Are you curious if you need to be paying taxes on or charging your customers sales tax on your sales of these revenue streams: Software-as-a-Service (SaaS), cloud computing and electronically downloaded software? The answer is, maybe. Because these three areas are defined differently by each state, it’s important to understand how each state’s tax codes approaches them.

Being aware of the tax ramifications in any state your company has established nexus is incredibly important, especially considering the Wayfair decision from earlier this summer. While the U.S. Supreme Court’s decision may seem like it was only directed at online sellers, the truth is that multi-state sellers (such as those generating revenue from SaaS and software) are also affected. Because of the ruling, it will be even easier to establish nexus in more states across the country; companies need to know which taxes they’re responsible for in regards to SaaS, cloud computing and electronically downloaded software.

Today is the final post in our series about the taxability of cloud computing and electronically downloaded software! We’ve been looking region-by-region, so today we finish up with three states in the Northeast: Massachusetts, New York and Pennsylvania.

Want to know about other states across the country? Read our previous posts for helpful details!

• Western States: California, Utah, Washington
• Southwestern States: Colorado, New Mexico, Texas
• Southeastern States: Florida, Georgia, South Carolina
• Midwestern States: Illinois, Indiana, Ohio

SaaS and Cloud Computing Rules in Northeastern States

Massachusetts: Taxable

Both SaaS and cloud computing are generally subject to sales and use tax in Massachusetts.

The sale, license, lease, or other transfer of a right to use software on a server hosted by a business or a third-party is generally taxable; Massachusetts has previously referenced the access of software from a hosted server as SaaS.

A company’s cloud computing sales that use either of the following do not involve taxable sales of prewritten software, and thus are not taxable when sold to customers in the state:

• A customer’s own software (not purchased from the company)
• Open-source (free) software available on the internet

However, a company’s cloud computing sales that include software licensed by the company aretaxable when sold to customers in Massachusetts, whether or not there is a separately stated charge for the software and whether or not there is a sub-license of the software to the customer, because the object of the transaction is acquiring the right to use the software.

New York: Taxable

Selling a New Yorker a license to remotely access prewritten software is subject to tax and the sale is sourced to the jurisdiction in which the purchaser uses or directs the use of the software. This applies to SaaS as well as cloud-based services.

The Department of Taxation and Finance decided that if a purchaser remotely accesses software over the internet, possession of the software transfers to the purchaser because he or she gains constructive possession and the right to use or control the software. As a result, selling a license to remotely access software is subject to tax and the sale is sourced to the jurisdiction in which the purchaser uses or directs the use of the software.

Pennsylvania: Taxable

Cloud computing in the form of SaaS is subject to the state’s sales and use tax if the user is located in Pennsylvania.

The taxability of remote access to software in Pennsylvania depends on the location of the user. If the user is accessing the software from within the state, the transaction is subject to tax. If the user is accessing the software from an out-of-state location, the transaction is not subject to tax, even if the server resides in Pennsylvania.

The Department of Revenue determined that because computer software is tangible personal property, the charge for electronically accessing taxable software is taxable if the user is accessing the software from within Pennsylvania. In accessing taxable software, the user is exercising a license to use the software, as well as control or power over the software, at the user’s location.

Electronically Downloaded Software Treatment in Northeastern States

Note: For purposes of this blog article, we address the taxability of pre-written or canned software (not custom software), which is delivered electronically. Custom software is exempt in most states, regardless of the method of delivery.

Massachusetts: Taxable

Sales of prewritten computer software, regardless of the method of delivery, are subject to the Massachusetts sales tax.

New York: Taxable

New York imposes sales and use tax on prewritten computer software because the state considers it to be tangible personal property.

Prewritten software that is merely accessed by customers electronically, but not actually transferred to customers, is taxable as a sale of prewritten software. Sales of access to software are considered the transfer of possession. If the customer accesses the software within the state, the sale is sourced to New York, even if the software is stored on a server out-of-state.

Pennsylvania: Taxable

The retail sale or use of canned software (including updates) transferred electronically is subject to Pennsylvania’s sales and use tax laws.

Canned software is considered taxable tangible personal property because it is actually stored on a computer and takes up space on the hard drive. Software licenses are considered licenses to use canned software and constitute tangible personal property, regardless of the method of delivery.

SaaS and Cloud Computing Vs. Electronically Downloaded Software

Massachusetts

SaaS, cloud computing and electronically downloaded software are all taxable in the state because the object of the transaction is acquiring the right to use the software.

New York

In New York, SaaS and cloud computing are considered taxable because they’re selling a license to use or direct the use of the software. Electronically downloaded software is also considered taxable because the state defines it as tangible personal property.

Pennsylvania

When it comes to SaaS and cloud computing, taxability is determined by the user’s location. Pennsylvania’s Department of Revenue considers a license to access the software a tangible, taxable item, just as it defines electronically downloaded software to be tangible and therefore subject to taxes.

Economic Nexus – Proposed Legislation

In light of the recent South Dakota v. Wayfair US Supreme Court case, we expect several states to enact economic nexus standards in the coming weeks and months. We anticipate that states will enact legislation closely resembling the South Dakota statute, which indicates that sales of $100,000 or 200 or more transactions into the state will create nexus and the requirement to collect sales tax in the state.

As of the date of this blog post, New York has not indicated any economic nexus legislation. Pennsylvania had previously enacted a fairly onerous standard earlier this year, which requires online sellers to either collect tax or report on their PA customers for sales in excess of $10,000. Massachusetts does not have an economic nexus statute similar to South Dakota’s, but recently commented that its existing nexus regulation (relating to “cookie” nexus among others) continues to apply and is not impacted by the Court’s decision in Wayfair. This is a particular state that will continue to be in the “watch” column!

Have tax questions? Contact Monika Miles.