IN Law Exempts SaaS from Sales & Use Tax

Spotlight on Information and Technology—Indiana Law Exempts SaaS from Sales and Use Tax

Although retail companies are getting most of the attention these days in view of the US Supreme Court reconsideration of its 1992 Quill nexus physical presence decision, it is important not to lose focus on key sales and use tax issues of companies in other key industries–manufacturers, wholesalers and distributors, information and technology, construction, and healthcare.  Such issues should not be overlooked by practitioners who advise in these target markets [See Sales Tax Needs for the IT Sector]

In one of those key industries—information and technology, Indiana has just provided some clarity to the particularly troublesome ongoing issue of how to tax so-called Cloud-based Services (CBS).  Recently, Indiana’s Gov. Holcomb signed a bill—SEA 257–to encourage Indiana’s growing tech sector at DemandJump—an Indianapolis-based software as a service company. The bill exempts software as a service from state sales tax, making Indiana one of only four states in the nation to do so. [https://calendar.in.gov/site/gov/event/gov-holcomb-signs-bill-to-encourage-indianas-growing-tech-sector/]

“This was an issue I didn’t know much about a year ago, but as I travelled the state, it came up again and again when I met with tech leaders,” Gov. Holcomb said. “To me, this is a prime example of how quick and responsive our state can be to meet the needs of our partners.”

Information and Technology Sector Growth

As we all know, the information and technology sector of the economy is growing at a frantic pace.  According to a recent report in Forbes, information-technology firms and construction-related companies dominate the fastest-growing industries in the U.S., [https://www.forbes.com/sites/sageworks/2017/04/09/the-10-fastest-growing-industries-in-the-u-s/#4f532b8c1ef2]

And according to Grant Thornton, “…Technology is accelerating faster than regulators’ ability to adapt. How will governments respond, and will policy keep pace with technology?” [https://www.grantthornton.com/future-growth-and-industry/technology.aspx]

More specifically with respect to SaaS, Cisco predicts by 2018, 59% of total cloud workspace will be SaaS increase from 41% in 2013 [https://www.networkworld.com/article/3233134/cloud-computing/5-cloud-computing-trends-to-prepare-for-in-2018.html]

Such SaaS growth is a double-edge sword.  On the one hand, states have taken a wide range of positions regarding the way they characterize CBSs for purposes of applying sales and use tax, some of which are difficult for businesses to understand and comply with. This inconsistency among the states has created, on the other hand, opportunities for companies who can timely deliver accurate content and technologies in the form needed by technology and other companies to help solve the cloud-based service tax issues that frequently arise across all state jurisdictions.

What is Software as a Service and How to Tax Them—A Quick Review

General Definition 

Cloud Based Services (CBS) is the general term given to a variety of services that are accessed via the Internet or a proprietary network. Broadly divided into three categories: Infrastructure as-a-Service (IaaS), Platform-as-a-Service (PaaS) and Software-as-a-Service (SaaS).  CBS allow users to store data, access software and access services and platforms from almost any device that can access the cloud via a broadband connection.

Types of Software

Broadly stated, here are the types of software that are typically referenced by the states in developing sales and use tax rules, and each one might have a different tax rule in each state:

  • Pre-written
  • Custom
  • Electronic Download
  • Software as a Service
    • Taxable in some states as prewritten software
    • Exempt in other states as a service
  • Maintenance
  • Related Service
    • Consulting Services
    • Training
    • Troubleshooting

National Conference of State Legislatures Recommendations

The National Conference of State Legislatures (NCSL) adopted a set of cloud-based services principles that are instructive here not only for understanding cloud-based services in general but also for specific solutions to address the challenges of taxing these services. [http://www.ncsl.org/research/telecommunications-and-information-technology/cloud-computing-principles.aspx]

These principles provide that the States should:

  • Establish consistent sourcing regimes that recognize the special challenges that cloud computing presents so as to avoid the multiple taxation of individuals or businesses in multiple states; and not impose discriminatory taxes on them.
  • Base their decisions on the nature of the service and not on the nature or type of provider.
  • Avoid imposing any tax on cloud based services through administrative action and only consider imposing the tax through statutory imposition;
  • Carefully draft definitions to provide clarity to buyers and sellers;
  • Recognize the broad range of services included in cloud based services and address those differences within the statutory scheme;
  • Design any tax impositions only on specific and clearly delineated services or where state statutes provide for broad taxation of services, exclusions or exemptions, if any, for certain cloud based services should be clearly delineated.
  • Encourage the involvement of providers of cloud based services in any drafting efforts involving the taxation or sourcing of those services; and
  • Provide clear and consistent rules to govern bundled transactions

Indiana Gets High Marks from the NCSL on its Legislation

One of the NCSL’s recommendations above was that the states should avoid imposing any tax on CBS through administrative action and only consider imposing the tax through statutory imposition.  The Indiana statute, which is effective after June 30, 2018 and expires July 1, 2024, does just that in saying explicitly by law that although prewritten computer software delivered electronically would be taxable (section (a) below), SaaS is not (section (b) below):

(a) Except as provided in subsection (b), a person is a retail merchant making a retail transaction when the person sells, rents, leases, or licenses for consideration the right to use prewritten computer software delivered electronically.

(b) A transaction in which an end user purchases, rents, leases, or licenses the right to remotely access prewritten computer software over the Internet, over private or public networks, or through wireless media:

(1) is not considered to be a transaction in which prewritten computer software is delivered electronically; and (2) does not constitute a retail transaction.

Are More States to Follow Indiana?

In a recent Insidesalt (McDermott & Emory) report, “…Indiana is not alone in its desire to legislatively exempt cloud-based services and provide clarity in this largely silent area of the law. In Arizona, an ad hoc legislative interim committee was formed in 2017 to review the taxation of digital goods and services. This initiative has since developed into comprehensive digital goods and services legislation (SB 1392 and HB 2479)…”[https://www.insidesalt.com/2018/03/breaking-indiana-enacts-cloud-software-tax-exemption/]

Although states like Indiana and Arizona are at least taking some steps to provide some clarity along the lines of the NCSL recommendations on the issue of taxing CBSs, most states have yet to do so. The resulting inconsistency between the states creates further complexity and confusion that makes it difficult to businesses to understand and comply with sales and use tax rules.  However, this inconsistency has created challenges and opportunities for companies who can timely deliver accurate content and technologies in the form needed by technology and other companies to help solve the cloud-based service tax issues that frequently arise across all state jurisdictions.

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AUTHOR

Jerome Nestor

Jerome Nestor, Esq., CPA, MBA-Accounting Information Systems Manager Tax & Accounting North America Wolters Kluwer Mobile: +1 847.312.5671 Email: jerry.nestor@wolterskluwer.com

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