After years of contemplation, the Illinois Department of Revenue (“Department”) has finally issued some guidance regarding the taxability of Software as a Service (“SaaS”).
For over a decade, the Department has declined to rule on whether transactions involving computer software Application Software Providers (“ASPs”), software hosting, and web-based software is subject to Illinois’ Retailer’s Occupation Tax (“ROT). See Ill. GL ST 06-0116 (05/16/2006); Ill. GIL ST 09-0057 (04/02/2009); Ill. GIL ST 10-0103 (10/29/2010); Ill. GIL ST 13-0049 (9/11/2013). The Department has previously explained that it believes that the “proper forum for providing guidance regarding transactions involving computer software ASP's, software hosting, and web-based software is through a formal administrative rulemaking process rather than through individual inquires such as letter ruling requests” and that it was in the process of researching the nature and type of services and products provided by these types of providers, including discussions with industry participants and intended to adopt regulations once its review was complete. Ill. GIL ST 10-0103 (10/29/2010); Ill. GIL ST 13-0049 (9/11/2013).
The Department has finally issued ST 16-0038-GIL (8/18/2016), regarding the application of ROT to SaaS. According to the Department, “a provider of software as a service is acting as a serviceman. If the provider does not transfer any tangible personal property to the customer, then the transaction generally would not be subject to Retailers’ Occupation Tax, Use Tax, Service Occupation Tax, or Service Use Tax. If the provider transfers to the customer an API, applet, desktop agent, or a remote access agent to enable the customer to access the provider’s network and services, it appears the subscriber is receiving computer software that is subject to tax.” The Department further explained that “although there may not be a separate charge to the customer for the computer software, it is nonetheless subject to tax, unless the transfer qualifies as a nontaxable license of computer software. If the provider, as a serviceman, is not otherwise required to be registered under Section 2a of the Retailers’ Occupation Tax Act and qualifies as a de minimis serviceman, the provider could elect to pay Use Tax on its cost price of the computer software.” See also ST 16-0034-GIL (8//17/2016) (the Department ruled that a service provider’s online sales of web collaboration software was not subject to tax because the computer software was provided through a cloud-based system, in which computer software was never downloaded onto a client’s computer and only accessed remotely).
In contrast, in ST 16-0035-GIL (8/17/2016), the taxpayer provided web based software tools for marketing, analytics, and search engine optimization on a subscription basis to its customer with a downloadable API as part of the services. The Department ruled that a service provider’s online sales of web-based software tools would be subject to ROT because its customers received a downloadable application program interface (“API”) as part of the service. The Department explained that sales of computer software provided through a cloud based delivery system, in which the computer software is downloaded onto a client’s computer, is taxable. Under Illinois law, “computer software” includes an API, applet, desktop agent or a remote access agent.
Therefore, based on the Department’s guidance, if no software is downloaded by the customer then the SaaS transaction is not subject to ROT. However, if software is downloaded by the customer: (1) Illinois’ five-part test under Ill. Admin. Code 130.1935(a)(1) should be applied to determine whether the license of software is a taxable retail sale; or (2) determine if the taxpayer qualifies as a de minimis serviceman. If the license of software does not meet all the requirements of Illinois’ five-part test (i.e., the software is a taxable retail sale) or the taxpayer does not qualify as a de minimis serviceman, then Department will deem the transaction subject to ROT.
The Department’s decision to finally issue some guidance regarding the taxability of SaaS cannot have come at a better time, especially in light of the City of Chicago’s efforts to tax SaaS. In addition, with the rise of class action and qui tam lawsuits across the nation (and especially in Illinois), taxpayers will welcome the guidance and an end to a decade of uncertainty. The Department’s next step should be to work with industry experts and taxpayers to promulgate comprehensive regulations regarding the taxability of cloud services.
Other recent “Cloud, Software & Digital Tax” posts by Carolynn Iafrate Kranz:
- SaaS Taxable in Rhode Island October 1, 2018
- Texas SaaS: Text & Messaging are Taxable Data Processing Service
- SaaS Characterized as Taxable Telecommunications Service
- Pennsylvania Tax on Software Support Services: Ruling Re-issued
- Illinois Finally Rules on SaaS