Businesses that purchase or sell software, cloud computing resources or digital information services face a host of challenges when it comes to sales/use tax compliance. The potential for unforeseen tax liability will only increase over time as software products and services become even more intricate and prevalent in the business world.
Vendors and providers of consumer products and services know the basic rules for sales tax but in the case of software and related services, the rules can be trickier.
Let’s start with the basics: most jurisdictions impose sales tax on the purchase of canned computer software, while customized software, on the other hand, is generally considered to be a nontaxable service. However, if customized software is sold to another customer who did not request the customization or if customized software is combined with other software, then the purchase may in fact be taxable.
The method of delivery of the software also adds a complication to determining taxability. In New Jersey, electronically-delivered software used in a business is not taxable provided no tangible media is received. New York and Pennsylvania do not have a similar exemption; those states impose tax on all purchases of canned software regardless of the method of delivery — whether in tangible form, a license, or even a software-as-a-service platform (SAAS).
SAAS presents another tricky situation because providers sell access to their software which is stored in the cloud or on the provider’s servers. New York and Pennsylvania treat SAAS as having the actual software or its source code on a user’s hardware. New Jersey, however, has issued guidance that accessing software is not treated as a sale of software. Similarly, accessing or streaming digital files or images is not taxable in New Jersey.
Because software is considered tangible personal property, many services provided in conjunction with the software are taxable, but this does not generally include remote help-desk support or training. Upgrades and updates of software generally receive the same treatment as the sale of the original software.
Another complex area that frequently comes up in the software context is the sale of information services. New Jersey and New York explicitly treat information services as being taxable, but not when the service involves data or information that is confidential or proprietary in nature. It is often difficult to distinguish between a taxable information service and a non-taxable specialized or particular report. Pennsylvania, on the other hand, does not explicitly tax information services, but will tax information retrieval services that use software or a SAAS platform to access the requested information.
As you can see, sales and use tax rules for software and digital services can be quite complex, even when considering only three states. The rules for sourcing these sales to specific taxing jurisdictions are even trickier. As such, it is imperative for your sales/use tax compliance staff or tax advisors to understand these concepts in the event a sales/use tax compliance issue or dispute arises—or better yet, before any more sales are rung up.
|Canned Software – Tangible Media||T||T||T|
|Canned Software – Electronic Delivery||T||T||T|
|Canned Software – Electronic Delivery, Used in Business||NT||T||T|
|Software Licenses – No Tangible Media, Used in Business||NT||T||T|
|Software Licenses – Tangible Media||T||T||T|
|Upgrades and Updates via Tangible Media||T||T||T|
|Upgrades and Updates – Electronic Delivery, Used in Business||NT||T||T|
|Customized Software Sold to Different Customer||T||T||T|
|Software Installation via Disk||T||NT||T|
|Software Installation – Electronic||NT||NT||T|
|Services to Maintain Software Compatibility||T||NT||T|
|SAAS w/ Remote Agent Installed||NT||T||T|
|Information Service – Data Retrieval Using Software||T||T||T|
|Streaming of Digital Products||NT||T||T|
|T = Taxable|
|NT = Not Taxable|