SaaS, Cloud Services Revenues Subject to NY Sales Tax
A recent New York State tax bulletin offers a valuable reminder that many states consider software as a service (“SaaS”) and other cloud services charges to be “sales” revenues subject to state sales tax.
Earlier this month, New York’s Department of Taxation and Finance issued Tax Bulletin ST-128, titled “Computer Software.” For the most part, TB-ST-128 is unremarkable. As is typical, TB-ST-128 characterizes non-customized, “prewritten” software as “personal property” subject to sales tax. As is also typical, TB-ST-128 describes custom software—meaning software “designed and developed to the specifications of a particular purchaser”—as a service not subject to sales tax. With regard to hybrid transactions involving both prewritten and customized software, TB-ST-128 advises services providers to itemize and separately state the taxable and non-taxable revenues, both on invoices and on any applicable contracts. So long as services charges are “reasonable” and separately stated, they aren’t subject to sales tax.
With regard to “computer software services,” however, TB-ST-128 stakes out a more controversial position. According to TB-ST-128, a taxable “sale” of software “includes any transfer of title or possession or both, including a license to use.” Because SaaS and other cloud services customers receive what could be described as a license to use a services provider’s software, TB-ST-128 reasons, those transactions are “sales” subject to New York State sales tax.
TB-ST-128’s reasoning has been criticized as less than persuasive. By definition, SaaS and other cloud services providers do not transfer title in their code to end users. Thus, any “sale” must be premised on a transfer of “possession.” The legal hallmark of possession is control. So the question becomes, do end users “control” a SaaS provider’s software? The answer to that question would seem to be “no.” Again by definition, SaaS and other cloud services providers offer multiple users concurrent access to the same code base. None of those users has the right to remove, or to relocate, or to change that code base, or even to exclude others from using it. The most an end user can do is request that the services provider’s software perform a set of predefined operations on a particular data set, usually within tightly restrictive parameters. That’s a far cry from the degree control usually required for a finding of legal possession.
To be sure, the law regarding sales tax, SaaS and cloud services is all over the map. Colorado levies sales tax on software only to the extent delivered on a tangible medium. Texas generally taxes SaaS and other cloud services, but as a “data processing service” and not as a sale. South Carolina regards SaaS as “communications,” a subset of personal property subject to sales taxation. And Wisconsin looks to the location of and control over the services provider’s server; if that server is not in Wisconsin and is not controlled by a Wisconsin end user, the end user’s fees are not subject to sales tax. For a good summary of SaaS and sales tax, see Taxation of the Cloud Still Hazy, an article from the AICPA’s Tax Adviser magazine.
The variability of taxation schemes can make it expensive for SaaS and other cloud services providers, especially small and startup ones, to comply. Still, services providers should make some effort to understand the sales tax issue, and the risks. Typically, sales taxes cannot be discharged in bankruptcy. So avoiding them in order to pay short term expenses may be unwise. More immediately, unpaid sales tax can be a significant diligence issue, especially at a time when cash-strapped states are less likely to let potential sales tax violations slip. Depending on your plans for your SaaS or other cloud services business, it may be better to deal with unpaid sales taxes sooner than later.