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Sales Tax on Information Services:  Navigating Aggressive State Policies  Understanding Taxable Features of a Database or Service for Multi‐State Compliance THURSDAY, AUGUST 11, 2011

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10am Pacific

Today’s faculty features: Irwin Mittleman, Mittleman Sales Tax Consultant, Consultant Meridian Global Services, Services New York Aaron Young, Partner, Reed Smith, New York Martin Eisenstein, Member, Brann & Isaacson, Lewiston, Maine

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Sales Tax on Information Service:  N i ti  A Navigating Aggressive State Policies  i  St t  P li i   Seminar Aug. 11, 2011

Irwin Mittleman, Meridian Global Services [email protected] Aaron Young, Reed Smith [email protected]

Martin Eisenstein, Brann & Isaacson [email protected]

Today’s Program Fundamental Concepts [Irwin Mittleman, Martin Eisenstein]

Slide 7 – Slide 15

Examples Of State Tax Treatment Of Information Services [Irwin Mittleman, Aaron Young, Martin Eisenstein]

Slide 16 – Slide 37

Related Sourcing Issues [Martin Eisenstein]

Slide 38 – Slide 45

Audit Risks And Audit Preparation Tactics [Aaron Young]

Slide 46 – Slide 56

IIrwin Mittleman, Meridian Global Services i  Mi l  M idi  Gl b l S i Martin Eisenstein, Brann & Isaacson

FUNDAMENTAL CONCEPTS

Info mation Se Information Services ices Defined

 In the most general terms, an information service is the right to access a common database. database 

Common examples include consumer product reports, employment history reports and junkyard parts-locator parts locator services.

8

Indicia Of What Constitutes An Information Service 

The dominant purpose for accessing the data is its content.



The same or similar information is sold or could be sold to another person [this is a objective, not subjective, determination].



The information is not personal in nature or restricted.

9

Indicia That Something Is Not An Information Service 

User owns the database but accesses software to manipulate the data.



The dominant purpose of application is not to gain access to the data.



The judgment of person providing the service is more important than the data.

10

How Information Services Are Distinguished From Access To Software 

When you have access to software software, you are utilizing software to perform a task or multiple tasks, e.g. add a column of numbers.



When you have access to a database, you can apply search parameters, but changes to the database are made by the owner of the information. information

11

Do All States Tax Information Services? 

Many states do not tax information services.



Many of the larger states, including New York, New Jersey Florida and Texas do tax information services. Jersey, services



Connecticut taxes computer services including “retrieving or providing access to information. information ”

12

Distinguishing An Information Service From A Professional Service 

The states are just beginning to analyze the distinctions between a professional service and an information service, but a true object test typically is applied.



A professional service generally involves a level of comfort with the individual providing the service and the client.

13

Chicago: The Hidden Tax On Information Services g •

•

Chicago imposes, via § 3-32-030(A) of its Municipal p C Code,, the “Personal Property p y Lease Transaction Tax,” an 8% tax on: •

The lease or rental in the city of personal property, or

•

The privilege of using in the city personal property that is leased or rented outside the city.

Under Rulings Nos. 3 and 9, the tax applies to charges for Chicago-based terminals to access servers located outside of Chicago for data processing services/information services such as credit bureau reports. • Ruling 1: Limit tax to if contract is signed in Chicago or if more than 50% of use is in Chicago 14

Chicago: The Hidden Tax on Information Services (Cont.)

•

Under Ruling 5, if data storage occurs on a server in Chicago, charges for this service are subject to personal property tax. •

•

However, if data storage occurs outside of Chicago, then the Chicago tax on lease of personal property doesn’t apply.

S Summary •

Review carefully your contracts that involve any form of data information and storage to determine where these activities take place. Also, be aware of the Chicago tax that focuses on where terminals are situated for access to computer services such as information services provided electronically, and where the servers are situated for purposes of storage charges.

15

Irwin Mittleman, Meridian Global Services Aaron Young  Reed Smith Aaron Young, Reed Smith Martin Eisenstein, Brann & Isaacson

EXAMPLES OF STATE TAX  TREATMENT OF  INFORMATION SERVICES

New York Taxation Of Information Services 

Information created or generated from a common database or information that is widely accessible is an information service.



The sale of a report that uses or relies on statistical models or historical data is generally considered to be an information service.



Includes single reports and subscriptions

17

New York Taxable Information Services         

Genealogic research services Investment reports and services Colleges and scholarship search services Employment history reports Archive services O li Online d dating ti services i People- or parts-locator services Sports scouting reports Public records furnished by a private entity

18

Risk Management g Services Are Taxable In New York 

Risk Ri k managementt iincludes l d analysis l i off market k t share, h investment portfolio, computer networks, security, etc.



Those services Th i rely l upon statistical t ti ti l data d t and d historical hi t i l data to generate a report.



A reportt to t a client li t may be b personall in i nature t but b t contains t i information from common database and that can be included in reports to others.

19

Web-Based Tenant Evaluation WebService Is Taxable In New York 

A Web-based report is used by developers to solicit selected retailers to the site.



Service is relying upon demographic data to find out which tenants have the best chance of success at location, and also the p proximity y of tenant’s competitors p



A report to a client may be personal in nature but contains information from common database and that can be included in reports to others.

20

Data--Mining Of Client Web Sites Data 

A taxpayer provided data warehousing and data-mining data mining services for client Web pages, with which it evaluated the number of hits per page, how long visitors remained on site etc site, etc.



This service was held to be personal, not a taxable information service service, because the information conveyed related exclusively to the client’s Web site, and information could not be sold to third parties.

21

New York  New York Technical Service Bureau Memorandum TSB M 10(7)S 07/19/2010 TSB-M-10(7)S,  Department has very broad view of taxable information services  Credit reports  Online dating  What is more personal that those types of services?

 Primary function  In the th Matter M tt off the th Petition P titi off T Telecheck l h kS Services, i IInc., DTA 822275, 11/05/2009 

22

Matter of Petition of SSOV '81 Ltd. d/b/a People Resources and Matter of Petition of Susan A. A Wallace, Wallace TAT 810966, 810966 810967, 01/19/1995

Examples Of How States Individually Treat Information Services: Texas • Texas in general • State with largest scope of tax on computer-related t l t d services i that th t iinclude: l d • Information services, data processing services i and d IInternet services i • Texas provides an exemption for 20% of charges for information services and data processing services.

23

Examples Of How States Individually  Treat Information Services: Texas (Cont.) •

34 TAC Sect. S t 3.344 3 344 d defines fi ttaxable bl iinformation f ti services i as ffurnishing i hi general or specialized news or other current information, including financial information, by print, electronic or any other method.

•

Examples of taxable information services: •

Newsletters

•

Mailing lists (only that percentage that represents names of persons located in Texas is taxable)

•

Real estate listings

•

Financial, investment, stock market, bond rating or financial reports

•

News clipping services and wire services

24

Examples Of How States Individually Treat Information Services: Texas (Cont.) •

Excludes: •

Sale of information to a particular report

•

Sale of information for medical research or scientific purposes

•

Internet access services or services furnished in conjunction j ti with ith IInternet t t access •

The first electronic information service were online services,, such as AOL and Prodigy. gy

•

Now, Internet access services/online services are taxable as Internet services, but there is a $25/month exemption ti per purchaser. h 25

Examples Of How States Individually Treat Information Services: Texas (Cont.) •

Sect. 151.0035, Tax Code; 34 TAC Sect. 3.330(a) seeks to tax all computerrelated services, thus taxing data processing services, which are those items not otherwise within the definition of information services including: •

•

Processing P i off information i f ti ffor th the purpose off compiling ili and d producing d i records of transactions, maintaining information, and entering and retrieving information

Data processing services include: •

Word processing, data entry, data retrieval, payroll and business accounting, entry of inventory control data, maintenance of records of employee work time, filing payroll tax returns, preparing W W-2 2 forms, and computing and preparing payroll checks

•

Reports in the nature of information services under other states’ definition, such as data production, data search, information compilation, and other computerized data and information storage or manipulation 26

Examples Of How States Individually  Treat Information Services: Florida • More narrow in scope than Texas but does tax “information services” • Fla. Fl C Code d SSect. t 12A 12A-1.062: 1 062 • Information services are defined to include collecting compiling and analyzing collecting, information or furnishing reports of information. • Examples include newsletters, tax guides, research publications and other written reports of compiled information. 27

Florida Information Services •

Broad exclusions from taxable services under Rule 12A-1.062 •

Furnishing of information to a person or individual of a personal or individual nature, even if incorporated in reports furnished to other persons

•

Furnishing information electronically or in digital form •

See Department of Revenue v. v Quotron Systems Systems, 615 So.2d So 2d 774 (Fla. 3rd DCA 1993): Seminal case that electronic transmission of information is not taxable as tangible personal property. property Case involved electronic delivery of various financial news and information to subscribers. Images on a screen are not capable of being touched or possessed, and therefore are not tangible g personal p p property. p y 28

Florida Information Services (Cont.) l d f ( ) •

E-delivered E d li d information i f ti iis exemptt ffrom sales l ttax and d communications i ti services tax. •

•

Technical Assistance Advisement No. 09A-049, (Sept. 23, 2009): •

Taxpayer that delivers terminal equipment to customers and electronic information to terminals is not subject to sales and use tax on charges to customers, because the information is e-delivered, and the taxpayer owns the terminals

•

Taxpayer is not required to pay a communications services tax;; information services are excluded from definition of communications services.

News research such as press clippings are also exempt.

29

Florida Information Services: The Caveat •

Note the Florida “sleeping dog” for providers and recipients of services using a Florida-based server. •

Rule 12A-1.032(3): Consumers are considered to be using a portion of a computer (renting the computer) when that computer is accessed through terminal devices that are connected to a computer in Florida.

•

Theory behind the rule: A customer is able to compile programs provide a variety of computations, programs, computations have computational results printed out on his terminal and keep data stored within the computer file for future use. This produces basically the same results as if the customer had processed the same data on his own computer; i.e., the customer performs the tasks of entering data into the computer, and all processing is accomplished under his control. control 30

New Jersey Definition Of Information Services 

Information o a o services se ces means ea s the e furnishing u s g of o any a y kind d of o information that has been collected, compiled, or analyzed by the seller, and provided through any means or method, other than personal or individual information that is not incorporated into reports furnished to others, NJSA 54:32B-3(b)(12), NJSA 54:32(B)-2(yy)

31

How New Jersey Sources Information Services 

The tax applies to the sale of information services received by customers in New Jersey. New Jersey Tax Notes, Information Services, 2-25-08.



Traditionally, New Jersey has taxed services based on where they occur, not on where the benefit of the service is received.

32

Is An Information Service An Exclusive Category?  

Not in any sense New Jersey taxes employment background checks as investigation service service, but they could in some jurisdictions be an information service.

33

New Jersey Taxable Information Services 

When information is sold to more than one person person, it is generally considered an information service. N.J.A.C. 18:24-35.4



Credit reports are an example of an information service, because a report of an individual’s creditworthiness can be purchased by multiple persons.



Getting severe weather alerts by e-mail or text is an information service, because it can be sold to multiple persons.

34

Services Not Considered Information Services In N.J. 

Services generally rendered by attorneys are generally not considered id d iinformation f ti services, i b because they th are personall in nature.



A multiple lti l li listing ti service i th thatt iis only l available il bl tto R Realtors lt is not considered an information service, because the dominant purpose is to create cooperation among brokers, not to gain access to the information. information

35

Connecticut 

36

T Taxable bl services i 

Information services are not per se taxable.



Enumerated taxable services 

Credit information and reporting



Computer and data processing



Private investigation

Connectic t (Cont.) Connecticut (Cont ) 

Credit information and reporting  Such S h services i iinclude l d b butt are nott lilimited it d tto th the assembling bli and evaluating of information regarding the credit standing, creditworthiness or credit capacity of any individual, corporation partnership or other type of entity; for the corporation, purpose of furnishing and disseminating written or oral credit reports.



C Computer t and dd data t processing i





1% tax rate



Lower tax rate may apply to taxable remote services?

Private investigation 

37

Includes engaging in detective or investigative duties, which could be an online service

Martin Eisenstein, Brann & Isaacson

RELATED SOURCING ISSUES

S Sourcing Issues: State Approaches i  I  S  A h • Three sourcing g situations • Delivery within the state by a provider situated in the state • All states treat this as an intra-state sale and subject to tax only in the state of service. ser ice •

No other state has nexus with the transaction and could tax the sale under the Commerce Clause. See Goldberg v. Sweet, 488 U.S. 252 (1989).

39

Sourcing Issues: State Approaches To Interstate Delivery •

Second situation: Customer has access via a terminal connected to a server in another state. •

All states tax 100% of taxable information services delivered in the state, except for Florida’s tax on use of a server located in FL, FL Chicago Chicago’ss tax on lease of personal property insofar as storage space (but not on data processing/information services), and the SSTA in limited circumstances as described in a subsequent slide. • See prior slides re: Florida and Chicago 40

Sourcing Issues: State Approaches (Cont.) • Second situation on interstate delivery: The general rule • See, e.g.. NYS (TSB-A-10(52)S 10/18/10); CT (ADC 12 426 27(d)) TX Rules 12-426-27(d)); R l 3.330 3 330 and d3 3.342). 342) Th The location of the terminal for access to the service controls • Issue is the proof of where the service is received • See Ohio and Texas statutes • Goldberg: Is billing address or service address in the state? 41

Sourcing Issues: State Approaches (SSTA) •

Th SSTA waterfall The t f ll approach h (OH: (OH R.C. R C 5739.033(C)) 5739 033(C)) •

If received (i.e., first use) at the vendor’s place of business,, sourced at the vendor’s p place of business

•

If not received at the vendor’s place of business, sourced at the location of receipt known to the vendor

•

If neither of the above, then at the address of the customer known from the vendor’s business records

•

If none of the above above, then the address given in the transaction

•

If none of the above, from where the service was provided

42

Sourcing Issues: State Approaches g pp (Several Locations For Receipt Of Service) • Third situation: Receipt of service at more than one location • NY, CT, DC rules are silent on multi-office access. • In TSB-A-10(52)S 10/18/10, New York permitted apportionment based on the ratio of New Yorkbased employees with access to the number of employees located throughout the U.S. with access. • This would be consistent with Goldberg and avoid multiple-taxation. .

43

Sourcing Issues: State Approaches (Several g pp ( Locations For Receipt Of Service), Cont. •

TX: Rule 3.342(g) provides a more straightforward approach. •

The general theme is for the purchaser to identify the segment of the business that the service benefits, benefits and then issue an exemption certificate to the service provider that bases the exempt amount on a reasonable method of allocation.

•

It is important that customer issue exemption certificate and be able to justify, from its books, its calculation. • A reasonable method of allocation is the ratio of employees with terminals located in TX to the total number of employees with terminals. terminals 44

Sourcing Issues: State Approaches (Several g pp ( Locations For Receipt Of Service), Cont. •

OH approach: R.C. 5739.033(D) •

If the purchaser provides an exemption certificate, the vendor is relieved of collection responsibility, responsibility and the purchaser may use any reasonable, consistent and uniform method of apportioning purchases by jurisdiction.

•

In the absence of an exemption certificate, the vendor and customer can work out a reasonable, consistent and uniform method of apportionment and the customer certifies to the same. Then, this governs.

•

If the customer does not certify, the law requires reversion to the waterfall. waterfall But But, that provides for uncertainty uncertainty. 45

Aaron Young, Reed Smith

AUDIT RISKS AND AUDIT  PREPARATION TACTICS

A dit Issues Audit Iss es 



 47

Substantive 

Nexus



Taxable service



Mixed transaction



Value



Other taxes

Dealing with the auditor 

Strategy



Correspondence



Documentation

Resolving the matter

S bstanti e A Substantive Audit dit Iss Issues es 

Nexus 

Software 



Affiliate nexus 

48

De minimis access software Statutory guidance



Click-through nexus



In-state vendors



Customers

Substantive Audit Issues (Cont.) ( ) 

Taxable service 



49

High-risk services 

ASP service i providers id



Any remote service



Data processing p g



Use of common database



Use of public records

D fi iti Definition 

Personal in nature



Report provided to others



Specifically enumerated  Credit reporting  Data processing  Title searches

S b t ti Audit Substantive A dit Issues I (Cont.) (C t ) 

Mixed transaction 

Risk 



Primary function/true object 



50

Specific state guidance

De minimis 



Entire charge subject to tax

Specific state guidance

Other taxable components 

Embedded software



Telecommunications

S b t ti Audit Substantive A dit Issues I (Cont.) (C t ) 

Value 



51

Strategy 

Do you provide a value computation?



Concede issue



De minimis

Documentation to compute value

S b t ti Audit Substantive A dit Issues I (Cont.) (C t ) 

Other taxes  Embedded software  Canned vs. custom  Used U d within ithi corporate t group  Telecommunications  Reimbursements  Resale  “Conduit” test • New York Article 9 Sect Sect. 186-e 186 e • TSB-M-08(4.1)C

52

Dealing With The Auditor A ditor 

53

Strategy 

Know the strength of your position



Review the documentation



Be prepared to address multiple taxation theories 

Software



Telecommunications

D li With The Dealing Th Auditor A dit (Cont.) (C t ) 

Correspondence 

Control the flow of information 



54

Active vs. passive

Strong position statement is vital 

Legal position



Threaten discovery y  Freedom of Information Act requests



Prepare tax computations



N Narrow responses



Be aware of additional issues

Dealing g With The Auditor (Cont.) ( ) 

Documentation 

Customer agreements 



Invoices 



55

What is the customer buying? May be misleading

Market and advertising 

Web site



Annual report



Marketing materials



Technical documentation



Affidavits

Dealing g With The Auditor (Cont.) ( ) 

Resolving the audit 

pp p procedure Appeal 





56

May result in additional leverage

Negotiated settlement 

Closing agreement



Principled vs. unprincipled



Refund action

Going forward 

Future transactions



Implications with other taxes  Receipts factor sourcing