Sales & Use Tax for Cloud Computing, Software, Apps, and Other Digital Products and Services Overcoming Vendor and Customer Compliance Challenges Due to Inconsistent Multi-State Tax Laws THURSDAY, NOVEMBER 20, 2014, 1:00-2:50 pm Eastern

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Sales & Use Tax for Cloud Computing, Software, Apps, and Other Digital Products and Services November 20, 2014

Andrew Appleby Sutherland Asbill & Brennan [email protected] Joseph Endres Hodgson Russ [email protected]

Laurie Wik DuCharme, McMillen & Associates [email protected]

Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

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Today’s Program Sales Tax of Cloud Computing—Introduction and Overview [Laurie Wik]

Slide 7 – Slide 21

Potential Nexus Issues [Joseph Endres]

Slide 23 – Slide 30

Sourcing and Compliance Issues [Joseph Endres]

Slide 31 – Slide 37

Cloud Computing Updates [Andrew Appleby]

Slide 38 – Slide 50

Consumer Digital Goods Updates [Andrew Appleby]

Slide 51 – Slide 59

Federal Legislation Updates [Andrew Appleby]

Slide 60 – Slide 64

Digital Currency [Andrew Appleby]

Slide 65 – Slide 71

Cloud Computing, Software, and Other Digital Products and Services - Introduction and Overview Laurie Wik, Sales and Use Tax Director

NORTH AMERICA’S TRUSTED CHOICE FOR CORPORATE TAX SOLUTIONS DuCharme, McMillen & Associates, Inc. All rights reserved. Reproduction of this document or any portion thereof without written consent is prohibited.

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INTRODUCTION AND OVERVIEW Digital products - products and services provided or furnished electronically via the Internet Cloud  Cloud Computing • Software as a Service, Platform as Service, Infrastructure as a Service  Hosted Services; e.g., searchable databases, information services, data processing services  Streaming Digital Goods; e.g., music, movies Not part of today’s presentation: “On-premises” software; i.e., downloaded, delivered on tangible media, or loaded onto customer’s server by vendor (“load and leave”).

NORTH AMERICA’S TRUSTED CHOICE FOR CORPORATE TAX SOLUTIONS DuCharme, McMillen & Associates, Inc. All rights reserved. Reproduction of this document or any portion thereof without written consent is prohibited.

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WHAT IS CLOUD COMPUTING?  Cloud Computing Product Characteristics

“Cloud computing is a model for enabling ubiquitous, convenient, on-demand network access to a shared pool of configurable computing resources (e.g., networks, servers, storage, applications and services) that can be rapidly provisioned and released with minimal management effort or services provider interaction.”  The National Institute of Standards and Technology Definition of Cloud Computing, Special Pub. 800-145 (Sept. 2011) U.S. Commerce Department

NORTH AMERICA’S TRUSTED CHOICE FOR CORPORATE TAX SOLUTIONS DuCharme, McMillen & Associates, Inc. All rights reserved. Reproduction of this document or any portion thereof without written consent is prohibited.

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WHAT IS CLOUD COMPUTING? Software as a Service (SaaS): Customer/User accesses a software application running on the SaaS provider’s cloud infrastructure .

NORTH AMERICA’S TRUSTED CHOICE FOR CORPORATE TAX SOLUTIONS DuCharme, McMillen & Associates, Inc. All rights reserved. Reproduction of this document or any portion thereof without written consent is prohibited.

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WHAT IS CLOUD COMPUTING? Platform as a Service (PaaS): Customer uses Cloud Provider’s cloud infrastructure and tools to build or deploy applications and content. Customer does not manage or control the underlying cloud infrastructure but controls its deployed applications/content. 3rd parties can access the customer’s applications/content.

NORTH AMERICA’S TRUSTED CHOICE FOR CORPORATE TAX SOLUTIONS DuCharme, McMillen & Associates, Inc. All rights reserved. Reproduction of this document or any portion thereof without written consent is prohibited.

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WHAT IS CLOUD COMPUTING? Infrastructure as a Service (IaaS): Customer is provided processing, storage, networks, and other fundamental computing resources. The customer does not manage or control the underlying cloud infrastructure but has control over operating systems, storage, and deployed applications, and possibly limited control of select networking components (e.g., host firewalls).

NORTH AMERICA’S TRUSTED CHOICE FOR CORPORATE TAX SOLUTIONS DuCharme, McMillen & Associates, Inc. All rights reserved. Reproduction of this document or any portion thereof without written consent is prohibited.

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Courtesy of Albert Barron, from his post“Pizza as a Service” posted on LinkedIn 07/31/2014. Used with permission. NORTH AMERICA’S TRUSTED CHOICE FOR CORPORATE TAX SOLUTIONS DuCharme, McMillen & Associates, Inc. All rights reserved. Reproduction of this document or any portion thereof without written consent is prohibited.

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CLOUD PRODUCT PRICING MODELS  Cloud Product Pricing Models

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Pay-Per-Use



Pay-Per-Gigabyte Used



Monthly or Annual Subscription

 

Pay-Per-User

Revenue-Share

NORTH AMERICA’S TRUSTED CHOICE FOR CORPORATE TAX SOLUTIONS DuCharme, McMillen & Associates, Inc. All rights reserved. Reproduction of this document or any portion thereof without written consent is prohibited.

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STATE GUIDANCE ON “CLOUD COMPUTING”  State guidance addressing “cloud computing” as a topic includes:      

Policy Letter - Cloud Computing, Iowa Department of Revenue, January 11, 2012. Letter Ruling 12-8, Massachusetts Department of Revenue, November 13, 2013. Information Guide 6-511-2011, Nebraska Sales and Use Tax Guide for Computer Software, Nebraska Department of Revenue, January 22, 2014. New Jersey Technical Bulletin, Cloud Computing, (SaaS, PaaS, IaaS) TB-72, New Jersey Division of Taxation, July 3, 2013 Fact Sheet 1001—The Sales and Use Tax Treatment of Cloud Computing, Vermont Department of Taxes, June 13, 2013 (expired 6/30/2014; new regulatory language released for public comment on 7/10/2014) Frequently Asked Questions—Sales and Use Tax Treatment—Computer Hardware, Software, Services, Wisconsin Department of Revenue, December 23, 2013 .

NORTH AMERICA’S TRUSTED CHOICE FOR CORPORATE TAX SOLUTIONS DuCharme, McMillen & Associates, Inc. All rights reserved. Reproduction of this document or any portion thereof without written consent is prohibited.

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OTHER DIGITAL PRODUCTS

 Other product offerings furnished via the Internet Cloud: include information services, searchable data bases, movies, songs, videogames, premium level subscriptions to online social networks.

NORTH AMERICA’S TRUSTED CHOICE FOR CORPORATE TAX SOLUTIONS DuCharme, McMillen & Associates, Inc. All rights reserved. Reproduction of this document or any portion thereof without written consent is prohibited.

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STATE POSITIONS ON DIGITAL PRODUCTS  Jurisdictions may regard a transaction to be taxable because the jurisdiction construes the transaction to be :  A taxable sale or lease of prewritten software, i.e. statutory tangible personal property (TPP)  Constructive possession vs. physical possession  A Taxable lease or rental of statutory TPP despite no physical possession because server is single-tenant server  A digital equivalent to traditional TPP  A digital good or specific digital good  An enumerated taxable service, e.g:  Data processing, data storage service  Digital Automated Service  “Canned” Information Service such as data processing or information service in the state  Not an enumerated exemption from general tax on services NORTH AMERICA’S TRUSTED CHOICE FOR CORPORATE TAX SOLUTIONS DuCharme, McMillen & Associates, Inc. All rights reserved. Reproduction of this document or any portion thereof without written consent is prohibited.

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TO BE OR NOT TO BE APPLICATION SOFTWARE  Identifying the nature of a transaction is key to determining taxability.  Form of the transaction, i.e., the contract, may or may not agree with the substance of the transaction.  Software tends to be involved in the provision of most digital products, but the use of application software may or may not be the true object sought by the customer/user.

NORTH AMERICA’S TRUSTED CHOICE FOR CORPORATE TAX SOLUTIONS DuCharme, McMillen & Associates, Inc. All rights reserved. Reproduction of this document or any portion thereof without written consent is prohibited.

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TRUE OBJECT/PRIMARY PURPOSE  Massachusetts Letter rulings in which a hosted product offering was deemed access to application software considered:   





Substantial use of software by the customer The level of taxable, i.e., software elements, to non-taxable elements included in a bundled product offering The automated functioning of tasks performed by the product offering The performance of tasks sought by the customer from the product offering and the role of the seller’s software in performing such tasks, i.e, is the software incidental to a task a human is performing or is the software the means of performing the task The intervention in the product offering by seller’s personnel or lack thereof

NORTH AMERICA’S TRUSTED CHOICE FOR CORPORATE TAX SOLUTIONS DuCharme, McMillen & Associates, Inc. All rights reserved. Reproduction of this document or any portion thereof without written consent is prohibited.

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TRUE OBJECT/PRIMARY PURPOSE Massachusetts:      

Massachusetts Dept. of Revenue Letter Ruling 11-4, (April 12, 2011) Massachusetts Dept. of Revenue Letter Ruling 12-5 (May 7, 2012) Massachusetts Dept. of Revenue Letter Ruling 12-10 (Sept. 12, 2012) Massachusetts Dept. of Revenue Letter Ruling 12-13 (Nov. 9, 2012) Massachusetts Dept. of Revenue Letter Ruling 13-2 (March 11, 2013) Massachusetts Dept. of Revenue Letter Ruling 13-5 (June 4, 2013)

NORTH AMERICA’S TRUSTED CHOICE FOR CORPORATE TAX SOLUTIONS DuCharme, McMillen & Associates, Inc. All rights reserved. Reproduction of this document or any portion thereof without written consent is prohibited.

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EXEMPTIONS APPLICABLE TO DIGITAL PRODUCTS  Resale and other exemptions  Texas: 20% exemption from the value of information services and data processing services. Texas Tax Code Sec. 151.351.  Washington: • Multiple Point of Use Exemption, Digital Products: RCW Section 82.12.02088, WAC458-20-15503(506) • Multiple Point of Use Exemption, Remote Access Software: RCW Section 82.08.02088, WAC458-20-15502(11) • Digital Products or Remote Access Software Made Available For Free to the General Public. RCW Section 82.08.02082, WAC458-2015502(10)(c)(ii), WAC458-20-15503(504) • Digital Goods Purchased for a Business Purpose. RCW Section 82.08.02087(1), WAC458-20-15503(505) NORTH AMERICA’S TRUSTED CHOICE FOR CORPORATE TAX SOLUTIONS DuCharme, McMillen & Associates, Inc. All rights reserved. Reproduction of this document or any portion thereof without written consent is prohibited.

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CONTACTS

Laurie Wik Tax Director, San Jose, California 408-955-0316, ext. 2717, [email protected]

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SALES & USE TAX FOR CLOUD COMPUTING, SOFTWARE, APPS, AND OTHER DIGITAL PRODUCTS AND SERVICES Joseph N. Endres Hodgson Russ LLP 1540 Broadway, 24th Floor New York, NY 10036 Phone: (716) 848-1504 Fax: (716) 819-4711

SALES AND USE TAX FOR DIGITAL PRODUCTS AND SERVICES NEXUS ISSUES

 First question: Nexus, what is it? 1.

Nexus is a fancy word for “connection.” In order for a state to require an out-of-state seller to collect its sales tax, there must be a requisite level of connection between the state and the seller.  Quill v. North Dakota, 504 U.S. 298 (1992)  The “Bright Line” Test: Physical Presence  Do you have any people or property in the state? •

Offices

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Employees or independent contractors

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Inventories

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Other property – servers and Texas

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SALES AND USE TAX FOR DIGITAL PRODUCTS AND SERVICES NEXUS ISSUES

 Just because you have “Nexus” with a state, doesn’t mean you have a sales tax exposure. 1.

Not all states tax digital goods. You have to know the rules in each state. Unfortunately the rules are complex and in flux!  For example, California exempts digital goods. New York taxes digitally accessed or transferred software, but exempts other digital products such as music, pictures, etc.  States that tax digital products, other than software: AL, AR, AZ, CO, CT (but at a lower rate), HI, ID, IN, IL, KY, LA, ME, MN (as of 7/1/13), MS, NC, NE, NJ, NM, OH (as of 1/1/14), SD, TN, TX, UT, VT, WA, WI, WY.

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SALES AND USE TAX FOR DIGITAL PRODUCTS AND SERVICES NEXUS ISSUES

 Can a third party’s activity in a state confer nexus on an out-of-state seller? 1.

Click-Through Nexus – New York’s Amazon Law.

>

Several states now impose some sort of click-through or affiliate nexus, including Arkansas, California, Colorado, Connecticut, Georgia, Illinois (currently unconstitutional), Kansas, Minnesota, Missouri, New York, North Carolina, Oklahoma, Pennsylvania, Rhode Island, Texas and Vermont

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SALES AND USE TAX FOR DIGITAL PRODUCTS AND SERVICES NEXUS ISSUES

 New York’s Recent Amazon Law(a quick history) 1.

In 2008, New York amended its Tax Law (§1101(b)(8)(vi)), expanding the definition of a “vendor” required to collect and remit sales tax on the vendor’s taxable sales in New York •

The amendment accomplished this by creating a presumption of solicitation on certain out-of-state sellers who had agreements with New York affiliates.

2.

Shortly thereafter, two out-of-state sellers with no physical presence in New York (no offices, employees, or property), Amazon.com and Overstock.com, challenged the constitutionality of the amendment

3.

Nearly five years after the initial challenge, New York’s highest appellate court, the Court of Appeals, issued a decision on March 28, 2013. See, 20 N.Y.3d 586.

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SALES AND USE TAX FOR DIGITAL PRODUCTS AND SERVICES NEXUS ISSUES

 The “Click-Through” Nexus laws are likely here to stay, though some have been invalidated recently in certain states. 1.

In late 2013 the Supreme Court refused to hear a challenge to New York’s Affiliate Nexus laws.

2.

In October 2013, the state's highest court found Illinois' Internet sales tax void and unenforceable because it conflicts with a federal law that temporarily blocked new state or federal taxes aimed at online retailers or Internet providers, the first court in the country to take that stance. More on this later….

 So it doesn’t look like a unified solution is going to come from the courts.  What about Congress?

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SALES AND USE TAX FOR DIGITAL PRODUCTS AND SERVICES NEXUS ISSUES

 The Marketplace Fairness Act of 2013 1.

The Marketplace Fairness Act grants states the authority to compel online and catalog retailers ("remote sellers"), no matter where they are located, to collect sales tax at the time of a transaction - exactly like local retailers are already required to do.

2.

However, States are only granted this authority after they have simplified their sales tax laws. •

Big retailers have supported the legislation fervently, including Walmart, Amazon, BestBuy, Bed, Bath and Beyond, Barnes and Noble, Target, and Staples, among others

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SALES AND USE TAX FOR DIGITAL PRODUCTS AND SERVICES NEXUS ISSUES  States have two options to simplify their sales tax codes: 1.

A state can join the twenty-four states that have already voluntarily adopted the simplification measures of the Streamlined Sales and Use Tax Agreement (SSUTA), which has been developed over the last eleven years by forty-four states and more than eighty-five businesses with the goal of making sales tax collection easy. Any state which is in compliance with the SSUTA and has achieved Full Member status as a SSUTA implementing state will have collection authority on the first day of the calendar quarter that is at least 90 days after enactment.

2.

Alternatively, states can meet essentially five simplification mandates listed in the bill. States that choose this option must agree to: •

Notify retailers in advance of any rate changes within the state

•

Designate a single state organization to handle sales tax registrations, filings, and audits

•

Establish a uniform sales tax base for use throughout the state

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Use destination sourcing to determine sales tax rates for out-of-state purchases (a purchase made by a consumer in California from a retailer in Ohio is taxed at the California rate, and the sales tax collected is remitted to California to fund projects and services there)

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Provide free software for managing sales tax compliance, and hold retailers harmless for any errors that result from relying on state-provided systems and data

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SALES AND USE TAX FOR DIGITAL PRODUCTS AND SERVICES SOURCING ISSUES

 What state’s tax rules apply? 1.

General Rule: For software and digital goods, the state where the end user is located typically controls……but be careful!

2.

But what happens when users are located across various states? Or what if a service is performed for a business with locations in multiple jurisdictions (e.g., software-based accounting services, accounts payable, payroll, etc.)?  Principal place of business approach.  Reasonable estimates of user locations.

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SALES AND USE TAX FOR DIGITAL PRODUCTS AND SERVICES SOURCING ISSUES

 Multiple Points-of-Use (“MPU”) Exemption Certificates 1.

A handful of states allow purchasers to provide sellers MPU Exemption Certificates when certain requirements are met. •

2.

For example, in order for the exemption to apply, most states require that the software be transferred or accessed digitally and that the software be used by the customer in multiple jurisdictions.

These certificates can be a very effective way for a seller to limit its compliance obligation. A seller that receives the exemption certificate is relieved of its obligation to collect tax on the transaction. Rather, the purchaser is obligated to remit the tax to the state once it determines where the software is used by its employees.

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SALES AND USE TAX FOR DIGITAL PRODUCTS AND SERVICES SOURCING ISSUES

 Multiple Points-of-Use (“MPU”) Exemption Certificates 1.

The following states have some type of MPU exemption: Colorado, Massachusetts, Minnesota (but only after mid-2013), Ohio and Washington

2.

Unfortunately, several states that previously offered the exemption but later repealed it: Indiana , Iowa, Kansas, Kentucky, Nebraska, New Jersey, North Dakota, South Dakota.

3.

Some states will still accept the MPU certificates informally.

4.

NY accepts information from the purchaser regarding use.

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SALES AND USE TAX FOR DIGITAL PRODUCTS AND SERVICES SOURCING ISSUES

 Practical advice for sellers 1.

Establish policy and procedure for sourcing sales transactions  e.g., SSTA sourcing hierarchy

2.

Implement a rule for each product (SKU) sold

3.

Information, information, information! Identify the best available information for sourcing purposes.

4.

Maintain excellent record keeping with respect to exemption certificates.  Keep both a hard copy and a digital copy. 35

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Strafford – Sales & Use Tax for Cloud Computing, Software, Apps, and Other Digital Products and Services

Andrew Appleby Associate Sutherland Asbill & Brennan LLP 212.389.5042 [email protected]

Digital Economy

CLOUD COMPUTING UPDATES 37

©2014 Sutherland Asbill & Brennan LLP

Arizona Letter Ruling • The AZ DOR determined that a taxpayer providing online backup and restoration services was subject to transaction privilege tax (TPT) because the services were taxable rentals of prewritten software. Ariz. Priv. Taxpayer Rul. No. LR 13-002 (Mar. 25, 2013)

• Notably, the Department did not undertake a “true object” analysis to examine whether or not the software conduit was de minimis compared to the overall backup service.

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Virginia Cloud Computing Exemption • The Virginia Tax Commissioner issued a taxpayer-favorable ruling addressing Virginia sales and use tax on (1) computer software sold to manufacturers and (2) cloud computing services. Va. Pub. Doc. Rul. No. 14-42 (Mar. 20, 2014)  The Commissioner determined that Virginia’s manufacturing exemption can apply to sales of computer software if the software is used directly in the manufacturer’s production process (i.e., as an indispensable and immediate part of the actual production process).

 As an example, the Commissioner distinguished between software used to direct or control production operations (exempt) and software used only to monitor such operations (taxable).  The Commissioner determined that cloud computing services were exempt from sales and use tax because they do not involve tangible medium and qualify as a nontaxable service under Virginia’s exemption for electronic transfers of software.

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Florida Information Services Ruling • The Florida Department of Revenue determined that the sale of remote storage and cloud computing services, along with related data transfer fees, are information services not subject to Florida sales tax or CST. Fla. Dep’t of Revenue, Tech. Asst. Advisement, TAA 14A19-001 (Mar. 13, 2014)  The Department determined that neither the remote storage nor cloud computing services offered by the taxpayer involve a customer paying for the transmission or routing of information  Rather, each offers a customer the capability to store and retrieve data—hallmarks of a nontaxable information service

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©2014 Sutherland Asbill & Brennan LLP

Tennessee Letter Ruling • The TN DOR determined that a taxpayer’s sale of remote storage services and virtual computing services are not subject to sales or use tax where the data centers and servers used to provide such services are located outside the state. Tennessee Letter Ruling 13-12 (Sept. 12, 2013)  The DOR determined neither service was subject to Tennessee sales and use tax because there was no sale, transfer or electronic delivery of tangible personal property or computer software in Tennessee in connection with the furnishing of these services  The DOR noted that the taxpayer prohibited customers from downloading any part of its remote storage interface or its virtual computing software

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©2014 Sutherland Asbill & Brennan LLP

Tennessee (cont’d) • The DOR determined that the primary purpose of the remote storage service was the remote storage of digital data, applications and information, and the primary purpose of the virtual computing service was to access processed data or information stored on the taxpayer’s servers located outside the state

• Accordingly, the DOR categorized both services as data processing and information services, which are specifically excluded from the definition of telecommunications services

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Georgia Letter Ruling • The Georgia Department of Revenue determined that a company’s cloud-based applications and related services are not subject to Georgia sales and use tax. Ga. LR SUT-2014-05 (June 9, 2014)  Cloud-based services and hosting services are not taxable services under Georgia law.  Because customers did not receive tangible personal property in the transaction, this is not a retail sale subject to sales and use tax.  The company is the end user of all tangible personal property it uses to provide its services and therefore is liable for sales and use tax on the purchase of those items.

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Michigan SaaS Case • The Michigan Court of Claims held that cloud computing, or software as a service (SaaS), is a nontaxable service rather than a taxable use of prewritten software. Auto-Owners Insurance Co. v. Dep’t of Treasury, Case No. 12-000082-MT (Mich. Ct. Cl. 2014)  The Michigan Department of Treasury asserted that the insurance company was liable for use tax because the transactions at issue involved the “use” of prewritten computer software “delivered by any means”

 The court disagreed, reasoning the software was not “delivered” because the third-party providers did not surrender possession or control of the software to the taxpayer, nor did the third parties actually transfer to the taxpayer the software needed to process and produce the outcomes

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Michigan Information Service Case •

The Michigan Court of Appeals held that Thomson Reuters’ sale of Checkpoint, an online tax and accounting research program, was the sale of a nontaxable information service and not tangible personal property for purposes of Michigan’s use tax. Thomson Reuters Inc. v. Dep’t of Treasury, No. 313825, LC No. 11-000091-MT (Mich. Ct. of App. May 13, 2014)  Department of Treasury argued Checkpoint was tangible personal property because it constituted the sale of “prewritten computer software subject to tax when plaintiff’s Michigan customers used and controlled the computer code that resided on the web browser interface and on the server side”  Applying Michigan’s “incidental to service test,” however, the Court of Appeals found Checkpoint customers sought access to information, not the underlying computer code that constituted less than one percent of the transaction  Thus, any transfer of tangible personal property was incidental to the information service

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©2014 Sutherland Asbill & Brennan LLP

New Jersey Technical Bulletin • The Division of Taxation issued a technical bulletin that confirmed the state does not tax sales of cloud computing services including SaaS, PaaS, and IaaS. New Jersey Division of Taxation Technical Bulletin TB-72 (July 3, 2013) • The Division explained:  SaaS retailers provide customers with access to software through remote means;  PaaS retailers provide customers with computing platforms through remote means; and  IaaS retailers provide customers with equipment and services necessary to support and manage the customer’s content and dataflow through remote means. 46

©2014 Sutherland Asbill & Brennan LLP

New Jersey (cont’d) • The Division stated that SaaS, PaaS, and IaaS do not fit within the definition of tangible personal property (which includes “computer software”) because the retailer does not transfer any software to its customers

• Further, New Jersey does not enumerate SaaS, PaaS, or IaaS as taxable services

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©2014 Sutherland Asbill & Brennan LLP

New York Tax Bulletin • The sale of prewritten software is taxable, and the sale of custom software is not subject to tax. N.Y. Tax Bulletin, TB-ST-128 (Aug. 5, 2014)  A sale of software includes any transfer of title or possession, including a license to use.  The sale to a purchaser in New York of a license to remotely access software is subject to tax because, by accessing the software, the purchaser gains “constructive possession of” and “the right to use or control” the software.  The situs of the sale is “the location from which the purchaser uses or directs the use of the software, not the location of the code embodying the software.”

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©2014 Sutherland Asbill & Brennan LLP

New York Division of Tax Appeals Decision • Web-based program that tracks the execution of customers’ securities transactions does not constitute a taxable license to prewritten software. Appeal of Sungard Securities Finance, LLC, N.Y. Div. of Tax App., No. 824336 (Feb. 6, 2014)  Customers simply outsource their back office tracking functions to the taxpayer, so the taxpayer’s activity constitutes “information services”  Since reports furnished as a result of the services are “personal or individual in nature,” the services constitute nontaxable information services

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Andrew Appleby Associate Sutherland Asbill & Brennan LLP 212.389.5042 [email protected] Digital Economy

CONSUMER DIGITAL GOODS UPDATES 51

©2014 Sutherland Asbill & Brennan LLP

What are Consumer Digital Goods • Often digital equivalents to historically-tangible items, e.g., books, music, video games, and video (movies, television)  *Video discussed below

• Important distinctions with cloud-based services and B2B services • Influence of the Streamlined Sales and Use Tax Agreement

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Streamlined – Definitions • “Specified digital products”  Digital audio works (includes “ringtones”)

 Digital audio-visual works  Digital books • Electronically transferred

 As used in the digital goods context, defined as “obtained by the purchaser by means other than tangible storage media”  Compare “delivered electronically,” as used in the computer software context, with “delivered to the purchaser by means other than tangible storage media”

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Streamlined Update • Digital Products Sourcing Workgroup  SLAC formed Digital Products Sourcing Workgroup in October 2011 to address sourcing regime for digital goods under the Agreement.  Location of “receipt” SSUTA § 310  Collecting and maintaining buyer address information  Sourcing allocation  Origin sourcing

• Options for the Workgroup:  Develop stand-along Issue Paper; or

 Develop Issue Paper with Interpretive Rule  Draft Issue Paper available on www.streamlinedsalestax.org 54

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Streamlined Member States Associate Member

Full Members • • • • • • • • • • • • 55

Arkansas Georgia Indiana Iowa Kansas Kentucky Michigan Minnesota Nebraska Nevada New Jersey North Carolina

• • • • • • • • • • •

North Dakota Ohio Oklahoma Rhode Island South Dakota Utah Vermont Washington West Virginia Wisconsin Wyoming

•

Tennessee

©2014 Sutherland Asbill & Brennan LLP

Oklahoma Letter Ruling – Sales of Digital Photos and Videos • The Commission ruled that receipts from sales of digital photos, videos and designs delivered via the Internet are not subject to sales tax when no tangible item is conveyed. Ok. LR-13-0131 (July 11, 2013)  The Commission also ruled that charges for Internet web designs are nontaxable

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Oklahoma Letter Ruling – Video Game Cards • The Commission also ruled that receipts from sales of video game console points cards, video game console online membership cards and online points cards are not subject to sales tax. Ok. LR-13-033 (Sept. 16, 2013)  The Commission resolved the issue under Oklahoma’s gift certificate regulation, which exempts sales of gift certificates from sales tax. However, the Commission clarified that sales tax must be collected to the extent that the certificates are later redeemed for tangible personal property

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Tennessee Letter Ruling – Video Games • The TN DOR determined that the sale of access codes for remotely accessed online games and virtual goods is not subject to Tennessee sales and use tax. However, the sale of access codes for downloadable video games, addon packs and play levels is subject to Tennessee sales and use tax. Tennessee Letter Ruling 13-15 (Oct. 14, 2013)  The DOR concluded that there was no sale of tangible personal property, including prewritten software, when the online games are accessed remotely on servers outside of Tennessee In addition, there is no download to the customers computer Finally, the DOR noted that there is no provision of a taxable service

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Tennessee (cont’d) • The DOR concluded that video games and add-on packs fit within the definition of computer software. Because the sale of the access codes for downloadable games allow the customer to download software, the access codes are subject to sales and use tax It is irrelevant that the customer is buying the access codes or the actual games • Lastly, the DOR addressed the sale of notional value or points card The DOR concluded that the sale of such cards is not subject to sales and use tax because the true object of the cards is the intangible right to purchase game items. However, when the cards are redeemed the purchased item may be taxable

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Andrew Appleby Associate Sutherland Asbill & Brennan LLP 212.389.5042 [email protected]

Digital Economy

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Permanent Internet Tax Freedom Act of 2013 • H.R. 434 & S. 31, introduced 1/2013  The bills would make permanent the existing ban on state or local taxes on internet access and on multiple or discriminatory taxes on e-commerce – retained grandfathering provisions

• The most recent extension of ITFA is scheduled to expire on December 11, 2014 • A permanent extension of ITFA passed the House. 

This version removes the grandfather clause from the previous version

• S. 1431 introduced 8/1/2013 – same bill but adds “Findings of Congress” for enacting permanent ban • S. 2609 introduced 7/15/2014 – 10 year extension (until November 1, 2014), retains grandfather clause – combined with Marketplace Fairness Act

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Application of ITFA – Illinois Case • In a 6-1 decision, the Illinois Supreme Court affirmed an Illinois Circuit Court holding that Illinois Public Act 96-1544 (The Click-Through Nexus Act), requiring out-of-state retailers to collect and remit use tax, violates the Internet Tax Freedom Act. Performance Marketing Ass’n v. Hamer, Docket No. 114496 (Oct. 18, 2013). • PMA is the most significant application of ITFA’s prohibition against “multiple or discriminatory taxes on electronic commerce” (Section 1101(a)(2)), which may have implications with respect to taxes on digital products. ©2014 Sutherland Asbill & Brennan LLP

Massachusetts Technical Information Release • The Massachusetts Department of Revenue addressed the possible expiration and subsequent retroactive enactment of the ITFA. The Department advised Internet Service Providers (ISPs) to continue to rely on previous guidance, until further notice, to determine the taxability of telecommunications services and Internet access services. The Department anticipates providing further guidance if the ITFA does expire. Mass. TIR 14-10 (Sept. 11, 2014).

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Digital Goods and Services Tax Fairness Act of 2013 • Introduced 7/25/2013, S. 1364

• Would regulate state taxation of downloaded music and movies and online services • Provides uniform sourcing rules for digital goods • Goal is to prevent “multiple and discriminatory” taxation of digital goods

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Andrew Appleby Associate Sutherland Asbill & Brennan LLP 212.389.5042 [email protected]

Digital Economy

DIGITAL CURRENCY

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Bitcoins – Generally • Decentralized Digital Currency  Peer-to-peer currency – all aspects of bitcoin creation and transactions take place over a distributed network.  There is no central authority or government that can create more bitcoins unilaterally.  There is no central authority or entity that clears or facilitates bitcoin transactions.  Bitcoins are not backed by any central authority or government and is not pegged against any currency.  Bitcoins are currently used for (1) the payments for goods and services and (2) trading and investments.

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Bitcoin Creation (“mining”) • Unlike other normal currencies or digital currencies, bitcoins are not minted or created. • Bitcoins are created through a process called mining.  Miners confirm and verify all bitcoin transactions that occur by solving a complex mathematical formula.  As transactions are confirmed and added to the public ledger, miners are given bitcoins based on the amount of contribution towards solving the formula.

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Bitcoin Transactions • Bitcoin transactions are not cleared or processed by any central authority or entity.  Bitcoin transactions are verified by the miners, within the entire bitcoin distributed network.  Every bitcoin transaction is recorded on the public ledger and the public address of the sending party and the receiving party are recorded as well.  The public ledger is the digital record of all bitcoin transactions. The ledger serves to maintain the integrity and security of bitcoin transactions.  One cannot determine the identities of the parties from the public addresses.

©2014 Sutherland Asbill & Brennan LLP

Bitcoin Storage • The storage of bitcoins requires a “digital wallet”. • There are two methods of storing bitcoins:  Personal digital wallets installed on individual user’s machines (computer, smart phones, etc.)  Hosted wallets operated by services providers on their servers. The wallets are accessible through the internet and is not hardware restricted.

• All bitcoin wallets have a private key and a public key.  Private key – allows individual users to access their bitcoins.  Public key – address that is used to send and receive bitcoins and is recorded on the public ledger.

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Sales and Use Tax Issues • Sale/exchange of bitcoins for cash  Will states follow characterization of bitcoins as intangible property?  What is the sales price?

• Sale of taxable property or service paid by bitcoin  Vendors who collect sales tax in bitcoins must convert to dollars to remit the sales or use tax to the state

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Missouri Letter Ruling • The operator of an ATM that exchanges cash for bitcoins is not required to collect and remit Missouri sales and use tax on such transactions. Missouri Letter Ruling No. LR 7411 (Sept. 12, 2014) • The Department stated that the exchange of cash for bitcoins is the sale of intangible property. Missouri law does not impose sales or use tax on intangible property, so the exchange of bitcoins for cash is not subject to Missouri sales or use tax.

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Andrew Appleby Associate Sutherland Asbill & Brennan LLP 212.389.5042 [email protected]

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SALES AND USE TAX FOR DIGITAL PRODUCTS AND SERVICES COMPLIANCE ISSUES

 Define the Product Appropriately  E.g., Tax Preparation Services  Primary Purpose Test

 Speak with One Voice 1.

Make sure the following items all define the product consistently:    

Contracts Invoices Marketing brochures Website material

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SALES AND USE TAX FOR DIGITAL PRODUCTS AND SERVICES COMPLIANCE ISSUES  Frequently, a company’s sales tax obligations are complicated by the manner in which its products are sold. For example, when the company sells multiple products or deliverables (some taxable and some exempt) its sales tax liability can unnecessarily increase if the transaction is not billed properly. 

New York’s Cheeseboard Rule: When taxable and exempt items are bundled into a single price, the entire charge can be subject to sales tax. See 20 NYCRR 527.1

 If multiple products are sold (some taxable and some exempt), the company must be able to track the different revenue streams. 

Sales tax audits are always more difficult and problematic if you don’t have good records detailing the transactions at issue.

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SALES AND USE TAX FOR DIGITAL PRODUCTS AND SERVICES COMPLIANCE ISSUES  In order to minimize potential sales tax exposure, a company must know the sales tax rules in effect in the jurisdictions where it is obligated to collect the tax. Simple changes in transaction structure can greatly reduce tax liability  EXAMPLE: A business in New York State maintains a catalog of stock photos that various magazines and other publications frequently purchase in order to reproduce. 1.

If the photo is sold in hard copy to a New York customer, then the sale constitutes a taxable sale of tangible personal property.

2.

If, however, the photo is transferred electronically via e-mail or download from a Web site, the sale is not subject to tax, because New York does not tax digital products such as photos, music, movies, etc.

3.

What if the seller also provided access to software through its Web site that allowed the purchaser to manipulate the digital photo? Then, the transaction is probably taxable. This demonstrates the need to separately state the taxable charge for the software from the nontaxable charge for the photograph.

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