11.05.10

Software and Technology Company Sales Tax Issues

by Michael Fletcher

Are you a software or technology company that licenses software or provides services electronically? Do you have employees located in various states throughout the country? If you answered yes to these questions, you may have a sales tax exposure or a compliance obligation even if your customers never purchase a product in tangible form. You should ask yourself the following three fundamental questions: (1) whether your sales are taxable; (2) if your sales are taxable, whether there is an applicable exemption from tax; and (3) if your sales are not taxable, whether you still have a compliance obligation in the state?

For sales and use tax purposes, having employees or any other form of physical presence in a state creates nexus (i.e., a connection to a state), subjecting you to that state’s taxing jurisdiction. Once nexus is established, the threshold question is whether your products and services are taxable. Generally, states tax the sale of tangible personal property and certain enumerated services. Also, it is common for most states to tax the sale of prewritten or “canned” software while exempting the sale of customized software. However, the application of taxing rules to companies that create and license software and provide services varies greatly depending on the jurisdiction and the nature of the sales transaction. For example, some states, such as California, Illinois, and Massachusetts do not impose tax on the sale of services such as on-line subscription access, data processing, or information services if no tangible personal property is transferred. Conversely, states such as New Jersey, New York, and South Carolina impose tax on such services.

If your sales are subject to taxation, you should evaluate whether an exemption may apply. A common exemption is provided for resale transactions in many states. Some states such as Massachusetts, New York, and Pennsylvania provide an exemption for sales to certain non-profit organizations. However, the scope of this exemption varies depending on the state and may be limited to specific types of non-profit entities. Also, states such as California and Virginia provide an exemption for software that is delivered electronically while other states, including Illinois and Massachusetts, tax software regardless of the method of delivery.

Even if your sales are not taxable, you may still have a compliance obligation. For example, in many states, registration is required for a seller to accept an exemption certificate furnished by a purchaser (e.g., an exempt non-profit organization). Additionally, some states such as Florida and Virginia require the filing of a sales tax return by sellers who are registered with the state even though the seller is not liable to remit any tax for the period covered by the return.

The foregoing discussion provides a broad overview of some of the significant issues affecting software and technology companies. While there are general sales tax rules that may apply, each state has its own unique set of rules and your company must analyze its distinctive facts under the law of each individual state to assess the level of sales tax exposure.

For more information, please contact our State and Local Tax Team Leader, Michael Fletcher, at mfletcher@argy.com or 703.770.0533.

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