Category Archives for Sales Taxability

How do States Tax Cloud Computing including Application Service Providers (ASPs) and Software as a Service (SaaS)?

Sales tax on software and SaaS is complicated.

SaaS and ASP (AKA “Cloud Computing,”) are now a very, and perhaps the most, common model for software delivery. Cloud Computing means that customers access specific software applications over the internet through third-party providers rather than through a single purchase loaded on a single computer.

The sales and use tax implications of Cloud Computing are far reaching and prompt many questions including:

  • Does the ASP or SaaS provider have nexus in the jurisdiction in which it is providing its product or services? Quick answer: “probably, yes, especially in light of Wayfair.”
  • Is the ASP or SaaS involved in the sale or license of software or the performance of a service?
  • Is Cloud Computing considered the sale of a service, and if so, are those services taxable?
  • Is Cloud Computing considered the sale of software, and if so, is it canned or custom software?
  • If Cloud Computing considered the sale of software, is an exemption available?

The basic problem in taxing cloud computing is that it’s not clear what is being sold. Is it considered tangible personal property or a service? It is not always clear whether anything has been delivered, or where it has been delivered, or whether the concept of delivery even applies.

Adding to the confusion, the distinctions between software, digital goods, and SaaS have become blurred. As a consequence, some states, like Colorado, that do not tax software delivered electronically will tax digital goods. Other states, such as New Jersey, taxes personal use software delivered electronically and digital goods, but does not tax SaaS.

Not surprisingly, the answers states have taken varying and inconsistent positions on these questions. In some states, Cloud Computing may not be taxable because they do not tax the sale of software delivered electronically or because there is no sale of tangible personal property (such as California).

Other states may not tax Cloud Computing because they consider it to be a nontaxable service. Still other states tax Cloud Computing as an information or data processing service (like Texas).

Check out this chart from CCH that summarizes the taxation of Cloud Computing across the US.

About Peisner Johnson and Company

We Have a Chart for That — You might call it a Taxability Matrix or a Taxability Chart, the name is not important. We have various tax matrices already put together based on survey questions made to the states each year. But remember, this chart is the result of a survey performed by the states and is research provided to us by CCH. The charts are fantastic resources, but cannot substitute for professional advice based on your specific facts and circumstances. By all means, have a look at the charts we can provide but then do your own research and consult an expert.

What’s the Best Way to Get Answers to Your State Tax Questions?

CALL THE STATE? — This may not be the best thing to do. Clients frequently remark that when the call the state for guidance, they often get hazy and even conflicting answers. We usually say that it’s not that people at the state don’t know what they’re talking about. In fact, if you get a hold of the right people with expertise in your industry, and they understand your question correctly, then you can almost always trust the answer you get from them. Just try to get the answer in writing, so you’re protected in the event of a future audit.

But you have to get the right people and you have to phrase the question appropriately using correct terminology so that misunderstandings are avoided. Certain words carry meaning in the sales tax world that might not be immediately apparent to a non sales tax person. Sales tax is much more a “form over substance” type of tax than income tax and how things are worded in a contract or invoice can be crucial to the taxability. How a question is worded can also make a big difference. Don’t get me wrong, I’m not saying there’s some sort of trick or code language that you must conform to or else, I’m just saying that you want to understand all the implications of the words you choose in asking for guidance so that you get the most accurate answer.

Plus, how do you know if you got the whole answer on your situation? You may have described your facts and circumstances accurately but left out something that you did not think was important. The answer you get would be dependent on the facts you presented. But in reality, the answer you get may not be appropriate when you consider all the relevant facts.

GOOGLE IT? — With so much information available on the Internet these days, you can Google your question and chances are, you’ll find something that seems to match your situation. The problem here, of course, is, does this answer really apply to your situation? Is there another contradicting ruling or law on this matter? Has this item you found been superseded?

GET A RULING? — What if there is no law, regulation, court case or state ruling that addresses your exact situation? Yes, this does happen and quite frequently. State revenue departments have not produced answers to every possible question. This is in stark contrast to the IRS, where it seems that no matter what situation you face, there is a regulation or revenue ruling or court case that addresses it on point — it’s just a matter of finding it. At the state level, we frequently run into situations where there is simply no documented answer to your question. In this case, we usually recommend obtaining private letter rulings from the revenue departments. Each state has their own procedure. We usually recommend only seeking a letter ruling where you have already discussed the question with a subject matter expert at the state, and gotten a pretty good idea of what you’re going to get in the ruling. It’s not always possible to do, but you don’t want bad precedent, if you can help it.

ASK THE EXPERTS? — Have you tried calling the state or just searching the Internet and came away wondering if you got the right answer? Have you considered asking an expert? You probably have, but hesitated, considering the cost. Well, this is what we do — We Solve State Tax Problems.

And, we don’t always charge for this service. How can that be, you ask? We subscribe to just about every service available and can find just about any law, regulation or court case that would bear on your facts and circumstances. And more than that, we use our many years of experience to evaluate your facts to form the correct questions. With that experience we can draw conclusions you can rely on. And we maintain contacts with key state personnel that we can confirm how the state will treat certain transactions that fall in gray areas.

Sometimes we just flat know the answer to a question you have. We always tell our clients: “If you have a question, just call us or email us. If we can answer you off the top of our heads, we’re not going to charge you. If we need to do some research, we’ll tell you before we do the work and seek your approval before we do it.” You can expect no surprise invoices from us.

So What Questions Do You Have?

Like we said earlier, we can deal with any state tax question you can think of. Of course, the answer to many questions we get is, “it depends!” And that may sound like a cop out, but it really does depend. The answer depends on which state we’re talking about number one and then on other possible variances in the facts. One of the helpful resources we subscribe to is provided by CCH. And one of the resources they give us access to are certain charts or tax matrices.

CAUTION ON CHARTS –A big word of caution is in order when it comes to charts. A chart is just a starting place when you want to do some research, and not the final answer by any means, but it’s still interesting and insightful. One particular chart they provide is unique in that it is based entirely on surveys of actual state tax departments and as such it is a good representation of state tax policy. But it is just state policy and this survey is not binding on them. Sometimes, a state’s own policy is at variance with the law, so take this with a grain of salt. But, it still makes for good state tax conversation. We’re here to help, give us a call.

How do States Tax Construction Contractors?

Sales tax and construction is complicated.

In most states, if a contractor is performing work on real property, the contractor is deemed to be the final consumer, or the end user of the tangible personal property used to build the real property and, accordingly, must pay sales tax upon those purchases. Accordingly, in most states, as a purchaser of construction services, you would not owe any sales/use tax on the contract price.

In the beginning days of sales tax, states applied the tax to tangible personal property (because real property was already taxed with property taxes). Services were not taxed in the early days. Therefore, construction historically has generally not been taxed because it was deemed a service. However, for construction and other service providers, they still owe sales or use tax on the tangible personal property used in performing those services.

This seems rather clear on its surface. A contractor is the end user of the tangible personal property because when the contractor finishes the job, the tangible personal property (the nails, sheet rock, lumber, cement, iron, etc.) has transformed into real property.

Unfortunately though, just paying sales tax on purchases does not begin to cover all the multitude of activities performed by contractors. In addition to contract jobs on real property, contractors sometimes act as retailers of fixtures or other tangible personal property such as furnaces, water heaters, cabinets, and air conditioners. Construction contractors will usually have questions over the different sales tax treatment depending on the types of contracts, such as cost-plus, fixed-price, time and materials. There are further complexities regarding contract work with federal and state governments, churches, and not-for-profit organizations. And then the distinction between real property and tangible personal property contracts is not always clear.

Construction contractors face some of the most complicated sales tax questions of any industry especially if they do business in different states. A contractor must always consider the impact of sales tax on its purchases when making a bid. They can be caught between a rock and a hard place because they face constant competition and the bid price is a major criteria for who gets the contract. But they also have to be very careful to accurately estimate the tax cost of the materials incorporated in the job so they don’t end up losing money on a job. For sure they need to be careful to bill the sales tax on the overall job, if state law requires it.

Gross receipts taxes and contractors

While the guidelines just provided are applicable to the majority of states, it is important to remember that there are always exceptions. Arizona is one of those exceptions. Arizona has a gross receipts tax called the Transaction Privilege Tax. In many ways, it operates like a sales tax in that it is billed separately. But technically speaking it is a tax on the seller, not the buyer. The differences become very apparent when it comes to construction. In Arizona “Prime Contractors,” who modify real property, which includes construction, improvement, removal, wreckage, or demolition activities, purchase their construction materials free of tax. Why? Because the Prime Contractor must pay a “Transaction Privilege Tax” (TPT) on 65% of the gross receipts on their contracts, a tax that is passed on to the building owner in much the same way a sales tax is passed on to a purchaser.

At first glance, the TPT on contractors may seem simple enough, but if a contractor performs maintenance, repair, replacement, or alterations (MRRA) work for the owner of real property, or the owners of improvements to real property, that contractor becomes a service contractor, not a prime contractor. As a consequence, instead of buying their building supplies free of tax like a prime contractor and paying tax on 65% of their gross receipts, a service contractor pays tax on the building materials when they buy them.

You can quickly see how this could be confusing. First, a contractor has to know what is included in MRRA and what is still modifications that are prime contracting. Second, contractors could be a prime contractor, or subcontractor to a prime, on one job and a service contractor on another job. In these cases, the prime contractor inventory and service contractor inventory must be accounted for separately.

Other states imposing special taxes upon contractors in addition to a general sales tax include Mississippi and South Dakota.

Check out this chart from CCH that indicates whether a contractor’s purchases of materials or equipment are subject to tax when used in performing a construction contract that is billed on a lump sum basis. Special rules may apply when construction is performed for government or not-for-profit entities. .

About Peisner Johnson and Company

We Have a Chart for That — You might call it a Taxability Matrix or a Taxability Chart, the name is not important. We have various tax matrices already put together based on survey questions made to the states each year. But remember, this chart is the result of a survey performed by the states and is research provided to us by CCH. The charts are fantastic resources, but cannot substitute for professional advice based on your specific facts and circumstances. By all means, have a look at the charts we can provide but then do your own research and consult an expert.

What’s the Best Way to Get Answers to Your State Tax Questions?

CALL THE STATE? — This may not be the best thing to do. Clients frequently remark that when the call the state for guidance, they often get hazy and even conflicting answers. We usually say that it’s not that people at the state don’t know what they’re talking about. In fact, if you get a hold of the right people with expertise in your industry, and they understand your question correctly, then you can almost always trust the answer you get from them. Just try to get the answer in writing, so you’re protected in the event of a future audit.

But you have to get the right people and you have to phrase the question appropriately using correct terminology so that misunderstandings are avoided. Certain words carry meaning in the sales tax world that might not be immediately apparent to a non sales tax person. Sales tax is much more a “form over substance” type of tax than income tax and how things are worded in a contract or invoice can be crucial to the taxability. How a question is worded can also make a big difference. Don’t get me wrong, I’m not saying there’s some sort of trick or code language that you must conform to or else, I’m just saying that you want to understand all the implications of the words you choose in asking for guidance so that you get the most accurate answer.

Plus, how do you know if you got the whole answer on your situation? You may have described your facts and circumstances accurately but left out something that you did not think was important. The answer you get would be dependent on the facts you presented. But in reality, the answer you get may not be appropriate when you consider all the relevant facts.

GOOGLE IT? — With so much information available on the Internet these days, you can Google your question and chances are, you’ll find something that seems to match your situation. The problem here, of course, is, does this answer really apply to your situation? Is there another contradicting ruling or law on this matter? Has this item you found been superseded?

GET A RULING? — What if there is no law, regulation, court case or state ruling that addresses your exact situation? Yes, this does happen and quite frequently. State revenue departments have not produced answers to every possible question. This is in stark contrast to the IRS, where it seems that no matter what situation you face, there is a regulation or revenue ruling or court case that addresses it on point — it’s just a matter of finding it. At the state level, we frequently run into situations where there is simply no documented answer to your question. In this case, we usually recommend obtaining private letter rulings from the revenue departments. Each state has their own procedure. We usually recommend only seeking a letter ruling where you have already discussed the question with a subject matter expert at the state, and gotten a pretty good idea of what you’re going to get in the ruling. It’s not always possible to do, but you don’t want bad precedent, if you can help it.

ASK THE EXPERTS? — Have you tried calling the state or just searching the Internet and came away wondering if you got the right answer? Have you considered asking an expert? You probably have, but hesitated, considering the cost. Well, this is what we do — We Solve State Tax Problems.

And, we don’t always charge for this service. How can that be, you ask? We subscribe to just about every service available and can find just about any law, regulation or court case that would bear on your facts and circumstances. And more than that, we use our many years of experience to evaluate your facts to form the correct questions. With that experience we can draw conclusions you can rely on. And we maintain contacts with key state personnel that we can confirm how the state will treat certain transactions that fall in gray areas.

Sometimes we just flat know the answer to a question you have. We always tell our clients: “If you have a question, just call us or email us. If we can answer you off the top of our heads, we’re not going to charge you. If we need to do some research, we’ll tell you before we do the work and seek your approval before we do it.” You can expect no surprise invoices from us.

So What Questions Do You Have?

Like we said earlier, we can deal with any state tax question you can think of. Of course, the answer to many questions we get is, “it depends!” And that may sound like a cop out, but it really does depend. The answer depends on which state we’re talking about number one and then on other possible variances in the facts. One of the helpful resources we subscribe to is provided by CCH. And one of the resources they give us access to are certain charts or tax matrices.

CAUTION ON CHARTS –A big word of caution is in order when it comes to charts. A chart is just a starting place when you want to do some research, and not the final answer by any means, but it’s still interesting and insightful. One particular chart they provide is unique in that it is based entirely on surveys of actual state tax departments and as such it is a good representation of state tax policy. But it is just state policy and this survey is not binding on them. Sometimes, a state’s own policy is at variance with the law, so take this with a grain of salt. But, it still makes for good state tax conversation. We’re here to help, give us a call.

How do States Tax Manufacturing Equipment?

Manufacturers are usually entitled to sales tax exemptions.

The first thing you need to think about in determining if certain manufacturing equipment can be purchased tax free is what is manufacturing? I’m sure that it comes as no surprise that the definition of the term “manufacturing” varies from state to state. For example, all manufacturing probably includes some processing and/or fabrication, but not all fabrication or processing is manufacturing. Similar questions arise over refining, assembly, and construction. This is where the confusion arises: trying to distinguish between what is fabrication, processing, refining, assembly, etc.

Not only are there disputes over the definition of manufacturing,there is also usually a question of when the “manufacturing process” begins or ends. Machinery used either before or after the manufacturing process begins or ends usually does not qualify for a state’s sales tax exemption for machinery used in manufacturing.  In general, the manufacturing process begins when the raw materials are removed from their first point of storage and ends when the completed product is taken off the line and placed in storage. Some of the more typical areas not qualifying for the manufacturing exemption include receiving, inspection, shipping, intraplant transportation, and finished goods warehousing equipment. The key is usually whether the activity or equipment contributes to a change in the product being produced or is an essential step in the manufacturing process.

Then comes the question of whether a state’s manufacturing exemption applies strictly to “manufacturers” as that term is defined by the state (usually by reference to an SIC code) or if the exemption is for equipment used in “manufacturing”. Equipment that is only exempt if it is used by a “manufacturer” in the “manufacturing process” is less broad than if the exemption is for equipment that is simply used in the “manufacturing process”.

Check out this chart from CCH that summarizes the taxation of manufacturing machinery across the US.

About Peisner Johnson and Company, LLP

We Have a Chart for That — You might call it a Taxability Matrix or a Taxability Chart, the name is not important. We have various tax matrices already put together based on survey questions made to the states each year. But remember, this chart is the result of a survey performed by the states and is research provided to us by CCH. The charts are fantastic resources, but cannot substitute for professional advice based on your specific facts and circumstances. By all means, have a look at the charts we can provide but then do your own research and consult an expert.

What’s the Best Way to Get Answers to Your State Tax Questions?

CALL THE STATE? — This may not be the best thing to do. Clients frequently remark that when the call the state for guidance, they often get hazy and even conflicting answers. We usually say that it’s not that people at the state don’t know what they’re talking about. In fact, if you get a hold of the right people with expertise in your industry, and they understand your question correctly, then you can almost always trust the answer you get from them. Just try to get the answer in writing, so you’re protected in the event of a future audit.

But you have to get the right people and you have to phrase the question appropriately using correct terminology so that misunderstandings are avoided. Certain words carry meaning in the sales tax world that might not be immediately apparent to a non sales tax person. Sales tax is much more a “form over substance” type of tax than income tax and how things are worded in a contract or invoice can be crucial to the taxability. How a question is worded can also make a big difference. Don’t get me wrong, I’m not saying there’s some sort of trick or code language that you must conform to or else, I’m just saying that you want to understand all the implications of the words you choose in asking for guidance so that you get the most accurate answer.

Plus, how do you know if you got the whole answer on your situation? You may have described your facts and circumstances accurately but left out something that you did not think was important. The answer you get would be dependent on the facts you presented. But in reality, the answer you get may not be appropriate when you consider all the relevant facts.

GOOGLE IT? — With so much information available on the Internet these days, you can Google your question and chances are, you’ll find something that seems to match your situation. The problem here, of course, is, does this answer really apply to your situation? Is there another contradicting ruling or law on this matter? Has this item you found been superseded?

GET A RULING? — What if there is no law, regulation, court case or state ruling that addresses your exact situation? Yes, this does happen and quite frequently. State revenue departments have not produced answers to every possible question. This is in stark contrast to the IRS, where it seems that no matter what situation you face, there is a regulation or revenue ruling or court case that addresses it on point — it’s just a matter of finding it. At the state level, we frequently run into situations where there is simply no documented answer to your question. In this case, we usually recommend obtaining private letter rulings from the revenue departments. Each state has their own procedure. We usually recommend only seeking a letter ruling where you have already discussed the question with a subject matter expert at the state, and gotten a pretty good idea of what you’re going to get in the ruling. It’s not always possible to do, but you don’t want bad precedent, if you can help it.

ASK THE EXPERTS? — Have you tried calling the state or just searching the Internet and came away wondering if you got the right answer? Have you considered asking an expert? You probably have, but hesitated, considering the cost. Well, this is what we do — We Solve State Tax Problems.

And, we don’t always charge for this service. How can that be, you ask? We subscribe to just about every service available and can find just about any law, regulation or court case that would bear on your facts and circumstances. And more than that, we use our many years of experience to evaluate your facts to form the correct questions. With that experience we can draw conclusions you can rely on. And we maintain contacts with key state personnel that we can confirm how the state will treat certain transactions that fall in gray areas.

Sometimes we just flat know the answer to a question you have. We always tell our clients: “If you have a question, just call us or email us. If we can answer you off the top of our heads, we’re not going to charge you. If we need to do some research, we’ll tell you before we do the work and seek your approval before we do it.” You can expect no surprise invoices from us.

So What Questions Do You Have?

Like we said earlier, we can deal with any state tax question you can think of. Of course, the answer to many questions we get is, “it depends!” And that may sound like a cop out, but it really does depend. The answer depends on which state we’re talking about number one and then on other possible variances in the facts. One of the helpful resources we subscribe to is provided by CCH. And one of the resources they give us access to are certain charts or tax matrices.

CAUTION ON CHARTS –A big word of caution is in order when it comes to charts. A chart is just a starting place when you want to do some research, and not the final answer by any means, but it’s still interesting and insightful. One particular chart they provide is unique in that it is based entirely on surveys of actual state tax departments and as such it is a good representation of state tax policy. But it is just state policy and this survey is not binding on them. Sometimes, a state’s own policy is at variance with the law, so take this with a grain of salt. But, it still makes for good state tax conversation. We’re here to help, give us a call.

Construction Contractors Subject to Tax on TPP

Based on a CCH survey of state tax departments, 41 states and the District of Columbia impose sales tax on purchases of tangible personal property (TPP) that are incorporated into realty. Three states responded to the survey with additional explanation — California, Nebraska, and Texas. As we pointed out in this article, Are Use Tax Amnesties Useful?, contractors are more prone for state audits because these rules are so complicated, and these survey results support that. This chart is helpful, but there are a few puzzling responses. Let’s check out a few states and see what the survey said.
California’s response to the CCH survey was brief, but still points to the complex nature of contracting rules. “Construction contractors owe tax either as the consumer or seller, depending on the facts.” The survey response gave no other details, but that’s because they’d need several pages to do so. A detailed review of the California regulations is needed to address contractor use tax issues in California.
Texas’ response was a lengthy explanation:
“Construction contractors under lump-sum contracts that do new construction or who do residential real property improvements are consumers. Construction contractors who do new construction and separate the charges for material and labor are retailers and purchase material for resale but must collect tax on the charge for material. Construction contractors that remodel or repair nonresidential real property under either lump-sum or separated contracts are retailers performing taxable services and purchase materials for resale.”
Does that clear it up for you in Texas? If you’re a contractor doing business in Texas, you know that complying with the labyrinth of rules and policies is daunting to say the least.
Nebraska offered the most vague response, “Yes, based on the option selected.” Hmmm…
Four states responded that they do not subject construction contractors to tax on purchases of TPP that are incorporated into the realty of their customers.

We Have a Chart for That

We have prepared a chart of the survey results for your reference. Your situation may very likely involve some particular facts and circumstances that would yield a different result. This chart is a good starting point, but should not be your only research source.

Updated chart: Sales Tax on Shipping Charges

Updated chart: Sales Tax on Shipping Charges

Sales tax on shipping charges is a tricky issue for tax professionals because states’ treatment of the tax varies widely. In Illinois, this issue was the subject of a class action lawsuit against the retailer Walmart. As we pointed out in our recent article, when the Illinois Supreme Court ruled in favor of Walmart in 2009, a situation was created that sparked many qui tam, or whistleblower, lawsuits over the taxation of shipping charges.
Where are Shipping Charges Taxable?
Some states tax shipping charges without condition, including New York and Texas, but almost half of the states do not tax shipping charges depending on certain conditions.
Let’s look at Illinois again. Illinois does not charge sales tax on shipping if charges are separately contracted and stated. That distinction is the crux of the Walmart’s defense in the class action lawsuit.
Other states do not tax shipping charges if additional, and sometimes critical, conditions apply. Massachusetts’ exclusions apply if several conditions are met. Charges:
  1. Reflect the costs of preparing and delivering goods to a location designated by the buyer,
  2. Are separately stated on the invoice, and
  3. Set in good faith and reasonably reflect the actual costs incurred by the vendor.
In Maine, sales tax on shipping charges are excluded if they are separately stated, the shipment is made direct to the purchaser, and a common carrier is used. 
We Have a Chart for That
We have developed a helpful chart that highlights the states’ treatment of sales and use tax on shipping charges for your reference. Your situation may very likely involve some particular facts and circumstances that would yield a different result. This chart is a good starting point, but should not be your only research source.

Good Sales Tax News for Manufacturers

These days, when it comes to sales/use taxes, good news is hard to come by. So many states are increasing taxes and rolling back exemptions and stepping up audit enforcement. A quick perusal of the headlines provides all the proof. New York, North Carolina, California and others are taking the position that merely having otherwise unrelated people sign up as affiliates in those states means that Amazon.com (and other similarly situated companies) have nexus in those states. That’s what you call aggressive.

Meanwhile, New Jersey, Illinois, California and many other states are increasing taxes and letting exemptions expire.

News is pretty bad no matter where you look. And if we polled our subscribers on which state would be the worst for bad news, then Louisiana would surely rank high up on that list. But Louisiana, has come out with some great news for manufacturers.

Louisiana had been phasing in an exemption for certain manufacturing machinery and equipment. The exemption was to have been fully phased in by July 1, 2010. The good news is that by virtue of Act 12 of the 2nd Extraordinary Legislative Session of 2008, the last segment of the phase-in made the exclusion fully effective on July 1, 2009. The exclusions are from the state sales, use, lease, and rental tax for machinery and equipment used by eligible manufacturers in plant facilities predominantly and directly in the actual manufacturing for agricultural purposes or in the actual manufacturing of tangible personal property that is for sale to another.

The LA Department of Revenue has published an Information Bulletin (No. 09-016) with some answers to questions that might arise.

Is this Exemption Good in the Parishes as well?

The legislation authorizes political subdivisions of the state to provide these exclusions from local sales, use, lease, and rental taxes but does not require that they do so. If you have a specific parish question, ask us and we’ll do the research for you.

What is Manufacturing “Machinery and Equipment”?

“Machinery and equipment” is defined by R.S. 47:301(3)(i)(ii)(aa) as tangible personal property or other property that is eligible for depreciation for federal income tax purposes and that is used as an integral part in the manufacturing of tangible personal property for sale. “Machinery and equipment” also includes tangible personal property or other property that is eligible for depreciation for federal income tax purposes and that is used as an integral part of the production, processing, and storing of food and fiber or of timber.

Specific examples of tangible personal property that this statute categorizes as eligible “machinery and equipment” are computers and software that are an integral part of the machinery and equipment used directly in the manufacturing process; machinery and equipment necessary to control pollution at a plant facility where pollution is produced by the manufacturing operation; machinery or equipment used to test or measure raw materials, the property undergoing manufacturing, or the finished product, when such test or measurement is a necessary part of the manufacturing process; machinery and equipment used by an industrial manufacturing plant to generate electric power for self consumption or co generation; and machinery and equipment used to produce news publications whether the news publications are ultimately sold at retail, for resale, or distributed at no cost.

Buildings (usually) Don’t Count — Categorized by the statute act as ineligible for the manufacturing “machinery and equipment” exclusions are a building and its structural components, unless the building or structural component is so closely related to the machinery and equipment that it houses or supports that the building or structural component can be expected to be replaced when the machinery and equipment are replaced; heating, ventilation, and air-conditioning systems, unless their installation is necessary to meet the requirements of the manufacturing process, even though the system may provide incidental comfort to employees or serve, to an insubstantial degree, non-production activities; tangible personal property used to transport raw materials or manufactured goods prior to the beginning of the manufacturing process or after the manufacturing process is complete; and tangible personal property used to store raw materials or manufactured goods prior to the beginning of the manufacturing process or after the manufacturing process is complete.

Used by a “Manufacturer”

Here’s one of the sticking points. To take advantage of this exemption, your company must be a “manufacturer”. The term “manufacturer” is defined in the statute as a person whose principal activity is manufacturing, and who is assigned by the Louisiana Workforce Commission a North American Industry Classification System (NAICS) code within the agricultural, forestry, fishing, and hunting Sector 11; the manufacturing Sectors 31-33; the information sector 511110, all as they existed in 2002, or under industry code 423930 as a recyclable material merchant wholesaler who is engaged in manufacturing activities, which must include shredding facilities. R.S. 47:301(16)(o) additionally defines the term manufacturer to include a person regulated by the Louisiana Public Service Commission or the Council of the City of New Orleans who is assigned a NAICS code 22111. This 22111 NAICS code applies to electric power generation businesses.

Persons whose principal activity is manufacturing, but who are not required to register with the Louisiana Workforce Commission for purposes of unemployment insurance, can apply to the Louisiana Department of Revenue to be classified as a “manufacturers” under NAICS sectors 11, 31-33, or 511110 for purposes of this sales tax exclusion. The department will determine from income tax data whether applicant would have been so classified had the applicant been required to register with the Louisiana Workforce Commission.

What is a “Plant Facility” and What is Meant by “Predominantly and Directly” in the Actual “Manufacturing Process”?

The term “plant facility” is defined as “a facility, at one or more locations, in which manufacturing referred to in sectors 11 and 31-33 of the North American Industry Classification System of 2002, of a product of tangible personal property takes place.” “Used directly” means used in the actual process of manufacturing or manufacturing for agricultural purposes.

“Manufacturing for agricultural purposes,” means the production, processing, and storing of food and fiber and the production, processing, and storing of timber.

“Manufacturing”, the statute provides, means putting raw materials through a series of steps that brings about a change in their composition or physical nature in order to make a new and different item of tangible personal property that will be sold to another. The statute provides that manufacturing begins at the point at which raw materials reach the first machine or piece of equipment involved in changing the form of the material and ends at the point at which manufacturing has altered the material to its completed form. Placing materials into containers, packages, or wrapping in which they are sold to the ultimate consumer is part of this manufacturing process.

For purposes of the sales tax exclusions, manufacturing does not include repackaging or redistributing; the cooking or preparing of food products by a retailer in the regular course of retail trade; the storage of tangible personal property; the delivery of tangible personal property to or from the plant; the delivery of tangible personal property to or from storage within the plant; and actions such as sorting, packing, or shrink wrapping the final material for ease or transporting and shipping.

What About Other States?

We put together a chart using our resources with CCH to show you the current status of the manufacturing exemptions in some of the top states. That chart is reproduced below. If you’d like more detail about those states, or in other states, just let us know and we can help you with that.

Missouri DOR Rules on Software Delivered Through “Load and Leave” Method

Back in October of 2010, we published an article entitled Missouri Policy on Software Load and Leave is Ruled Out Is Software Even Taxable in Missouri Now? The article was in response to an administrative hearings decision that held that software delivered through a “load and leave” method was not taxable because it was not tangible property.

But, as we said then, this decision seemed to throw the whole question out in the open. Is software even taxable at all regardless of how it is delivered? Is the means of delivery completely superfluous and is it all about the true object of the transaction? That certainly seems to be the reasoning underlying the ruling. Consider this: the AHC stated that while it was true that precedents from the Missouri Supreme Court have applied to sales of software, the prior cases did not squarely address the issue of whether software is tangible personal property. In fact, tellingly, the AHC compared the sale of software on a disk to the sale of a share of stock. The sale of stock is not taxed because it is intangible in nature. Yes, it is represented on some fancy parchment stock paper, but the value of the paper is inconsequential to the value of the ownership interest it represents. It could certainly be argued using the reasoning in this case that in Missouri all software is intangible by nature and whether it is transferred electronically, by load and leave, or by tangible medium does not matter.

We said this issued should be watched in Missouri. And we have been watching.

The Missouri Department of Revenue has now issued a detailed ruling outlining its policies on software. Unfortunately, they do not go as far as to conclude that all software is exempt because it is not tangible property, but they do affirm all other aspects of the administrative hearing referenced above. According to the DOR, the taxability of canned software depends totally on how it is delivered. If by tangible personal property that remains at the purchaser’s location, then it is taxable. Below is the entire text of the ruling for your reading pleasure.

We still believe that this distinction is shaky at best. In sales/use tax, form often trumps substance and we understand that. But this treatment by MO strains all credibility. For example, let’s say a company in MO buys 10,000 licenses to MS Office for use by its employees all over the world. According to this ruling, if the software is installed electronically on the company’s server in MO and then subsequently downloaded and installed by employees in and outside MO, no, MO tax is due. However, if even one CD is part of the “originally delivery” of the software, then all licenses would be taxable in MO. That seems to be a huge stretch. If this comes up on audit and an assessment is made, I would expect someone to fight this and the issue of whether software is even tangible property will be raised again.

For now, though, at least we have some definite policies on software taxability in Missouri. Here is the ruling in its entirety.

Letter Ruling No. LR 7001, Missouri, (Jan. 27, 2012)

LR 7001

Taxability of Canned Software, Custom Software, Software Licenses, Mandatory & Optional Maintenance Agreements, Non-Downloadable Software Kept by Vendor & Load and Leave

January 27, 2012

Dear Applicant:

This is a letter ruling issued by the Director of Revenue under Section 536.021.10, RSMo, and Missouri Code of Regulations 12 CSR 10-1.020, in response to your letter dated October 14, 2011.

The facts as presented in your letter ruling request, your previous letter, and through telephone conversations with Legal Counsel Eva Vlachynsky are summarized as follows:

Applicant purchases canned and customized software programs, licenses to use canned software programs, and mandatory and optional software maintenance and support for the software programs from a variety of vendors. Applicant purchases licenses to use original canned software programs that are downloaded to Applicant’s local servers electronically through the internet. In the alternative, Applicant sometimes purchases an original canned software program that is downloaded from a tangible format. Once a software program is downloaded onto Applicant’s local servers that are located in Missouri, the software is copied onto Applicant’s other computers electronically according to the number of licenses purchased by the Applicant.

The maintenance and support that Applicant purchases provide updates, upgrades, or modifications to the software programs. Certain vendors will include the mandatory maintenance and support for a set period of time with the Applicant’s software program purchase or license agreement. Support services provide the ability to speak with a representative via telephone or the ability to look up answers to a problem via website. Examples of maintenance and support materials are instruction manuals and troubleshooting information. Support service contracts may include software updates referred to as “patches.” Patches repair problems or allow additional functionality based upon problems with the software after its release date. Maintenance and support materials are distinguishable from any part of the actual software. The costs for the maintenance and support, whether mandatory or optional, are stated separately on the vendor’s invoice or are billed as a separate invoice.

Applicant also purchases access to non-downloadable software programs through vendors’ internet web sites. The non-downloadable software programs are not downloaded onto Applicant’s local servers in Missouri but are merely accessible for Applicant’s use via each vendor’s web site.

Occasionally, Applicant will enter into a single agreement to purchase several products. In these instances, some products are downloaded electronically through the internet and some are delivered in tangible format. The vendor will separately state each item on a single invoice.

ISSUE 1:

Are Applicant’s purchases of canned software downloaded electronically over the internet subject to sales or use tax?

RESPONSE 1:

No. Applicant’s purchases of canned software downloaded electronically over the internet are not subject to sales or use tax.

Section 144.020.1, RSMo, imposes a sales tax upon retail sales of tangible personal property and certain enumerated services. Section 144.610.1, RSMo, imposes a use tax “for the privilege of storing, using or consuming within this state any article of tangible personal property.” Missouri Code of State Regulations 12 CSR 10-109.050(1) provides that “the sale of canned computer software programs is taxable as the sale of tangible personal property.” A “canned program” is defined as a standardized program “purchased ‘off the shelf’” or is a program “of general application developed for sale to and use by many different customers with little or no modifications.” 12 CSR 10-109.050(2)(A). A computer program may be a canned program “even if it requires some modification, adaptation or testing to meet the customer’s particular needs.” Id.

Missouri Code of State Regulations 12 CSR 10-109.050(3)(A) further provides:

Tax applies to the sale of canned programs delivered in a tangible medium which are transferred to and retained by the purchaser. Examples of canned programs delivered in a tangible medium would include coding sheets, cards, magnetic tape, CD-ROM or other tangible electronic distribution media on which or into which canned programs have been coded, punched or otherwise recorded. 12 CSR 10-109.050(3)(A). If a purchaser does not receive a tangible medium of the original canned software, there is no sale of tangible personal property under Section 144.020, RSMo.

Here, the software is downloaded directly from the internet at the time of installation. Applicant never takes possession of any tangible personal property. Therefore, the purchase of the software downloaded electronically from the internet is not subject to sales or use tax.

ISSUE 2:

Are Applicant’s purchases of customized software programs downloaded by tangible format or electronically through the Internet subject to sales or use tax?

RESPONSE 2:

No. Applicant’s purchases of customized software programs downloaded by tangible format or electronically through the internet are not subject to sales or use tax. But purchases of canned software by tangible format that by has been adapted for Applicant’s use is not custom software and is subject to sales or use tax.

Missouri Code of State Regulations 12 CSR 10-109.050(1) provides:

In general, the sale of canned computer software programs is taxable as the sale of tangible personal property. The sale of customized software programs, where the true object or essence of the transaction is the provision of technical professional service, is treated as the sale of a nontaxable service.

Missouri Code of State Regulations 12 CSR 10-109.050(3)(C) provides:

Programming changes to a canned program to adapt it to a customer’s equipment or business processes, including translating a program to a language compatible with a customer’s equipment, are in the nature of fabrication or production labor that are a part of the sale and are taxable.

Here, if the software is custom software and not canned software that has been adapted for a customer’s use, whether Applicant purchases the customized software program in a tangible format or in an electronic format, the sale of customized software is treated as a nontaxable service. Therefore, Applicant’s purchases of customized software programs are not subject to sales or use tax.

ISSUE 3:

Are Applicant’s purchases of licenses to use canned software, when the original software was downloaded electronically through the internet to Applicant’s server and afterward individual users download copies based on the number of licenses purchased, subject to sales or use tax?

RESPONSE 3:

No. Applicant’s purchases of licenses to use canned software, when the original software was downloaded electronically through the internet to Applicant’s server and afterward individual users download copies based on the number of licenses purchased, are not subject to sales or use tax.

Missouri Code of State Regulations 12 CSR 10-109.050(3)(B) provides:

Tax applies to the entire amount charged to the customer for canned programs. Where the consideration consists of license fees or royalty payments, all license fees or royalty payments, present or future, whether for a period of minimum use or for extended periods, are includable in the measure of the tax.

License fees are taxable if the original purchase of the canned program was subject to sales or use tax. A purchase of canned software that is downloaded through the internet is not taxable. If Applicant purchases licenses to use canned software that was originally downloaded through the internet, the purchases are not subject to Missouri sales or use tax.

ISSUE 4:

Are Applicant’s purchases of mandatory software maintenance and support delivered electronically through the internet subject to sales or use tax if delivery of the initial software occurs electronically through the internet?

RESPONSE 4:

No. Applicant’s purchases of mandatory software maintenance and support delivered electronically through the internet are not subject to sales or use tax if delivery of the initial software occurs electronically through the internet.

Missouri Code of State Regulations 12 CSR 10-109.050(3)(E) provides:

Program installation, training, and maintenance of software services are taxable under the following circumstances:

1. The purchase of the services is mandatory under the terms of an agreement to purchase software[.]

Under the regulation, the Director assumes, if the original purchase of the software was subject to sales or use tax, then program installation, training, and maintenance of software services are taxable if these services are mandatory under the terms of the purchase agreement. Here, although Applicant’s purchases of the software maintenance and support are mandatory, the original software was not subject to tax because it was not purchased in a tangible format, but downloaded through the internet. Therefore, Applicant’s purchases of mandatory maintenance and support downloaded electronically are not subject to Missouri sales or use tax when the original software was downloaded electronically.

ISSUE 5:

Are Applicant’s purchases of optional software maintenance and support delivered electronically through the internet subject to sales or use tax if delivery of the initial software occurs electronically through the internet?

RESPONSE 5:

No. Applicant’s purchases of optional software maintenance and support delivered electronically through the internet are not subject to sales or use tax if delivery of the initial software occurs electronically through the internet.

Missouri Code of State Regulations 12 CSR 10-109.050(3)(F) provides:

Program installation, training and maintenance of software services are not taxable under the following circumstances:

1. The purchase of the services is not mandatory under a software purchase agreement and the services are separately stated on the purchase invoice from software or other items purchased; or

2. The services are purchased separately from software or other tangible personal property.

Applicant’s purchases of the software maintenance and support are optional. If an optional maintenance and support fee is separately stated on the invoice, it is not subject to sales or use tax. Applicant’s purchases of optional software maintenance and support downloaded electronically through the internet are not subject to sales or use tax when the initial software was downloaded electronically through the internet or if the optional software maintenance and support is separately stated on the invoice and does not include software updates.

ISSUE 6:

If Applicant purchases canned software originally delivered in electronic format, licenses to use the canned software, mandatory and optional maintenance and support with delivery of some items occurring in tangible form and delivery of others occurring electronically, which products are subject to sales or use tax when the vendor separately states each product on a single invoice?

RESPONSE 6:

Purchases of canned software delivered electronically, licenses to use canned software when the initial software was delivered electronically, and mandatory and optional maintenance and support delivered electronically when the initial software was delivered electronically are not subject to sales or use tax when the vendor separately states each product on a single invoice. See Responses 1, 3, 4, and 5. However, any portion of these items delivered in a tangible format will be subject to sales or use tax.

ISSUE 7:

If Applicant purchases canned software originally delivered in tangible format, licenses to use the canned software, mandatory and optional maintenance and support with delivery of some items occurring in tangible form and delivery of others occurring electronically, which products are subject to sales or use tax when the vendor separately states each product on a single invoice?

RESPONSE 7:

Purchases of canned software in a tangible format, licenses to use the canned software when the initial software was in a tangible format, and mandatory maintenance and support when the initial software was in tangible format are subject to sales or use tax when the vendor separately states each product on a single invoice. Optional maintenance and support is also subject to sales or use tax when the initial software was in a tangible format. See Responses 1, 3, 4, and 5.

ISSUE 8:

Are Applicant’s purchases of access to non-downloadable software housed on vendor internet web sites on servers located outside of Missouri subject to sales or use tax?

RESPONSE 8:

No. Applicant’s purchases of access to non-downloadable software housed on vendors’ Internet web sites on servers located outside of Missouri are not subject to Missouri sales or use tax if Applicant does not receive a tangible form of a software program that will allow it to access the non-downloadable software. See Response 1.

ISSUE 9:

Are Applicant’s purchases of software programs subject to sales or use tax when the programs are installed by the vendor using a tangible storage media at the Applicant’s web site and the tangible media is taken by the vendor after installation?

RESPONSE 9:

No. Applicant’s purchases of software programs are not subject to sales or use tax when the programs are installed by the vendor using a tangible storage media at the Applicant’s web site and the tangible media is taken by the vendor after installation.

Applicant does not take possession of any tangible media because the software is downloaded by the vendor from tangible media at the Applicant’s web site and the tangible media is taken by the vendor after installation. Therefore, the purchase of the software is not subject to sales or use tax. See Response 1.

This letter ruling is binding upon the Department of Revenue with respect to Applicant for three (3) years from the date of this letter and is subject only to statutory changes by the General Assembly and to changes in the interpretation of law by the courts or administrative tribunals. If a change occurs, the taxpayer who relies upon an outdated interpretation may be subject to additional taxes, interest and penalties, which may be imposed prospectively from the date of the change. For this reason, the interpretation set forth above should be reviewed on a regular basis. Please note that any change in or deviation from the facts as presented will render this ruling inapplicable.

Should additional information be needed, please contact Legal Counsel Eva Vlachynsky, General Counsel’s Office, Post Office Box 475, Jefferson City, Missouri 65105-0475 (phone 573-751-0961), or me.

Sincerely,

Alana M. Barragán-Scott

The Grinchiest States — Some States Make You Pay Tax on Charitable Donations?

Pick your favorite charitable organization, the Boy Scouts, the Habitat for Humanity, the Salvation Army, the Red Cross, the American Cancer Society, the local schools, or any other. These organizations are always looking for contributions especially at this time of year when the Christmas spirit seems to move people to want to give.

Let’s say you are a tent manufacturer and you have a surplus of last year’s model of tents that would be a blessing to inner-city Boy Scout troops or to provide life-saving shelter for survivors of the earthquake in Haiti. Or let’s say you’re a retailer of home improvement goods and your company wants to donate some space heaters to the Red Cross. Or you’re a contractor who has committed to donating materials and labor to building a house for a needy individual.

WAIT! There may be sales/use tax consequences to consider. You might not know it, but many states actually impose a tax on the giver for donating their own inventory. That just seems wrong on so many levels, doesn’t it? Actually, a majority of states do make you pay tax on your donations of inventory. The question is then what is the basis of the tax and what state’s tax applies. In some cases, you would owe tax on just your materials cost of the inventory (don’t include your internal labor in that cost) and in others you would owe tax on the fair market value of the inventory donated.

You may be better off financially just trashing the inventory instead of giving it to these worthy organizations that could use it for good. Why would states have such a grinchy approach?

We already know what the states will say in rebuttal: “Inventory items have never been taxed. In making the donation, companies are “using” that item and so tax must be paid upon the “use” of the item.” There is some [Scrooge-esque] logic to taxing the donated items. Heaven forbid that a tent be donated to the Red Cross and that it would escape the long-arm of the Department of Revenue.

What About Non Inventory Items?

But what if you’re giving away non-inventory items like some surplus office furniture to the local elementary school?

Non-inventory items are items you’re not holding for resale. You paid tax on these items when you bought them. The state got their money. Surely, no state would make you pay tax again just for donating the item to a exempt entity? How many sizes too small is the heart of a state that would tax donations of something that was already taxed once?

But there are states that do tax you even in this situation. We can not understand why they would even trying to put on our Grinchiest green-colored glasses. In fact, according to a review of the Healy & Schadewald Annual Revenue Department Surveys as published by CCH, 28 states actually tax this transaction.

Let’s name names! Let’s look at the top 10 states by population and see how Grinchy they are.

CA — Not Grinchy — They don’t tax most donations to most federally-exempt entities.

TX — Not Grinchy — They don’t tax donations.

NY — Grinchy — They tax non-inventory donations and only inventory by manufacturers are exempt.

FL — Grinchy — They tax it all.

IL — Grinchy — They tax inventory donations and non-inventory if no tax already paid.

PA — Grinchy — See NY.

OH — Grinchy — They don’t tax inventory donations but they do tax the non-inventory. Seems backward.

MI — Grinchy — It looks like they may tax inventory donations and they do tax non-inventory.

GA — Grinchy — Georgia has something in common with NY.

NC — Not Grinchy — If you want to donate something and you’re in Georgia, go to NC and donate it.

Go to this link to see a chart of all the states tax inventory and what states tax non-inventory.

The Grinch’s heart grew three sizes the day he saw all the people in Whoville celebrated Christmas whether they had all the trappings and the presents. Scrooge needed three terrifying and sobering ghostly visits to change his ways. What will it take for these Grinchy states to stop taxing charitable giving?

About Peisner Johnson and Company, LLP

We Have a Chart for That — You might call it a Taxability Matrix or a Taxability Chart, the name is not important. We have various tax matrices already put together based on survey questions made to the states each year. This particular matrix addresses this question of how the states tax companies who make charitable donations. If you like to receive one of these charts, please go to this link and download it. But remember, this chart is the result of a survey performed by the states and is research provided to us by CCH. The charts are fantastic resources, but cannot substitute for professional advice based on your specific facts and circumstances. By all means, have a look at the charts we can provide but then do your own research and consult an expert.

What’s the Best Way to Get Answers to Your State Tax Questions?

CALL THE STATE? — This may not be the best thing to do. Clients frequently remark that when the call the state for guidance, they often get hazy and even conflicting answers. We usually say that it’s not that people at the state don’t know what they’re talking about. In fact, if you get a hold of the right people with expertise in your industry, and they understand your question correctly, then you can almost always trust the answer you get from them. Just try to get the answer in writing, so you’re protected in the event of a future audit.

But you have to get the right people and you have to phrase the question appropriately using correct terminology so that misunderstandings are avoided. Certain words carry meaning in the sales tax world that might not be immediately apparent to a non sales tax person. Sales tax is much more a “form over substance” type of tax than income tax and how things are worded in a contract or invoice can be crucial to the taxability. How a question is worded can also make a big difference. Don’t get me wrong, I’m not saying there’s some sort of trick or code language that you must conform to or else, I’m just saying that you want to understand all the implications of the words you choose in asking for guidance so that you get the most accurate answer.

Plus, how do you know if you got the whole answer on your situation? You may have described your facts and circumstances accurately but left out something that you did not think was important. The answer you get would be dependent on the facts you presented. But in reality, the answer you get may not be appropriate when you consider all the relevant facts.

GOOGLE IT? — With so much information available on the Internet these days, you can Google your question and chances are, you’ll find something that seems to match your situation. The problem here, of course, is, does this answer really apply to your situation? Is there another contradicting ruling or law on this matter? Has this item you found been superseded?

GET A RULING? — What if there is no law, regulation, court case or state ruling that addresses your exact situation? Yes, this does happen and quite frequently. State revenue departments have not produced answers to every possible question. This is in stark contrast to the IRS, where it seems that no matter what situation you face, there is a regulation or revenue ruling or court case that addresses it on point — it’s just a matter of finding it. At the state level, we frequently run into situations where there is simply no documented answer to your question. In this case, we usually recommend obtaining private letter rulings from the revenue departments. Each state has their own procedure. We usually recommend only seeking a letter ruling where you have already discussed the question with a subject matter expert at the state, and gotten a pretty good idea of what you’re going to get in the ruling. It’s not always possible to do, but you don’t want bad precedent, if you can help it.

ASK THE EXPERTS? — Have you tried calling the state or just searching the Internet and came away wondering if you got the right answer? Have you considered asking an expert? You probably have, but hesitated, considering the cost. Well, this is what we do — We Solve State Tax Problems.

And, we don’t always charge for this service. How can that be, you ask? We subscribe to just about every service available and can find just about any law, regulation or court case that would bear on your facts and circumstances. And more than that, we use our many years of experience to evaluate your facts to form the correct questions. With that experience we can draw conclusions you can rely on. And we maintain contacts with key state personnel that we can confirm how the state will treat certain transactions that fall in gray areas.

Sometimes we just flat know the answer to a question you have. We always tell our clients: “If you have a question, just call us or email us. If we can answer you off the top of our heads, we’re not going to charge you. If we need to do some research, we’ll tell you before we do the work and seek your approval before we do it.” You can expect no surprise invoices from us.

So What Questions Do You Have?

Like we said earlier, we can deal with any state tax question you can think of. Of course, the answer to many questions we get is, “it depends!” And that may sound like a cop out, but it really does depend. The answer depends on which state we’re talking about number one and then on other possible variances in the facts. One of the helpful resources we subscribe to is provided by CCH. And one of the resources they give us access to are certain charts or tax matrices.

Is an iTune Taxable in California?

How About in Other States?

Back in 2008, we wrote that the CA legislature was contemplating a change to its sales tax statutes to tax downloaded software. As it turned out, they didn’t change the law after all and electronically downloaded music and other digital goods in CA remained exempt from sales/use taxation. Meanwhile, a song purchased on a CD has always been taxable in CA. That may seem a bit unfair. If you buy a song on iTunes and download it to your iPod, you owe no tax in CA, but that same song on a CD is taxable in CA.

This may seem arbitrary and capricious, but there is a reasonable explanation for the different tax treatment.

It’s a good general rule in most states that the purchase/sale of tangible personal property is, by default, taxable. The distinction between tangible and intangible property is always tricky. Is software tangible? Can you see it, touch it, smell it or sense it? Most people would say no. As intangible property, software would not be taxable. So, many states, to get around this, have focused on the media on which the software is delivered and have simply passed a law saying that software on some sort of tangible media is by definition “tangible personal property.” In fact, many states don’t even bother with the whole tangible media part; they simply call software “tangible personal property” and tax it regardless of how the software is delivered. California was one of the few states remaining that drew a line based on how the software was delivered, if delivered by electronic means, then it wasn’t tangible property.

Well, thanks to the recent Nortel case in CA, things may be changing. The Nortel case may mean that songs on CD’s are not taxable either. The Nortel case may mean that most software, even software delivered via diskette or other media, is not taxable. We will be keeping a sharp eye on how the State Board of Equalization reacts to this case because the effects of it may be far reaching indeed. Perhaps even songs on CD’s will be deemed nontaxable. Interestingly, the Nortel case did not take the tack that the software taxed in their audit was intangible. They argued (successfully) that it was exempt because it was subject to a “technology transfer agreement”.

The appeals court agreed with them and when the CA Supremes refused to take up the appeal, the ruling became final. The Nortel case may mean that even software delivered on tangible media is nontaxable.

This case has prompted a lot of questions on the taxability of digital goods in general. As technology has evolved, businesses have devised new ways to sell goods (electronic downloads) and governments have scrambled to devise new ways to tax those products. Read on for a more complete explanation of this change in CA and for how digital goods are taxed in other states.

What is a Digital Good?

The term digital good pops up every so often in the tax world, increasingly so as the usage of the Internet in business has exploded. The term has been loosely interpreted, with varying definitions depending on the state you ask. According to the DOR website for the state of Washington for example, digital goods include downloaded goods like movies and music, as well as software that is streamed or otherwise accessed. A recent ruling amended the description of digital goods to also include photographs sent via electronic means. But this is just one state. Contrast Washington’s take with that of Missouri, where a recent ruling of the Administrating Hearing Commission (AHC) in FileNet Corp. v. Director of Revenue, held that software was intangible and therefore could not be taxed with a traditional sales tax. We wrote about this issue back in October, 2010. You would be hard pressed to find identical definitions (or a single unified definition for that matter) for digital goods/products anywhere.

In an almost eerie symmetry, state tax departments are nearly 50/50 on the issue. Where some states are unapologetically aggressive, others are (perhaps) uncharacteristically generous. According to a CCH review of the taxability of digital products, of the 45 states and Washington D.C. that charge a sales tax, 24 have declared the sale of digital goods to be generally tax exempt, while the other 22 have declared them to be generally taxable. Maybe it’s just us, but it sounds like there’s some disagreement on the issue. What are the implications for the average consumer? What about all the businesses who regularly buy software, and from more than one state? And how does your state deal with the sale of digital goods?

For the sake of time, we have chosen to highlight some of the more prominent and interesting state positions on digital goods. To obtain a copy of the whole CCH chart, simply let us know, and we will be happy to make it available to you.

Ohio

Digital goods are exempt, but digital products that fall within definitions of “electronic information services” or “electronic publishing” are taxable when sold for use in a business. As explained by the Ohio Revised Code, “Electronic information services means providing access to computer equipment by means of telecommunications equipment for the purpose of either of the following: (1) Examining or acquiring data stored in or accessible to the computer equipment; (2) Placing data into the computer equipment to be retrieved by designated recipients with access to the computer equipment.”

“Electronic publishing means providing access to one or more of the following primarily for business customers, including the federal government or a state government or a political subdivision thereof, to conduct research: news; business, financial, legal, consumer, or credit materials; editorials, columns, reader commentary, or features; photos or images; archival or research material; legal notices, identity verification, or public records; scientific, educational, instructional, technical, professional, trade, or other literary materials; or other similar information which has been gathered and made available by the provider to the consumer in an electronic format. Providing electronic publishing includes the functions necessary for the acquisition, formatting, editing, storage, and dissemination of data or information that is the subject of a sale.

Tennessee

Digital goods are “exempt [only] if [the] tangible equivalent is exempt.” According to the Tennessee Sales Tax Guide, “The retail sale, lease, licensing, or use of specified digital products transferred to or accessed by subscribers or consumers in this state shall be subject to the tax levied by this chapter on the sales price or purchase price thereof at a rate equal to the rate of tax levied on the sale of tangible personal property at retail by the provisions of Section 67-6-202.

Retail sales subject to tax under this section shall not include any sale, lease, licensing, or use of a specified digital product if the sale, lease, license, or use of the equivalent in a tangible form would be exempt as a sale for resale, sublease, or subrent, including any further broadcast, distribution, license, or retransmission of the digital product by a provider of video programming services, who shall not be deemed a subscriber or consumer for purposes of this section.”

Washington

Digital goods are taxable. Additionally, “Digital goods that are streamed or remotely accessed are also taxable. Digital goods include photographs transferred electronically to the end user.”
A special notice issued by the Washington DOR explained that, “Digital products, since the passage of ESHB 2075, are all subject to sales and use tax, although there are exclusions and exemptions. Digital products include downloaded digital goods, streamed and accessed digital goods, and digital automated services.

Digital automated services (DAS) are services that have been automated and are transferred electronically. DAS is not software, but includes one or more software applications in providing the service.

SHB 2620 specifically excludes the following services from DAS:

  • Data processing services
  • Live interactive presentations
  • Advertising services
  • Web hosting, storage, and back up

This legislation also clarifies that sales of photographs by a photographer who takes the photo and sends the photo electronically are sales subject to sales tax, as long as the customer is the end user.”

Texas Digital goods are taxable. For tax purposes, a “Taxable item means tangible personal property and taxable services. Except as otherwise provided by this chapter, the sale or use of a taxable item in electronic form instead of on physical media does not alter the item’s tax status.”

California

Digital goods are exempt with a few exceptions*. In a State Board of Equalization publication, it was explained that, “Your sale of electronic data products such as software, data, and digital images is generally not taxable when you transmit the data to your customer over the Internet or by modem. However, if as part of the sale you provide your customer with a printed copy of the electronically transferred information or a backup data copy on a physical storage medium such as a CD-ROM, your entire sale is usually taxable.

For example, if your company sells canned (non-custom) software programs to customers who download them from a server, those sales are generally not subject to tax. However, if you also provide your customers with a backup copy on a CD-ROM, the entire transaction is taxable. Similarly, if you transmit a stock (non-custom) database to your customer over the Internet and also provide a printed copy of the contents, the entire sale is subject to tax.”

So What?

Well if you’ve been paying attention to recent events in California, you will be aware of the Nortel decision. The ruling by the State Supreme Court to deny the State Board of Equalization’s petition for review in Nortel Networks, Inc. v. State Board of Equalization is a big deal. For those who have missed it, the ruling comes as a frustration to state tax authorities, but a boon to businesses. Essentially, the decline by the state supreme court to hear an appeal of the Nortel case means that all software in California that is covered by a Technology Transfer Agreement (TTA) is exempt from state sales/use taxes. The SBE had issued a regulation that canned software could not be exempt under the TTA exemption, but this case overruled that SBE policy.

Now this doesn’t mean that anyone who has paid sales tax buying Windows 7 in the last 3 years can just rush out and expect a check from the state. On the contrary, you can expect the SBE to use every means of bureaucratic resistance to delay and distract businesses from obtaining refunds. However if you have made some investment in software in California for which you paid tax, there is a potential opportunity for refunds. As in most matters with the state, we recommend getting someone involved that has the time and resources to devote to getting results and securing refunds. If you have questions regarding refunds, or would like more information about how this ruling might affect your company, feel free to contact Peisner Johnson & Company at our website, send us an email, or call us at 800-940-9433 ext. 716.

The “Buy One, Get One Free” Sales Promo Can End Up Costing You Big!

When A Penny Charged is Worth Two Dollars In The Bush

I don’t think Yogi Berra ever said “a penny charged is worth two dollars in the bush”, but he might have. But I doubt even Yogi’s craziest statements could match the twisted logic used by the Wisconsin DOR in its recent Release. The Release details the DOR’s position on how sales and use tax applies in various  “buy one, get one free” scenarios. To say that it their position is Yogi-like would be to ignore or down-play just how costly it could be for the unwary seller in WI. One thing is certain though, if you are a seller in Wisconsin, you may want to seriously consider charging people for free stuff you give them. A penny charged now could save you many dollars later on.

Where were you on December 14, 2010? Of course you don’t know.  Most regular folks were in the middle of the “holidays” during that time period. Going to company parties, shopping for last minute gifts, etc. Most folks were probably not putting their full attention on releases issued by the various taxing jurisdictions. But Peisner Johnson was keeping watch. The Wisconsin Department of Revenue issued a Tax Release on December 14, 2010, that could cost your company a lot of money if you’re not careful.

Do You Use “Buy One, Get One Free” Promotions?

How about buy two get one half off? How about come in for 10 lunches (oil changes, haircuts, palm readings, etc.) and the 11th is free or some such? If you do use these types of promotion, then this article is going to save you big money and headaches at least in Wisconsin.

It’s All About The Invoice

The Wisconsin DOR says: The sales and use tax treatment of buy one, get one free and similar promotions is determined by the invoice or receipt provided by the seller to the customer. If the invoice or receipt provided by the seller to the customer indicates that a second item is provided free to the customer when the customer buys the first item, then the seller is the consumer of the second item and is required to pay Wisconsin sales or use tax on its purchase of this item.

That defies most people’s logic. Wisconsin says that if you sell a shirt for $30 and give another shirt away for free, then you owe the tax on the free one. Then, what if you sell both shirts for $15? In substance, this is the same as selling one for $30 and the other for $0. But in the case where you sell each for $15, you charge tax on the $30 and owe no tax yourself. If you sell one for $30 and give one away free, you collect tax on the $30 and pay tax yourself on the cost of the other. Crazy, eh?

Query: Isn’t this purely form over substance? Answer: Yes. Query: How can states get away with this? Answer: To quote Yogi Berra: “I wish I had an answer to that because I’m tired of answering that question.” Actually, I do have an [admittedly somewhat weak] answer to this question. Sales and use tax is a transaction tax. It usually taxes discrete transactions that stand on their own. The transactions are usually represented by invoices. How the transactions are presented on the face of the invoice is usually critical. So, yes, almost always, sales/use tax is form over substance. The form or presentation controls the taxation. This can be deeply troubling to accountants who are trained to give weight to substance over form. It’s troubling to any logical person for that matter. But to paraphrase Yogi, sales tax is 90% mental and the other half is physical.

So what is Wisconsin trying to do to us? I think this is all about setting companies up to be caught on audit. Note that even if you show on the invoice a charge for both $30 shirts but then show a discount on one of the shirts such that the charge for one of the shirts ends up to be $0, you still owe the tax. So this is form over substance and then substance over form all on the same invoice. But, if you show both shirts on the invoice for $30 each and then give a $30 discount equally applied to both shirts such that the actual selling price is $15 per shirt, then you’re good. This is when you need Yogi Berra to lend his analysis.

Buy One, Get One For A Penny

Don’t despair, it’s not over til it’s over.

When I first read about this release in CCH, I asked myself, why don’t these companies sell the other “free” item for a penny? Since this is all about the form of the transaction, could a company “sell” that other item for a penny and then they wouldn’t owe any use tax on the cost of the item? This would seem to meet the technical requirements. But, would WI come back to a “substance” argument at that point and call it a sham? CCH’s paragraph explanation didn’t address this idea. But, I found it in the actual release in one of the many examples they gave.  I will give you all the examples the WI DOR gave in its release, you may find one or two that apply on point to your situation..

What About Other States?

Good question, other states have their own rules as to whether sellers must charge tax on cash discounts given at the time of the transaction (yes, some states do tax those) or cash discounts if the invoice is paid in a certain time (like 2% discount if paid in 10 days), and whether tax is owed on the original sales price before a price reduction for coupons issued by the merchant and/or manufacturer, and how to treat rebates. Every state has their unique rules.

For example, in Texas a similar (but different:) issue arises in connection with the annual tax holidays. Stores like to run sales in connection with sales tax holidays. Shoe stores frequently offer the “buy one pair of shoes, get the next pair at 50% off”. Well, if you find two pairs you like that both sell for $120, then the first pair will cost $120 and the next one will cost $60. So you get two pairs for $180. Depending on how you invoice those shoes is how they are taxed to the consumer. If one pair stays at $120 on the invoice, it will be taxed because the exemption is for articles costing less than $100. If the discount applies to both items and the invoice shows each pair for $90, then neither of them is taxed since they both come under the $100 threshold. Of course, in no case, does the seller owe use tax on either pair if they end up giving one away free. But, that’s Texas, and this article is all about Wisconsin, so we limit our discussion accordingly. Just understand every state has their own peculiarities and of course, we’re here to help you get a handle on the other states too.

Read On — The Key Is In the Details

Here are the examples given in the Release. Example 13 is the one that confirms that you can charge a penny for the second item and avoid the use tax on that item. One penny is all it takes. How many people will see this and take advantage of this?

Note that this Release addresses a law change that was effective back in October, 2009. Presumably, this treatment applies to sales made back to that date. But you can fix things going forward and hope for the best on audit. I guarantee this is an issue WI auditors will be looking for in their audits of sellers.

Examples:

The following examples illustrate this change. ( Note: In all of the following examples, the retailer’s purchases and sales are made on or after October 1, 2009.)

Example 1: Taxable Item Given Away with Required Purchase of Nontaxable Item – Retailer A provides a hat free of charge to any customer that purchases a certain number of gallons of gasoline (i.e., a nontaxable item). The price of the gasoline does not vary depending on whether the hat is included in the transaction. The receipt given by Retailer A to the customer indicates the sales price of the gasoline but does not mention the hat at all. Since Retailer A is giving a hat at no charge to any customer that purchases the required number of gallons of gasoline, Retailer A is the consumer of these hats, as provided in sec. 77.52 (21), Wis. Stats., and is required to pay Wisconsin sales or use tax on its purchases of the hats.

Example 2: Taxable Item Given Away with Required Purchase of a Different Taxable Item – Retailer B provides a bicycle free of charge to every customer that purchases a new couch. The price of the couch does not vary depending on whether the bicycle is included in the transaction. The receipt given by Retailer B to the customer indicates that the bicycle is given to the customer for no charge. Since Retailer B is providing a bicycle free of charge to every customer that purchases a couch, Retailer B is the consumer of these bicycles, as provided in sec. 77.52 (21), Wis. Stats., and is required to pay Wisconsin sales or use tax on its purchases of the bicycles.

>