Cover Your SaaS: A Semi-Regular Publication on State and Local Tax Developments in the Cloud Computing and Digital Space – 4/10/20

Welcome to the first edition of Cover Your SaaS, a new semi-regular publication from HMB Legal Counsel’s State & Local Tax team. Using the latest in news-scanning technology, i.e., the daily emails that land in our inbox, our goal is to keep you updated on key SALT developments in the digital and cloud computing space. The format is simple. We organize stories by jurisdiction, give you the headline, the context, and let you know why the story matters. If you have follow-up questions, please let us know.

Massachusetts

The Headline:

• Massachusetts Supreme Court upholds sales taxes on SaaS offering

The Authority:

• Citrix Systems Inc. v. Commissioner of Revenue, 139 N.E.3d 293 (Mass. 2020)

The Context:

• Citrix Systems Inc. provides numerous SaaS products, including GoToMyPC, GoToAssist and GoToMeeting. Massachusetts sought to impose sales tax on subscriptions to these offerings based on a regulation which states that the transfer of rights to use software is treated the same as a sale of software and is subject to sales tax. This regulation is based on a statute which states that transfers (sales) of software are subject to sales tax regardless of how the software is transferred. Citrix argued that there was no “transfer” of software within the meaning of the statute because the subscriber did not acquire anything more than the right to use the software for a limited period of time. Citrix also argued that it was selling a nontaxable service rather than taxable software
• Unfortunately, the Court determined that the Massachusetts legislature intended that the statute taxing transfers of software also taxes transfers of rights to use software because the statute taxes transfers regardless of the method of delivery. The Court further found that Citrix was not selling services because customers were interested primarily in obtaining access to and using the functionality offered by Citrix’s products

Why it Matters:

• The Citrix case presents the classic problem faced today by cloud computing vendors. Sales tax is typically imposed on the transfer of transfer tangible personal property (including canned computer software) and cloud computing, almost by definition, does not include the actual transfer of software (or at most, it’s a nominal and incidental part of the cloud transaction).  Yet the Massachusetts DOR was able to convince the state’s Supreme Court that is should be allowed to tax Citrix’s products simply because there was a transfer of the right to use the software.  While not necessarily objectionable as a matter of policy, the conclusion arguably goes well beyond the scope of the controlling statute

Alabama

The Headline:

• Alabama revises regulations to codify Alabama Supreme Court’s holding that all computer software is tangible personal property

The Authority:

• Alabama Administrative Code Rule 810-6-1-.37; Ex parte Russell Cty. Cmty. Hosp., LLC v. State Dep’t of Revenue, 2019 WL 2150922 (Ala. 2019)

The Context:

• The Alabama Supreme Court surprised the tax community in 2019 when it ruled that all software, regardless of the means of delivery, is tangible personal property and therefore subject to sales taxes when licensed, leased, or sold. The Alabama Department of Revenue’s updated regulations expand the definition of “computer software” to broadly include any sequence of automatic data-processing equipment instructions and codify the Court’s ruling on taxability

Why it Matters:

• Alabama’s position represents a troubling trend among states that are not sure how to approach cloud computing and therefore decide to treat all cloud products like copies of Windows 95 on the shelves at Circuit City. While this position is perfectly legal, (as we like to say, a state can call the sky green so long as it is constitutional) it is a trap for the unwary and cloud providers should be alert as to their sales tax collection obligations for Alabama clients

Illinois – Chicago

The Headline:

• City of Chicago expands the lease for re-lease exemption from the Personal Property Lease Transaction Tax to include leased cloud computing products in some instances

The Authority:

• Revised November 2015 Transaction Tax Information Bulletin (Revision issued February 2020)

The Context:

• Chicago imposes a tax on leases of personal property for use in the City of Chicago. The tax includes “nonpossessory” computer leases, which the City has interpreted to include cloud computing as reflected in a Bulletin issued by the City in November 2015.  This tax has several exemptions, one of which is for products that are leased by one lessee and subsequently re-leased to another lessee. In the cloud computing sphere, Chicago previously allowed this exemption only for software products which were not modified by the sub-lessee. The recent revisions to the November 2015 Information Bulletin expand the lease for re-lease exemption to include any leased cloud computing products which are incorporated into the sub-lessee’s products

Why it Matters:

• The expanded exemption is an opportunity to review your cloud product offering and identify source code which your company licenses from other companies. The license fees for this code can then be subtracted from the license fee which you charge your Chicago-based customers, eliminating the Lease Transaction Tax owed by these customers. Please note that this does not affect the amount of tax owed by the ultimate end users, which will still owe the full amount of Lease Transaction Tax

The Chicago Bonus – Hot Private Letter Ruling News

The Headline:

• The City of Chicago recently issued a private letter ruling (PLR) stating that subscriptions of cloud-based security software stored on servers outside of Chicago are not subject to the City’s Personal Property Lease Transaction Tax

The Authority:

• Private Letter Ruling issued to an anonymous taxpayer

The Context:

• Chicago’s Personal Property Lease Transaction Tax applies to “nonpossessory computer leases”, including licenses of cloud computing products. In this instance, the anonymous Taxpayer develops and sells encryption software that functions as an add-on to third-party’s cloud platforms and is stored on the third-party’s server farms located outside of Chicago. The software secures data transmissions while in transit between the subscriber’s computer terminal and their rented space in the third-party provider’s cloud. Other than a brief initial configuration that occurs at the third-party’s server farm, the subscriber has no further interaction with the security software.  Accordingly, the City determined that the software was not a “nonpossessory computer lease” and therefore not subject to the Lease Transaction Tax

Why it Matters:

• Chicago recently increased the Lease Transaction Tax rate from 5.25% to 7.25% to input, modify, or retrieve data supplied by the customer. The City has also demonstrated increased aggressiveness in enforcing the Lease Transaction Tax. SaaS providers that partner with third-party cloud providers such as AWS or Azure and store their software source code on the cloud provider’s server should consider the amount of interaction that Chicago-based subscribers have with their software. If the subscriber has minimal interaction, then it is possible that the SaaS license is not subject to the Lease Transaction Tax

Florida

The Headline:

• For income tax purposes, SaaS license fees are sourced to the licensee’s billing address. Fees to (1) access an app or (2) purchase goods and services via an app are sourced to the app user’s billing address

The Authority:

• Florida Department of Revenue, Technical Assistance Advisement 20C1-001 (Issued January 13, 2020)

The Context:

• An anonymous Florida taxpayer provides a platform for developers (“Users”) to create and sell apps. The taxpayer charges fees for (1) basic access to the development platform; (2) optional add-on development tools; and (3) any purchases made by retail consumers through apps developed on the taxpayer’s platform. Florida’s income tax apportionment formula includes a sales factor so the taxpayer inquired regarding the sourcing rules for these fees. Relying on court decisions from other states, the Florida Department of Revenue determined that these fees are properly sourced to the payor’s billing address regardless of whether the payor is a User or retail consumer

Why it Matters:

• Unlike other jurisdictions that source receipts from cloud computing products based on licensee users’ physical location at the time of use, Florida has re-affirmed that billing address is the appropriate method of sourcing receipts for such transactions