Complex Compliance – Where Does Your Business Owe State Sales Tax?
A decision handed down in September has captured the attention of state and local tax practitioners – particularly those connected to clients in the software industry – for good reason.
In the case, the Texas Comptroller held that an out-of-state taxpayer had a sales and use tax filing obligation with Texas even though its only connection with the state was the licensing of electronically downloaded software in the state. [SOAH Dkt No. 304-13-5657.26, Hearing No. 106,632 (Tex. Compt. Public Accts. 9/19/2014).]
Does your business license software to customers in Texas or other states?
“Substantial Nexus” and Physical Presence
You may be aware that key variables to determining in what states sales tax is owed include substantial nexus and physical presence.
The US Supreme Court addressed substantial nexus in 1992, dismissing the idea that the existence of some floppy discs licensed to customers in North Dakota triggered a filing obligation in the state for an out-of-state remote seller. The physical presence of the disks did not rise to the level of “substantial nexus” as required under the U.S. Constitution’s Commerce Clause. [Quill v. North Dakota, 504 U.S. 298 (1992)]
The Texas Comptroller however defines electronically downloaded software as tangible personal property. The taxpayer owned the tangible personal property in Texas and thus had nexus in Texas. Furthermore, the ownership rights exercised over that property rose to the level of substantial nexus.
In Quill it was not clear what rights over the software were retained by the company, but in this case, the remote seller retained all the property rights to the software in Texas and, given the revenue earned from the licensing of the software, it was “substantial.” According to the administrative law judge (ALJ), “nexus is not automatically conferred by the statutory characterization of a computer program as taxable tangible personal property. The substantial physical presence requirement is determined by the character of the rights and interest [the taxpayer] retained in the software . . . downloaded by users located in Texas.”
How Will This Decision Impact Your Business?
Since no one really buys and owns software (the fine print usually indicates that users are licensing a program), depending upon how broadly the terms are going to be defined and the identified rights applied, this ruling could affect anyone "selling" software online with customers in Texas.
There will certainly be more to come on these complex and ever-changing state tax issues, but in the meantime, smart software developers and sellers are investigating their compliance.
This post was written by EKS&H State and Local Tax expert, Bruce Nelson. For more information about your state sales tax compliance, please contact him at 970-282-5400 or firstname.lastname@example.org.