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

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SaaS Sales and Use Tax: Reconciling Varying

State Rules to Avoid Unforeseen Tax Traps

TUESDAY, JUNE 7, 2016, 1:00-2:50 pm Eastern

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mailto:[email protected]

June 7, 2016

SaaS Sales and Use Tax

Gerald J. Donnini, II, Esq., Partner

Moffa Gainor & Sutton, Ft. Lauderdale, Fla.

[email protected]

Nicole R. Ford, Esq.

McDermott Will & Emery, Dallas

[email protected]

Martin Eisenstein, Managing Partner

Brann & Isaacson, Lewiston, Maine

[email protected]

Kelley C. Miller, Attorney

Reed Smith, Washington, D.C.

[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.

Essential Characteristics of Cloud Computing

• Remote Access – Accessed over the Internet or other network.

• Broad access – The cloud can typically be accessed by a number of devices, software, or

platforms.

• No Fixed Payments – Pay ‘as you go’.

• Resource Sharing – Shared resources amongst many different customers.

• Scaling – Resources can be scaled up or down based on per-moment demand.

• Self-Service – Customers may typically access services whenever they want, without

needing anything other than a web interface.

5

What is the Cloud?

• Cloud offerings are electronic versions of traditional commercial

transactions

• ASPs: Software hosting.

• Software as a Service (SaaS): Software accessed over the Internet, with either no,

or de minimis downloads.

• Platform as a Service (PaaS): Platform for developers to develop, test, and distribute

applications.

• Infrastructure as a Service (IaaS): Purchase of remote computing resources.

6

What is NOT Cloud Computing?

• Downloaded Software

• Specified Digital Products (electronic music, books, video)

• Digital Automated Services

• Information Services

• Data Processing Services

• Cloud-facilitated professional services

7

An entity retains custody over (or “hosts”) software for use by third

parties.

Users of the software hosted by the ASP typically will access the

software via the Internet.

The ASP may or may not own or license the software, but generally will

own or maintain the hardware and networking equipment required for the

user to access the software.

The ASP may charge the user a license fee for the software (in instances

where the ASP owns the software) and/or a fee for maintaining the

software/hardware used by its customer.

Application Service Providers (ASPs)

8

The SaaS model allows the consumer to use the provider’s software

applications running on a cloud infrastructure.

The applications are accessible from various client devices through a

client interface such as a web browser (e.g., web-based email).

The consumer does not manage or control the underlying cloud

infrastructure including network, servers, operating systems, storage, or

application capabilities.

Under the SaaS model a service agreement is almost always executed

(vs. a software license agreement or services agreement for an ASP).

SaaS model is familiar to most Internet users, and includes such

offerings as web-based e-mail, calendars, word processing, and digital

photo applications.

Software as a Service (“SaaS”)

9

The PaaS model allows the consumer to run consumer-created or

acquired applications on the cloud provider’s platform.


infrastructure including network, servers, operating systems, or

storage, but has control over the deployed applications and possibly

the application hosting environment configurations.

Platform as a Service (“PaaS”)

10

The IaaS model provides the consumer with processing, storage,

network capabilities, and other fundamental computing resources

where the consumer is able to deploy and run software, which can

include operating systems and applications.


infrastructure but has control over operating systems, storage, deployed

applications, and possibly limited control of select networking

components (e.g., host firewall).

An example of an IaaS model includes web hosting and managed

services.

Infrastructure as a Service (“IaaS”)

11

IaaS PaaS SaaS

Users Users Users

Applications Applications Applications

Tools Tools Tools

OS OS OS

Hardware Hardware Hardware

Network Network Network

Physical Physical Physical

Indicates separation between Provider and Customer

Cu

sto

me

r

Se

rvic

e P

rovid

er

Indicates separation between Provider and Customer

Division of Ownership

12

Pizza as a Service

13

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

Kelley C. Miller

[email protected]

How the States Got Their

Positions on Cloud Computing

*

www.reedsmith.com/statetax

What is cloud computing?

15

*


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?

16

*


How did the states develop their cloud computing guidance?

17

*


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

Remote Access

Software

Digital Automated

Service

Digital Good

The Cloud

Software Services that use software

Books, music,

video, data, facts,

information

18

*


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).

If the software license only allows a customer to access or use the software for a limited time then the software license is taxed as a rental of tangible personal property. Because hosted software is usually limited in duration, Arizona generally treats such software as a rental of tangible personal property.

19

*


Idaho

Idaho’s 1965 definition of tangible property is that which a person could “feel, touch, lift.” However, in 1986, Idaho included software in the definition of tangible property, regardless of the delivery method. In this manner, Idaho’s statutory construct was deemed open-ended and seemed archaic as applied to the cloud computing products flooding the market.

For years, the Commission viewed sales of cloud computing products as a sale of tangible personal property and notified taxpayers of millions due under audit.

Technology industry leaders fought back against the Commission’s view. The Idaho Tech Council submitted a position paper urging the Commission and legislators to work together on reform efforts, and suggested adopting the approach taken by states such as Kansas, which find cloud computing services non-taxable because they lack a transfer of tangible personal property.

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 New statute: Remotely accessed software is not TPP. Idaho Code 63-3616(b).

Previous ruling: Department gave narrow interpretation to prior statutory exemption.

20

*


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.

In Auto-Owners, the Michigan Court of Appeals determined that the majority of software contracts between an insurance provider and third party companies were not subject to taxation under Michigan's Use Tax Act (UTA) because they did not involve the delivery of prewritten computer software.

The Court of Appeals also determined that prewritten computer software was only an incidental component of the professional services purchased by the insurance provider and did not subject the charges to tax.

As a result of this and other similar cases, the Department of the Treasury indicated that it will apply the guidance in Auto-Owners retroactively to all open tax years, despite contrary guidance issued by the Department prior to the date of the decision. Notice to Taxpayers Regarding Auto-Owners Insurance Company v. Michigan Department of Treasury (1/6/2016)

21

*


Sales tax is on receipts from transfers of ‘‘title or possession’’ to items of tangible

personal property.”

NY Definition of TPP includes prewritten software. There is no legislative guidance as to when a license to use exists regarding software. (‘‘Rentals, leases, and licenses to use’’ includes all transactions in which there is a transfer for a consideration of “possession of tangible personal property without a transfer of title.”

NY Position: Cloud computing sales made by ASPs are taxable licenses to remotely use prewritten software.

Online services constitute sale of pre-written software. See Adobe Systems Inc., TSB-A-08(62)S; TSB-A-09(19)S (May 21, 2009); TSB-A-10(2)S (January 20, 2010); TSB-A-10(44)S (Sept. 22, 2010); TSB-A-11(17)S (June 1, 2011), TSB-A-13(22)S (July 25, 2013).

Remote access to canned software is taxable. Taxpayer deemed to have constructive possession of the software via "right to use or control or direct the use" of the software. The situs of the sale was the location associated with the license to use (i.e., the location of the taxpayer’s employees that use the software). TSB-A-09(37)S, New York Commissioner of Taxation and Finance, Aug. 25, 2009); TSB-A-13(22)S (July 25, 2013).

New York

22

*


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…

23

*


Tennessee

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

Both the affiliate-hosted and vendor-hosted software remain on a server located outside of Tennessee at all times, and no sale or transfer of tangible personal property or electronic delivery of the software occurs in Tennessee. Instead, the taxpayer is purchasing, remote access to the software.

Effective July 1, 2015, software accessed remotely is subject to tax in Tennessee. Internally hosted software is subject to Tennessee sales and use tax insofar as the purchased software is physically or electronically transferred to the taxpayer in Tennessee.

However, charges incurred for software that is purchased and downloaded or installed in locations outside of Tennessee, and remotely accessed by the taxpayer in Tennessee, are not subject to tax. Letter Ruling No. 15-09, Tennessee Department of Revenue (12/17/2015, released 1/20/2016)

24

*


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)

25

*


Income Tax - Sourcing the Cloud

Is it a sale of TPP or of a service? Or, both?

TPP – Sourced to the customer; Services – sourced to where the service is performed

Why does this matter? Single-factor sourcing; market v. COP

Colorado – Sale of TPP, source to delivery location. PLR 13-008 (Oct. 2, 2013). But what is the delivery location? The server? The end user’s address?

Illinois, Massachusetts, Pennsylvania – Sale of a service, sourced to customer location.

But how do you determine customer location?

26

*


Income Tax - Sourcing the Cloud

What if customer location is unclear? States’ default rules vary:

Illinois – PLR 14-003

(1) Customer order location; (2) billing address.

Massachusetts – (Jan. 2, 2015 final 830 CMR 63.38.1)

These are the general rules, but there are many exceptions:

Rules of reasonable approximation apply if delivery state cannot be determined. Otherwise,

For individuals, use billing address.

For businesses, use (1) contract management location; (2) customer order location; (3) billing address.

Billing address safe harbor rules may apply.

Pennsylvania – (Info Notice 2014-1; Eff. 2015)

Market- based sourcing guidance: (1) Customer’s street address; (2) IP address records or other network data if it “corresponds reasonably well to the estimated locations” of customers.

Tennessee

27

Cloud Computing Trends

G E R A L D J . D O N N I N I I I , E S Q .

L AW O F F I C E S O F M O F FA , S U T T O N , & D O N N I N I , P. A .

J E R R Y D O N N I N I @ F L O 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


Gerald J. Donnini II, Esq.

[email protected]

Gerald "Jerry" Donnini II is an associate who joined the Law Offices of Moffa, Gainor, & Sutton, 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 LL.M. in Taxation at New York University.

Education:

◦ New York University School of Law, L.L.M., Taxation (2014)

◦ Nova Southeastern University, J.D., magna cum laude (2011)

◦ University of Central Florida, B.B.A, Accounting (2007)

Bar Admissions:

◦ Florida

◦ US Tax Court

Gerald J Donnini II, Esq., Shareholder Moffa, Sutton, & Donnini, P.A. Office: 954-642-9390 Fax: 954-761-1004 Email: [email protected] Website: http://www.FloridaSalesTax.com One Financial Plaza, Suite 2202 100 S.E. Third Avenue Fort Lauderdale, FL 33394

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/

Cloud Computing Step 1: Apply Test

◦ True Object

Step 2: Is the product software or a service? ◦ If software, which category?

1. Tangible Personal Property

2. Canned vs. Custom

3. Delivery

◦ If service, is it taxable? ◦ Taxable

◦ Nontaxable

30

Traditional Tests ◦ True Object

◦ Dominant Purpose

◦ Essence of the Transaction

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

31

Massachusetts Treats ALL canned software as Tangible Personal Property

◦ Regulation – Taxes Use of Software

◦ Object to Obtain Database Access – Nontaxable ◦ Ltr. Rul. 11-4, Mass. Dep't of Revenue (Apr. 12, 2011)

◦ Object of Workflow Add-Ons – Taxable ◦ Ltr. Rul. 11-2, Mass. Dep't of Revenue (Mar. 4, 2011).

◦ Object of Subscriptions – Taxable ◦ Accord Ltr. Rule 14-1 Mass. Dep't of Revenue (Feb. 10, 2014).

◦ But see – automated email communications are taxable ◦ Ltr. Rul. 12-13, Mass. Dep't of Revenue (Nov. 9, 2012).

32

Tangible Personal Property Taxable

◦ Washington ◦ The term "sale at retail" or "retail sale" also includes the sale of prewritten computer software

to a consumer, regardless of the method of delivery to the end user.

◦ Wash. Rev. Code § 82.04.050(6)(a)

Nontaxable ◦ 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.

33

Canned vs. Custom Software Canned

◦ 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)(19).

Custom ◦ 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).

34

Canned vs. Custom Software Four General Categories

1. Prewritten, tangible medium

2. Customized, tangible medium

3. Prewritten, delivered electronically

4. Customized, delivered electronically

35

Canned vs. Custom Software Tangible Personal Property

◦ Digital Automated Services ◦ Washington

◦ 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 ◦ Form of Delivery

◦ Florida

36

Electronic Delivery Generally non-taxable, but sometimes explicitly taxable

◦ 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

37

Electronic Delivery Taxable License of an Intangible

◦ 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).

38

Service Treatment Taxable

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

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

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

39

Service Treatment Non-taxable

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

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

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

◦ Massachusetts ◦ Ltr. Rul. 08-6, Mass. Dep't of Revenue (Mar. 26, 2008).

40

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

Martin Eisenstein, Brann & Isaacson

[email protected]

June 7, 2016

41

SOURCING ISSUES

AND NEXUS

42

Outline of Topics

• Preliminary Sourcing Questions

• Location of User or Users

• Location of Server Where Software Is Housed

• Sourcing: Single location of Users

• Both Server and User Located in State

• Multiple Locations of Users

• Use of Certificates of Multiple Points of Use Certificates

• Nexus

• Provider

• User

43

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).

44

• 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. Miss. Admin. Code 35-IV-5.06 (300).

45

Sourcing Issues: Single Location User Within Same State As Server

• Second situation: Customer uses SaaS in state where software is not 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.")

• AZ Department of Revenue Private Taxpayer Ruling 13-005, April 29, 2014. ("For remote access software arrangements, the server location where the software and files are “physically” stored makes no difference for Arizona TPT purposes. 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

46

Single Location of User But Different States of Server and User

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.")

• 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).

47

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-10(52)S (10/18/10); TSB-A-03(5)S,(1/31/03)

• Chicago Approach in Transaction Tax Ruling No. 12: Similar to but not the same as New York (based on location of users within city limits)

48

• 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.

49

Sourcing Issues: Users Located in Multiple States

• At one time the SSUTA provided for a certificate of Multiple

Points of Use to eliminate or reduce the provider’s requirement

to collect tax on its sales to multiple states. This provision of

the SSUTA was repealed.

• Many states (including SSUTA members) but not all states

permit a retailer to accept a certificate of multiple points of use,

despite the SSUTA deletion of that form.

• Some states require the retailer to collect tax only with

regard to the proportion of users in the state. NY (attached

form); NC (Form E-595E)

50

Users Located In Multiple States: Certificate of Multiple Points of Use

Users Located In Multiple States: Certificate of Multiple Points of Use

• Other states do not require the seller to collect the state's sales tax, but

place the obligation on the purchaser to remit tax to the state and every

other state where the users are located. See attached KS and OH MPU

Sourcing Certificates; attached MI Sales and Use Tax Exemption

Certificate; and VT Regulation Section 1.9701 (8)-4;

• MA, SD, TN, WA additionally do not require seller to collect sales tax.

• TX does not require provider to pay any 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.

51

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, 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.

52

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

53

• 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

54

Sourcing Issues: SSUTA Waterfall Approach

Special Sourcing Issues: TX Approach and Best Practices

• Where benefit is received if identified by buyer:

• SaaS is taxed as data processing, which is taxable where the

benefit of the service is received. Rule 3.330(f) presumes

that the benefit is at the location of the customer’s

principal place of business if the customer cannot (or does

not) assign the use of the service to an identifiable segment

of its business and then issues an exemption certificate for

users located outside of TX. See (Comptroller Decision in

Hearing No. 106,058 (5/31/2013)(CCH ¶ 403-909)

• Best practice for providers: Obtain certificate on MPU format

or state-specific format such as TX exemption certificate as to

line of business in which service is used and number of users by

state.

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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?

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• Quill Corp. v. North Dakota, 504 U.S. 298 (1992), sets the constitutional standard.

• Quill states (quoting Bellas Hess):

• There is a “sharp distinction … between mail-order sellers with retail outlets, solicitors, or property within a state and those who do more than communicate with customers in the state by and or common carrier as a part of general interstate business.” (505 U.S. at 307) (emphasis added).

• Quill requires a physical presence.

• Through retailers own employees, properties or facilities.

• Attribution nexus: Agent/representative.

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Nexus-Related Issues: General

• Some commentators have suggested that Quill may be overturned, citing Justice Kennedy's concurring opinion in Direct Marketing Association v. Brohl, 135 S. Ct. 1124, 1131 (2015) (Quill was "questionable even when decided.")

• Several states are currently taking up arms against Quill:

• Alabama and South Dakota are the most noteworthy examples

• Ala. Admin. Code r. 810-6-2-.90.03:

• Requires annual sales to Alabama of $250,000 and satisfaction of one of the ten categories of the statute, Section 40-23-68.

• The AL DOR has issued a number of assessments, which are wending their way through the administrative channels

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Nexus-Related Issues: Quill

• South Dakota SB No. 106, provides that nexus is established by annual SD sales of more than $100,000 or 200 or more deliveries into SD

• Statute provides that law is not retroactive (unlike the AL Rule)

• SD has already filed suit for a declaratory judgment against Wayfair, Newegg, Overstock, and Systemax seeking “a declaration in its favor [that] will require abrogation of the United States Supreme Court’s decision in Quill”

• VT Legislature had adopted HB 873 (but Governor has yet to sign) that provides that nexus is established based on SD economic presence standard, but law is not in effect until “after a controlling court decision or federal legislation abrogates the physical presence requirement of Quill.”

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• Quill is still good law

• Note that Justice White’s dissent in Quill is very similar to Justice Kennedy’s concurrence in DMA v. Brohl.

• In Comptroller of the Treasury of Maryland v. Wynne, 575 U.S. ___ (5/18/15), the majority opinion written by Justice Alito and the dissenting opinion of Justice Ginsburg cited Quill with approval as providing that the Due Process standard is different than the Commerce Clause standard.

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• Quill held that while the Commerce Clause requires a physical presence, due process is satisfied without a physical presence if the out of state retailer had sufficient contacts with the state and “purposefully directed its activities” at the state. 504 U.S. 298, 308

• The test advocated by the states to replace Quill is in effect the Due Process test of a company purposefully directing its activities to the state.

• Stare decisis is an important consideration for the Supreme Court, especially in cases where Congress can act. See Justice Scalia’s dissenting opinion in Wynne and concurring opinion in Quill itself.

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Nexus Implications To Purchaser

• Basic principle: Remote Access to Software located on a server in another

state should not create nexus of purchaser in state where server is located.

• While software may be deemed tangible personal property in the

state where the server is located, the purchaser has no ownership

rights and should not be deemed the owner of tangible personal

property where the server is located.

• The right of access to the software is no different than the ownership

by Quill of floppy diskettes in North Dakota, which was deemed by

the U.S. Supreme Court to create nexus.

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

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

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Lack Of Nexus Of Purchaser: Is Sales Tax Due In State Where Server is located?

• Is sales tax due if state where the server is located assesses a tax on SaaS?

• First prong of Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977) test

requires substantial nexus with the transaction.

• Arguably if the state taxes SaaS and the fifth tier of the waterfall is implicated,

the state has substantial nexus with the transaction because of the location of

the server there. Oklahoma Tax Com'n v. Jefferson Lines, Inc., 514 U.S. 175

(1995). But under the waterfall approach, when the state where the user is

located imposes tax on SaaS if customers use it in the state, the internal

consistency test (i.e. if every state were to impose the tax there would be

double taxation and discrimination against interstate commerce) is satisfied.

See the U.S. Supreme Court's recent decision in Wynne.

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Nexus: Does the Provider Have Nexus Over the Service Where 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.

• Decision is contrary to Quill, but SaaS, since it remains in the

server state, should not be deemed tangible personal property at

the user’s location.

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How Do We Characterize?

Customer’s “true object,” “primary purpose?

Which of these various elements of the service was

“predominant”?

What ownership rights (to what is being purchased) are

transferred?

What does the purchase agreement say?

What do the marketing materials say?

Is there a software license agreement?

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Animal, Vegetable or Mineral?

States struggle to characterize transactions in the cloud:

• Is it taxable software?

• All Internet-based platforms necessarily utilize software

• But that doesn’t mean software is the “true object” of the transaction

• Is it a taxable information service?

• Internet-based services may draw upon a database of information

• But that doesn’t mean the “true object” of the transaction is the information

• Is it a taxable communications service?

• When, if ever, does a cloud based service that “routes” messages or information constitute a communications service itself?

• Who supplies the telecommunications transport?

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True Object: Examples

Thomson Reuters Inc. v. Dep’t of Treasury, Dkt. No. 313825 (Mich. App. May 13, 2014)

• “In the instant case, any transfer of tangible personal property was incidental to the service

provided. Checkpoint subscribers primarily sought access to up-to-date information relevant to their

needs. . . . Customers sought the expert knowledge of Checkpoint's content creators in synthesizing,

compiling, and organizing the materials, thereby rendering research more efficient. There is no

evidence that any de minimus amount of software transferred was the object of the transaction, or

that customers sought to own or otherwise have responsibility for the prewritten computer software.

Further, considering the transaction as a whole, the fact that the license agreement entitles users to

access and use the Checkpoint program does not establish that users primarily sought the physical

software. . . . Any transfer of prewritten computer software was an insignificant part of the overall

transaction aimed at providing a service.”

Comptroller v. CheckFree Services Corp., Dkt. No. 14-15-00027-CV (Tex. App. Apr. 19, 2016)

• “[T]he trial court’s findings and conclusions properly focused on the ‘essence of the transaction’ at

issue, rather than simply the involvement of a computer, to determine the nature of the services

CheckFree provided. . . . [T]he trial court was required to determine whether CheckFree does

something more than ‘compiling and producing records of transactions, maintaining information, and

entering and retrieving information,’ such as providing physical science, legal, or accounting services

based on the information—i.e., providing professional services that are facilitated by the use of a

computer.”

Mass. Letter Ruling 14-4 (May 29, 2014); Mass. Letter Ruling 14-1 (Feb. 10, 2014); Mass. Letter

Ruling 12-8 (Revised Nov. 8, 2013)

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True Object: Examples

New York Department of Taxation and Finance TSB-A-15(2)S

(April 14, 2015)

The product described in the opinion allowed customers to access

computing power provided by the requestor, not just software.

The Department determined that although the requestor “transferred” a

license of an operating system to the customer as part of the transaction,

the entire product was not taxable.

The Department determined that the customer was purchasing the right to

use computing power, and not prewritten software.

Although not directly using the term, the Department appears to have

applied the true object test.

As such, the Department distinguished this service from the products

described in other advisory opinions addressing remote access to

prewritten software where the customer ‘primarily’ wants specific software,

as opposed to a computing power product.

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