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Jamie C. Yesnowitz
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On May 21, 2021, the Massachusetts Supreme Judicial Court issued an opinion affirming the Massachusetts Appellate Tax Board’s earlier decision granting an abatement of tax to software vendor taxpayers who had originally collected and remitted sales tax based on the total cost of the software purchased by a customer.1
After the software vendors remitted the sales tax, the customer informed the vendors of its intended and actual use of the software in multiple locations, resulting in a refund request for the tax on software outside the state.
During the tax periods at issue,2
the taxpayers’ customer, Hologic, purchased or licensed software from the taxpayers and installed it on Massachusetts servers for use by its employees located both within and outside Massachusetts. Hologic’s employees ultimately accessed the software from these specified work locations. At the time of purchase, Hologic remitted sales tax to the vendors based on the total amounts that it paid for the software. The software vendors timely remitted the sales tax to Massachusetts and reported it on their corresponding sales and use tax returns.
Subsequently, Hologic informed the vendors of its intended and actual use of the software in multiple locations and provided supporting data showing the percentage of use outside Massachusetts. The vendors each filed abatement applications, requesting abatement and refunds of sales tax based on the usage data and apportionment percentages received, that were denied by the Massachusetts Commissioner of Revenue.3
Notably, the Commissioner and the taxpayers agreed on the apportionment percentages claimed by the taxpayers.4
The Appellate Tax Board granted a hearing to the taxpayers, and concluded the taxpayers had a statutory right to apportionment for software used in more than one state, and that the general abatement process is available to these vendors. The Commissioner appealed the decision, and the Massachusetts Supreme Judicial Court granted a hearing.
Massachusetts apportionment of software sales
Generally, sales of tangible personal property are taxable in Massachusetts.5
Prior to 2005, whether standardized software was considered tangible personal property and subject to sales or use tax depended on its method of delivery.6
If standardized software was delivered in tangible form, such as a CD-ROM or a floppy disk, it was subject to tax. Massachusetts addressed this disparity between delivery methods through legislation 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].”7
Further, the statutory amendment authorized the Commissioner to promulgate regulations to “provide rules for apportioning tax in those instances in which software is transferred for use in more than one state
The Commissioner ultimately promulgated a regulation that included provisions for how to apportion sales of standardized software.9
This provision became effective October 20, 2006 and applied retroactively to transactions on and after April 1, 2006.
The regulation includes two separate apportionment provisions which relieve vendors of specific liabilities by: (a) transferring reporting liability from a vendor to a purchaser;10
and (b) relieving vendors of “any further obligation” after collecting and remitting tax.11
Under option (a), a purchaser of prewritten computer software with knowledge at the time of purchase that the software will be used in more than one jurisdiction must provide Form ST-12, Exempt Use Certificate, to the vendor no later than the time the transaction is reported for sales or use tax purposes. Option (b) is intended for a seller with knowledge that the prewritten software will be concurrently available for use in more than one jurisdiction, but has not been provided an exempt use certificate by the purchaser. Under the terms of option (b), a seller “may work with the purchaser to produce the correct apportionment,” to which the purchaser must certify, and the seller must accept. No specific time frame is stated regarding when the related apportionment determination and certification must take place. Regulatory language in both options (a) and (b) includes substantive guidance concerning how to apportion tax, generally allowing the use of any reasonable, consistent method of apportionment based on records existing at the time of reporting for sales and use tax purposes.
Software vendors may pursue refunds
In this case, the Massachusetts Supreme Judicial Court considered whether there is a statutory right to apportionment for software transferred for use in more than one state, and whether the general abatement process is available to the vendors who paid sales tax in excess of that properly apportioned amount. The Commissioner maintained that the statutory language provided him the right to determine whether to allow apportionment of sales tax in instances where software is transferred for use in multiple states. Further, the Commissioner argued that the taxpayers’ failure to follow the process outlined in the regulations for apportioning sales tax precluded them from partaking in the general abatement process. The Court rejected these arguments, ruling in the taxpayers’ favor and affirming the Board’s 2019 decision.
The Commissioner based his denial of the abatement on the belief that the statute itself does not afford the right to apportion sales of standardized software. Instead, the sole method by which apportionment could be achieved is as directed under the terms of the related regulation. This argument is based on the word “may” in the statute. The statute provides the Commissioner “may, by regulation, provide rules for apportioning tax” in instances where software is transferred for use in more than one state.12
The Court held that the legislative intent of this statute was to allow taxpayers to apportion sales tax on software in situations such as this. The Court then considered the constitutionality, and more specifically separation of powers concerns, under the Massachusetts Constitution. The Massachusetts Constitution grants the power to tax solely with the state legislature, and prohibits the legislative, executive, and judicial branches from exercising the powers of each other.13
The Board stated that the question of whether to allow apportionment was addressed by the legislature, with the Commissioner having the limited right to implement the apportionment rules. The Court affirmed this approach and concluded that the statute creates a statutory right to apportionment for software used in multiple states.
Further, the Commissioner argued that even if the statute created a right for the taxpayer to apportion the sales tax on software used outside the state, the taxpayer’s failure to follow the apportionment regulations precludes apportionment altogether. The regulations outline three procedures for apportionment of sales tax on software used outside the state: (i) the purchaser, at the time of the purchase and by the time the transaction is reported for sales or use tax purposes, delivers an exemption certificate to the seller claiming multiple points of use, and then the purchaser is responsible for remitting the use tax; (ii) the seller works with the buyer to produce the correct apportionment and the buyer certifies the accuracy of the apportionment; or (iii) the purchaser provides the seller with the purchaser’s direct pay permit, and the purchaser remits the tax to the appropriate jurisdictions.14
The Court noted that the general abatement process is in place to provide a remedy for taxpayers who have paid excessive taxes. Examining whether the abatement process was available for the apportionment of sales tax for software used outside the state, the Court compared the regulations at issue to those surrounding a purchaser providing a resale certificate. Under the resale certificate regulations, even if a purchaser does not provide a vendor with a resale certificate at the time of the purchase, the seller may pursue a refund of the tax paid through the general abatement process. The Court stated there is “no reason why the same would not be the case” in instances where a purchaser does not provide a vendor Form ST-12, Exempt Use Certificate, for software purchases.
The Commissioner also argued that there is a time limit set forth by the regulations. However, the Court explained that the second and third method both do not expressly state any time constraints. The second method of apportionment provides only that the seller and buyer may work together to produce the correct apportionment, which is certified by the buyer. The section does not provide a period of time following which the two parties cannot work together to produce the correct apportionment. Therefore, this component does not preclude the seller from participating in the general abatement process.
Finally, the Court rejected the Commissioner’s argument that allowing taxpayers to obtain apportionment through the abatement process renders the regulations providing the apportionment process meaningless. The Court determined the regulations provide a simple and efficient process for taxpayers to use for apportionment at the time the tax is due. Accordingly, the Court concluded that the regulations do not preclude the taxpayer from pursuing the general abatement process.
After nearly a decade since the tax period in question ended, this case was finally decided by the highest court in the Massachusetts court system. The Massachusetts Supreme Judicial Court held decisively in the taxpayer’s favor, clarifying the ability of software vendors to pursue refunds of sales tax related to Massachusetts-based software that is ultimately accessed remotely by a customer located outside the state. The ability to apportion sales tax in a situation in which software is used in multiple jurisdictions ensures that each state imposing sales tax on software receives an appropriate share of tax based on the location of use. It also ensures that taxpayers with locations in multiple states, including in states that impose a sales tax on software, such as Massachusetts, and other states that do not, are not required to overpay sales tax.
In affirming the Board’s ruling, the Court rejected the attempt by the Commissioner to limit a taxpayer’s ability to seek relief from a potential double imposition of tax in the location of storage as well as the location of use through the normal abatement process. In the instant case, the taxpayers’ customer presumably paid tax in the states where the software was being used in addition to Massachusetts. Thus, it is possible that double tax was being paid on the software.
Vendors with Massachusetts-based customers and Massachusetts-based companies with locations in other states should be aware of this ruling as this allows purchasers located in Massachusetts to apportion sales tax correctly after the tax may have already been collected and remitted to Massachusetts by the taxpayer. Taxpayers have received a favorable ruling from the highest court, setting the precedent to allow them to seek refunds (generally over the prior three-year period) for overpaid sales tax. Massachusetts-based companies with additional locations outside the state should review recent software purchases, ensuring they did not overpay Massachusetts sales tax. However, if they did overpay, a remedy and process is now in place for purchasers and taxpayers to seek relief.
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