Participation in product review or price comparison web sites

• Use of third-party advertising relationships

• Behavioral advertising

• “Customized” promotions

35 Strafford 35

Recent Decisions

• The Ohio CAT Challenges

• Texas Comptroller Decision, CPA Hearing No. 106,632 (9/19/2014)

• Avent, Inc. v. Department of Revenue ( Washington 2015), review

granted by U.S. Supreme Court

• Harley-Davidson, Inc. v. Franchise Tax Board (California 2015)

• Staples, Inc. v. Comptroller of the Treasury (Maryland 2015)

• Direct Marketing Association v. Brohl (2015), on remand to 10th Circuit

36

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Working Through A Tax Analysis

of a Sample Contract for Data Center Services

By

Michael Carey

37 Strafford 37

The Sales and Use Tax Analysis of a Data

Center Services Contract?

• Six Major Questions To Answer:

(1) What is the service or product?

(2) Is it a bundled service/product?

(3) To what state(s) is the service/product

sourced?

(4) Does the state tax the product or service?

(5) Do exemptions and/or direct pay permits apply?

(6) Does the provider have nexus with the state

where the service is sourced?

38 Strafford 38

Question 1:

What is Data Center Service?

• An IT Service Provider manages services in a data center that

maintains and stores a customer’s data, which the customer can

access at will.

• The provider may refer to its services by a specific function (e.g.

hosting, email, or data storage services), or by the servers’

operating system (e.g. Windows server or Unix virtual server).

• The tax characterization of Data Center Service may include

Data Processing, Monitoring, Information Services, Hardware

Repair, IMAC (“Install, Move, Add, Change”), or a cloud service

such as IAAS depending on the contract language and the

nature of the service.

39 Strafford 39

Question1:

What is the service? Data Processing

• Data Processing is the service of compiling/processing information,

manipulating data, and maintaining and storing customer information.

See, e.g., Ohio Rev. Code Ann. § 5739.01 (Y)(1)(a).

• Other examples:

− Texas imposes a tax on 80% of the charges for a data processing

service whether the data processing is performed by the provider or

customer. V.T.C.A. Tax Code §§ 151.0035, 151.0038, and 151.0101.

− Connecticut imposes a 1% sales tax on “computer and data

processing services.” Conn. Gen. Stat. Ann. §§ 12- 407(a)(37)(A)

and 12-408(1)(D)(i).

− Washington excludes data processing from the definition of taxable

digital automated service. Wah. Rev. Code § 82.04.192(3)(a)

40 Strafford 40

Question 1: What is the service?

Data Processing vs. Monitoring

• To determine the tax characterization of the provider's services, it is

important to determine the ownership/licensee of the hardware and

software.

1) Data Processing – generally, if the provider owns the computer it

likely compiles and produces records and is characterized as data

processing.

• But in TX Data Processing is taxed whether the provider or

customer owns the equipment.

2) Monitoring - if the provider does not own the assets but monitors the

equipment and software only to determine whether there are any

security problems or disruptions in the service, generally, it should be

classified as a monitoring service, and not a data processing service,

because any data processing is performed by assets not owned by the

provider.

3) Taxable Protective Services: If the service includes monitoring for

unauthorized access to, or use of, customer’s IT assets in New York,

the charges are taxable as a protective service. N.Y. Tax Law §

1105(c)(8). TSB-A-15(47)S (Nov 18, 2015).

41 Strafford 41

Question 1:

What is the service? Hardware Repair

• Data center equipment may break-down, so Hardware Repair will

be deemed part of provider’s service unless provider’s contract

clearly states that customer has responsibility for Hardware

Repair.

• Hardware repair is taxable in many states, including Connecticut,

Ohio, Texas and Washington. See e.g., Conn. Gen. Stat. Ann. §

12-407(a)(37)(cc); Tex. Tax Code Ann. §151.0101(1)(5).

• Does the contract provide explicitly who is responsible for spare

parts? If provider is responsible for spare parts:

− More states tax repair labor if the provider’s service includes

supplying the parts for the repair without billing the parts

separately. See e.g., 103 Ky. Admin. Regs. 27:150.

42 Strafford 42


IMAC (“Install, Move, Add, Change”)

− A provider performs an IMAC when it introduces an asset into the

customer’s IT environment, or adjusts how an asset interacts with the

operating environment

− The provider performs an onsite IMAC (or Hard IMAC) in person, whereas

a Remote IMAC (or Soft IMAC) is performed remotely via the internet.

− In Connecticut, Ohio, Texas and Washington both Onsite and Remote

IMACs are taxable. See, e.g. Ohio Rev. Code Ann. §

5739.01(B)(3)(b).

− A provider may perform an IMAC on client hardware or software.

• Connecticut, Ohio, Texas and Washington tax IMACs performed on

both hardware and software. See, e.g. Ohio Rev. Code Ann. §

5739.01(B)(3)(b).

• Other states tax, like New York, tax IMACs performed on hardware but

not software. See N.Y. Tax Law § 1115(c)(3), (o).

43 Strafford 43


Information Services

• Information services is the provision of a right of access to a common database.

The definition is broad enough to encompass many IT services (e.g. data

processing).

- Many information services provisions parallel data processing. See e.g.

V.T.C.A., Tax Code 151.351, 34 TX Admin. Code §§ 3.330, 3.342.

- New Jersey does not tax data processing, and does tax the furnishing of

information collected, compiled or analyzed by the seller, but has an exclusion

for providing “personal or individual information which is not incorporated into

reports furnished to other people.” N.J. Sta. Ann, §54:32b-2(44).

- New York law generally parallels New Jersey, but the exclusion for “personal

or individual information” does not apply if the information comes from a

common database. NY State Dept. of Taxation and Finance TSB-

M.10(7)(s(7/19 2010). The Department ignores the “primary purpose” test

that it sets forth, and could make taxable many personal IT Services. Id. But

See, Matter of SunGard Securities Fin. LLC, DTA No. 824336 (N.Y.S. Div. of

Tax App., Feb. 6, 2014).

44 Strafford 44


Responsibility for Software Upgrades

• If the provider is financially responsible for

patches or other software upgrades, the

transaction may be treated as sale or license of

software.

• If the customer is financially responsible for

upgrades, the provider’s service will likely be

treated as IMAC for software.

45 Strafford 45

Question 2: Is The Data Center Service

a Bundled Service?

Let’s compare three ways in which the Provider may bill for Data

Center service for a data center that contain customer-owned

equipment, in Connecticut, Ohio, Texas, or Washington, like HW Repair

and IMAC are taxed.

This provider performs Hardware Repair and IMAC services, and may

prepare the monthly bill in two ways.

Sample Invoice A Sample Invoice BData Center Services Data Center Services

Windows Servers 33% Mainframe: Processing 33%

Linux Servers 33% Mainframe: Storage 33%

Unix Servers 33% IMAC and Onsite 33%

100% 100%

46 Strafford 46

Question 2: Is The Data Center Service a Bundled Service?

With Sample Invoice A, provider bills according to the Operating

System of the server. Charges for each of the three types of servers

are each a bundled charge, with about 1/3 of the charge pertaining to

HW Repair and IMAC services, both of which are taxable.

Sample Invoice A

Data Center Services

Windows Servers Monitoring/IMAC/HW Repair Taxable 33%

Linux Servers Monitoring/IMAC/HW Repair Taxable 33%

Unix Servers Monitoring/IMAC/HW Repair Taxable 33%

Total Taxable 100%

47 Strafford 47

Question 2: Is The Data Center Service a Bundled Service?

Sample Invoice B bills according to the type of service, isolating all of

the taxable charges in a separate line item.

Sample Invoice B

Data Center Services

Mainframe: Processing Monitoring Not Taxable 33%

Mainframe: Storage Monitoring Not Taxable 33%

IMAC and Onsite IMAC/HW Repair Taxable 33%

Total Taxable 33%

48 Strafford 48

Question 3: To Which States is the Service Sourced?

• Where are the data centers located? If there are multiple data

centers, how are the costs allocated between data centers

(e.g., number of servers, a measure of traffic)?

• From which states do users access the data stored at the

data center? How are costs allocated among different states

(number of employees, device count, offices, etc.)?

• Effect of Bundling

49 Strafford 49

Question 3:

To Which States is the Service Sourced?

• Does the use of the data processing service or the location of a data

center involve a state where most services are taxed?

− Hawaii and South Dakota tax most services performed in the

state or used in it. See, Haw. Rev. Stat. § 237-13(6); S.D.

Codified Laws § 10-45-4.

− New Mexico – the gross receipts tax is generally limited to

services performed in New Mexico. See, N.M.Stat. Ann. § 7-9-

13.1.

− Is the use of the data processing service sourced to a state that

taxes data processing? See, V.T.C.A. Tax Code §§ 151.0035,

151.0038, and 151.0101.

50 Strafford 50

Question 3: To Which States is the Service Sourced?

• Will the Data Processing Service give rise to tax as a charge for

terminal access?

− Chicago imposes a personal property lease transaction tax

at the rate of 5.25% on the use of data processing services

(and cloud services) by users in the City of Chicago. See,

Chicago Municipal Code 3-32. Note that the code

presumes that 50% or more of the use will occur in Chicago

for contracts signed there.

− Florida’s sales tax is imposed as a taxable rental of the

computer on charges for access to a provider’s computer,

but only if the provider’s computer is located in Florida. See,

Fla. Admin. Code Ann. r. 12A-1.032(3).

51 Strafford 51

Question 5: Is an Exemption Available?

• An exemption for the data center may be available in a particular state, but

possible exemptions tend to be unique. For example,

• Connecticut’s Outsourcing Exemption may apply to data processing

services performed on equipment purchased from the customer.

• Ohio has a purchase for resale exemption for data processing services

purchased for data processing services if the purchased service is

integral to the data processing service being provided, and for the

purchase of tangible personal property that will be transferred to the

consumer of the service.

• Many states have highly prescriptive data center exemptions; e.g., the

Texas exemption may be available on certain items necessary to run a

data center one is opened, that houses servers for a single company,

with a $200 million capital investment, and which adds 20 full-time jobs

at over 120% of the media county wage.

52 Strafford 52

Question1: Does the Data Center Service Have a

Help Desk Service or End-User Service?

• End-User Service is Provider support for customer’s users’ devices,

such as desktops, laptops, and hand-held devices. The service

classically includes on-site hardware repair and IMAC, but is also

implicated if provider performs remote IMAC and monitoring.

Analysis of Desktop Service is similar to the Data Center Services

analysis.

• In a Help Desk Service (sometimes called Service Desk), Provider’s

employees answer questions from customer’s employees posed via

telephone, instant message, or email. The Help Desk Service likely

will be characterized as monitoring unless the SOW provides for

provider employees to remotely access the customer employee’s

computer to diagnose and fix a problem, in which case it is likely

Remote IMAC. Generally the service is sourced based on the

location of the customer’s employees.

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Question 1:

What is Managed Network Service?

• Managed Network Service involves the management of

data and voice networks, with the provider ensuring that

both network machines and the network itself function

well.

− A data network may be either a Local Area Network

(LAN) or a Wide Area Network (WAN).

• A voice network may have signals carried over wired

lines, mobile signals, transmission through the Internet, or

a combination of the three.

− A critical question is whether the provider is providing

telecommunications.

54 Strafford 54

Question1:

What is the service?

Telecommunications Service (1)

• Most states follow definitions similar to the SSUTA which defines

telecommunications as “electronic transmission, conveyance, or

routing of voice, data, audio, video or any other information or

signals to a point, or between or among points.”

• Providers perform telecommunications if they are financially or

operationally responsible to procure telecommunications.

Typically the IT provider provides monitoring to and possibly

repair of, equipment and devices used to transmit and route

calls, but is not actually providing the transmission of the data or

voice communication.

• Providers perform telecommunications if it owns the routers.

55 Strafford 55

Cloud Computing

By

Martin Eisenstein

56 Strafford 56

Cloud Computing: What Is it?

• Characteristics

– Provider owns/leases equipment and software and

sells/resells access to software and/or equipment.

– Customer vs. provider use of equipment/software

– Access is “shared”

– Access often on demand and on a fee per use basis.

– Access is usually over the Internet through any of a

number of platforms (mobile devices, laptops, tablets,

desktops).

57 Strafford 57

Cloud Computing Services

Data Processing / Storage

Software

SaaS

IaaS

Pre-loaded

On Separate Disk

Electronically Delivered

Data Processing

Storage

58 Strafford 58

Cloud Computing: What Is It? (Cont.)

• Types of service

– IaaS: Infrastructure as a service

• Access to data storage and computing resources

• E.g., Amazon Web services (“elastic compute cloud … elastic block storage”)

– SaaS: Software as a service (e.g., Salesforce.com)

• Access to software and/or applications

• Similar to application services

• Software remains on provider’s equipment and is not downloaded or physically delivered on CDs or DVDs.

59 Strafford 59

Cloud Computing: What Is It? (Cont.)

• PaaS: Platform as a service

− Platform for software developer to create and test its

own applications E.g., Google app. engine

− May be a hybrid of SaaS and IaaS, but is treated most

often as SaaS as true object

• Miscellaneous services such as privacy protection, or

hosting Web page or virtual private network within the

cloud

60 Strafford 60

DRIVERS OF TAXABILITY

DETERMINATION: THE FRAMEWORK

• What is the service?

– True object test governs:

• MA Letter Ruling 12-8 (11/8/13)(true object was access to equipment to use software and not software itself.)

• Opinion of OH Tax Commissioner CCH ¶ 404-196 (2/4/14) A cloud collaboration service offering g the customer with hosted software applications via access to the provider’s owned computer hardware deemed a taxable automatic data processing service because the true object is to provide customers access to equipment to process data

• NY TSB-A-15(2)S(4/14/15): Department noted that while there was a license of software, the customer was purchasing right to use the provider’s computing power; software was simply a means to access the servers/operating systems of provider

61 Strafford 61

Taxability Test by Service: IaaS

• Is it a lease of property?

− TN Letter Ruling 1414 (charges for cloud infrastructure

services and co-location services not taxable, because

possession, title and control of tangible personal

property or computer software is never transferred to

the user.

− But:

− Chicago lease personal property transaction tax if

storage on Chicago server

− Florida if server located there

• Subject to tax under general services statute: NM, SD, HI.

62

Strafford 62

Taxability Test by Service: IaaS

• As a kind of data processing?

– TX: if benefit received in TX (80% of the charge)

– CT: computer and data processing service (1% rate)

– OH: deemed automatic data processing Where does

first use occur?

– Chicago, based on location of terminals

• Use of Servers and Software

63 Strafford 63

Taxability Test by Service: SaaS/PaaS

• Characterization

– About 20 states do not tax pre-written software delivered electronically, so they don’t tax SaaS.

– Increasing number of states have dealt with taxability of SaaS and App Service Provider Services

• Generally treated under a true object test as pre-written software delivered electronically but exceptions in certain states for taxation of SaaS when electronic downloaded software is otherwise taxable

– Tenn. Code Ann. § 67-6-231(a) taxes SaaS

– CT treats it as a computer service subject to 1% tax.

– SC treats it as a communications service

64 Strafford 64


• Sourcing – To state where used/accessed

• Increasing number of states DC, HI,`NC, NY, NM, OH, PA, TN, TX, UT, and WA

– PA Letter Ruling No. SUT-12-001: Reverses prior ruling so taxable if used in PA

» Presumption used in PA if billed to PA unless submit PA certificate REV-1220

– UT – Letter Ruling No. 10-001 reverses course like PA. Also see Utah PLR 13-003 (12/4/2013), providing that remote access to software by UT residents is taxable.

– TN: By statute if users located in TN. Tenn. Code Ann. § 67-6-231(a)

65 Strafford 65


– Not taxable in certain states

• By statute (e.g. VA Code Sec. 58.1-609.5(1), ID Code §63-

3616(b))(treated like electronically downloaded software).

• GA: LR SUT-2014-05 (cloud-based services including

hosting customer-provided software applications were non-

taxable services). Treated like electronic downloaded

software, which is not taxable because not deemed tangible

personal property. Ga. Comp. R. & Regs. r. 560-12-2-

.111(4)(a), (b)

• RI and WI : Electronically delivered software is taxable but

SaaS and data processing services, delivered by a Software

as a Service platform, are not taxable.

• SC: taxes only intrastate communications.

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66


• Has a sale taken place of SaaS (when treated as tangible personal property)?

– Expansive Definition

• NY: sale is “any transfer of title or possession or both and any lease or license to use” and a right to use constitutes a license to use. 20 N.Y. Comp. Codes R and Regs. Section 526.7(e)(4)(iii).

• North Carolina Dep't of Rev., Important Notice: Certain Digital Property Subject to Sales and Use Tax, December 2009

– Narrow Definition

• AZ (Ariz. Reg. 15-5-154.B), and IL 86 IL Admin. Code Sec. 130.1935(a)(1).

• NJ (Division of Taxation TB-72)(7/3/2013)(Not taxable because users do not take possession or control over software.)

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67

Taxability Test by Service: Web Hosting

• True object test governs?

– Is the object tangible personal property?

• Treated similarly to IaaS if object is service, unless pure management services.

• Treated as SaaS if object is software program.

• Is there an exemption under the ITFA?

– ITFA (Section 1105 definition of Internet access)

• Services packaged with access to the Internet, such as a home page, electronic mail and instant messaging, video clips, and personal electronic storage capacity.

• Services described in bullet above that are not packaged with Internet access.

• Any other products and services even if they utilize Internet protocol are not exempt Internet access.

Strafford 68

68

Other Issues Regarding Taxability

• Billing

– Should there be a bundled fee or a fee by type of service?

• SSUTA may not permit unbundling as relates to cloud

computing

• Some state statutes may permit unbundling

– 34 Texas Admin. Code section 3.330(d)(2)

– N.C. Gen. Stat. Ann. § 105-164.4D

• Ideal is to break up fee into separate charges by

service.

– Into IaaS, SaaS/PaaS, and other services

– Characterization on invoice is important

69 Strafford 69

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-three member states (TN associate member

state): AR, GA, IN, IA, KS, KY, MI, MN, NE, NV, NJ, NC, ND,

OH, OK, RH, SD, 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.

70 Strafford 70

Sourcing Issues:

SSUTA Waterfall Approach

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

• WA approach: Wash. Rev. Code. § 82.12.010(6)(f). (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 but best approach is to follow OH and WA and then

71 Strafford 71

Sourcing Issues:

SSUTA Waterfall Approach

– 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

• Knowledge of Address of the User: Duty of Provider

– Chicago Transaction Ruling Number 12

– Certificate of Multiple Points of Use

72 Strafford 72

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