|January 3, 2014|
Previously published on December 19, 2013
Due to the rapid advancements in technology and software-related products, states and sellers are struggling to properly determine whether the sale is considered a sale of software-related products that are taxable sales of pre-written software or a sale of software-related products that are non-taxable sales of services, which may involve incidental use of pre-written software. The Massachusetts Department of Revenue (“Department”) has recently provided updated guidance (LR 12-8) on the application of Massachusetts sales and use tax to cloud computing services in response to a recent letter ruling request.
The company requesting the letter ruling sells “Cloud Computing” products to customers. These products allow customers to access computing resources and storage capacity through the Internet without a significant hardware or software outlay. In order to use such Cloud Computing products, the customers must either: (1) use their own operating system software or open-source operating system software; or (2) use designated third-party operating system software that the company has licensed from a third party. For option two, the software is not downloaded or transferred to the customer and there is no contractual sublicensing of the software to the customer.
The company provides a few bundled pricing options for the Cloud Computing products. There is no specific charge for utilizing the company’s designated third-party software (option two), but the bundled prices for the Cloud Computing products utilizing such software are higher than if the customer utilized its own software or open-source software.
The company also separately sells “Remote Storage Services,” which allow customers to store, retrieve and maintain content, data, applications and software on the company’s servers. Customers purchasing the Remote Storage Services do not use any software provided by the company. Pricing is based on storage capacity and the amount of data uploaded or downloaded.
The Department explained that where both non-taxable services and the right to use software are bundled in one transaction, the Commissioner will apply an “object of the transaction” test. If the object of the transaction is the purchase or use of the software, then the transaction is taxable. If the object of the transaction is a non-taxable service, and any use or access to pre-written software is incidental to the service, then the entire transaction will be non-taxable.
The Department determined that sales of Cloud Computing products are non-taxable, even if the customer utilizes the company’s licensed third-party operating software. The Department determined that the object of the transaction is access to the company’s computing resources and storage capacity, and the provision of any third-party operating software is incidental to the transaction because the operating system merely facilitates the customer’s use of the company’s computing resources and storage capacity. However, the Department noted that the company is liable for use tax on the share of the cost of the pre-written operating software that it uses in the provision of the non-taxable services to customers in Massachusetts.
The Department determined that the sale of the Remote Storage Services were also a non-taxable service, even though such services involve the lease of the company’s hardware to store and back-up the customers’ information. In this case, the transaction is non-taxable because the customer does not operate, direct or control the computer hardware.
The Department went on to explain that in general, the sales of cloud computing services and software services are taxable sales of pre-written software, unless: (1) the customer is only acquiring computing resources or storage capacity services as opposed to the right to use the software; or (2) the non-taxable computing resources or storage capacity services are bundled with the provision of pre-written operating software that is incidental to the provision of such services.