Retail tech firms: Navigating the sales and use tax landscape

Tax Hot Topic - RetailTax Hot Topics Retail Update
States with budget deficits are attempting to add revenue by expanding their sales and use tax bases to include digital products and cloud services. There is, however, no one uniform approach. A number of states are relying on general tax laws, while others have enacted laws addressing the taxability of these types of products and services, and still others have done little.

Retailers like to be all things to all customers, but additional options further complicate transaction taxability matters. Numerous lines of business can be characterized as follows:

Digital goods
  • Specified digital products include audio works (music), books and digital audio-video works (video)
  • Not included in the definition of tangible personal property  
  • Limited to permanent use unless statute specified otherwise
  • Not conditioned on continued payment unless statute specified otherwise
  • “Transferred electronically” does not require actual transfer but only access to the product (Sec. 332 of the Streamlined Sales and Use Tax Agreement)

Digital services

  • Sometimes referred to as other digital goods, other digital products or data processing
  • Not cloud computing, because the customer is not seeking to gain access to metered computing infrastructure/software, and not digital goods
  • Examples: payment processing services, online travel bookings, live webinars or e-discovery

“As a service” provider  
  • An “as a service” provider hosts the product in the cloud and allows clients to access it via the Internet, including SaaS (software as a service), IaaS (infrastructure as a service) and PaaS (platform as a service)

Most of these goods and services are offered through different delivery mechanisms, and for tax purposes, the delivery method can be more important than the good or service. For example, a transaction may be considered a sale of a digital good if the purchaser obtains permanent use of the good. The same sale may not be considered a digital good, however, if the purchaser has access only on a subscription basis that doesn’t allow for permanent use. Consider the tax consequences when determining which methods to use with new and rebranded service offerings.
One challenge, myriad solutions
To create additional tax revenue, state tax authorities may develop or reconsider the state’s current tax position on sales and use tax topics, particularly in newly developed technology.  Doing this with digital products and as-a-service offerings may disadvantage companies that have migrated their method of delivery to a digital good/service or an as-a-service provider but haven’t updated source documents such as contracts, invoices and purchase orders.  If company documents refer to a license or location of delivery, states may infer that previous business practices are still used and assess tax accordingly. Thoroughly review all transaction-related documentation and make sure it agrees with the company’s intended business model. Next, try to anticipate how states are likely to apply sales and use tax guidance to the business model.  

Some states have worked to clarify their positions. The New Jersey Division of Taxation’s Tax Bulletin No. 72 details the tax obligations of digital services, including SaaS, IaaS and PaaS. Guidance has also come from states including Iowa, Kansas and Massachusetts.

At the other extreme, some states have made decisions on an as-needed basis. States like New York and Utah have determined that SaaS is the sale of prewritten computer software, while Texas and Ohio have determined the same service is the provision of data processing.  Finally, Arizona defines SaaS as a taxable lease.

So far, more than 20 states and the District of Columbia have indicated they would tax some form of “as a service” provision.

Preparation is key
In anticipating the future of digital sales taxation, the watchwords are “be prepared.”
  • Determine your business model ― When determining your business model, learn about the likely sales and use tax effects of different options.
  • Update your documentation ― Although the taxability of digital sales is still unclear in many states, compliance determinations are often made by considering all available facts and documentation on a case-by-case basis. Maintain readily retrievable records with detailed, updated information reflecting your business model.
  • Stay on top of new and rebranded products and service offerings ― Be involved in the beginning stages of product/solution development. A high-tech retailer is apt to more quickly adapt new technology and migrate products and services from one type of tax determination to a new one. Ensure that your current systems and processes sync with your business model, and your staff is up to date on the newest state tax laws where you do business.

Joel Waterfield

Jamie Yesnowitz

Steve Skiba

Chuck Jones

Tax professional standards statement
This document supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the subject of this document, we encourage you to contact us or an independent tax adviser to discuss the potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this document may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this document is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.