Sales and Use Tax for Cloud Computing, Software, Apps, and Other Digital Products and Services

Presenting a live 110-minute teleconference with interactive Q&A Sales and Use Tax for Cloud Computing, Software, Apps, and Other Digital Products and Services Overcoming Vendor and Customer Compliance Challenges Due to Inconsistent Multi-State Tax Laws THURSDAY, DECEMBER 12, 2013 1pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Andrew Appleby, Sutherland Asbill & Brennan, New York Joseph Endres, Hodgson Russ, Buffalo, N.Y. Laurie Wik, Tax Director, Deloitte Tax, San Jose, Calif. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.

FOR LIVE EVENT ONLY Sound Quality If you are listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection. If the sound quality is not satisfactory, you may listen via the phone: dial 1-866-873-1442 and enter your PIN when prompted. Otherwise, please send us a chat or e-mail sound@straffordpub.com immediately so we can address the problem. If you dialed in and have any difficulties during the call, press *0 for assistance. Viewing Quality To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again.

FOR LIVE EVENT ONLY Attendees must listen throughout the program, including the Q & A session, in order to qualify for full continuing education credits. Strafford is required to monitor attendance. Record verification codes presented throughout the seminar. If you have not printed out the Official Record of Attendance, please print it now (see Handouts tab in Conference Materials box on left-hand side of your computer screen). To earn Continuing Education credits, you must write down the verification codes in the corresponding spaces found on the Official Record of Attendance form. Please refer to the instructions emailed to the registrant for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.

FOR LIVE EVENT ONLY If you have not printed the conference materials for this program, please complete the following steps: Click on the ^ symbol next to Conference Materials in the middle of the lefthand column on your screen. Click on the tab labeled Handouts that appears, and there you will see a PDF of the slides and the Official Record of Attendance for today's program. Double-click on the PDF and a separate page will open. Print the slides by clicking on the printer icon.

Sales and Use Tax for Cloud Computing, Software, Apps, and Other Digital Products and Services Dec. 12, 2013 Joseph Endres, Hodgson Russ jendres@hodgsonruss.com Andrew Appleby, Sutherland andrew.appleby@sutherland.com Laurie Wik, Deloitte Tax lwik@deloitte.com

Today s Program Sales Tax of Cloud Computing Introduction and Overview [Laurie Wik] Potential Nexus Issues [Joseph Endres] Sourcing Issues [Joseph Endres] Streamlined Sales Tax Update [Andrew Appleby] State-by-State Legislative and Regulatory Update [Andrew Appleby] Compliance Issues [Andrew Appleby] Slide 8 Slide 28 Slide 29 Slide 36 Slide 37 Slide 41 Slide 42 Slide 44 Slide 45 Slide 77 Slide 78 Slide 82

Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

Dan Davis, Associated Sales Tax Consultants SALES TAX OF CLOUD COMPUTING INTRODUCTION AND OVERVIEW

What Are Cloud Computing Services?

What are Cloud Computing Services? Digital products - products and services provided or furnished electronically via the Internet Cloud Popular terms include - SaaS, Hosted, Cloud Computing, Web-enabled and Web-based Digital products examples - Sales to businesses: software, data, information services, searchable databases Sales to consumers: movies, songs, videogames and premium level subscriptions to online social networks 11 Copyright 2013 Deloitte Development LLC. All rights reserved.

Cloud Product Characteristics Pay per use Ubiquitous network access Rapid elasticity On-demand self service Location independent resource pooling 12 Copyright 2013 Deloitte Development LLC. All rights reserved.

Cloud Product Offerings Software as a Service (SaaS): Customer/User accesses a software application running on the SaaS provider s cloud infrastructure 13 Copyright 2013 Deloitte Development LLC. All rights reserved.

Cloud Product Offerings Platform as a Service: (PaaS) Customer uses Cloud Provider s cloud infrastructure and tools to build or deploy applications and content. Customer does not manage or control the underlying cloud infrastructure but controls its deployed applications/content. 3 rd parties can access the customer s applications/content. 14 Copyright 2013 Deloitte Development LLC. All rights reserved.

Cloud Product Offerings Infrastructure as a Service: IaaS: Customer is provided processing, storage, networks, and other fundamental computing resources. The customer does not manage or control the underlying cloud infrastructure but has control over operating systems, storage, and deployed applications, and possibly limited control of select networking components (e.g., host firewalls). 15 Copyright 2013 Deloitte Development LLC. All rights reserved.

Taxability Overview

Taxability States may assign a Cloud Computing transaction to one of the following taxable categories: Sale, rental, or access to prewritten software Data processing or data storage service Digital Automated Service Computer Service Canned Information Service Digital equivalent to traditional tangible personal property aka digital goods Digital good or specified digital good 18 Copyright 2013 Deloitte Development LLC. All rights reserved.

Slide Intentionally Left Blank

States Positions on Cloud Computing Taxable because: Taxable sale or lease of prewritten software (TPP) despite no physical transfer because customer has constructive possession Taxable lease or rental of TPP despite no physical possession because server is single-tenant server Not an enumerated exemption from general tax on services Customer receives the benefit of a taxable service such as data processing or information service in the state 20 Copyright 2013 Deloitte Development LLC. All rights reserved.

States Positions on Cloud Computing Not Taxable because: Not a sale or lease of prewritten software, i.e., statutory Tangible Personal Property ( TPP ) because customer does not have physical possession Not a sale or lease of software because vendor s server is not in the state The product is not prewritten software and not an enumerated taxable service 21 Copyright 2013 Deloitte Development LLC. All rights reserved.

States Positions on Cloud Computing Not Taxable because: Not a sale or lease of prewritten software, i.e., statutory Tangible Personal Property ( TPP ) because customer does not have physical possession Not a sale or lease of software because vendor s server is not in the state Excluded from definition of a taxable sale; the product is not prewritten software and not an enumerated taxable service 22 Copyright 2013 Deloitte Development LLC. All rights reserved.

Exemptions Resale and other exemptions Texas: 20% exemption from the value of information services and data processing services. Texas Tax Code Sec. 151.351. Washington: o Multiple Point of Use Exemption, Digital Products: RCW Section 82.12.02088, WAC458-20-15503(506) o Multiple Point of Use Exemption, Remote Access Software: RCW Section 82.08.02088, WAC458-20-15502(11) o Digital Products or Remote Access Software Made Available For Free to the General Public. RCW Section 82.08.02082, WAC458-20-15502(10)(c)(ii), WAC458-20-15503(504) o Digital Goods Purchased for a Business Purpose. RCW Section 82.08.02087(1), WAC458-20-15503(505) 23 Copyright 2013 Deloitte Development LLC. All rights reserved.

True Object/Primary Purpose Massachusetts Massachusetts Letter rulings in which a hosted product offering was deemed access to software considered: Substantial use of software by the customer The level of taxable to non-taxable elements included in a bundled offering The automated functioning of tasks performed by the product offering The tasks the customer seeks to be performed by the product offering and the role of the seller s software in performing such tasks, i.e, is the software incidental to a task a human is performing or is the software the means of performing the task The intervention in the product offering by seller s personnel or lack thereof 24 Copyright 2013 Deloitte Development LLC. All rights reserved.

True Object/Primary Purpose Massachusetts: Massachusetts Dept. of Revenue Letter Ruling 11-4, (April 12, 2011) Massachusetts Dept. of Revenue Letter Ruling 12-5 (May 7, 2012) Massachusetts Dept. of Revenue Letter Ruling 12-10 (Sept. 12, 2012) Massachusetts Dept. of Revenue Letter Ruling 12-13 (Nov. 9, 2012) Massachusetts Dept. of Revenue Letter Ruling 13-2 (March 11, 2013) Massachusetts Dept. of Revenue Letter Ruling 13-5 (June 4, 2013) 25 Copyright 2013 Deloitte Development LLC. All rights reserved.

About this presentation This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation. 27 Copyright 2013 Deloitte Development LLC. All rights reserved.

About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.com/about for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and its member firms. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Certain services may not be available to attest clients under the rules and regulations of public accounting. Copyright 2013 Deloitte Development LLC. All rights reserved. Member of Deloitte Touche Tohmatsu Limited

Sales and Use Tax for Digital Products and Services Potential Nexus Issues Where value is law. Joseph N. Endres, Esq. Hodgson Russ LLP 140 Pearl Street, Suite 100 Buffalo, New York 14202 Phone: (716) 848-1504 Fax: (716) 819-4711 jendres@hodgsonruss.com 2013 Hodgson Russ LLP www.hodgsonruss.com Doc. # 11629792

Nexus First question: Nexus, what is it? 1. Nexus is a fancy word for connection. In order for a state to require an out-of-state seller to collect its sales tax, there must be a requisite level of connection between the state and the seller. Quill v. North Dakota, 504 U.S. 298 (1992) The Bright Line Test: Physical Presence Do you have any people or property in the state? Offices Employees or independent contractors Inventories Other property servers and Texas 30 Where value is law.

Nexus Continued Just because you have Nexus with a state, doesn t mean you have a sales tax exposure. 1. Not all states tax digital goods. You have to know the rules in each state. Unfortunately the rules are complex and in flux! For example, California exempts digital goods. New York taxes digitally accessed or transferred software, but exempts other digital products such as music, pictures, etc. States that tax digital products, other than software: AL, AR, AZ, CO, CT (but at a lower rate), HI, ID, IN, IL, KY, LA, ME, MN (as of 7/1/13), MS, NC, NE, NJ, NM, OH (as of 1/1/14), SD, TN, TX, UT, VT, WA, WI, WY. 31 Where value is law.

Nexus Continued Can a third party s activity in a state confer nexus on an out-of-state seller? 1. Yes. Affiliate or Click-Through Nexus! Scripto, Inc. v. Carson, 362 U.S. 207 (1960) Tyler Pipe Industries, Inc. v. Washington Dep t of Revenue, 483 U.S. 232 (1987) 2. Several states now impose some sort of click-through or affiliate nexus, including Arkansas, California, Colorado, Connecticut, Georgia, Illinois, New York, North Carolina, Oklahoma, Rhode Island, South Dakota, Tennessee, Texas and Vermont. 32 Where value is law.

Nexus Continued The Click-Through or Affiliate Nexus laws are likely here to stay, though some have been invalidated recently in certain states. 1. This month the Supreme Court refused to hear a challenge to New York s Affiliate Nexus laws. 2. In October, the state's highest court found Illinois' Internet sales tax void and unenforceable because it conflicts with a federal law that temporarily blocked new state or federal taxes aimed at online retailers or Internet providers, the first court in the country to take that stance. So it doesn t look like a unified solution is going to come from the courts. What about Congress? 33 Where value is law.

Nexus Continued The Marketplace Fairness Act of 2013 1. The Marketplace Fairness Act grants states the authority to compel online and catalog retailers ("remote sellers"), no matter where they are located, to collect sales tax at the time of a transaction - exactly like local retailers are already required to do. 2. However, States are only granted this authority after they have simplified their sales tax laws. Big retailers have supported the legislation fervently, including Walmart, Amazon, BestBuy, Bed, Bath and Beyond, Barnes and Noble, Target, and Staples, among others 34 Where value is law.

Nexus Continued States have two options to simplify their sales tax codes: 1. A state can join the twenty-four states that have already voluntarily adopted the simplification measures of the Streamlined Sales and Use Tax Agreement (SSUTA), which has been developed over the last eleven years by forty-four states and more than eighty-five businesses with the goal of making sales tax collection easy. Any state which is in compliance with the SSUTA and has achieved Full Member status as a SSUTA implementing state will have collection authority on the first day of the calendar quarter that is at least 90 days after enactment. 2. Alternatively, states can meet essentially five simplification mandates listed in the bill. States that choose this option must agree to: Notify retailers in advance of any rate changes within the state Designate a single state organization to handle sales tax registrations, filings, and audits Establish a uniform sales tax base for use throughout the state Use destination sourcing to determine sales tax rates for out-of-state purchases (a purchase made by a consumer in California from a retailer in Ohio is taxed at the California rate, and the sales tax collected is remitted to California to fund projects and services there) Provide free software for managing sales tax compliance, and hold retailers harmless for any errors that result from relying on state-provided systems and data 35 Where value is law.

Sales and Use Tax for Digital Products and Services Sourcing Issues Where value is law. Joseph N. Endres, Esq. Hodgson Russ LLP 140 Pearl Street, Suite 100 Buffalo, New York 14202 Phone: (716) 848-1504 Fax: (716) 819-4711 jendres@hodgsonruss.com 2013 Hodgson Russ LLP www.hodgsonruss.com Doc. # 11629792

Sourcing Issues What state s tax rules apply? 1. General Rule: For software and digital goods, the state where the end user is located typically controls but be careful! 2. But what happens when users are located across various states? Or what if a service is performed for a business with locations in multiple jurisdictions (e.g., software-based accounting services, accounts payable, payroll, etc.)? Principal place of business approach. Reasonable estimates of user locations. 38 Where value is law.

Sourcing Issues Multiple Points-of-Use ( MPU ) Exemption Certificates 1. A handful of states allow purchasers to provide sellers MPU Exemption Certificates when certain requirements are met. For example, in order for the exemption to apply, most states require that the software be transferred or accessed digitally and that the software be used by the customer in multiple jurisdictions. 2. These certificates can be a very effective way for a seller to limit its compliance obligation. A seller that receives the exemption certificate is relieved of its obligation to collect tax on the transaction. Rather, the purchaser is obligated to remit the tax to the state once it determines where the software is used by its employees. 39 Where value is law.

Sourcing Issues Multiple Points-of-Use ( MPU ) Exemption Certificates 1. The following states have some type of MPU exemption: Colorado, Massachusetts, Minnesota (but only after mid- 2013), Ohio and Washington 2. Unfortunately, several states that previously offered the exemption but later repealed it: Indiana, Iowa, Kansas, Kentucky, Nebraska, New Jersey, North Dakota, South Dakota. 3. Some states will still accept the MPU certificates informally. 4. NY accepts information from the purchaser regarding use. 40 Where value is law.

Sourcing Issues Practical advice for sellers 1. Establish policy and procedure for sourcing sales transactions e.g., SSTA sourcing hierarchy 2. Implement a rule for each product (SKU) sold 3. Information, information, information! Identify the best available information for sourcing purposes. 4. Maintain excellent record keeping with respect to exemption certificates. Keep both a hard copy and a digital copy. 41 Where value is law.

Digital Products STREAMLINED SALES TAX UPDATE 2013 Sutherland Asbill & Brennan LLP

Streamlined Digital Products Sourcing Background SSUTA 309, 310, 311 (sourcing) and SSUTA 332, 333, and Library of Definitions (digital products) Formation of the Digital Products Sourcing Workgroup Issues Location of receipt SSUTA 310 Collecting and maintaining buyer address information Sourcing allocation Origin sourcing 43 2013 Sutherland Asbill & Brennan LLP

Streamlined (cont d) Options for the Workgroup: 1. Develop stand-along Issue Paper; or 2. Develop Issue Paper with Interpretive Rule Draft Issue Paper available on www.streamlinedsalestax.org 44 2013 Sutherland Asbill & Brennan LLP

Digital Products STATE-BY-STATE LEGISLATIVE AND REGULATORY UPDATE 2013 Sutherland Asbill & Brennan LLP

Digital Products LEGISLATIVE UPDATE 2013 Sutherland Asbill & Brennan LLP

Maine Legislation Explained as a codification of existing administrative practice, Maine enacted legislation that imposes sales tax on products transferred electronically. See MRS 36 1752(9-E), 1811 (eff. 6/23/2013). Products transferred electronically means a digital product transferred to the purchaser electronically the sale of which in nondigital physical form would be subject to tax under this Part as a sale of tangible personal property. 47 2013 Sutherland Asbill & Brennan LLP

Maine (cont d) Sourcing Rules A product transferred electronically is sold in this State if: the product is delivered electronically to a purchaser located in this State, the product is received by the purchaser at the seller s location in this State, a Maine billing address is provided by the purchaser in connection with the transaction or a Maine billing address is indicated in the seller s business records 48 2013 Sutherland Asbill & Brennan LLP

Minnesota Legislation Minnesota imposes sales or use tax on specified digital products or other digital products. Minn. Stat. 297A.61, Subd. 3(l) (eff. 6/30/2013); see also Minnesota Sales Tax Fact Sheet No. 177, 07/01/2013. Tax applies to sales of specified digital products or other digital products to an end user with rights of permanent use (downloaded) or less than permanent use (streaming), and regardless of whether rights or use are conditioned upon payment by the purchaser is a taxable retail sale (subscriptions). Minn. Stat. 297A.61, Subd. 4(o). 50 2013 Sutherland Asbill & Brennan LLP

Minnesota (cont d) Digital Codes Minnesota follows the Streamlined Sales and Use Tax Agreement s rules related to digital codes. Digital code means a code which provides a purchaser with a right to obtain one or more specified digital products or other digital products. A digital code may be transferred electronically (e-mail) or it may be transferred on a tangible medium (plastic card). Minn. Stat. 297A.61, Subd. 53. When a digital code has been purchased that relates to specified digital products or other digital products, tax applies at the time of purchase of the code not the subsequent receipt of or access to the related specified digital products or other digital products is not a retail sale. Minn. Stat. 297A.61, Subd. 4(o). 51 2013 Sutherland Asbill & Brennan LLP

Minnesota (cont d) A digital code is not a code that represents a stored monetary value that is deducted from a total as it is used by the purchaser, and it is not a code that represents a redeemable card, gift card, or gift certificate that entitles the holder to select a digital product of an indicated cash value. The end user of a digital code is any purchaser except one who receives the contractual right to redistribute a digital product which is the subject of the transaction. Minn. Stat. 297A.61, Subd. 53. 52 2013 Sutherland Asbill & Brennan LLP

Minnesota (cont d) Digital audiovisual works means a series of related images which, when shown in succession, impart an impression of motion, together with accompanying sounds, if any, that are transferred electronically. Digital audiovisual works includes such items as motion pictures, movies, musical videos, news and entertainment, and live events. Digital audiovisual works does not include video greeting cards sent by electronic mail. Unless the context provides otherwise, in the sales and use tax law audiovisual works includes the digital code, or a subscription to or access to a digital code, for receiving, accessing, or otherwise obtaining digital audiovisual works. Minn. Stat. 297A.61, Subd. 51. 53 2013 Sutherland Asbill & Brennan LLP

Minnesota (cont d) Digital books means any literary works, other than digital audiovisual works or digital audio works, expressed in words, numbers, or other verbal or numerical symbols or indicia so long as the product is generally recognized in the ordinary and usual sense as a book. It includes works of fiction and nonfiction and short stories. It does not include periodicals, magazines, newspapers, or other news or information products, chat rooms, or weblogs. Unless the context provides otherwise, in the sales and use tax law digital books includes the digital code, or a subscription to or access to a digital code, for receiving, accessing, or otherwise obtaining digital books. Minn. Stat. 297A.61, Subd. 52. 54 2013 Sutherland Asbill & Brennan LLP

Minnesota (cont d) Definitions In general, Minnesota adopts the Streamlined Sales and Use Tax Agreement s specified digital products definitions, but with more specificity, and separately defines other digital products in a unique manner. Specified digital products means digital audio works, digital audiovisual works, and digital books that are transferred electronically to a customer. Minn. Stat. 297A.61, Subd. 55. Other digital products means the following items when transferred electronically: (1) greeting cards; and (2) online video or electronic games. Minn. Stat. 297A.61, Subd. 54. 55 2013 Sutherland Asbill & Brennan LLP

Minnesota (cont d) Digital audio works means works that result from a fixation of a series of musical, spoken, or other sounds, that are transferred electronically. Digital audio works includes such items as the following, which may either be prerecorded or live: songs, music, readings of books or other written materials, speeches, ring tones, or other sound recordings. Digital audio works does not include audio greeting cards sent by electronic mail. Unless the context provides otherwise, in the sales and use tax law, digital audio works includes the digital code, or a subscription to or access to a digital code, for receiving, accessing, or otherwise obtaining digital audio works. Minn. Stat. 297A.61, Subd. 50. 56 2013 Sutherland Asbill & Brennan LLP

Ohio Legislation Ohio will impose sales or use tax on specified digital products. See ORC 5739.01(B)(12) (eff. 1/1/2014). Tax applies when a specified digital product is provided for permanent (downloaded) or less than permanent use (streaming), and regardless of whether continued payments are required (subscriptions). 57 2013 Sutherland Asbill & Brennan LLP

Ohio (cont d) 58 As a full member in the Streamlined Sales and Use Tax Agreement, Ohio adopted the Agreement s specified digital products definitions and operating rules. See ORC 5739.01(B)(12) (QQQ). Note Ohio does not statutorily define digital code, but in order to remain compliant with the Agreement, Ohio will be required to follow the rules in Section 332 related to the purchase such codes. Specified digital product means an electronically transferred digital audiovisual work, digital audio work, or digital book. Electronically transferred means obtained by the purchaser by means other than tangible storage media. 2013 Sutherland Asbill & Brennan LLP

Ohio (cont d) Digital audiovisual work means a series of related images that, when shown in succession, impart an impression of motion, together with accompanying sounds, if any. Digital audio work means a work that results from the fixation of a series of musical, spoken, or other sounds, including digitized sound files that are downloaded onto a device and that may be used to alert the customer with respect to a communication. Digital book means a work that is generally recognized in the ordinary and usual sense as a book. 59 2013 Sutherland Asbill & Brennan LLP

Massachusetts Repeal Less than two months after enacting a tax on computer design and software services (eff. 7/31/2013), Massachusetts repealed the new tax with the passage of HB 3662 (eff. 9/27/2013). Computer system design services were defined as the planning, consulting, or designing of computer systems that integrate computer hardware, software, or communication technologies and are provided by a vendor or a third party. MA also briefly taxed other software-related services including: the modification, integration, enhancement, installation or configuration of standardized software, but excluding data access, data processing or information management services. Mass. St. 2013 c. 46; Mass. G.L. c. 63 38(f), c. 64H 1. 60 2013 Sutherland Asbill & Brennan LLP

Massachusetts (cont d) Under HB 3662, a taxpayer that collected and remitted the software tax to the DOR may claim a refund for the full amount paid by filing an application for abatement by 12/31/2013. A taxpayer must refund all relevant amounts to its customers within 30 days of receiving the refund. A taxpayer who previously collected but did not remit such funds to the DOR must make reasonable efforts to refund such amounts to its customers. 61 2013 Sutherland Asbill & Brennan LLP

New York State Proposal Draft tax reform legislation under consideration by Governor Cuomo (drafted by the Department of Taxation and Finance) includes the impose of sales and use tax on the sale of, license to use, or granting of remote access to digital products in the state, according to hierarchical sourcing rules. 62 2013 Sutherland Asbill & Brennan LLP

New York State Proposal (cont d) Draft defines digital product as any property or service, or combination thereof, of whatever nature delivered to the purchaser through the use of wire, cable, fiber-optic, laser, microwave, radio wave, satellite or similar successor media, or any combination thereof [including] an audio work, audiovisual work, visual work, book or literary work, graphic work, game, information or entertainment service, storage of digital products and computer software by whatever means delivered. 63 2013 Sutherland Asbill & Brennan LLP

Digital Products ADMINISTRATIVE GUIDANCE AND LITIGATION UPDATE 2013 Sutherland Asbill & Brennan LLP

New Jersey Technical Bulletin The Division of Taxation issued a technical bulletin that confirmed the state does not tax sales of cloud computing services including SaaS, PaaS, and IaaS. New Jersey Division of Taxation Technical Bulletin TB-72 (July 3, 2013). The Division explained: SaaS retailers provide customers with access to software through remote means; PaaS retailers provide customers with computing platforms through remote means; and IaaS retailers provide customers with equipment and services necessary to support and manage the customer s content and dataflow through remote means. 66 2013 Sutherland Asbill & Brennan LLP

New Jersey (cont d) The Division stated that SaaS, PaaS, and IaaS do fit not within the definition of tangible personal property (which includes computer software ) because the retailer does not transfer any software to its customers. Further, New Jersey does not enumerate SaaS, PaaS, or IaaS as taxable services. 67 2013 Sutherland Asbill & Brennan LLP

Arizona The AZ DOR determined that a taxpayer providing online backup and restoration services was subject to transaction privilege tax (TPT) because the services were taxable rentals of prewritten software. Ariz. Priv. Ltr. Rul. No. LR 13-002 (Mar. 25, 2013). Notably, the Department did not undertake a true object analysis to examine whether or not the software conduit was de minimis compared to the overall backup service. 68 2013 Sutherland Asbill & Brennan LLP

Minnesota Tax Court Decision The MN Tax Court held that computer software consulting and implementation services were not subject to sales tax. SAP Retail, Inc. v. Comm r of Revenue, No. 8345-R (Minn. Tax Ct. Sept. 19, 2013). The taxpayer licensed enterprise resource planning software. It also provided consultation and implementation services to configure the software to a customer s particular business activities. The court recognized that consulting and implementation services were not specifically enumerated as taxable services. 69 2013 Sutherland Asbill & Brennan LLP

Minnesota (cont d) The taxpayer s services did not constitute taxable fabrication services because the consumers of the services did not furnish materials used to create the software. Further, the Tax Court found that the services were not part of the taxable software license fee because (1) they were provided pursuant to a separate agreement and, even if sold as a package, were separately itemized, and (2) the services were not necessary to complete the sale of a software license that could be purchased without the services and vice versa. 70 2013 Sutherland Asbill & Brennan LLP

Tennessee Letter Ruling The TN DOR determined that a taxpayer s sale of remote storage services and virtual computing services are not subject to sales or use tax where the data centers and servers used to provide such services are located outside the state. Tennessee Letter Ruling 13-12 (Sept. 12, 2013). The DOR determined neither service was subject to Tennessee sales and use tax because there was no sale, transfer or electronic delivery of tangible personal property or computer software in Tennessee in connection with the furnishing of these services. The DOR noted that the taxpayer prohibited customers from downloading any part of its remote storage interface or its virtual computing software. 71 2013 Sutherland Asbill & Brennan LLP

Tennessee (cont d) The DOR determined that the primary purpose of the remote storage service was the remote storage of digital data, applications and information, and the primary purpose of the virtual computing service was to access processed data or information stored on the taxpayer s servers located outside the state. Accordingly, the DOR categorized both services as data processing and information services, which are specifically excluded from the definition of telecommunications services. 72 2013 Sutherland Asbill & Brennan LLP

Missouri Letter Rulings The MO DOR has recently issued to notable letter rulings. In the first ruling, the DOR determined that a company s telecommunications services provided to customers on its cloud computer network are subject to sales tax. L.R. 7248, Mo. Dept. of Rev. (May 24, 2013). The company hosted its cloud network on servers located outside of MO, and customers accessed the network through public telecommunications lines and through the customers internal network; customers separately purchased the necessary hardware and Internet access. Services provided to customers through the cloud network include voice, video, messaging, and conferencing. 73 2013 Sutherland Asbill & Brennan LLP

Missouri (cont d) The DOR determined that the company is providing taxable telecommunication services because it transmits information through its services that direct and control its customers hardware and because it stores messages on its server, which are taxable events in Missouri. The DOR also noted that customers would not be able to use their equipment without the company s software and hosting unless the customer was willing to engage another telecommunications company or built its own in-house system. 74 2013 Sutherland Asbill & Brennan LLP

Missouri (cont d) In the second notable MO ruling, the DOR ruled that a telecommunications services provider that employs VoIP technologies may use a customer s registration IP address for sourcing purposes in determining the applicable sales tax rate on sales of its subscription-based and prepaid credit telecommunication services since the service is delivered to the customer at the time payment is remitted. L.R. No. 7314, Mo. Dept. of Rev. (Nov. 4, 2013). 75 2013 Sutherland Asbill & Brennan LLP

Missouri (cont d) Further, the service provider s presentation of applicable sales tax to customers on the sale of its services is in compliance with MO sales tax law. The provider does not itemize tax on the statement but instead notifies the customer on an online invoice that taxes are included in the price of each of its offered telecommunications services and directs the customer, at the customer s option, to view and examine a table listing such taxes. The provider also separately accounts for sales tax collected in its books and records. 76 2013 Sutherland Asbill & Brennan LLP

Illinois Supreme Court ITFA Decision In a 6-1 decision, the Illinois Supreme Court affirmed an Illinois Circuit Court holding that Illinois Public Act 96-1544 (The Click-Through Nexus Act), requiring out-of-state retailers to collect and remit use tax, violates the Internet Tax Freedom Act. Performance Marketing Ass n v. Hamer, Docket No. 114496 (Oct. 18, 2013). PMA is the most significant application of ITFA s prohibition against multiple or discriminatory taxes on electronic commerce (Section 1101(a)(2)), which may have implications with respect to taxes on digital products. 77 2013 Sutherland Asbill & Brennan LLP

Sales and Use Tax for Digital Products and Services Compliance Issues Where value is law. Joseph N. Endres, Esq. Hodgson Russ LLP 140 Pearl Street, Suite 100 Buffalo, New York 14202 Phone: (716) 848-1504 Fax: (716) 819-4711 jendres@hodgsonruss.com 2013 Hodgson Russ LLP www.hodgsonruss.com Doc. # 11629792

Compliance Issues Define the Product Appropriately E.g., Tax Preparation Services Primary Purpose Test Speak with One Voice 1. Make sure the following items all define the product consistently: Contracts Invoices Marketing brochures Website material 79 Where value is law.

Compliance Issues Frequently, a company s sales tax obligations are complicated by the manner in which its products are sold. For example, when the company sells multiple products or deliverables (some taxable and some exempt) its sales tax liability can unnecessarily increase if the transaction is not billed properly. New York s Cheeseboard Rule: When taxable and exempt items are bundled into a single price, the entire charge can be subject to sales tax. See 20 NYCRR 527.1 If multiple products are sold (some taxable and some exempt), the company must be able to track the different revenue streams. Sales tax audits are always more difficult and problematic if you don t have good records detailing the transactions at issue. 80 Where value is law.

Compliance Issues In order to minimize potential sales tax exposure, a company must know the sales tax rules in effect in the jurisdictions where it is obligated to collect the tax. Simple changes in transaction structure can greatly reduce tax liability EXAMPLE: A business in New York State maintains a catalog of stock photos that various magazines and other publications frequently purchase in order to reproduce. 1. If the photo is sold in hard copy to a New York customer, then the sale constitutes a taxable sale of tangible personal property. 2. If, however, the photo is transferred electronically via e-mail or download from a Web site, the sale is not subject to tax, because New York does not tax digital products such as photos, music, movies, etc. 3. What if the seller also provided access to software through its Web site that allowed the purchaser to manipulate the digital photo? Then, the transaction is probably taxable. This demonstrates the need to separately state the taxable charge for the software from the non-taxable charge for the photograph. 81 Where value is law.

Thank You Joseph N. Endres, Esq. Hodgson Russ LLP 140 Pearl Street, Suite 100 Buffalo, NY 14202 Phone: (716) 848-1504 Fax: (716) 819-4711 jendres@hodgsonruss.com 82 Where value is law.