The New York Department of Taxation and Finance (Department) recently issued an Advisory Opinion providing their interpretation of yet another Taxpayer's provision of Software As a Service (SAaS). In TSB-A-15(36)S, Taxpayer sought an Advisory Opinion from the Office of Counsel for the Department, as to the application of New York sales tax to its provision of a cloud-based software platform service delivered through four key offerings: (1) Line-Item IT billing, (2) budgeting and financial reporting, (3) service costing, and (4) business unit planning. [TSB-A-15(36)S, New York State Department of Taxation and Finance, Sales Tax Advisory Opinion (September 18, 2015)] The Line Item IT billing service enables the customer to upload data via transfer protocol to Taxpayer’s platform. Taxpayer is then responsible for processing the data using its platform, using pre-set customer rules. Taxpayer then provides the customer with information (and access thereto) about the cost of each function performed by the IT department. The other three hosted services enable the customer to access and use the Taxpayer’s software platform for budgeting and financial reporting, comparing competitor costs and updating IT service costs in its service catalog, and conduct business unit planning at the product, service, application, and business unit by plugging “what if” scenarios into a forecasting engine.
Cloud-based Services: “The Wild West” and the Cavalry
The imposition of sales tax on cloud-based services remains “the Wild West”, in that technology is continually changing at a pace that exponentially outpaces states’ ability to adopt sales tax laws, or even policies, to clearly define and fairly impose their tax laws.
Considering Tax Code Section 1105, Department determined that Taxpayer’s Line-Item IT Billing product is an information service. However, the Department concluded that the exclusion for information that is personal or individual in nature (based on the source of the information), and that is not or may not be substantially incorporated in reports furnished to other persons applies to this service, rendering it nontaxable. While the Department considered that the Taxpayer allows access to software for this service, which could be considered the taxable sale of software, “because the customer's use of the software is a single aspect of a more comprehensive information service, which appears to be the primary function of the Line-Item IT Billing service, we conclude that Petitioner's Line-Item IT Billing service constitutes the sale of an information service, and not the sale of prewritten computer software.”
But what about these same services in another state? Some states would say that all four offerings are taxable software... Others would say they are taxable information services... Some would say that some or all are taxable software, taxable information and / or taxable data processing... and still others, taxable communications services. And others still might conclude that the services are nontaxable.
With regard to Taxpayer’s other three services, the Department concluded that these services each provide the customer with additional software tools to analyze on Taxpayer’s platform the information produced as part of Petitioner's Line-Item IT-Billing service. Thus, while Petitioner's Line-Item IT Billing service appears to be a nontaxable information service, these additional optional products appear to constitute prewritten software. [TSB-A-15(1)S, New York State Department of Taxation and Finance, Sales Tax Advisory Opinion (January 1, 2015)] The accessing of these software tools by Petitioner's customers for consideration constitutes the sale of prewritten computer software, which is taxable under Tax Law §1105(a).
Lastly, the Department determined that the Taxpayer shall source the transaction to the location of the client's employees that use the software, and if the employees are located inside and outside the state, they shall allocate the charges based on the portion of users inside New York.
But what about these same services in another state? Some states would say that all four offerings are taxable software. Others would say all four offerings are taxable information services. Some would say that some or all of the offerings are taxable software, taxable information and / or taxable data processing. Still others, taxable communications services. And other still might conclude that the services are nontaxable. Even less clear would be how to situs the transaction, as some states would source the sale to the customer’s service address, and other to the customer’s billing address. The sourcing rules of each state would serve to further muddy an already murky tax issue, as the guidance, to the extent it even exists, tends to conflict with one another from state to state.
New York’s recent advisory opinion reminds taxpayers that the imposition of sales tax on cloud-based services remains “the Wild West”, in that technology is continually changing at a pace that exponentially outpaces states’ ability to adopt sales tax laws, or even policies, to clearly define and fairly impose their tax laws. As states struggle to catch-up, often through individual taxpayer audit determinations, opinions rulings, this creates an ambiguous, arbitrary and cloudy tax regime in each state, so the transparency, fairness and clarity that should exist in the tax laws is difficult to find, even for a company that is proactively seeking to identify and define its multistate sales tax compliance obligations.
While its true that proactive sales tax compliance can be costly, the cost of “not knowing what you don’t know”, or worse, ignoring these obligations, can be even more expensive
Despite states continual efforts to identify and define aggressive nexus standards and sales tax rules for digital goods and cloud-based services, taxpayers and their advisors must take ownership of this process to:
- determine in which states they have nexus and sales tax compliance requirements
- source the sales of digital goods and cloud-based services to each state, and
- define their products and services, and deductively apply the rules and rulings in each state
While its true that proactive sales tax compliance can be costly, the cost of “not knowing what you don’t know”, or worse, ignoring these obligations, can be even more expensive – in my experience – by multiples of 4 or 5. Just ask the companies that get audited after having ignored these obligations, or the company that has its acquisition or investment derailed by a $Multi-million sales tax contingent liability for overlooked nexus and sales tax compliance.
The key: Ask the questions . . . Or better yet, confess you don’t have all the answers and aren’t even sure what the questions are. And then call in the cavalry to begin asking the right questions, and building the protocol to manage and minimize risk.