When it comes to Software-as-a-Service (SaaS) companies, there’s often confusion regarding both nexus and the taxability of this revenue stream.
And while the recent Wayfair decision seems like it’s directed only at online sellers, traditional multi-state sellers (including those that generate revenue from SaaS and software) will also be affected, as nexus will be easier to establish. Once it is established – either by traditional physical presence or by sales volume, then companies will need to consider the taxability rules of SaaS in each state in which they have nexus.
Is SaaS even taxable? Because SaaS and cloud computing doesn’t always clearly fall into existing tax definitions, different states interpret its taxability in different ways. Some regard it as similar to electronically downloaded software, while others consider it a service, which may be taxable or not. And what about electronically downloaded software? Is it treated differently from SaaS?
This series will take a look at how key states in various regions of the country interpret SaaS, cloud computing and electronically downloaded software within their different state tax statutes. First up, the “Western” states: California, Utah and Washington!
SaaS/Cloud Computing Tax Rules in Western States
Sales and use tax does not apply to SaaS, which California defines as, “A customer gains access to software on a remote network without receiving a copy of the software, while the seller retains exclusive possession and control of it.” While California has not specifically codified the SaaS revenue stream, the state takes the position that it is akin to electronically downloaded software, which is exempt.
Utah imposes sales and use tax on license fees for remotely accessed prewritten software purchased for use of the software in Utah including:
- Hosted software
- Application service provider software
- Cloud computing applications
The Utah Tax Commission interprets Utah Code to mean that prewritten software accessed by a user in the state is subject to tax without regard to the location of the server. Therefore, the use of prewritten software over the internet that is not downloaded by the purchaser is subject to Utah sales tax.
One exception to this is databases (as of July 1, 2013). Amounts paid or charges to access a database are exempt from sales and use tax as long as the primary purpose for accessing the database is to view or retrieve information. The exemption does not apply to amounts paid or charged for a digital audio work, digital audio-visual work, or digital book.
Washington considers charges made to consumers for the right to access and use prewritten computer software, where possession of the software is maintained by the seller or a third party, to be a taxable service regardless of whether the charge for this service is on a per use, per user, per license, subscription or some other basis. This service includes the right to access and use prewritten computer software to perform data processing.
Also subject to tax are “digital automated services,” which include services transferred electronically that use one or more software applications. However, taxable digital automated services do not include services that primarily involve the application of human effort by the service provider, such as alarm monitoring systems. Nontaxable digital automated services require an average of the services provided through the expenditure of human effort representing more than 50 percent of the time and cost of providing the services.
Electronically Downloaded Software Treatment in Western States
Note: For the purposes of this article, we are addressing the taxability of pre-written or canned software (not custom software) that is delivered electronically. Custom software is exempt in most states, regardless of the method of delivery.
According to California’s statutes, the sale of a prewritten program is not taxable if the program is electronically delivered to the customer and the customer does not obtain possession of tangible personal property (e.g. storage media) in the transaction.
Sales and use tax is imposed on prewritten computer software delivered electronically, and sales, rentals, leases and charges for using prewritten software in Utah are taxable regardless of delivery method.
Prewritten computer software, regardless of the method of delivery, is generally subject to use tax when it is used in Washington as long as the state’s retail sales tax was not previously paid.
SaaS and Cloud Computing vs. Electronically Downloaded Software
In this state, SaaS, cloud computing and electronically downloaded software are all defined as nontaxable in all instances where the customer doesn’t physically obtain tangible property.
In this state, SaaS, cloud computing and electronically downloaded software are all defined as taxable.
In this state, SaaS, cloud computing and electronically downloaded software are all defined as taxable as well.
Economic Nexus – Proposed Legislation
In light of the recent Supreme Court case (South Dakota v. Wayfair), we expect many states to enact economic nexus standards in the coming weeks and months. Many experts in the state tax field believe, as do we, 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, neither California nor Utah have enacted economic nexus statutes. In Washington, the state has already enacted an online seller statute, which requires sellers to choose to either collect and remit tax or satisfy reporting requirements.
Have a tax question? Contact Monika Miles.