Insights Blog

23 Mar, 2016

The State of Tennessee to Tax Remotely Accessed Software

Posted by Dan Larson on Mar 23, 2016 11:00:13 AM

Sales and Use Tax, State Tax

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As technology continues to advance and consumer practices evolve to take advantage of that technology, state tax authorities often struggle to keep pace.  In 2015, Tennessee took a step toward addressing one such change, enacting legislation with new rules governing the taxation of the access and use of computer software.[1]  In part, the new legislation provides that the taxable use of computer software in Tennessee includes the access and use of software that remains in possession of the seller and is remotely accessed by a customer for use in the State. [2]  The new law seeks to ensure that the taxability of software does not depend upon a customer’s method of accessing that software.

The Tennessee Department of Revenue quickly issued guidance in the form of Notice #15-14 to assist taxpayers in understanding the new rules governing the use of computer software.  For example, the Notice explains that the new legislation has no effect on the taxation of services.  Thus, information or data processing services, data storage, or services involving the conversion, management, or distribution of digital products remain exempt from Tennessee sales and use tax.[3]  However, despite the best efforts of the Department, certain questions regarding the taxation of remotely accessed software remained. 

In Letter Ruling No. 15-07, the Department attempted to answer some of these questions by applying the “true object” test to transactions involving remotely accessed software.  The Taxpayer in this case requested a ruling as to whether Tennessee sales and use tax applied to two products offered to clients.  The first product was a Subscription Package, under which the Taxpayer licensed software providing clients with a central depository to view and upload documents.  The Taxpayer hosted the software on its own servers, from which clients were able to access over the Internet from locations within Tennessee.  The second product was a Business Process Outsourcing Package, delivering management services as well as access to the same software provided under the Subscription Package.

The Department ruled that the Subscription Package was subject to Tennessee sales and use tax as remotely accessed software because the sole value of the package was the access to taxable computer software.  Under the newly enacted legislation, the fact that the Taxpayer’s clients remotely accessed the software from within Tennessee did not alter the taxability of the transaction.  The Department noted that prior to the enactment of the 2015 legislation, no sale, transfer, or electronic delivery of tangible personal property or computer software would have occurred in Tennessee when the clients were able to access the software over the Internet. 

By contrast, the Department held that the Taxpayer’s Business Process Outsourcing Package, under which it provided the same software included in the Subscription Package, was not subject to Tennessee sales and use tax.  The Department noted that this was a bundled transaction, as the software was previously held to be taxable when remotely accessed over the Internet from clients within Tennessee, and the management services were not specifically enumerated as taxable under Tennessee law.  Under the true object test, however, the Department ruled that because the software services were merely incidental to the primary purpose of the provision of business process management services, the Business Process Outsourcing Package was not subject to Tennessee sales and use tax.

 

GMG Insight 

Letter Ruling No. 15-07 is important as it provides guidance as to how the Department will attempt to analyze a taxpayer’s online activity under the new legislation. Under prior law, Tennessee taxpayers generally could avoid sales and use tax liability by either selling or purchasing software remotely over the Internet. Under Tennessee’s new law, such a transaction will no longer escape taxation. 

Accordingly, taxpayers should reconsider the nature of their online activity to determine whether some of their online transactions may be exempt from tax as the purchase of nontaxable services.  Exempt services include information, data, and payroll processing services, billing and collection services, as well as the service of converting, managing, and distributing digital products.

As illustrated in Letter Ruling No. 15-07, when a transaction involves both taxable and nontaxable components, the Department may look to true object of the transaction to determine the appropriate tax treatment. Where a taxable component is merely incidental to the provision of exempt services, the Department may treat the entire transaction as exempt. However, we recommend that as a precaution, taxpayers purchasing both taxable software and services online should request that the fees for nontaxable services be separately stated to ensure their treatment as exempt purchases.

  

Receive a copy of the  Tennesee Tax Notice and Letter Ruling

 

For more information about Grant McCarthy Group, visit http://www.gmgconsulting.com


[1] 2015 Tenn. Pub. Acts Ch. 514, §22.

[2] Tenn. Code Ann. §67-6-231(a)(2).

[3] Sales and Use Tax Notice #15-14, Tennessee Department of Revenue (June 2015).