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State Sales Tax in the Digital Economy: Navigating Electronic Taxability and the Factor Presence Rule

Determining When and Where Your Services and Products Trigger Liability

THURSDAY , JANUARY 26, 2017, 1:00-2:50 pm Eastern

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• Jan. 26, 2017

State Sales Tax in the Digital Economy

David W. Bertoni, Partner Brann & Isaacson, Lewiston, Maine dbertoni@brannlaw.com Michael E. Carey, Esq. Brann & Isaacson, Lewiston, Maine mcarey@brannlaw.com Martin Eisenstein, Managing Partner Brann & Isaacson, Lewiston, Maine meisenstein@brannlaw.com

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.

STATE SALES TAX IN THE DIGITAL ECONOMY: NAVIGATING ELECTRONIC TAXABILITY AND THE FACTOR PRESENCE RULE

January 26, 2017 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 neither the author(s) nor Strafford Publishing (and its representatives) are engaged in rendering legal, accounting, investment, or any other professional service directly through this webinar. Neither Strafford Publishing (and its representatives) nor the author(s) assume any liability for any errors or omissions, or how this webinar or its contents are used or interpreted, or for any consequences resulting directly or indirectly from the use of this webinar. For legal, financial, strategic or any other type of advice, please personally consult the appropriate professional.

Background Issues Regarding Sales Tax

• n IT Services/Products

By Martin Eisenstein

7

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

8

Categories of IT Products: Software

• Software:

– Custom

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

situations)) tax custom software

– Prewritten software: taxation 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)

9

Categories of IT Products: Software

• Software: Is there a taxable sale or lease?

– NY: "Sale" includes a lease or license to use. Tax Law § 1101(b)(5) – ME: Software license deemed a taxable lease in lieu

• f a sale under 36 M.R.S. 1752(13) only if the license

is for at least 10 years. See Maine Instructional Bulletin 20, revised on June 17, 2016 – IL: License of software not taxable based on certain conditions, including prohibition of relicensing. ST 14- 0052-GIL (2014) – CO: License of less than 36 months not taxable if licensor pays tax on acquisition.

10

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

11

Categories of IT Products: 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)

12

Categories of IT Products: 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?

13

Categories of IT Products: 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)

14

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?

15

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.

16

Question 1:

What is the service or product?

• 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
• nline 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.

17

Question 1:

What is the service or product?

• 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.”

18

Question 1:

What is the service or product?

• 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.

19

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?

20

Question 2:

Is it a bundled service/product

• r 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

21

Question 2:

Is it a bundled service/product

• r separate services/products?
• “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

22

Question 2:

Is it a bundled service/product

• r separate services/products?
• 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.

23

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).

24

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

• f 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

25

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)

26

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

27

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

28

Question 4: Does the State Tax The Product or Service? The Cloud

• See Background and Cloud Computing

Discussion

29

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

30

Tax Jurisdiction Rules Under Assault

By David Bertoni

32

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 this is becoming less true as states move to a “factor presence” approach based on gross receipts alone

• You should also carefully examine tax department

publications and administrative opinion letters and rulings for helpful nuances – enforcement practices may be nuanced – 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 may have

been breathed

33

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 – when does it apply?

• 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

34

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 and recent Ohio Supreme Court decisions that conflict directly with Tyler Pipe

35

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.”

36

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

• Adverse Ohio Supreme Court decisions set the stage for a

potential battle before the U.S. Supreme Court

37

“Virtual Presence”

• Raised by the Ohio Tax Commissioner in defense of the CAT, but never

reached by the Ohio Supreme Court or the Board of Tax Appeals – 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

38

Recent Decisions

• Crutchfield Corp. v. Testa (Ohio 2016)
• Texas Comptroller Decision, CPA Hearing No. 106,632 (9/19/2014)
• Avent, Inc. v. Department of Revenue (Washington 2016)
• Harley-Davidson, Inc. v. Franchise Tax Board (California 2015)
• Staples, Inc. v. Comptroller of the Treasury (Maryland 2015)
• Direct Marketing Association v. Brohl (10th Circuit 2016)
• Capital One Auto Finance v. Department of Revenue (Oregon 2016)
• Florida Dep’t of Revenue v. American Business USA (Fla 2016)
• Lorillard Licensing Co. LLC v. Director, Div. of Taxation (N.J. 2015)

39

Working Through A Tax Analysis

• f a Sample Contract for Data Center Services

By Michael Carey

40

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?

41

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’

• perating 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.

42

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).

43

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).

44

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? 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; 86 Ill. Admin.

Code 140.101(e)(50% of the charge is taxed).

45

Question 1: What is the service? 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

• perating 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’s 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).

46

Question 1: What is the service? 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. Stat. Ann, § 54:32b-2(44).

• New York law generally parallels New Jersey, but the exclusion for “personal
• r 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).

47

Question 1: What is the service? 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.

48

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

To see the effect of bundling, let’s compare two alternatives for how Provider may bill for service in a data center that contains customer-

• wned equipment, in state such as Connecticut, Ohio, or Washington

where 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 B

Data Center Services Data Center Services Windows Servers 33% Mainframe: Processing 33% Linux Servers 33% Mainframe: Storage 33% Unix Servers 33% IMAC and HW Repair 33% 100% 100%

49

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 Tax Characterization CT/OH/WA Taxability 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%

50

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

Tax Characterization

Mainframe: Processing Monitoring Not Taxable 33% Mainframe: Storage Monitoring Not Taxable 33% IMAC and Onsite IMAC/HW Repair Taxable 33% Total Taxable 33%

CT/OH/WA Taxability 51

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 (e.g., number of employees, device count, offices)?

• Effect of Bundling

53

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. 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. 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.

54

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. − 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).

55

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.

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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.

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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
• perationally 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.

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Cloud Computing

By Martin Eisenstein

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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).

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Cloud Computing Services

Data Processing / Storage Software

SaaS

IaaS

Pre-loaded On Separate Disk Electronically Delivered

Data Processing Storage 62

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.

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Cloud Computing: What Is It? (Cont.)

• PaaS: Platform as a service

− Platform for software developer to create and test its

• wn applications E.g., Google app. engine

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

• ften as SaaS as true object
• Miscellaneous services such as privacy protection, or

hosting Web page or virtual private network within the cloud

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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

• wned 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

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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.

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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

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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

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Taxability Test by Service: SaaS/PaaS

• 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)

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Taxability Test by Service: SaaS/PaaS

– 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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Taxability Test by Service: SaaS/PaaS

• 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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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.

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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

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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.

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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

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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

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