Health care information technology service providers (HCIT) are facing new sales tax compliance obligations and complexities because of the recent U.S. Supreme Court case, Wayfair, Inc.
Whether the HCIT has a taxable presence or nexus may be easier to determine. The more difficult part is determining what to do next. For example, the HCIT may have nexus in additional states creating an obligation to register and file sales tax returns. However, sales tax may not be required to be collected depending on what the HCIT is selling, and who the customer is.
This is the time for HCITs to manage risk and avoid the ‘domino effect’ of this change.
What Did the Wayfair Case Say?
The U.S. Supreme Court issued its decision in South Dakota v. Wayfair, Inc. on June 21, 2018. The ruling eliminated the physical presence requirement for sales and use tax nexus. Although the Court did not create a new bright-line test, it simply said that the South Dakota statute at issue in the case was acceptable.
South Dakota’s statute requires out-of-state retailers who lack a physical presence in South Dakota to collect and remit the state's sales tax if the retailer has $100,000 in sales or 200 transactions delivered into South Dakota in the preceding year. As of September 21, 2018, approximately thirty states have enacted provisions similar to South Dakota with effective dates ranging from July 1, 2018, to January 1, 2019. (Link to the current chart: https://www.lbmc.com/blog/new-sales-tax-economic-nexus-standards)
Tip: when determining whether your company exceeds the sales threshold set by a state ($100,000 for South Dakota), the total sales must include both exempt and non-exempt sales. Exempt sales cannot be excluded when making the determination.
What Are You Selling?
The sales tax treatment of what a HCIT is selling can be difficult to ascertain since it is often a combination of software, services or artificial intelligence (which is becoming more common). Generally, what a HCIT is selling falls into the category of information services, data processing, or Software-As-A-Service (SaaS). Most states have addressed the sales tax treatment of these types of services. However, some still haven’t, and even those who have, may not provide explicit guidance.
Several states do not define information services. Those that do may define information services to include the services of collecting, compiling, or analyzing information of any kind as well as the furnishing of reports of such information to other persons. Some states define information services as services that allow information to be generated, acquired, stored, processed, or retrieved and delivered electronically to a purchaser whose primary purpose for the transaction is the information.
The tax treatment of information services varies by state; however, most states do not tax information services unless tangible property is provided or the service is specifically identified as taxable. Consequently, HCITs should ensure they don’t miss the few states that tax it.
Data processing services are defined differently (although somewhat similar) depending on the state. For example, some states define it as services that allow data to be generated, acquired, stored, processed, or retrieved and delivered electronically to a purchaser whose primary purpose for the transaction is the data. Some define it as the performance of a series of automated or manual functions upon data supplied by the purchaser for processing the data through a computer. Other states define it as the developing of original information from raw data furnished by a client, which can include summarizing, computing, extracting, sorting, sequencing, or the updating of a continuous file of information maintained by the customer.
Similarly to information services, the tax treatment of data processing services varies by state. Most states do not tax data processing services, but HCITs should ensure they don’t miss the few states that tax it.
Software-As-A-Service (SaaS) generally allows a customer to use a provider's software running on a cloud infrastructure. The software is accessible from various client devices (e.g., laptop computer or smartphone) through a web browser or a program interface. The customer does not manage or control the underlying cloud infrastructure, including network, servers, operating systems, storage, or even individual application capabilities.
Like information services and data processing services, the tax treatment of SaaS varies by state. Some states hold that if the customer is simply accessing prewritten software provided by a host and located on the host's server, the service is not taxable if the customer does not have physical access to the server or control the operation of the server. If, however, the customer downloads a copy of the prewritten software onto computer equipment, the transaction may then become taxable. Additionally, if the customer downloads a copy of the prewritten software to computer equipment located outside the state, the charges could still be taxable if the customer uses such software within the state.
Other states consider 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.
Where Should the Sale Be Sourced?
Determining which state to source the sale of SaaS can be complex. For example, if sourced based on use, what is the state of use? The location of the customer, or the location of the server?
If sourced by the location of the customer, determining how to allocate the licenses for users in multiple locations can be difficult. Additionally, determining the location of the server can be complicated when multiple servers are utilized.
For example, in Tennessee, the sales 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 that is not registered in Tennessee for sales and use tax purposes may instead provide its seller with a completed Streamlined Sales and Use Tax Certificate of Exemption to claim an exemption for the portion of the price that corresponds to the percentage of users located outside Tennessee. In this case, the seller must collect tax on the portion of the price that corresponds to the percentage of users in Tennessee.
In Ohio, the service is generally considered to be received at the customer's terminals. The nature of such services might produce instances in which the service provider cannot ascertain the location from which the service is accessed. In this case, the service is presumed to be used at the location of the customer's billing address.
In Pennsylvania, the taxability of remote access to software 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.
In New York, the Department of Taxation and Finance has issued guidance explaining that if a purchaser remotely accesses software over the internet, possession of the software transfers to the purchaser because the purchaser gains constructive possession and the right to use or control the software. As a result, the sale to a New York purchaser of 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.
Historically, the taxability of remote access to software applications in Utah depended on the server's location. For example, a Utah customer was considered in possession of software when the software was downloaded onto server space the customer leased from an application service provider in Utah. In 2011, Utah amended its law to provide that if a purchaser uses computer software, and a copy of the software is not transferred to the purchaser, the location of the transaction is determined by the customer’s location in the state.
Do Exemptions Apply?
Regardless of the nexus and tax treatment conclusions, HCITs may not be required to collect sales tax if the HCIT is selling to tax-exempt hospitals (non-profit, governmental, etc.) and exemption certificates are received. However, there are a few states that do not exempt sales to non-profit hospitals regardless of whether the hospital is tax-exempt for federal tax purposes. Consequently, HCITs should not assume the sale to a hospital is exempt.
Tip: an exempt sale isn’t an exempt sale until an exemption certificate is received from the customer.
What Actions Should HCITs Take?
HCITs can make themselves audit-ready, and mitigate sales and use tax risk by completing the following steps:
- Determine Prospective Nexus. Compare the chart to your company’s sales-by-state for the last calendar year or prior 12-months (depending on the state). If your company is over the threshold in any state, move on to Step 2.
- Determine Prior-Year Nexus. Review your company’s connections or physical presence activity in prior years for the states you identified in Step 1.
- Evaluate State Income Tax Impact. Conduct both #1 and #2 for state income tax purposes to avoid collateral damage.
- Determine Taxability. The tax treatment (taxability) of what your company is selling (i.e., products, services, bundled transactions, etc.) may be different in each new state.
- Identify Exemptions. Determine if any exemptions apply to the products or services your company is selling in each new state.
- Get Your Use Tax Right. Perform a reverse audit of your company’s purchases (accounts payable) to determine overpayments/underpayments in preparation for more vendors charging your company sales tax.
- Obtain Exemption Certificates. Prepare to offer exemption certificates to vendors that start charging your company sales tax on your purchases.
- Mitigate Liability. Consider whether your company should enter into Voluntary Disclosure Agreements with any new states before collecting sales tax prospectively.
- Consider Tax Decision Software. Determine whether your company needs to acquire and implement new tax decision software, or will continue to use a manual process.
- Assess Outsourcing Compliance. Determine whether outsourcing your sales tax compliance would be cost-beneficial.
- Register and File. Register in each new state for sales tax collection while considering the income tax impact and other taxes. File timely returns on a go-forward basis.
- Monitor and Maintain. Monitor state tax law changes and business changes. Maintain taxability engine rules or a manual taxability matrix for sales and purchases on an annual basis.
LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.