During a recent Sales Tax Rate Update webinar given by ONESOURCE Indirect Tax the following question was submitted by an attendee. Our tax experts have submitted their response below.
Distinguish the difference between the taxation on license fees, access fees and hosting fees; is there a difference. Also, explain the determining factors to analyze on maintenance and support contracts on computer software, e-commerce products and other computer-related products. It would be interesting to hear about updates regarding sales taxability with relation to perpetual software licenses, are states taxing on place of use, place of server, “shipping location”, splitting of sales tax among states, etc.
License fees for the use of software is a hot topic for a number of states, and the taxability and sourcing vary depending on the state. One method for sourcing the license depends on where the software is being used. E.g. in Utah, license fees for remotely accessed software are taxable if the software is used in Utah. See Utah Pub. 64, (rev. 5/12). However, if the software is used in multiple locations in Utah, and the buyer provides the seller with a “reasonable and consistent method for allocating the transaction between those locations,” then a seller must source and allocate the sale to those locations. Id. If the buyer has locations in Utah and outside of Utah, the seller may reasonably allocate the sales price based on the number of employees using the software in each location. Id. Minnesota also allows for sourcing to multiple locations if a seller knows that the software will be used in more than one taxing jurisdiction. Minn. Sales Tax Fact Sheet 134 (rev. 6/13). Compare the Utah result to the one in Wisconsin, where the analysis depends on where the software is located. If the software is used by a Wisconsin resident, but the software is located on a server outside of the state, then Wisconsin tax would not apply.
Many states consider cloud computer software tangible personal property, while others do not. c.f. Pennsylvania, which considers cloud computing software tangible personal property with New Jersey, which does not. Pennsylvania taxes the sale if the customer’s users are located in Pennsylvania. PA SUT 12-001, Cloud Computing (May 31, 2012). Whereas New Jersey generally exempts cloud computing services. N.J. Tech. Bulletin 72 (July 31, 2013).
Relevant factors to consider when reviewing maintenance contracts on computer-related products include whether the maintenance agreement is Mandatory or Optional. Many states exempt optional maintenance agreements, but tax mandatory agreements. These states include Arizona, California, Colorado, Georgia, Illinois, Kentucky, Maryland, Maine, Michigan, Missouri, North Dakota, Nevada, Oklahoma, Rhode Island, and Wyoming.
Even if a state taxes mandatory maintenance agreements, some states alter taxability based on what the agreement covers. Does the agreement cover labor only, or both parts and labor? Both Arizona and Virginia base a taxability determination on whether the mandatory agreement covers parts and labor. If labor only, then the agreement is exempt in both states. If the agreement covers both parts and labor, then the agreement remains taxable.
Taxability for optional maintenance agreements may differ when purchased in conjunction with or separately from tangible personal property. For example, both Mississippi and South Carolina impose tax on optional maintenance agreements when purchased at the time of the sale of the tangible personal property covered by the agreement, but exempt the same agreement if purchased separately from the covered tangible personal property. Like Optional Maintenance agreements, some states base taxability on whether the optional maintenance agreement covers parts and labor or labor only for example, both Indiana and Virginia exempt optional maintenance agreements if only labor is covered by the agreement.
Of course, none of those factors matter in the states that choose to exempt all maintenance agreements, like Alabama, or tax all maintenance agreements, like Arkansas. Similarly, some states do not consider e-commerce or software tangible personal property, and therefore the analysis would of course change based on that. Beginning on December 6, 2008, Software Maintenance Contracts are defined in the Streamlines Sales and Use Tax Agreement (pg. 101), but SST states are given leeway to limit the definition based on a number of the factors listed above. Streamlined Sales and Use Tax Agreement (October 30, 2013). Please review our Product Taxability User Guide and current Taxability Matrix for state-by-state taxability of maintenance agreements.