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Do you owe TN sales tax on cloud-based software?

03/29/2017  |  By: Brian McCuller, JD, CPA, Shareholder, Practice Leader Tax

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Cloud computing impacts every industry. In fact, cloud computing contracts can be one of a company’s largest recurring expenses, year after year. Consequently, knowing how the purchase of cloud computing is taxed is vital.

Unfortunately, the sales taxation of cloud computing has been a slowly evolving process that has created uncertainty. As a result, companies should not assume the vendor is handling the sales tax correctly; companies should develop a practical approach to manage and simplify the analysis.

Background
Cloud computing generally takes the form of “software as a service" (SaaS), “infrastructure as a service” (IaaS), or “platform as a service" (PaaS). SaaS, which is the focus of this post, generally refers to the ability of a user to access software and/or to receive services provided remotely via the internet.

Tennessee changes stance
According to the Tennessee Revenue Modernization Act of 2015 (which took effective July 1, 2015), Tennessee changed its stance on the taxation of cloud computing. Tennessee now imposes sales and use tax on amounts charged to a purchaser to remotely access and use software that remains in the seller’s possession, if the purchaser accesses the software within Tennessee. The tax applies to any access and use of software from a location in Tennessee, regardless of whether the software is delivered electronically, delivered by use of tangible storage media, loaded or programmed into a computer, created on the premises of the consumer or otherwise provided. Additionally, the tax applies whether the charge for the software is on a per use, per user, per license, subscription or other basis. A customer’s access to software from a location indicated by a residential street address or primary business address in Tennessee, is equivalent to the sale or licensing of the software and electronic delivery of the software for use in Tennessee.

Prior to the 2015 act, Tennessee had published several letter rulings holding the monthly fee charged by a software vendor to a taxpayer for online access to customer relationship management software was not subject to Tennessee sales and use tax. Previously, the granting of a license to use computer software constituted a taxable sale, but if the server was located outside Tennessee, the sale was not taxable. Tennessee stated no sale or use of tangible personal property occurred in Tennessee when the taxpayer accessed the software application via the Internet because the vendor was not transferring title, possession or control of the software application to the taxpayer. Unfortunately, these prior rulings no longer apply.

Situs becomes key factor
If more states adopt a position similar to Tennessee, the key factor becomes knowing where the users of the software are located (i.e., situs). Previously, the type of software and how that software was delivered were the most important factors.

For example, for Tennessee sales tax purposes, the sales or purchase price for the purchase in a single transaction of remote access to software to be used by individuals located both within and outside the state may be allocated based on the percentage of users located in Tennessee, as determined by the user’s residential street or business address.

Purchasers of remote software access used in multiple states that provide their sellers with a completed Remotely Accessed Software Direct Pay Permit may purchase remote software access without paying tax to the seller. The purchaser is then required to directly report and pay tax to the department of revenue on the portion of the price that corresponds to the percentage of users located in Tennessee.

A purchaser not registered in Tennessee for sales and use tax purposes may provide the seller with a completed Streamlined Sales and Use Tax Certificate of Exemption to claim exemption for the portion of the price that corresponds to the percentage of users located outside of Tennessee. In this case, the seller must collect tax on the portion of the price that corresponds to the percentage of users in Tennessee.