New Technologies How to Classify/Determine Nexus and Other Issues

Transcription

1 Tax Executives Institute Region VIII Conference Santa Barbara June 15, 2015 Jeff Friedman Michele Borens New Technologies How to Classify/Determine Nexus and Other Issues

2 Agenda Background on Nexus What we know from Quill Application of Historical Rules to New Technologies Characterization Digital Goods Software E-Commerce Services Delivery Methods Electronically Delivered Streaming Remote Access 2

3 What we know from Quill. In order for a state to impose a sales and use tax collection obligation on an out-of-state seller, the U.S. Supreme Court has held that a physical presence in the state is required. The physical presence must be more than de minimis. The landmark case that is referenced by SALT for this principle is Quill Corp. v. North Dakota (1992). 3

4 What we know from Quill. 4 In North Dakota, Quill engaged in the following activities: Solicited business through numerous catalogs and flyers, advertisements in nationally distributed card packs, advertisements in notional periodicals and trade journals and telephone solicitation of existing customers (amounted to more than 230,000 separate pieces of mail, weighing over 24 tons, sent annually by Quill); Delivered merchandise to customers by mail or common carrier from locations outside of North Dakota; Provided an unconditional 90-day guaranty on merchandise purchased; Held title to a few floppy diskettes located in the state; and Licensed a computer software program to some of its North Dakota customers that enabled them to check Quill s current inventories and prices and to place orders directly, but Quill maintained all rights in the software and the right to terminate the license without prior notice and without cause.

5 What we know from Quill Court held that substantial nexus is required and that Quill s activities did not meet the physical presence nexus standard. Substantial nexus entails some level of physical presence; i.e., more than a de minimis physical presence may result in substantial nexus. What constitutes physical presence? More than slightest presence: Employees working in the state Employees performing activities in the state Lease or ownership of tangible property Lease or ownership of real property 5

6 Application to New Technologies Applying U.S. Supreme Court guidance to new forms of services, products and other activities can be challenging. Quill addressed the physical presence of a seller of tangible personal property. However, in today s modern economy many types of property that were historically purchased in tangible form are now purchased in a digital or electronic form and may be streamed, transferred electronically or are remotely accessed. These changes in characterization and delivery methods raise additional nexus considerations. 6

7 New Characterizations Digital Property Digital good is used to describe any goods that are stored, delivered and used in electronic format. Generally, digital goods are comprised of e-books, music files, digital images, and videos that are downloaded, accessed or received in a digital format. However, states are free to adopt their own terminology and definitions. 7

8 New Characterizations Digital Property (Music, Movies, Books) In many states digital property is characterized as tangible personal property and subject to sales tax. Alabama imposes sales tax on sales of tangible personal property. However, digital goods are deemed to be tangible personal property for Alabama sales tax purposes are therefore subject to sales tax. FlipFlopFoto v. State of Alabama, Admin. Law Div. Dkt. No. S, (April 30, 2007). Arizona imposes the transaction privilege tax on the retail sale, use or consumption of tangible personal property, which includes all personal property which can be seen, weighed, measured, felt, touched, or in any other way perceived by the senses. A.R.S (16). The Department takes the position that sales of digital property delivered electronically are subject to Arizona sales tax. 8

9 New Technology 9 Software With progresses in technology, software is no longer delivered and accessed in only tangible form. In fact, software is most often accessed or delivered electronically. In more than half the states electronic software is characterized as tangible personal property and subject to sales tax. In Texas, tangible personal property means personal property that can be seen, weighed, measured, felt, or touched or that is perceptible to the senses in any other manner, and, for the purposes of this chapter, the term includes a computer program and a telephone prepaid calling card. Tx. Tax Code Taxable item means tangible personal property and taxable services. The sale or use of a taxable item in electronic form instead of on physical media does not alter the item's tax status. Tx. Tax Code

10 New Technology Software In Massachusetts, tangible personal property, personal property that can be seen, weighed, measured, felt, or touched, or that is in any other manner perceptible to the senses. Tangible personal property includes electricity, gas, steam, and prewritten computer software. See M.G.L. c. 64H, 1. Sales in Massachusetts of computer hardware, computer equipment, and prewritten computer software, regardless of the method of delivery are generally subject to the Massachusetts sales tax. 830CMR64H.1.3(3)(a) 10

11 New Technology Ecommerce Services In addition to the shift in form of traditional tangible personal property to digital or electronic property, there are numerous services provided via the Internet that were not historically offered: Cloud Computing services Software services Platform services These services may involve access to hardware, platforms and/or software. 11

12 New Technology Ecommerce Services If state characterizes the service as software, the service may be taxable as tangible personal property In evaluating the taxability of an ASP service in Michigan, the Department concluded that a right to access/use prewritten computer software is analogous to a license to use prewritten computer software. Therefore, the purchase of a downloadable license for the use of prewritten computer software or the purchase of the right to access or use prewritten computer software in Michigan is subject to Michigan use tax as tangible personal property. Unofficial Department Guidance, Michigan Department of Treasury, June 4,

13 New Technology Ecommerce Services In other states, the service is characterized as a taxable data processing service. In Connecticut, Ruling , Connecticut Department of Revenue Services, February 17, 2012, the Department concluded that medical records, data, and information about particular patients furnished to patients, insurance companies, healthcare providers, attorneys, and federal or state agencies by allowing access to an online database are subject to Connecticut sales and use taxes at a 1% rate as computer and data processing services because the transaction provides access to the taxpayer s database. Computer and data processing services include, among others, storing and filing information, and retrieving or providing access to information. 13

14 New Delivery Methods 14 Electronically Delivered Tangible personal property was historically delivered via common carrier. However, in the last two decades delivery methods for traditional types of tangible personal property have shifted to electronic methods. In numerous states the delivery of tangible personal property electronically is subject to sales tax. The deciding factor for the taxability of computer software is whether the software is canned or custom software. Neither the software medium (e.g., CD, disk, tape, or other data processing storage media) nor the method used to deliver the software to the purchaser (e.g., tangible delivery or download via a network, intranet, the Internet, or other electronic method) has any bearing on the taxability of the software. RAB , Michigan Department of Treasury, September 28, 1999

15 New Delivery Methods Electronically Delivered Electronic delivery is generally required for many forms of property digital goods, software, etc. Electronic delivery requires use of different types of infrastructure by sellers Servers Internet access Telecommunication services Point of Presence locations 15

16 New Delivery Methods Streaming Delivery of content in a streaming format has also become a common delivery method. With streaming content, the content is a stream of data from a server. The decoder is a stand-alone player or a plugin that works as part of a Web browser. The server, information stream and decoder work together to let people watch live or prerecorded broadcasts. The delivery of digital and electronic goods via a streaming method can have differing tax consequences. In some states delivery of tangible property (e.g., software) via a streaming method is nontaxable. 16

17 New Delivery Methods Streaming The user may not have permanent use of the content when the content is streamed. Indiana only imposes sales tax on digital products when the user has permanent use that is not conditioned on continued payment by the purchaser. Rentals of downloaded or streaming video are not subject to tax because the customer does not have rights of permanent use. IC

18 New Delivery Methods Remotely Accessed Certain services and electronic goods are accessed remotely and not downloaded or delivered. This form of delivery or access can often result in different tax consequences for the same type of property. Information or data that is downloaded electronically, such as downloaded books, musical recordings, newspapers or magazines, does not constitute the transfer of tangible personal property. These types of transactions represent the transfer of intangibles and are thus not subject to Retailers' Occupation and Use Tax. Ill. Admin. Code (a)(3). 18

19 Impact on Nexus Based on state taxation of digital and electronic property there is an increased risk of assertion by states that these forms of property establish nexus for sellers. States may assert: the presence of digital goods in the state establishes a physical presence because the digital goods are tangible personal property for state taxing purposes; or the use of in-state technology (e.g., the Internet) or infrastructure (e.g., servers) to deliver digital goods to customers or for customers to access digital goods establishes a physical presence in the state. 19

20 Presence of Electronic Property South Carolina In Revenue Ruling #14-Draft the Department indicated that electronically delivered items that are considered tangible personal property for South Carolina sales and use tax purposes (e.g., software) are nexus creating for out-of-state sellers/licensors. This language was redacted from the draft ruling after public comment. However, in Quill, Quill licensed software programs to some ND customers. This presence did not change the Court s conclusion. 20

21 Presence of Electronic Property Texas In Decision, Hearing No. 108,626, Texas Comptroller of Public Accounts, September 19, 2014, an out-of-state corporation s sales of licensed software and digital content to Texas users primarily through Internet downloads established the requisite substantial nexus with Texas that required the taxpayer to collect Texas sales and use tax from Texas customers because the taxpayer retained title to tangible personal property (software) that was physically present and generating license revenue in Texas. 21

22 Presence of Electronic Property Louisiana Louisiana has aggressively asserted that the presence of digital property in the state is nexus creating. Parishes have take similar positions. However, see Parish of Jefferson, v. Cox Communications Louisiana, LLC. Court of Appeal of Louisiana, Fifth Circuit, No. 14-CA-563, December 23, On appeal from Louisiana District Court, 24th Judicial District, No Affirmed. A cable company s charges to customers for video on demand (VOD) and pay per view (PPV) programming were not subject to Jefferson Parish, Louisiana, local sales tax because the transactions constituted nontaxable regular cable services rather than taxable software or taxable leases or rentals of tangible personal property. 22

23 Presence of Electronic Property Alabama In draft amendments to Alabama Administrative Code Rule the Department stated that Video On Demand services are taxable as tangible personal property. This amendment would allow Alabama to assert that sellers of VOD have physical presence in Alabama. 23

24 Delivery Methods - Servers The use of in-state technology also creates additional concerns. More than half the states assert that leasing space on an in-state server is nexus creating BNA Survey. Several states assert that paying an web-hosting provider for hosting services on an in-state server is nexus creating BNA Survey. 24

25 Delivery Methods - Servers However, in some states use of an instate server to host website is not nexus creating. In Texas a person whose only activity in this state is conducted as a user of Internet hosting is not engaged in business in this state. Tx. Tax Code (b). "Internet hosting" means providing to an unrelated user access over the Internet to computer services using property that is owned or leased and managed by the provider and on which the user may store or process the user's own data or use software that is owned, licensed, or leased by the user or provider. The term does not include telecommunications services. Tx. Tax Code (a) 25

26 Delivery Methods The delivery of digital or electronic property also generally requires procuring Internet access and telecommunication services. Depending on the nature of these contracts or arrangements, states may attempt to assert that these arrangements are nexus creating. Lease of telecommunication lines. Use on in-state telecommunications provider for delivery. 26

27 Delivery Methods - Other Considerations The Internet Tax Freedom Act ( ITFA) contains a significant nexus protection in its discriminatory tax definition. The provision provides that use of an in-state server is not nexus creating for an out-of-state seller. A discriminatory tax is one that is imposed by a state based on the sole ability to access a site on a remote seller's out-of-state computer server. 27

28 Where do we go from here. The longevity of Quill continues to be debated as a result of the DMA case and the continued push for federal legislation. If Quill is overturned by the U.S. Supreme Court or federal legislation, the establishment of nexus as a result of new technologies may no longer be of concern. However, if Quill remains the law, it is likely that one or more states will begin to assert that the presence of various new technologies and property in the states establishes a physical presence. 28

29 Questions? Jeffrey A. Friedman Michele Borens

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