|June 24, 2014|
Previously published on June 19, 2014
On May 13, 2014, the Michigan Court of Appeals rendered an opinion of significance to businesses in the database subscription industry, and to a somewhat lesser extent, the software industry (Thompson Reuters Inc. v. Dept. of Treasury, No. 90-345 (Mich. Ct. App. May 13, 2014)). Thompson analyzed the proper treatment of sales of subscriptions to an information service for use (and, by analogy, sales) tax purposes.
Factual summary and procedural background
The plaintiff, Thompson Reuters Inc. (“Thompson”), sold information products during the relevant period. These products included CD-ROM computer software and online-research products and tools. At issue was one of these products named Checkpoint. Checkpoint is an online tax and accounting research program that provides subscribers access to information. Subscribers of Checkpoint can search and retrieve up-to-date sources, browse compiled topical information, and click on links between sources. Access to the information on Checkpoint can be accessed through a web browser.
In 2009, the defendant, the Michigan Department of Treasury (the “Department”), conducted an audit of Thompson’s business for the period April 2004 through December 2007. The Department assessed Thompson a use tax deficiency of $814,260, inclusive of interest, as a result of this audit. The Department determined that Thompson’s sale of Checkpoint subscriptions constituted the sale of taxable “prewritten computer software.”
Thompson disputed the assessment in the Michigan Court of Claims. The Court of Claims granted the Department’s motion for summary disposition. The Court of Claims reasoned that this case involved an evolution of services and because this product was taxable when it was sold in book or CD format, it remained taxable. The Court of Claims further held that the primary object in selling subscriptions was the sale of tangible personal property because what the customers wanted was “information,” which was “tangible personal property.” Thompson appealed the Court of Claims’ decision to the Court of Appeals (the “Appeals Court”).
Appeals Court analysis
The Appeals Court reviewed the Court of Claims’ decision granting summary disposition de novo (i.e., anew or considering the action for the first time without deference to the Court of Claims).
Under the Michigan Use Tax Act (UTA), use tax is generally imposed on the privilege of “using, storing, or consuming tangible personal property and is complimentary to the Michigan General Sales Tax Act, as it is designed to cover those transactions not subject to sales tax. As such, the taxes are mutually exclusive but complimentary and designed to assess an equal tax based on the purchase price of underlying property. Generally, use tax applies to tangible personal property, not to services, in Michigan. The UTA defines “tangible personal property” to include “prewritten computer software.” Computer software, under the UTA, is “a set of coded instructions designed to cause a computer or automatic data processing equipment to perform a task.”
However, there are times when a transaction involves the transfer of both tangible personal property and service. In such cases, the Michigan Supreme Court has adopted the “incidental to service test,” which is an evaluation of the entire transaction “to determine whether the transaction is principally a transfer of tangible personal property or a provision of a service." Catalina Mktg. Sales Corp. v. Dep't of Treasury, 470 Mich. 13, 24-25 (2004). In Thompson, the Appeals Court determined that any transfer of tangible personal property was incidental to the service. It reached this determination based on a number of factors, including:
Checkpoint subscribers sought access to up-to-date information relevant to their needs
Thompson’s clients sought the expert knowledge of Checkpoint’s content creators in synthesizing, compiling and organizing the materials, rendering their research more efficient
There was no evidence that even a 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 Checkpoint license agreement entitles users to access and use the Checkpoint program
Thompson holding and concluding thoughts
The Appeals Court ultimately found in favor of Thompson, as it determined the sale of subscriptions to Checkpoint (the transactions at issue), were primarily the provision of a service and not the transfer of tangible personal property. Therefore, the Appeals Court determined, the assessment of use tax on Thompson was improper.
One of the takeaways from this case is that it can be extremely valuable to involve tax counsel from an early stage in any tax case. Competent counsel can suggest an array of solutions, assist you in evaluating the costs and benefits of litigation, and craft a solution that fits your factual situation and needs.
In general, it remains the “wild west” on many matters of electronic commerce in the state tax arena, not to mention electronic subscription services specifically. Therefore, while a state tax department may have solidified its position on a particular matter, that position may not always be the correct or appropriate one.