Sales Tax: Is Your Offering Taxable SaaS or Non-Taxable Services? Or Both? How You Invoice Makes a Difference
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Issue No: 2024-21
Summary
A mixed or bundled transaction involves both taxable and non-taxable items for a single charge to the customer. If invoice amounts for each item is separately stated, tax is due only on the taxable item. If bundled together for one charge, the taxable component may render the entire invoice amount taxable.
Mixed transactions often involve taxable tangible personal property (TPP) and non-taxable services. A recent ruling by the New York Division of Tax Appeals held that a taxpayer was providing taxable prewritten software as part of its “Integrated Facilities Management” services subscription. Many businesses consider their “service platforms” to be non-taxable services when, in fact, the “true object” of the transaction includes access and use of taxable prewritten software.
Businesses should contact Armanino’s National State & Local Tax team to discuss recent developments and available opportunities and pitfalls related to invoicing of software subscriptions, sales, and related services.
In Detail
The Division concluded that the taxpayer’s subscription sales of facilities management services included sales of prewritten software and were subject to tax, and acknowledged that, in addition to prewritten software, the taxpayer also sold services as part of a mixed bundle of property and services. Where the sale of bundled taxable and nontaxable services is considered, the taxation of such is determined according to the primary function of the bundle (see Matter of Strata Skin Sciences, Inc., Tax Appeals Tribunal, May 5, 2022). However, the Tribunal has reserved judgment on whether “all mixed bundled sales of tangible personal property and services should be analyzed using the primary function test” (id.). The taxpayer asserted that the primary function of their business is to provide facilities management services to their customers, claiming that the services are “merely tech-enabled.”
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Contract language included phrasing such as “FacilitySource does hereby grant to Customer a non-exclusive, revocable, limited license to use the fmPilot software to copy, distribute, transmit, display and otherwise use fmPilot”. As such, FacilitySource contracted with its customers to permit them to enjoy the functionality of the software and not access to a communication portal. As opposed to a mere communication portal, petitioners’ witnesses acknowledged that the customer may see calendars of work, review service orders, submit work orders, and program in price limits for anticipated facility maintenance.
Clearly, FacilitySource sold subscriptions comprised of access to a bundle of prewritten computer software and services for one charge. When a bundle of taxable and non-taxable property is sold together for one charge, the entire charge is taxable (see Matter of Strata Skin Services). The Division’s determination that FacilitySource’s subscriptions were taxable prewritten software was proper.
Insights
With the emergence of technology-enabled “as-a-service” business models, it is important to understand the components of the services being offered and the extent to which any related software is accessed and “used” by the customer. One should review the contract and understand the extent to which that software is being controlled by the customer and how important that control is to the overall service being provided, i.e., is there functionality available to the customer to use the software to accomplish tasks or is the “platform” access merely a dashboard to observe the inputs and outputs of the service provided or a portal to upload data to the service provider for analysis.
This is especially important as a business grows and evolves. Many software companies originally were the users of their software in providing services, but over time evolved to where the customer was using their software to accomplish the desired tasks/results.
Armanino is happy to assist in evaluating your business model from a sales tax perspective whether for ongoing compliance as the business scales or as part of due diligence readiness ahead of a transaction.