Cover Your SaaS – Issue IV

With the holidays upon us, it seems like a good time to take a pleasant stroll through the cloud computing and digital product SALT developments you and your clients should be aware of. We returned to the “classic” format for this edition, organizing the stories by jurisdiction, headlining them in summary fashion, and then providing context and snappy analysis. If you have follow-up questions, please let us know.

Colorado

The Headline:

Colorado Confirms that Data Backup Services Not Subject to Sales Taxes

The Authority:

– Colorado Private Letter Ruling No. PLR-20-008 (6/23/2020)
– https://us.eversheds-sutherland.com/portalresource/SS10202006

The Context:

The Colorado Department of Revenue determined that a Denver-based IT service provider’s data backup services are not subject to sales taxes. The Department discussed the way the taxpayer used a combination of hardware it owns and a web-based application to provide backup services to its clients. Interestingly, the taxpayer delivered the rented servers to its clients’ locations, but only the taxpayer’s employees could access the content on the devices and performed all file retrievals on their clients’ behalf. The Department considered whether this placement of the servers constituted a taxable lease of tangible personal property but concluded that the facts and circumstances of the matter suggested that the true object of the transaction was obtaining nontaxable computer software products and services.

Why it Matters:

Facts matter, particularly in states that employ a “true object” or other similar test to determine what the purpose of a transaction is. In these states, it still pays to carefully limit the subscriber’s access to any physical hardware or software downloads in order to protect the intended tax effect of a carefully-drafted subscription agreement.

Illinois

The Headline:

Illinois GIL Confirms that Software-as-a-Service Providers Should Not Charge Sales Tax on Licensed Software Unless Tangible Personal Property is Also Sold.

The Authority:

Illinois Department of Revenue General Information Letter (“GIL”) ST 20-0002-GIL 01/21/2020.

The Context:

In a letter ruling requested by an anonymous out-of-state taxpayer, the Illinois Department of Revenue confirmed its long-standing rule that computer software provided electronically is not subject to sales tax. The taxpayer in this instance provides cloud-based data storage services and requested confirmation that this service is not subject to Illinois sales tax. In reviewing the relevant law, the Department reminded the taxpayer that software delivered in a tangible medium is taxable, but software delivered through a cloud-based delivery system, i.e., never downloaded onto a client’s computer and only accessed remotely, is not subject to sales taxes.

Why it Matters:

Illinois, generally a gleeful taxer of all things taxable, continues to take the position that cloud products are not subject to sales tax unless tangible personal property is also transferred to the purchaser. Sellers of cloud products who want to take advantage of Illinois’ position should be careful not to charge subscribers for downloadable “tangible” property such as APIs, applets, desktop agents, or remote access agents.

The Headline:

Illinois Determines that Cloud-Based Fleet Management Products Are Not Subject to Sales Tax.

The Authority:

– Illinois Department of Revenue Private Letter Ruling (“PLR”) ST-20-0004-PLR (6/10/2020).
– https://www2.illinois.gov/rev/research/legalinformation/letterrulings/st/Documents/2020/ST20-0004-PLR.pdf

The Context:

An anonymous SaaS provider offers fleet management services to its customers, enabling them to upload and track vehicle information. The taxpayer offers two products to its subscribers: access to the cloud-based software and a free downloadable application, which enables subscribers to more readily upload vehicle information to the cloud. In a letter ruling requested by the taxpayer, the Illinois Department of Revenue determined that these services are not subject to sales tax for the same reasons discussed above in ST 20-0002-GIL. However, unlike the data storage services in the GIL above, the taxpayer here provided a downloadable app – usually a taxable event. Fortunately, the Department has previously ruled that Illinois customers who download free computer software from an out-of-state retailer’s server do not exercise power or control over the software in Illinois and therefore do not have a use tax obligation. Accordingly, the Department concluded that no sales or use tax is due on the transaction.

Why it Matters:

As we stated above, be careful when charging for downloadable apps. Here, the taxpayer smartly offered the app as a free download from its out-of-state servers, thereby avoiding sales and use tax liabilities for its customers.

The Headline:

Chicago Increases Excise Tax on Certain Cloud Computing Products to 9.0%

The Authority:

– Chicago 2021 Budget;
– https://www.chicago.gov/city/en/depts/obm/supp_info/budgetdocuments.html

The Context:

Chicago, low on funds pre-pandemic and now in “break glass in case of emergency” territory, has taken the “raise rates” option to bridge a portion of its 2021 budget gap. A modest 1.75% increase to the Personal Property Lease Transaction Tax, as applied to non-possessory computer leases of cloud software and cloud infrastructure to allow a customer to modify or retrieve the customer’s own data or information, brings the tax on these products in line with the 9.0% tax imposed on all other lease, rental, or use of rented personal property. The rate increase goes into effect January 1, 2021.

Why it Matters:

This was an inevitable move from the City of Chicago as it sought ways to raise revenue without imposing new taxes. Although the tax is broad, there are still several simple ways for cloud software businesses and businesses that lease cloud products to limit their exposure to this tax. Please let us know if you would like to discuss these planning tools. On a related note, the Chicago suburb of Evanston formally amended its local amusement tax, discussed in a prior edition, to include “amusements delivered electronically”, including video streaming, audio streaming, and online games.

Indiana and Texas

The Headline:

Indiana and Texas Municipalities Seek to Tax Netflix, Hulu and Others as Utilities

The Authority:

– City of New Boston, Texas v. Netflix Inc. et al., case number 5:20-cv-00135, in the U.S. District Court for the Eastern District of Texas, Texarkana Division.
– https://aboutblaw.com/SH5
– City of Fishers, Indiana et al. v. Netflix, Inc. et al., case number 49D01-2008-PL-026436, in the Indiana Commercial Court, Marion County.
– https://aboutblaw.com/SH6

The Context:

In mid-August, a group of municipalities in Indiana and Texas filed lawsuits against Netflix Inc., Hulu, LLC, and several other streaming services, arguing that these companies owe franchise fees for use of existing public infrastructure to deliver entertainment services. Simply put, these municipalities believe they are entitled to a percentage of Netflix’s and Hulu’s local gross revenues because the videos are streamed over internet service provided from servers either inside of, or directly connected to, the video subscriber’s internet service provider’s network within the local region. This theory has been questioned by numerous commentators on numerous grounds, but the dollars at stake are substantial enough to make settlement less likely.

Why it Matters:

This is intriguing both now and potentially in the future. As municipalities grapple with massive budget deficits for 2021, we expect to see more of this type of long-shot litigation testing the boundaries of what is taxable. Furthermore, private class action attorneys are involved, suggesting that the appetite for such litigation is powerful. Although decisions in these cases are not expected for several more months, this space is definitely worth watching. These cases also raise the question of whether the franchise fees in issue were intended to apply only to cable providers whose equipment in the ground occupies a right of way.

Missouri

The Headline:

– Missouri Finds Digital Copies of Medical Records Sent Electronically Not Subject to Sales Tax

The Authority:

– Missouri Department of Revenue Letter Ruling LR 8095 (2/27/20).
– https://dor.mo.gov/rulings/show/8095

The Context:

In a ruling requested by a taxpayer, the Missouri Department of Revenue held that a taxpayer’s charges for digital copies of medical records transmitted electronically to customers are not subject to sales taxes. The taxpayer at issue here, a release-of-information service provider, contracted with hospital and medical facilities to provide copies of medical records to third parties upon receipt of an authorized request. The taxpayer’s fees for these services included an administrative fee as well as a per chart/per page fee. Although the taxpayer’s services would have been taxable if the records were provided in physical form, the sale of information delivered electronically is not specifically taxed in Missouri. Accordingly, the Department determined that taxpayer’s sales are not subject to sales tax.

Why it Matters:

Many states still have a strong taxing divide between digital and physical products – taxing a transaction in which physical items change hands but excluding its digital twin. Multistate service providers that provide both physical and digital services should therefore be aware of which products are taxable and which are not, making sure not to overcharge their customers for sales tax.

New York

The Headline:

New York Finds Digital Ad Software Sales Subject to Sales Taxes

The Authority:

– New York Department of Taxation and Finance, Advisory Opinion TSB-A-20(22)S (Issued 6/30/2020, Published 11/6/20).
– https://www.tax.ny.gov/pdf/advisory_opinions/sales/a20_22s.pdf

The Context:

An anonymous taxpayer headquartered outside of New York state provides digital advertising products through an advertising campaign management platform. The platform, licensed as SaaS, grants customers access to a package of software tools for creating, delivering, and managing digital advertising. The taxpayer also offers consulting services which are contracted for separately but billed with the license fees as a single lump sum each billing period. In a requested opinion, the New York Department of Taxation and Finance explained that the licensed software is subject to sales tax as tangible personal property because the software fell within the definition of “prewritten computer software”. The Department also explained that the taxpayer’s consulting services would not have been subject to sales taxes if the charges were separately stated and reasonable in relation to the overall receipt. However, the taxpayer invoiced its clients a single amount for each billing period, mixing both taxable and nontaxable items. As a result, the entire amount billed to the taxpayer’s customers is subject to sales taxes.

Why it Matters:

We have two lessons for the price of one advisory opinion. First, the words that you use to describe the products and services sold to your clients do not always matter to states. In this instance, the taxpayer’s license agreements with its customers described the software as “services”, but this made no difference to the ultimate taxability of the products. Accordingly, it is always best to be sure that what you are selling truly is a service under a state’s laws and not a form of tangible personal property. The second lesson is to always invoice as a separate line item any products or services which may not be taxable. It may look nice to have a single charge on an invoice, but it is much nicer to avoid an additional sales tax charge.

The Headline:

New York Finds Online Learning Courses Not Subject to Sales Tax

The Authority:

– New York Department of Taxation and Finance, TSB-A-20(18)S (Issued 6/16/20, Published 10/22/20).
– https://www.tax.ny.gov/pdf/advisory_opinions/sales/a20_18s.pdf

The Context:

An anonymous New York taxpayer offers tiered subscriptions to an online course library, which contains pre-recorded video classes taught by industry experts in business, software, technology, and creative skills areas. Top-tier “premium” subscriptions enable users to download courses for offline viewing and access downloadable course documents used by the instructor, including worksheets, practice problems, and examples. “Basic” subscribers can access the video library but cannot download course videos or documents. All subscribers can access the video library from a web browser or through a free app. In a requested opinion, the Department explained that neither tier of subscription is subject to sales taxes because their purpose is to impart knowledge by providing access to instructional course material. Premium subscribers’ ability to download videos and course materials are provided to enhance the learning experience and are therefore free from sales tax as well.

Why it Matters:

This is a good example of the “object of the transaction” test that state Departments of Revenue often apply to cloud products when taxation is unclear. Although Departments often find in favor of taxability despite taxpayer-favorable facts, having a compelling “object of the transaction” narrative is always a good idea. Interestingly, Tennessee took an opposite approach when addressing the question of whether the sale of pre-recorded video products is subject to sales tax. In a series of FAQs posted on the Tennessee Department of Revenue’s website in mid-September, the state determined that such products are taxable sales of specified digital products. As always, check the local statutes for the taxability of cloud product rather than relying on a general rule of thumb.

North Carolina

The Headline:

North Carolina Finds Network Equipment Support Services Subject to Sales Taxes.

The Authority:

North Carolina Private Letter Ruling, SUPLR 2020-0014 (10/16/2020).

The Context:

An anonymous North Carolina taxpayer offers managed network equipment and software support services. Specifically, the taxpayer’s services agreement provides that the taxpayer will perform all labor related to maintaining network configuration, logging, and monitoring network equipment, as well as installing software updates. In a requested opinion, the North Carolina Department of Revenue explained that the contract for these services constitutes a “service contract”, the gross receipts of which are subject to sales tax. Under North Carolina law, contracts to maintain, monitor, inspect, repair, or provide certain other services to specified digital property, tangible personal property, or real property are subject to sales tax. Here, the taxpayer’s service agreement fell squarely within the definition of a service contract and is therefore subject to sales taxes.

Why it Matters:

The fine print of the law can be just as disappointing as the fine print of a contract.

Virginia

The Headline:

Strike Three? Yet Another Virginia Municipal Gross Receipts Tax on Internet Access Struck Down

The Authority:

Cox Communications Hampton Roads LLC v. King, CL19-3711, First Judicial Circuit of Virginia (8/14/2020).

The Context:

It’s like deja vu all over again in Virginia for a municipal Business, Professional, Occupational, and Licensing (“BPOL”) tax imposed on Cox Communications’ (“Cox”) internet access services. As a reminder, the federal Internet Tax Freedom Act (“ITFA”) prohibits state and local governments from taxing internet access or placing multiple and discriminatory taxes on electronic commerce. This Act, originally enacted in 1998 and made permanent in 2016, previously contained a grandfather clause which allowed jurisdictions to continue taxing internet access if they had such a tax in place and enforced it before October 1, 1998. The clause was eliminated by the permanent legislation, effective June 30, 2016. The Virginia court decided two issues: (1) whether the BPOL is a “tax” under the ITFA and (2) whether the BPOL is an impermissible tax on internet access. The court determined that the BPOL is a tax under the ITFA because it is imposed to generate revenue for government purposes rather than a fee imposed for a specific privilege, service, or benefit conferred. The BPOL applies to internet access services and was therefore an impermissible tax under the ITFA.

Why it Matters:

This is quickly becoming a passim citation, but repetition may just be what Virginia municipalities need for understanding what is and is not permitted under the ITFA. Although we may yet see a fourth case contesting this issue (a younger brother once had a four-strike strikeout in Little League when the umpire lost count), the takeaway for internet service providers in Virginia – and other jurisdictions with similar taxes – is clear.