While a number of state taxing authorities have taken the position through administrative rulings and policy pronouncements that cloud based services involving remotely accessed software constitutes the sale of prewritten computer software, Michigan courts have rejected the Michigan Department of Treasury’s classification of cloud transactions as the taxable sale of prewritten computer software. In Thomas Reuters, Inc. v. Department of Treasury, No. 313825 (Mich. Ct. App. 5/13/2014) (unpublished), the Court of Appeals reversed the ruling of the Court of Claims and held that access to Checkpoint, an online tax and accounting research tool, did not constitute the sale of taxable prewritten computer software, but rather, constituted the provision of a nontaxable service.
The Court of Claims had reasoned that the case "involved an evolution of services, and because this product was taxable when it was in book or CD format, it was taxable now.” The Court of Appeals found the lower court’s reasoning “unpersuasive.” Applying the “incidental to service test,” the Court of Appeals concluded that “any transfer of tangible personal property was incidental to the service provided. . . . Customers sought the expert knowledge of Checkpoint’s content creators in synthesizing, compiling, and organizing the materials, thereby rendering research more efficient. There is no evidence that any de minimus amount of software transferred was the object of the transaction, or that customers sought to own or otherwise have responsibility for the prewritten computer software." The Court of Appeals also noted that the fact that the license agreement entitles users to access and use Checkpoint program does not establish that users primarily sought the physical software.
The Thomas Reuters, Inc. decision follows on the heels of the Michigan Court of Claims decision in Auto-Owners Insurance Co. v. Department of Treasury, Case No. 12-000082-MT (3/20/2014), in which the Court of Claims similarly held that an insurance company's access to a third party's software via the Internet was not subject to the state's use tax as a use of pre-written computer software. Rather, the court determined that the software-as-a-service transactions were properly characterized as a nontaxable service under the statute. In Auto-Owners Insurance, Co., the Court of Claims ruled that mere access to the property did not constitute use because the taxpayer had not "exercised a right or power incident to ownership in the underlying software." In addition, the court noted that even if the pre-written software was delivered to and was used by the taxpayer, under the statute, that use was exempt from taxation because it was "merely incidental to the services rendered by the third-party providers and would not subject the overall transactions to use tax."
The Michigan decisions along with the New York Division of Tax Appeals decision In Re SunGard Securities Finance LLC, DTA No. 824336 (2/12/2014) (see prior blog, "NY Appeal - ASP is Not Software"), indicate that courts are rejecting the taxing authority’s policy of classifying cloud transactions as the taxable sale of prewritten computer software and instead properly concluding that such services constitute the nontaxable sale of services. These decisions provide additional guidance to taxpayers seeking to challenge the aggressive positions taken by taxing authorities with regard to cloud computing services.
Other recent “Cloud, Software & Digital Tax” posts by Carolynn Iafrate Kranz:
- SaaS Characterized as Taxable Telecommunications Service
- Pennsylvania Tax on Software Support Services: Ruling Re-issued
- Illinois Finally Rules on SaaS
- Tennessee’s Situsing of Accessed Software Runs Afoul
- Chicago Taxes the Cloud