“Cloud computing”, “Software-as-a-Service”, “business solutions” which include an incidental transfer of software – subject to Massachusetts sales tax, or not? A recently issued Massachusetts Department of Revenue Working Draft Directive establishes criteria for determining whether transactions involving software and related solutions are subject to the Massachusetts sales tax.
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Massachusetts Issues Working Draft Directive 13-XX, Criteria for Determining Whether a Transaction is a Taxable Sale of Pre-written Software or a Non-taxable Service
Within the last two years, the Massachusetts Department of Revenue (“the Department”) has issued numerous private letter rulings addressing the taxability of Software-as-a-Service, cloud computing and other business solution offerings which have involved a software component that in some instances, has been bundled with other non-taxable services. (For more on these Private Letter Rulings, see below.)
In response to the large volume of related ruling requests, on February 7, 2013, the Department issued Working Draft Directive 13-XX, Criteria for Determining Whether a Transaction is a Taxable Sale of Pre-written Software or a Non-taxable Service. The Directive, which is intended to be a general guide for taxpayers, provides the criteria the Commissioner considers when determining whether a transaction is a taxable sale or other transfer of the right to use prewritten software or instead, involves a product that is a non-taxable personal or professional service. The Working Draft states that the list of factors provided in the Directive will be considered cumulatively and that no one factor is determinative of taxability.
Revisiting Massachusetts’ Treatment of Prewritten Software Transfers, Computer Industry Services and Products Regulation, 830 CMR 64H.1.3
Before delving into the Working Draft’s criteria for distinguishing between a taxable transfer of prewritten software, or a non-taxable personal or professional service, I thought it would be helpful to provide a brief overview of Massachusetts’ treatment of prewritten software in general.
In 2005, Massachusetts adopted legislation which expanded the definition of prewritten software subject to the Massachusetts sales and use. The statutory change, which was subsequently reflected in the Massachusetts Computer Industry Services and Products Regulation, 830 CMR 64H.1.3, provides that transfers of prewritten software sold to a customer in Massachusetts or purchased for use in Massachusetts is deemed a transfer of tangible personal property subject to the sales or use tax regardless of the method of delivery. The regulation adds that transfers may be effected in any of the following ways: licenses and leases, transfers of rights to use software installed on a remote server, upgrades and license upgrades. Prior to the April 1, 2006 effective date of the statutory change, Massachusetts sales or use tax was imposed on sales of prewritten software delivered in tangible form such as a disk, but not on prewritten software delivered electronically or by “load and leave.” On February 10, 2006, prior to the effective date of the expanding legislation and the amendment to 830 CMR 64H.1.3, the Department issued Technical Information Release (TIR), 05-15, Transfers of Prewritten Computer Software, to clarify the Department’s position, provide additional guidance on the law change, and revoke prior administrative guidance that was inconsistent with the then new law.
Factors the Department Will Consider for Distinguishing between a Taxable Transfer of Pre-Written Software or a Non-Taxable Service
To date, the Computer Industry Services and Products Regulation, 830 CMR 64H.1.3, and TIR 05-15 were the primary sources of guidance available to taxpayers to assist them in determining the taxability of their offerings. Recognizing that additional guidance is needed, the Department has included the following criteria in its Working Draft for distinguishing between a taxable transfer of prewritten software or a non-taxable personal or professional service.
Working Draft Directive 13-XX indicates that the following are indicative of a transaction that should be characterized as a taxable transfer of prewritten software:
- A contract or written agreement that provides for a transfer by license, sale, subscription, lease, or other means, of prewritten software for consideration.
- A customer’s ability to access a seller’s prewritten software on its own or the seller’s or a third party server, and into which the customer can enter its own information, manipulate that information, and/or run reports. On this point, the Working Draft parenthetically notes that a mere search queries in a seller’s database are not considered “entering information.”
- The seller provides the customer with the use of software that functions with little or no personal intervention by the seller or seller’s employees other than “help desk” assistance for customers having difficulty using the software.
- The seller refers to itself as an Application Service Provider (ASP) or its product as Software-as-a-Service (SaaS) or in a similar manner, although the seller’s characterization of a product is not ultimately determinative of its treatment for tax purposes.
- The seller provides access to software, including operating system software or application software, even if no software is transferred to the customer. The Working Draft notes that this may be referred to as “cloud computing.”
- The software provides an organizational tool or function that is used by the seller’s customers, e.g., screen sharing.
- Prewritten software is bundled with a non-taxable service and is sold for a single price, but only where the software constitutes the predominant value of the sale.
- The seller provides a “for charge” (not free) application that is downloaded to any device, including but not limited to a Smart-phone, PC or Tablet.
Working Draft Directive 13-XX indicates that the following are indicative of a transaction that should be characterized as a non-taxable service:
- The seller’s employees provide data processing, create and run reports for customers and provide the resulting reports in any form, which are unique to the customer.
- The seller provides additional, different or restructured information to the customer (e.g., credit card or check verification services, ATM terminal driving services, database access).
- The customer does not interface with the prewritten software either on its own or on the seller’s or third-party servers or enters information that will be further manipulated by the software. On this point, the Working Draft parenthetically notes that search queries by the customer in the seller’s database are not considered entering the customer’s own information or interfacing with the software.
- A seller provides a personal or professional service (e.g., legal, accounting, data management, data storage).
- The transaction is for an optional maintenance contract that does not include software updates or upgrades.
- The seller is providing custom software.
- The seller is providing data storage and back-up.
- The customer runs its own software, which was not obtained from the seller, on the seller’s hardware in a “cloud computing” environment.
- The seller provides customized reports to the customer that are personal and individual to that specific customer and which are not shared with or sold to others.
- Substantial personal or professional services are performed by the seller’s employees and are bundled with the use of software and sold for a single price, and such services constitute the predominant value of the sale.
Additionally, as previously noted, the Working Draft emphasizes that no one factor is determinative as to whether a transaction is one that should be characterized as a taxable transfer of pre-written software or a non-taxable personal or professional service.
The Directive also states that in those instances where both services and the right to use software is integrated or bundled in one transaction, the Commissioner applies an “object of the transaction” test. Thus, where the object of the transaction is the purchase or use of the software, the transaction will be taxable. But where the object of the transaction is determined to be a non-taxable service, and any use or access to prewritten software is incidental, the transaction will be non-taxable.
Sylvia’s Summation
An issue that State revenue officials throughout the country are facing is the rapid evolution of technology and the need to address the taxability of new technologies by applying “slower to evolve” laws. The Department acknowledges this in its working draft when it states that, “software-related products and the terminology used to describe and market them are evolving at a rapid rate.” The Working Draft also points out that as technology develops, purchasers increasingly have access to sophisticated software which is hosted on sellers’ or third party servers and marketed in various ways and with terminology that may be suggestive of the provision of services, e.g., as Software-as-a-Service, Cloud Computing, or “business solutions”. The issue of taxability becomes even “cloudier” when access to software is bundled with the provision of services. The recent flurry of scenarios involving these new offerings on which the Department has been asked to rule (see Private Letter Ruling below), confirm that taxpayers are not always certain how existing law applies to their situation. The Department’s Working Draft (and the final Directive upon issuance) will provide additional guidance to taxpayers, in particular those whose products or business offerings includes a transfer or right to use software along with a provision of services and where the “object of the transaction” is not clear.
Finally, as these technologies, and the terms used to market them, continue to evolve, it is important when assessing the taxability of any “product” or “business offering” to understand what is actually being sold, regardless of the description or terminology used to market the offering. If this is an issue for your company, I would be happy to assist you in understanding the application of Massachusetts’ rules to your situation.
Additionally, the Department is soliciting taxpayer and practitioner comments through Friday, Friday, February 22, 2013. Interested taxpayers and/or their tax advisors should send their comments to the Massachusetts Rules and Regulations Bureau at RulesandRegs@dor.state.ma.us by this deadline.
Additionally, the Department is soliciting taxpayer and practitioner comments through Friday, Friday, February 22, 2013. Interested taxpayers and/or their tax advisors should send their comments to the Massachusetts Rules and Regulations Bureau at RulesandRegs@dor.state.ma.us by this deadline.
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Massachusetts Private Letter Rulings Issued Within the Past 2 Years: As noted above, in the past two years, the Massachusetts Department of Revenue has issued several Private Letter Rulings applying the rules in the Computer Industry Services and Products Regulation to specific factual situations. Incidentally, the issues and activities described in these rulings are many of the same “criteria activities” listed in the Working Draft.
These rulings and their issue dates, are as follows: (Note, clicking on any ruling will take you the actual ruling on the DOR’s website. I have also summarized all of the 2012 rulings – if you interested in this summary, please post a comment, or contact me at sylviadion@verizon.net):
- LR 12-13: Massachusetts Sales/Use Tax on Internet-Based Marketing and Customer Communications Solutions, 11/9/12
- LR 12-11: Data Back-up and Restoration, 9/25/12
- LR 12-10: Screen-Sharing Software and the Massachusetts Sales/Use Tax,9/25/12
- LR12-8: Cloud Computing, 7/16/12
- LR 12-6: Sales/Use Tax on Publishing Software, 5/21/12
- LR 12-5: Massachusetts Sales/Use Tax on Business Offerings to Physician Practice Customers, May 7, 2012
- LR12-4: Massachusetts Sales/Use Tax on “Call Tracking Service”, May 7, 2012
- LR 12-1: Teleconferencing Services, January 12, 2012
- LR 11-4: MA Sales/Use Tax: Online Services for Prospective Employees, 4/12/11
- LR 11-2: MA Sales/Use Tax; Sales of On-line Services, 3/4/11
- LR 10-1: Litigation Support Services, 2/22/10
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