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Massachusetts: Remotely accessed software hosted in-state is taxable

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On Nov. 2, 2018, the Massachusetts Appellate Tax Board issued an opinion concluding that online software hosted in the state and accessed remotely is considered tangible personal property and thus subject to sales tax.1

Background The taxpayer, Citrix, is a publicly traded Delaware corporation that did business in Massachusetts and other states during the periods at issue. For each of these periods, Citrix filed sales and use tax returns, and timely paid tax. Following audits of Citrix’s sales and use tax returns for the periods ended April 30, 2007, through June 30, 2009, and Oct. 31, 2009, through Dec. 31, 2011, the Commissioner issued Notices of Assessment. Specifically, the Commissioner assessed tax on Citrix’s sales of three popular online software products, “GoToMyPC,” “GoToAssist,” and “GoToMeeting” (collectively referenced as the “Online Products”).

Though each of the Online Products has its own unique properties, they share some common characteristics. The Online Products are provided principally through proprietary software and a dedicated network of computer hardware owned by Citrix and located in Massachusetts to facilitate a screen-sharing connection between an Internet-connected host computer and one or more remote computers. Each of the subscription-based Online Products resides on Citrix’s servers, and customers are granted explicit access via download of the relevant software pursuant to a sales agreement. For the Online Products to work, the host computer must have and be able to run its own operating system and software applications. The screen-sharing connection allows the user of the remote computer to view the host computer’s screen and, if applicable, to share access to input control via the computer’s keyboard and mouse. Both the host computer and remote computer may be owned or controlled by a Citrix customer, or one of the computers may be owned or controlled by a third party who is not a Citrix customer.

Both the taxpayer and the Commissioner agreed that the Online Products constitute software within the meaning of the Massachusetts sales tax law that is not customized for individual customers in any way. While customers may choose to purchase certain options designed to enhance their user experience, none are actually customized by Citrix for specific customers’ usage.

After receiving Notices of Assessment for the relevant periods, Citrix filed abatement applications with the Massachusetts Commissioner of Revenue which were denied. The taxpayer then filed petitions with the Appellate Tax Board, which granted a hearing.

Appellate tax board decision The sole issue considered by the Board was whether the Online Products are subject to sales tax. Generally, sales of tangible personal property are taxable in Massachusetts.2 Prior to 2005, whether standardized software was considered tangible personal property and subject to sales or use tax depended on its method of delivery.3 If standardized software was delivered in tangible form, such as a CD-ROM or a floppy disk, it was subject to tax. If, however, standardized software was delivered electronically or by load and leave, it was not.4 Massachusetts addressed this disparity between delivery methods through legislative means in 2005 by creating uniform sales tax treatment for sales of standardized software. Specifically, the legislation expanded the definition of tangible personal property to incorporate transfers of standardized computer software “including but not limited to electronic, telephonic, or similar transfer[s].”5

Subsequently, the Commissioner promulgated a related regulation in 2006 that, in pertinent part, construed the application of the sales tax to sales of prewritten software, including “transfers of rights to use software installed on a remote server” in the list of delivery methods constituting taxable transfers.6 The Commissioner defined the term “prewritten software” as computer software “which is not designed and developed by the author or other creator to the specifications of a specific purchaser.”7 Conversely, custom software is “a software program prepared to the special order of a customer that is not prewritten software.” For the years at issue, Massachusetts taxed prewritten or canned software whether delivered by tangible media or electronically, as well as remotely accessed software.8


Because the Online Products were not customized in any way and Citrix presented no contrary evidence, the Board summarily concluded that they were considered to be prewritten software. As for taxability, Citrix argued that its customers’ use of software on servers located outside Massachusetts was not a taxable transfer of software and outside the scope of the sales tax. First, Citrix argued that there was no taxable sale because there was no actual “transfer” of software. Specifically, while Citrix acknowledged the 2005 statutory change to the definition of tangible personal property, it argued that the change was not intended to encompass access to software remotely hosted by a vendor. In rejecting this argument, the Board noted that the definitional change “is facially broad in scope and not only specifies various types of transfers to which it applies but, by incorporating the words ‘including but not limited to,’ anticipates others.” Further, the Board endorsed the Commissioner’s regulatory interpretation including transfers of rights to use software installed on a remote server.9

Citrix further contended that its sales were nontaxable sales of services in an effort to come within an exception contained in the Commissioner’s regulation.10 The regulation acknowledges the distinction between sales of tangible personal property and services in the context of charges for remote access to standardized software, indicating that when “there is no charge for the use of the software and the object of the transaction is acquiring a good or service other than the use of the software, sales or use tax does not apply.”11 Referencing the object of the transaction test12 typically applied to determine the taxability of bundled transactions, the Board noted that, where the service and property components of a transaction are integrated, the character of the transaction must be analyzed.

In Letter Ruling 12-10,13 issued soon after the periods at issue in this matter, the Commissioner actually considered a request by Citrix to determine whether the sales of the Online Products were subject to sales tax. In concluding that the sales were taxable, the Commissioner determined that the object of the transactions was Citrix’s sale of the right to use its prewritten software. Finding that the Commissioner’s analysis in the letter ruling implicitly addressed the same concerns raised by Citrix in this appeal and properly focused on the customer’s experience in using the product, the Board rejected the taxpayer’s argument. While Citrix’s employee operations in supporting the Online Products may be numerous and costly, the Board did not believe that Citrix’s customers actively sought those particular services. Rather, Citrix’s customers intended to subscribe to, access, and use the Online Products without considering Citrix’s unseen support operations.14 In conclusion, the Board found that the Online Products constituted taxable standardized software and, therefore, tangible personal property subject to tax.

Commentary In this era of ongoing technological innovation, this important ruling by the Massachusetts Appellate Tax Board clarifies the taxability of software residing in Massachusetts which is accessed remotely by servers located outside the state. The Board explicitly rejected the taxpayer’s own categorization of its products as services to conclude that they are remotely accessed taxable software. Further, the Board (while acknowledging the substantial and costly services underlying the software, including development, testing, and troubleshooting) focused solely on the customer experience in making its determination. It will be interesting to see whether the Commissioner, emboldened by the Board’s endorsement of the Commissioner’s interpretations in its regulation and the letter ruling issued to Citrix prior to audit, applies similar reasoning to conclude that other remotely accessed products/services are also taxable.


 
1 Citrix Systems, Inc. v. Commissioner of Revenue, Massachusetts Appellate Tax Board, Docket Nos. C321160, C325421, Nov. 2, 2018.
2 MASS. GEN. LAWS ch. 64H, §§ 1, 2
3 Also, a distinction had been drawn between standardized and custom software, with only the former being subject to sales and use tax. See, e.g., Letter Ruling 88-14: Computer Software Sales, Massachusetts Dept. of Rev., Nov. 21, 1988.
4 See Directive 01-3: Sales Tax Consequences of Computer Software “Load and Leave” Transactions, Massachusetts Dept. of Rev., May 8, 2001. In a load and leave transaction, a vendor installs software directly onto a customer’s computer using tangible storage media, but does not transfer the tangible medium used to load the software as part of the sale.
5 MASS. GEN. LAWS ch. 64H, § 1, as modified by Ch. 163, Laws 2005, § 34 (eff. Apr. 1, 2006
6 MASS. REGS. CODE tit. 830, § 64H.1.3(3).
7 MASS. REGS. CODE tit. 830, § 64H.1.3(2). Notably, Massachusetts law does not distinguish between standardized software, prewritten software, and canned software for purposes of sales tax.
8 MASS. REGS. CODE tit. 830, § 64H.1.3(4)(d), (14).
9 MASS. REGS. CODE tit. 830, § 64H.1.3(3).
10 Massachusetts sales tax law distinguishes between sales of tangible personal property, which are generally taxable absent an exemption, and sales of services, which are generally not subject to tax. MASS. GEN. LAWS ch. 64H, § §1, 2. In support of this contention, Citrix relied on several facts, including: (i) the testimony of its vice president regarding the complexity of the hardware and software systems needed to provide the products; (ii) consistent references to the Online Products in sales agreements, marketing documents, and securities filings as services; and (iii) the required activities of numerous employees to operate and maintain network hardware and server software systems that function together to provide the Online Products.
11 MASS. REGS. CODE tit. 830, § 64H.1.3(14)(a).
12 See Commissioner of Revenue v. Houghton Mifflin Co., 487 N.E.2d 1388 (Mass. 1986).
13 Letter Ruling 12-10: Screen Sharing Software and the Massachusetts Sales/Use Tax, Massachusetts Dept. of Rev, Sept. 25, 2012.
14 Referencing MASS. REGS. CODE tit. 830, § 64H.1.3(14)(a) Example



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