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Texas is one of many states beginning to tax software as a service. Known as SaaS, these new impositions of tax are still struggling with practical application. Software as a service typically includes a situation in which a software company develops software to be accessed via the internet. The software company then operates or hosts the website through which the software is accessed by customers online. It is important to note that customers do not possess or own the software; rather they pay for access to it online.

To understand the difference, let’s use the example of a video game. A user can purchase a game and access it remotely online. That would be considered software as a service. However, is the game allows users to download the program, that is not software as a service because the customer ultimately has possession of the software on his or her computer. The distinguishing feature of SaaS is that the user does not own or possess the software.

The type of SaaS addressed by Texas in a a recent letter ruling is one in which a customer uses a web-based dashboard application to receive and process data, translate and store messages, and create analytic reports for the customer’s use. The Taxpayer describes and markets their business as “a better, faster way to communicate with today’s customers.” By using a dashboard application, subscribing businesses communicate and interact with their customers via text and other types of mobile messaging channels. Customers are able to text questions, orders, etc. to the business directly. The Taxpayer reconfigures the incoming message from the customer and so that it can be displayed in English on the business’s dashboard application. Following that, custom or canned replies, or both, are reconfigured and sent back to the customer. Meanwhile the analytic services provided include the generation of reports on the number of requests per day, the categories of requests, and the average response times.

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As it turns out, Colorado really was just the beginning. As of January 1, 2018, Washington will begin requiring remote sellers to either remit sales and use tax or comply with reporting and notice requirements similar to those in Direct Mktg. Ass’n v. Brohl (DMA IV), 814 F.3d 1129 (10th Cir. 2016). Who is subjected to this burden in the land of Nirvana and the Space Needle? Remote sellers with gross receipts in the current or preceding year of at least $10,000 are, which makes Washington state another to skirt around Quill, the SCOTUS case that requires actual, physical presence for a state to have nexus with a taxpayer, with a reporting requirement.

But the legislative change goes further. Not only are retailers who make income from sales within the state required to follow this, but referrers who receive income from referral services within the state are subject to it as well if the total gross income from that is at least $267,000.

With 33 states facing revenue shortfalls in fiscal years 2017 and 2018, there is no doubt a need to increase taxes. However, states can go about this in a wide variety of legal ways. They can expand the tax base by taxing services or currently nontaxable technology. They can even increase the tax rate if they want to. Instead, Washington is imposing these reporting requirements to reach companies with whom they fail to meet the nexus standard to impose collecting and remitting requirements.  This overreaching of the states will likely be challenged. The question is: by whom?

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The rise of internet sales has created a tax problem for states. States are having difficulty getting revenue from these sales because the sellers lack nexus. In the legal community, that nexus is known as a connection with a state which allows for it to exercise jurisdiction over a vendor. Nexus is a growing concern for internet sellers because they are not physically present and states have begun overreaching in their extension of jurisdiction over them. Last year, Oklahoma enacted the Oklahoma Retail Protection Act of 2016. The purpose of the act was to (1) expand nexus to include a presumption of its existence in cases where a vendor has certain relationships or arrangements with people who do have a physical presence in the state, and (2) require out-of-state vendors to provide annual reports to their customers acknowledging the potential use tax liability on their purchases without disclosing which particular items were purchased.

This first part, which expands the jurisdiction of Oklahoma to cover more out-of-state vendors than it did previously, ultimately only applies a presumption to vendors who fall into a particular category. That presumption can be overcome with proof that the person with physical presence who has a relationship with the vendor does not establish or maintain the sales market in Oklahoma for that vendor. But is even a presumption of nexus in those cases crossing a line? In Quill Corp. v. North Dakota, the United States Supreme Court made it very clear that physical presence must be required by a vendor for it to have nexus within a state. To extend that to “physical presence of anyone associated with the business” is, at the very least, stretching the holding in Quill.

Meanwhile, the second requirement of the Oklahoma Retail Protection Act of 2016 requires out-of-state vendors that are not required to collect tax to send records to their customers to whom sales have been made within the state. These records need to identify the total sales made by the vendor to its in-state customer without revealing the particular items purchased. As this requirement appears to be on vendors who have no physical presence whatsoever, even by a third party, it is questionable whether Oklahoma has the authority to enforce such a burden on companies who are located entirely outside of their state.[1]

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Effective August 1, 2016, Pennsylvania has joined the ranks of states attempting to expand their sales and use tax jurisdiction over digital downloads. With out-of-state internet sales taking away sales tax revenue from the states in conjunction with the sharp decline in “hard copy” sales of various media, states are scrambling to expand their tax base and capture categories of items that escaped their grasp when they evolved with the internet and technology.

ACT 84 of 2016 specifically extends to items delivered to “a customer electronically or digitally or by streaming unless the transfer is otherwise exempt. This includes music or any other audio, video such as movies and streaming services, e-books and any otherwise taxable printed matter, apps and in-app purchases, ringtones, online games, and canned software, as well as any updates, maintenance or support of these items.” While e-books and videos otherwise would be printed or “hard copy” materials subject to tax, apps and certain in-app purchases have never been available through a tangible medium.

Ultimately, the Act regains a lost tax base while also adding new items to it. The question remains that if a Pennsylvania resident makes a purchase while on vacation in Florida and listens to, for example, a one-time podcast while still in Florida, then does Act 84 of 2016 extend to that purchase? In other words, if the sale and entire use occurs within Florida but the purchaser is a resident of Pennsylvania, is the sale subject to Pennsylvania tax?

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On April 25, 2016 an important decision for the sports world came down from the U.S. 2nd Circuit Court of Appeals involving Tom Brady. Being a sports fan and a tax lawyer, the opinion sparked my interest. Challenging the National Football League seemed to mirror the challenges we launch against government agencies every day. While the case is not exactly analogous for a few reasons, it was not that dissimilar for a taxpayer’s challenge to a government agency.

From a procedural perspective, the case stems from the infamous “deflate gate” scandal of the 2015 AFC Championship Game. During the game Tom Brady, of the four-time Super Bowl champion New England Patriots, allegedly instructed personnel to deflate the footballs below the legal pressure level in order to enhance his ability to grip the football. Specifically, after the game in question, the NFL officials determined that all 11 of the Patriots balls were inflated below the allowable level of 12.5 PSI, while none of the Colts balls were below.
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A few weeks ago, I discussed the apportionment of NFL Players’ income for state tax purposes in the article “Saturday’s Challenge to Cleveland Income Tax for NFL Players.” The Supreme Court of Ohio determined that the proper allocation of an NFL Player’s salary is to take the number of work days in a state divided by the number of overall work days. For example, if a player spends 7 days in a state for work (more specifically, preparation for a game) and has 206 overall workdays, then the relative percentage of the allocated income to the state is 3.39%. As a result, each state can get their fair share of the NFL Player’s income.

Forbes Business published an interesting article claiming that if the Carolina Panthers were to win in Sunday’s Super Bowl, then Cam Newton’s effective tax rate would be 99.6%. Compare this to the outrageous effective tax rate of 198.8%. This does not even include the 40.5% Cam Newton would owe the IRS.

Taking a step back and looking a Cam Newton’s “incentivized” earnings, if (or “when” for all those optimistic sports fans out there) the Carolina Panthers win the Super Bowl, Cam Newton will earn Super Bowl winning bonuses of $102,000, add this to the mere $58,800 earned for Week 17 of the Regular Season and $71,000 of playoff bonuses to date. If Cam Newton and his Carolina Panthers lose, he will “only” earn a Super Bowl bonus of $51,000. This totals to $231,800 in earnings if Cam Newton were to win the Super Bowl compared to $180,800 if he were to lose. All of this is on top of Cam’s salary of about $10 million per season.

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Over the past few years, we have been intricately involved in ongoing litigation with the Department of Business and Professional Regulation, Division of Alcoholic Beverages and Tobacco (“ABT”). There still remains ongoing litigation in connection with the Micjo issue. Micjo dealt with whether non-tobacco charges, such as federal excise tax and shipping charges, are subject to Florida Other Tobacco Products Tax and the Surcharge on Other Tobacco Products (“OTP Tax”). Down another path there is current litigation in Brandy’s, which deals with cigar wraps, or blunt wraps, which are subject to Florida’s OTP Tax. Recently, however, another case was filed in late 2014 that has a far broader reach than any other case filed to date.
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Over the past few years, taxpayers throughout Florida have been in a never ending battle with the Department of Business and Professional Regulation, Division of Alcoholic Beverages and Tobacco (“ABT”). At the forefront is the Micjo issue. Micjo was a case that determined that Florida wholesale tobacco tax should not apply to the full invoice. Rather, the 85% should only apply to the tobacco while charges and items such as federal excise tax and shipping should not be included in the taxable base. There are 8 pending cases throughout Florida being litigated on this issue. In addition, there are two cases in which the taxpayer has argued that blunt wraps, or cigar wraps, are not included in the tobacco products definition and, are therefore, not taxable. In Brandy’s, a taxpayer received a favorable ALJ opinion spelling out the same.

In response, ABT has attempted to change Florida law. Specifically in Senate Bill 7074, ABT is attempting to fix the Micjo opinion and change the taxable base to include the full price paid by the distributor, including the federal excise tax. The amended law will read as follows:

“Wholesale sales price” means the sum of paragraphs (a) and (b): (a) The full price paid by the distributor to acquire the tobacco products, including charges by the seller for the cost of materials, cost of labor and service, charge for transportation and delivery, the federal excise tax, and any other charges, even if the charge is listed as a separate item on the invoice paid by the established price for which a manufacturer sells a tobacco product to a distributor, exclusive of any diminution by volume or other discounts, including discount provided to a distributor by an affiliate. (b) The federal excise tax paid by the distributor on the tobacco products, if the tax is not included in the full price under paragraph (a).

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Most states attempt to encourage manufacturers to set up a business in their state. Manufacturers typically provide numerous benefits to a state’s economy such as job creation. One of the carrots typically used by a state is to offer sales and use tax incentive for a manufacturing company. In almost every state with a sales and use tax, machinery and equipment purchased for use in the manufacturing process is exempt from tax. What if a glass manufacturer purchased chemicals, such as nitrogen and hydrogen for use in its glass manufacturing process? Would that be a tax exempt purchase of equipment?
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