Last week, we described the Michigan Department of Treasury’s stance on the taxation of cloud computing, as clarified in its current Treasury Update. We noted that whether a given transaction is subject to Michigan’s 6 percent sales and use tax is a factual determination. However, as a general rule, software which is designed for the exclusive use and special needs of a single purchaser—custom software—is exempt from the sales and use tax, while prewritten computer software, pursuant to a transaction involving a license or subscription fee, delivered by any means, is subject to the 6 percent tax. While there has been litigation regarding what qualifies as a taxable cloud computing service, there have not been any decisions. Now, a recent decision in the case Auto-Owners Insurance v. Department of Treasury may begin to offer some guidance.
Headquartered in Lansing, Michigan, the plaintiff, Auto-Owners Insurance Company (Auto-Owners) provides insurance services through 35,000 independent agents in 26 states. The department conducted an audit involving the four years between Dec. 1, 2006, and Dec. 31, 2010, and determined that there was a basis for tax liability. The department assessed Auto Owners $871,625.24, for taxes due plus interest, as a result of the audit. Auto-Owners paid the assessment, under protest, and filed a complaint with the Court of Claims. That Court of Claims agreed with Auto-Owners that the transactions were not taxable and ordered a refund. The department appealed.
To render its decision, the appellate court considered contracts that Auto-Owners had with third-party companies for various services and organized them into six types:
- Insurance industry specific contracts, including the provision of building valuation data, standardized formats for the flow of information, data confidentiality management systems, motor vehicle records, and electronic notification of coverage.
- Technology and communications contracts, like videoconferencing, webinar, and online meeting services, along with other remote communications services for off-site employees.
- Online research contracts providing for access to insurance-specific laws, filing guidelines, attorneys general opinions, and bulletins.
- Payment remittance and processing support contracts, also including support, maintenance, and training.
- Equipment maintenance and software customer support contracts.
- Marketing and advertising contracts.
The operative issue in the case was whether the “complex and modern computing arrangements” at issue in the contracts were taxable.
Ultimately, the court affirmed the lower court’s determination that the transactions inherent in the contracts were not subject to taxation, disagreeing with the conclusion reached by the department.
The determination was reached, in part, based upon the fact that in many transactions, “the mere transfer of information and data that was processed using the software of the third-party businesses does not constitute delivery by any means of prewritten computer software.”
Even in cases where Auto-Owners did receive “pre-written computer software that was delivered to it,” the court concluded that this was only incidental to the services that the third-party companies provided to Auto-Owners. In the end, the court did not see any indication that Auto-Owners “could purchase the software or other tangible personal property independent of the services, and the services gave value to the software and other tangible personal property.”
The department is not faring well in tax disputes concerning the taxation of cloud-based computing. In two other cases, Rehmann Robson & Co., P.C. v. Dept of Treasury, which was decided on Nov. 26, 2014, and GXS, Inc. v. Dept of Treasury, decided on March 25, 2015, the Court of Claims determined that the transactions at issue were not taxable.
The legislature does not appear inclined to help clarify the matter. Senate Bills 142 and 143, which would have amended the definition of "prewritten computer software" and excluded such transactions from taxation, have been idle since September 2013. Consequently, the department will likely be forced to continue fighting its tax assessments in the courts.