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Pain the SaaS: Navigating Sales Tax on Cloud Computing

Over the past several years software as a service (“SaaS”) has been a booming industry.  Pioneers in the cloud computing industry, like Salesforce, have developed web based applications that offer a wide range of services to the user.  Driven by competitors such as Microsoft, Adobe, Sap, ADP, Oracle, IBM, Intuit and Google, the SaaS industry has become a $204 billion industry and grown by more than 16% last year.

Traditionally, from a sales tax perspective, states tax the sale of tangible personal property but not services.  While many states adhere to that mantra, several states have moved towards taxing software despite being intangible in nature.  Still, it can be difficult to determine whether SaaS is more like a software, which may be taxable, or if it feels more like a service provided, which is not taxable in many states.

States have been consistently inconsistent across the country in determining whether to tax SaaS.  States often have similar statutes and reach completely different conclusions in their quest to analyze SaaS.  Further, many situations occur in which a state can treat two seemingly similar SaaS companies differently within their own state.  In an attempt to comply, companies often struggle with charging the appropriate sales tax in the correct state and/or their state income tax obligations, with respect to SaaS.

Setting aside the income tax obligations for now, the first step in a sales tax analysis is whether the company has nexus, or a connection, with the taxing state.  If a company lacks a physical presence, then it likely does not have a sales tax collection obligation and the SaaS inquiry becomes largely irrelevant.  If, however, a company has nexus (a sales rep, independent contractor, or inventory) in a state, then it must determine if its specific service is subject to sales tax.  It is also noteworthy that states such as Alabama, South Dakota, Tennessee, Nebraska, and Mississippi, have or are in the process of adopting an economic nexus standard which would create nexus for a company over a certain threshold of sales.

Assuming nexus is met, the company must turn to state law to determine whether its service is taxable. As mentioned above, the state results can vary depending on the particular type of SaaS provided; but the following states generally tax SaaS:

Arizona, Connecticut (1% rate), Hawaii, Indiana, Massachusetts, Minnesota, New Mexico, New York, Ohio, Pennsylvania, South Carolina, South Dakota, Tennessee, Texas, Utah, Washington, and Washington D.C.

With the trend of taxing SaaS on the rise, more and more companies may unsuspectingly be selling a taxable service in a state only to be blindsided by a state revenue department.  If the tax was not collected, the money can come right out of the company’s pocket.  Equally common, a company’s obligation may come up during a business transaction, in which a buyer may want assurances the sales tax liabilities have been addressed.

Our firm regularly represents company’s at the audit level, during the voluntary disclosure process to report a recently discovered liability, or as special counsel during a business transactions.

About the Authors: Gerald “Jerry” Donnini II is a partner of the Law Offices of Moffa, Sutton, & Donnini, P.A. Mr. Donnini concentrates in the area of Florida and Federal tax matters, with a heavy emphasis on the tobacco, convenience store and petroleum industries . He also handles a myriad of multi-state state and local tax issues. Mr. Donnini is a co-author for CCH’s Expert Treatise Library: State Sales and Us Tax and writes extensively on multi-state tax issues for

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