Jeffrey A. Friedman, Partner Michele Borens, Partner TEI ... · ©2014 Sutherland Asbill & Brennan LLP Notable 2014 Legislation • Michigan S.B. 142/S.B. 143 (2013 carryover) clarifies

Legislative and Administrative Update on State Sales Taxation of Business Services

Jeffrey A. Friedman, Partner Michele Borens, Partner TEI – Orange County Chapter March 5, 2014

©2014 Sutherland Asbill & Brennan LLP 2

Taxation of Services

©2014 Sutherland Asbill & Brennan LLP

Current Status of Sales Taxation of Services

• All 45 SUT states impose sales tax on sales of tangible personal property, unless specifically exempt by statute, but most of these states tax only a modest number of services specifically enumerated by statute.

• Almost all of the SUT states impose sales tax on utilities. • Over one-half of these states impose sales tax on digital

goods – some under rules designed for tangible personal property, some under rules focused on services.

• One-third to one-half of the SUT states tax repair services, cleaning services, and landscaping services.

• Only three states tax legal and accounting services. • Generally, educational, health care and financial services

are exempt from sales tax.

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Sales Tax Expansion: Tax Base & Taxability

• Numerous recent legislative efforts to expand the scope of sales and use taxes. Reconsider current exemptions for health care, housing,

education, certain food items Most states exempt a broad range of services Significant 2013 legislative efforts in Louisiana,

Massachusetts, Minnesota, Nebraska, North Carolina, Ohio, et al.

Additional proposals expected in 2014

• Expansion of the Sales Tax Base to Services Politically unpopular

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Services That are Frequently Part of Base Broadening

• Computer software and related installation and maintenance services

• Digital goods and services • Cleaning services • Repair services (labor component) • Credit services • Processing and printing services • Photographic services • Information services • Recreational services • Entertainment services • “Luxury” services

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2013 – An Unprecedented Number of Proposals

• Louisiana – Gov. Jindal “parked” his broad-based services tax after significant opposition; enacted budget ultimately relied on tax amnesty, limits on certain tax credit programs.

• Nebraska – Gov. Heineman’s broad-based services tax put on hold; study underway.

• Minnesota – Gov. Dayton abandoned broad-based sales tax on services proposal. Expanded sales tax to certain repair/maintenance and warehousing/storage services and digital goods.

• Ohio – House GOP scaled down Governor Kasich’s broad-based service tax proposal. The final bill taxes certain digital products, but eschews service tax.

• Other states – Massachusetts; North Carolina; Maine

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The History of Large Scale Efforts to Expand the Sales Tax Base to Services

• Florida – Enacted in 1987 - repealed after 6 months • Massachusetts – Passed in 1990 – repealed after 3

days • Michigan – Passed in 2007 – repealed after 17 hours • Current states with Broad Based Sales Taxes on

Services: Historically only three smaller states – South Dakota, New Mexico and Hawaii – have broad-based sales taxes that include a wide range of both business-to-business and business-to-consumer services

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Massachusetts Repeal – Round Two

• Less than two months after enacting a tax on computer design and software services (eff. 7/31/2013), Massachusetts repealed the new tax with the passage of HB 3662 (eff. 9/27/2013). “Computer system design services” were defined as “the

planning, consulting, or designing of computer systems that integrate computer hardware, software, or communication technologies and are provided by a vendor or a third party.”

MA also briefly taxed other software-related services including: “the modification, integration, enhancement, installation or configuration of standardized software,” but excluding “data access, data processing or information management services.” Mass. St. 2013 c. 46; Mass. G.L. c. 63 § 38(f), c. 64H § 1.

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Proposed Minnesota Repeal

• Minnesota legislators introduced legislation on February 25th that would repeal sales taxes passed last year on business-to-business services involving machine maintenance, telecommunication equipment purchases, and storage and warehouse services.

• During the 2013 legislative session, legislation was passed that expanded the scope of Minnesota sales tax to include business-to-business activities.

• A coalition of Minnesota business groups have criticized the taxes and have been lobbying to have them repealed.

• Minnesota Gov. Mark Dayton has also indicated that he would back the repeal of the business-to-business taxes.

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The Rationale for Sales Tax Base Expansion to Services

• The sales and use tax base is narrow, including only about 25% of all goods and services purchased by households.

• Services represent over 65% of individual spending nationally and are the fastest-growing area of consumption.

• Most countries rely more on consumption taxes as a percentage of total taxes than the United States (at all levels of government).

• Finally, many groups in this country favor consumption taxes over income taxes. 10

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Reasons Why Sales Tax on Services Proposals Have Failed

• Most of the proposals have been introduced as part of sweeping tax reform – which is often a “tough sell,” even as “replacement” taxes.

• In choosing to tax so many new categories at once, these proposals often garner opposition from widely diverse service industries.

• Some political groups oppose sales tax expansions as “regressive”; others are concerned consumption taxes will raise too much money.

• Many local factors are also at work in individual states. • But the most frequent explanation for failure has been the

disproportionate impact of these proposals on business.

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Kentucky Tax Reform Proposal

• Governor Beshear’s tax reform bill will “clarify” that sales tax applies to retail sale of prewritten computer software accessed via the “digital cloud” is subject to tax.

• The Kentucky tax reform bill will also expand the sales and use tax base by imposing tax on installation and repair of taxable goods, including digital products and prewritten computer software.

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Notable 2014 Legislation

• Michigan S.B. 142/S.B. 143 (2013 carryover) clarifies that prewritten computer software does not include software installed on another’s server.

• Missouri H.B. 1444 (intro. 1/15/2014) establishes a sales tax exemption for data storage centers and server farm facilities.

• New Jersey A.B. 2008/S.B. 1080 (intro. 1/16/2014) expands exemption for electronically delivered prewritten software used by a business to related services performed on such software.

• New Mexico S.B. 175 (intro. 2/7/2014) expands definition of “software development services” for purposes of software development deduction from gross receipts.

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Administrative Developments


Administrative Taxation of Services

• While many proposals to expand the sales tax base to tax services have failed, many states have attempted to tax various services through administrative guidance.

• Most of the guidance has focused on taxing services that involve software.

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Arizona Letter Ruling

• The AZ DOR determined that a taxpayer providing online backup and restoration services was subject to transaction privilege tax (TPT) because the services were taxable rentals of prewritten software. Ariz. Priv. Ltr. Rul. No. LR 13-002 (Mar. 25, 2013).

• Notably, the Department did not undertake a “true object” analysis to examine whether or not the software conduit was de minimis compared to the overall backup service.

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Indiana Letter of Finding

• Internet-based information platforms and computer software maintained on servers outside the state, but accessed via the Internet may be taxable transfers of prewritten software. Indiana Letter of Finding 04-20130306 (Feb. 12, 2014). Access of prewritten software, even if via the cloud,

constitutes a taxable transfer of software because customers gain “constructive possession and the right to use, control, or direct the use of the software.”

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Massachusetts Letter Ruling

• Subscription to online merchandise database is not subject to sales and use tax whether or not bundled with additional support or services. Massachusetts, Letter Ruling LR 14-1 (Feb. 10, 2014). True object of the transaction is the provision of access to

the information, which constitutes a nontaxable “database service.”

Not the taxable "sale, license, lease or other transfer of a right to use software on a server hosted by the taxpayer or a third party.”

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Minnesota Tax Court Decision

• The MN Tax Court held that computer software consulting and implementation services provided with the sale of ERP software were not subject to sales tax. SAP Retail, Inc. v. Comm’r of Revenue, No. 8345-R (Minn. Tax Ct. Sept. 19, 2013). The services were not specifically enumerated as taxable services. The services did not constitute taxable fabrication services

because the consumers of the services did not furnish materials used to create the software.

The services were not part of the taxable software license fee because (1) they were provided pursuant to a separate agreement and, even if sold as a package, were separately itemized, and (2) the services were not necessary to complete the sale of a software license that could be purchased without the services and vice versa.

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New York Advisory Opinions

• Sales of a product that provides users single sign-on access to electronic research and data from multiple sources are subject to sales and use tax because the product, in aggregating the information, is a taxable information service. N.Y. Advisory Opinion, TSB-A-14(3)S (Jan. 27, 2014).

• Electronic training course published under limited license for use across multiple devices qualifies as a nontaxable e-book. N.Y. Advisory Opinion, TSB-A-14(1)S (Jan 23., 2014).

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New York Division of Tax Appeals Decision

• Web-based program that tracks the execution of customers’ securities transactions does not constitute a taxable license to prewritten software. Appeal of Sunguard Securities Finance, LLC, N.Y. Div. of Tax App., No. 824336 (Feb. 6, 2014). Customers simply outsource their back office tracking

functions to the taxpayer, so the taxpayer’s activity constitutes “information services”

Since reports furnished as a result of the services are “personal or individual in nature,” the services constitute nontaxable information services.

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Questions?

Jeffrey A. Friedman, Partner Sutherland Asbill & Brennan LLP

202.383.0718 [email protected]

Michele Borens, Partner Sutherland Asbill & Brennan LLP

202.383.0936 [email protected]

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Documents

Jeffrey A. Friedman, Partner Michele Borens, Partner TEI ... · ©2014 Sutherland Asbill & Brennan LLP Notable 2014 Legislation • Michigan S.B. 142/S.B. 143 (2013 carryover) clarifies