State and local tax news for December 2024

As 2024 drew to a close, several recent SALT developments addressed the elemental issue of sourcing, both for income and sales tax purposes. In Illinois, the Department of Revenue issued guidance on the new destination-based sales tax provisions that apply to certain retailers beginning in 2025. The Minnesota Tax Court released a decision concerning the proper sourcing of receipts for sales factor purposes for pharmacy benefit management services. In addition, a Texas district court struck down certain provisions in the local sales tax sourcing rule concerning fulfillment centers and the place of business. Beyond the issue of sourcing provisions, the Florida Court of Appeal held that a software company that mistakenly collected sales tax on exempt sales could not pursue a refund claim with the Florida Department of Revenue until it had refunded the tax to its customers. Finally, in Pennsylvania, the Department of Revenue issued detailed guidance on the taxability of canned computer software, digital goods, and related services. The State and Local Thinking for December discusses all these developments.  

Illinois issues guidance on new destination-based sales tax provision           

The Illinois Department of Revenue issued guidance, Informational Bulletin FY 2025-10, in November 2024 that explains the new sales tax sourcing provisions that became effective on Jan. 1, 2025. Retailers previously obligated to collect and remit Illinois use tax (UT) on retail sales sourced outside Illinois and made to Illinois customers are now subject to Illinois sales tax. Specifically, the destination-based retailers’ occupation tax (ROT) applies to these retailers. This change affects retailers with physical presence in Illinois who make sales that are sourced outside the state to Illinois customers.  

In August 2024, Illinois enacted legislation, S.B. 3362, which addressed an issue concerning the Leveling the Playing Field Act that was effective beginning in 2021, specifically whether the destination or origin sales tax rate should be used by certain Illinois retailers. Beginning Jan. 1, 2025, a retailer maintaining a place of business in Illinois that makes retail sales of tangible personal property to Illinois from locations outside the state is subject to destination-based ROT. Those retailers are liable for all applicable state and locally imposed sales taxes administered by the Department on retail sales made to Illinois customers from locations outside the state. Furthermore, for sales that would otherwise be sourced outside the state, a retailer maintaining a place of business in Illinois that makes retail sales of tangible personal property from outside Illinois is subject to destination-based ROT. Thus, the destination tax rate, rather than the origin tax rate, applies to Illinois retailers for items shipped from outside the state to Illinois customers.

The guidance clarifies that “destination-based ROT” means the total state and local ROT rate calculated for a sale using the rate in effect at the Illinois location to which the tangible personal property is shipped or delivered, or at which possession is taken by the purchaser. For destination-based sales, retailers must register a tax site for each local jurisdiction where they have made a sale or plan to make sales. The Department will change the registration status for out-of-state retailers from UT to ROT, if applicable. Because Illinois retailers should already be registered to remit ROT, their registration status will not change. However, Illinois retailers are responsible for registering new tax sites to their account for any sales sourced outside Illinois.

Retailers that make all their sales through a marketplace facilitator that has met a tax remittance threshold may close their sales tax account with the Department, as the marketplace facilitator is then required to collect and remit the sales tax instead of the retailer. Marketplace facilitators must ensure they collect and remit the proper ROT for sales on behalf of the retailers identified above.

For sales occurring on or after Jan. 1, 2025, the retailers subject to these new rules must:

• Determine the correct state and local tax amounts to remit based on the taxing location to which the tangible personal property is shipped or delivered, or at which possession is taken by the purchaser;
• Register any new changing location tax site to their account before filing their January 2025 return (due Feb. 20, 2025), or the return for the period in which the sale took place;
• Properly report destination-based sales on Form ST-1, Sales and Use Tax and E911 Surcharge Return; and
• Complete Form ST-2, Multiple Site Form, to report destination-based sales by changing location tax site.

The Department notes that retailers who incorrectly report taxing locations may be billed for additional tax at the proper rate, late payment penalties, and interest associated with the tax. The guidance also explains how retailers can add tax sites to their account and where they can find the proper tax rate to charge on their sales tax return.  

Minnesota court considers sourcing of pharmacy benefit management services   

On Nov. 21, 2024, the Minnesota Tax Court held in Humana MarketPoint, Inc. v. Commissioner of Revenue that a taxpayer’s receipts from providing services under a pharmacy benefit management (PBM) agreement should be sourced for sales factor apportionment purposes to the state where the plan member purchases a drug plan from the insurer. The court determined that plan members received the benefit of the PBM services in their states of residence, including Minnesota, even though they did not directly contract with the PBM service provider.

This case concerned the sourcing of sales received pursuant to a PBM agreement between two of the taxpayer’s subsidiaries: Humana Insurance Company (HIC) and Humana Pharmacy Solutions, Inc. (HPS). The taxpayer and its subsidiaries were incorporated and based outside Minnesota. HIC is an insurer that provides or services medical and drug insurance programs for its plan member customers, who are both individuals and employer groups. During 2016, the relevant tax year at issue, HIC provided medical and drug insurance coverage to its plan members located both within and outside Minnesota. As a PBM company, HPS established a network of participating pharmacies to process prescription drug orders for HIC’s plan members. HPS does not contract with HIC plan members or sell or take possession of any pharmaceutical drugs.

Under the PBM agreement, HPS provided a wide range of services to HIC, including the administration of retail, mail order, and specialty drug pharmacy benefits for members, as well as point-of-care, physician office communications, cost containment services, and other services developed and implemented by HPS. The PBM agreement required HIC to pay HPS amounts in two separate components consisting of covered drug reimbursements and base service provider fees.

The taxpayer initially filed a 2016 Minnesota corporate franchise tax return in which HPS’s receipts from services provided under the PBM agreement were sourced to Minnesota if the plan member was located in the state when purchasing a drug plan from HIC. In April 2021, the taxpayer amended its 2016 tax return and recomputed the numerator of HPS’s sales factor by sourcing all HPS’s receipts from PBM services to Wisconsin, where HIC is headquartered. On this basis, the numerator of HPS’s sales factor for 2016 was calculated as zero and the taxpayer requested a refund. The Department rejected the refund claim, and the taxpayer appealed the denial to the Minnesota Tax Court. The parties agreed that receipts derived from the covered drug reimbursements and base service provider fees should be sourced together. Both parties filed motions for summary judgment with the Tax Court.

Minnesota law uses a cascading approach to source service receipts. The law provides that receipts from the performance of services must be attributed to the state where the services are received. Amounts received from providing a service to a corporation, partnership, or trust may only be attributed to a state where it has a fixed place of business. If the state where the services are received is not readily determinable or is a state where the entity receiving the service does not have a fixed place of business, the services are deemed to be received at the location of the office of the customer from which the services were ordered in the regular course of the customer’s trade or business. If the ordering office cannot be determined, the services are deemed to be received at the office of the customer to which the services are billed.

As explained by the court, the dispute concerned whether the Minnesota law for sourcing service receipts limits the recipients of the services to “direct” recipients or customers, and whether HIC, or its individual plan members, was the recipient of HPS’s services under the PBM agreement. The taxpayer argued that it was entitled to summary judgment because Minnesota law does not allow the Minnesota Commissioner of Revenue to source receipts from services to an “indirect beneficiary” of those services such as HIC’s customers, the plan members. The Commissioner argued that the first sentence of the cascading statute providing for sourcing sales to the state where the services are received was applicable because there is no requirement that the recipient of the service be the same person who contracted or paid for the service. The Commissioner argued that the taxpayer’s interpretation would require the court to add language to the statute.

In granting the Commissioner’s motion for summary judgment, the court closely examined the statutory language for sourcing service revenue. The court determined that application of the cascading rules is not necessary unless the state where the services are received is not readily determinable or the corporate recipient of services lacks a fixed place of business in the state. As noted by the court, the plain language of the statute does not limit the receipt of services for attribution purposes to “direct customers” of the taxpayer. Because courts cannot add language to a statute, the court concluded that the taxpayer’s interpretation that limits how “services are received” to “direct recipients” and excluding “customers of customers” is not reasonable. The court determined that the sourcing statute requires a fact-specific determination of who received the services and where that individual or entity is located.

The court next considered application of the statute to source the receipts from the performance of the PBM services. The Commissioner successfully argued that HIC’s plan members received the services generating these receipts, and that HPS’s receipts must be sourced to the location of the plan members in 2016. Accordingly, to the extent plan members were located in Minnesota, HPS’s receipts were required to be included in the numerator of HPS’s sales factor. After acknowledging that HPS contracts with HIC to provide PBM services to HIC under the agreement, the Commissioner contended that many of the services provided by HPS directly mentioned serving plan members. As there were no facts in the record giving rise to a genuine issue for trial as to any one of the essential elements of the taxpayer’s case, the court held that the Commissioner was entitled to summary judgment as a matter of law.  

While Minnesota was one of the first states to adopt a market-based sourcing approach with respect to the sourcing of service revenue, many other states have followed in recent years (though not all market-based sourcing approaches are uniform). As market-based sourcing has taken hold throughout much of the nation, the question of whether a business is supposed to source according to the location of its immediate customer or to its ultimate customer has become a prime point of focus by taxpayers and tax authorities alike. Therefore, this case is likely to be instructive for sourcing receipts from PBM and other intermediary-styled services in Minnesota, and potentially other states. 

Texas court enjoins certain provisions of local sales tax sourcing rule  

On Dec. 3, 2024, the District Court of Travis County, Texas, enjoined the Texas Comptroller of Public Accounts from enforcing certain amendments to the local sales tax sourcing rules in City of Coppell v. Hegar. Under the injunction, the Comptroller may not enforce specific provisions in the local sales and use tax rule, 34 Texas Admin. Code Sec. 3.334, concerning fulfillment centers, place of business, and consummation of sales.

In consolidated cases, a group of Texas cities challenged the Comptroller’s amendments to the local sales tax sourcing rules that are designed to curb the practice of cities entering into agreements to provide tax incentives or rebates to companies that locate fulfillment centers or offices in the city. Prior to the amendments to the rule, the sales in this situation were sourced to the fulfillment center as the seller’s place of business. However, the rule as amended by the Comptroller generally takes a destination approach, which would have significantly reduced the revenues sourced to the localities housing the fulfillment centers.

A Texas statute generally defines “place of business of the retailer” as a location operated for the purpose of receiving orders for taxable items and includes any location where three or more orders are received during the year. However, the rule’s corresponding “place of business” definition has been amended to provide additional requirements and limitations. For example, the rule states that a place of business usually requires staffing by sales personnel but excludes a “computer server, Internet protocol address, domain name, website, or software application.”

Before the district court, the cities argued that the rule’s definition of “place of business” and the provisions that implement it are facially invalid and void because they: (i) contravene specific statutory language; (ii) run counter to the general objectives of the statutory definition; or (iii) impose additional burdens, conditions, or restrictions beyond or inconsistent with the statutory definition. Furthermore, the cities argued that the Comptroller did not satisfy the requirements of the Texas Administrative Procedure Act (APA) in promulgating the regulation.  

The district court entered a brief final judgment enjoining certain provisions of the local sales tax sourcing rule. According to the court, the rule’s definition of “fulfill” contravenes existing statutes by adding a definition at the agency level that the legislature has not defined in the sales tax law and for which Texas law already provides a detailed scheme for determining where the sale of a taxable item is consummated. In addition, the court found that rules defining the place of business and consummation of sale contravene the specific statutory language that also defines the place of business and consummation of sale. Finally, the court found that the Comptroller did not substantially comply with the notice or “reasoned justification” requirements under the APA. The court also declared that the local sales tax sourcing rule or its threatened application interferes with a legal right or privilege of the cities.

Effective July 4, 2024, the court permanently enjoined the Comptroller from enforcing the subsections of the rule concerning fulfillment, place of business, and consummation of sale. These provisions were remanded to the Comptroller for further consideration. The decision generally favored the cities, but the court denied the cities’ request to declare fulfillment centers receiving only internet orders to be places of business.

This is a significant Texas district court decision that should be considered by Texas taxpayers and cities that have agreements with companies to locate fulfillment centers within the city. Because this decision expressly invalidates certain portions of the Comptroller’s local sales tax sourcing rule and significant revenue for fulfillment center localities is at stake, there likely will be further developments concerning this rule. 

Florida court holds dealer could not claim sales tax refunds          

On Dec. 4, 2024, the Florida Court of Appeal held in Oracle America, Inc. v. Florida Department of Revenue that a software company that mistakenly collected sales tax from its customers on certain tax-exempt purchases could not claim a refund from the Florida Department of Revenue because the software company did not first refund the excess tax to its customers. To make matters worse, the software company could not challenge the Department’s denial of the refund claims.   

Oracle provides computerized business technology to commercial customers and sells computer software, including future maintenance and support services. On certain purchases, Oracle collected sales taxes and local surtaxes from its customers and remitted the collected taxes to the Department as a dealer. Oracle later discovered that it had collected excess local surtaxes and sales taxes on purchases that were exempt from tax.

At its customers’ request, Oracle filed claims with the Department for tax refunds. The Department denied the refunds because Oracle had not refunded the excess collected taxes to its customers. After the Department denied petitions for refund for the same reason, Oracle filed petitions for a formal administrative hearing. The administrative law judge agreed with the Department that Oracle needed to refund the taxes to the customers before the Department could approve the refund application. The Department issued orders dismissing the petitions after concluding that Oracle lacked standing because Oracle was not the taxpayer, and did not have a sales tax obligation as the dealer in the transaction. As a result, the Department determined that it did not have subject matter jurisdiction over the petitions. Oracle appealed these orders to the Florida Court of Appeal.

Before the Florida Court of Appeal, Oracle argued that the sole issue was whether it had the right to apply for a refund before it refunded the taxes to its customers. The court agreed with the Department that Oracle was not entitled to a refund, again because it was not the taxpayer. In reviewing Florida law, the court explained that “dealers” sell tangible personal property at retail and collect sales tax owed from their purchaser or customer. The dealers then remit the tax collected to the Department. At the time of collection, the taxes become state funds that are due to the Department the following month.

Florida statutes and the administrative code provide instructions for applying for tax refunds, but the court noted that these provisions are not always consistent. In reviewing the relevant authority, the court determined that Florida law only allows a taxpayer to receive a refund or contest a refund denial by the Department. Meanwhile, the administrative rules state that a dealer is the proper party to seek a refund. A statute provides that taxes collected from a purchaser are not subject to refund absent proof that they have been refunded to the purchaser. Similarly, an administrative rule states a dealer must refund to the customer any tax that it erroneously collected before the dealer’s refund claim to the state may be approved. Under the rules, a “taxpayer” who paid excess taxes “must secure a refund from the dealer and not from the Department of Revenue.” The court explained that the administrative rules provide a refund process for a “dealer,” “purchaser,” “customer,” and “taxpayer,” but they do not define these terms or apply them consistently. Florida courts decide disputes based on statutory language, even when it may conflict with an administrative rule.

Applying the relevant statutory language, the court agreed with the Department that Oracle could not receive a refund or contest a refund denial because it was not the “taxpayer.” Without first returning the collected excess taxes to its customers, Oracle acted only within its prescribed duties as a dealer that collected and remitted taxes from its customers. In effect, Oracle was acting as the state’s agent in collecting the tax. The court denied Oracle’s argument that, because the parties agree a refund is due, the Department should conditionally approve Oracle’s refund application, and once approved, Oracle could then refund its customers to become entitled to a refund. There is no basis in Florida law permitting an application for a tax refund to be conditionally approved.  

Pennsylvania issues sales tax guidance on software and digital goods  

In October 2024, the Pennsylvania Department of Revenue issued sales and use tax guidance on the taxability of canned computer software, digital goods, and related services. This release is significant because it provides examples addressing the taxation of licenses, consulting, modification, project management, website development, and data sales. This is the first time that the Department has issued guidance on the tax treatment of many of these transactions.

After reviewing the relevant statutes and regulations, the guidance notes that canned computer software is taxable as tangible personal property. The taxable portion of the purchase is the total paid in complete performance of the sale at retail. A vendor is not allowed to exclude the cost of labor or service from the price of a sale at retail of tangible personal property. Any charges for modifying or configuring canned computer software are taxable as the alteration of tangible personal property regardless of whether this is performed in conjunction with the sale of canned computer software. However, the sale of custom software and any related services are not subject to sales tax.

The guidance includes examples of the taxation of transactions related to software, but notes that each sale at retail must be evaluated to determine the taxable purchase price for each separately stated item. In determining whether a charge is part of the otherwise taxable purchase price, consideration is given to whether there are separate agreements, the timing of the various agreements, whether the charge is for an item that is necessary for the property to function, and whether the decision to incur the charge was dependent on events after the initial purchase.

Licenses: An example provides new information concerning licenses. A license to use tangible personal property, including canned software, is subject to tax. The transaction remains taxable regard​less of whether the canned software is digitally delivered, streamed, or accessed by other means, and regardless of the billing method used. Remotely accessed tangible personal property is subject to tax when the user is in Pennsylvania. If the billing address for the item is a Pennsylvania address, all users are presumed to be in Pennsylvania. A purchaser may only allocate licenses to out-of-state users if the users are the purchaser’s employees. If the user is an employee of a different entity, the purchaser is considered the end user. However, the purchaser may claim a resale exemption.

Consulting: The term “consulting” is defined as gathering information related to the goals and needs of the customer and linking these to software or hardware solutions. This involves analyzing a customer’s business process and requirements, in addition to documenting the customer’s needs for new or existing software or hardware. The taxability of consulting services related to software or hardware varies depending on the facts and circumstances surrounding the provision of the consulting service. Consulting is taxable as part of a purchase price if sold in conjunction with the sale of tangible personal property or other taxable services, even if invoiced separately. However, consulting is not taxable when the result is only a recommendation regarding the need for changes in implemented software or process and there is no transfer of tangible personal property.

Modification: The guidance explains that “modification” means custom computer software programming for the specific customer that adds, edits, or changes proprietary software. Modifying the source code of canned computer software is taxable as the alteration of tangible personal property, while modifying source code of custom computer software is nontaxable. Programming performed to add functionality to canned software is taxable as part of the purchase price if sold in conjunction with the sale of tangible personal property or other taxable services, even if invoiced separately. In contrast, programming is nontaxable if performed on, or for the development of custom computer software.

Project management: This is taxable as part of the purchase price if sold in conjunction with sales of tangible personal property or other taxable services, even if invoiced separately. Also, project management may be taxable as “help supply” even if not sold in conjunction with the sale of tangible personal property. For instance, it is taxable if there is no specific deliverable or outcome required of the vendor, but nontaxable if there is a contract that identifies a specific deliverable that is guaranteed or warranted, and the work is not supervised by the customer. 

Website development: This is the process of creating, building, and maintaining websites and web applications. This may include web design, programming, and database management. Website development is taxable if the website is transferred to the customer. Both the website and the maintenance of the website are subject to sales and use tax as the transfer and maintenance of tangible personal property. The example explains that tangible personal property may be canned software or any otherwise taxable tangible personal property electronically or digitally delivered, streamed, or accessed. Also, website development is taxable if the service provides access to a canned software program that allows the user to develop a website using no or low code interface or html programming with or without access to stock images or art that can be used on the website. In contrast, website development is nontaxable if the developer retains possession or control of the website. The creator is responsible for remitting tax on materials used or consumed in creating and maintaining the website. Finally, separately stated fees for website hosting services are nontaxable.  

Data sales: The guidance describes data sales as the sale of or providing access to data or databases containing data that is generated, created, aggregated, or collected by a data vendor. These sales are taxable if the vendor provides customers access to a previously compiled database or mailing list. In addition, data sales are taxable if the vendor allows the customer to generate a unique list of the data through using filters and search terms to the previously compiled database. The transaction is taxable as a license to use a software program. However, data sales are nontaxable if the vendor is using its database to generate a unique report for a customer regardless of how the report or list is delivered. A data sale also is nontaxable if it is a one-time license to use a list of names and mailing addresses for a delivery of direct mail advertising literature or materials.