Arizona Issues Letter Ruling on Taxation of SaaS

In 2015, Arizona issued a Taxpayer Information Ruling determining that a SaaS subscription to a hosted website development application was subject to the transaction privilege tax as a rental of tangible property.

Software-as-a-service (SaaS) and cloud computing are well-known terms and have become popular services for businesses and consumers. But it’s still difficult to fit them into the sales tax laws and policies of many states. Updates to their sales tax statutes and helpful guidance are lacking.

Because of this, taxpayers have needed to reach out in their states for private letter rulings on the sales tax classification of their products and services.

This is hardly ideal, but now there’s a clarification in Arizona.

Arizona’s Taxpayer Information Ruling determines that a SaaS subscription to a hosted website development application is subject to the transaction privilege tax as a rental of tangible property. [1] Software, whether provided electronically or via a tangible medium, is considered taxable tangible property by the state under its broad definition of tangible personal property, which includes music played from a jukebox.

So, the software is treated as tangible personal property. But what about whether or not this particular activity constitutes personal property rental?

The ruling states that the pivotal question is whether the customers “gain sufficient control and use of [the] software to constitute the rental of tangible personal property.”

In analyzing this issue, the ruling notes that the granting or non-granting of a license is not definitive and that constructive possession (and not actual possession) is sufficient.

Constructive possession “may be established through a level of use that establishes the user’s possession of the software.”

In looking at constructive possession, the ruling focuses on the level of manipulation that the customer has with the software and notes that the manipulation does not require that the user have access to the source code or the ability to change it. Rather, the type of manipulation depends on the software. For word processing software, for example, manipulation occurs by typing; for database software, manipulation involves entering search parameters.

Important: the taxability of SaaS depends on the facts. The difficulty lies in drawing a line between when a transaction is a “use of software” versus when it may be the provision of an exempt service under state laws. Just because software is utilized in providing a service, that doesn’t make it SaaS and vice versa.

The determination may come down to how state law and policy has defined certain terms surrounding the transaction. For example, there is an important distinction between Arizona’s position that SaaS can be “constructive possession” of software and those of other states, such as Georgia.

Georgia has ruled that computer software is not a sale of tangible personal property and thus is not subject to sales tax since delivery is made electronically and not via tangible medium. [2] Both positions rely on the taxation of tangible property; Arizona simply has a more broadly defined view of what constitutes a transfer of tangible property.

Bottom line

The range of different products and services offered by SaaS providers and the lack of definitive guidance in many states makes it hard to determine sales tax obligations.

On top of that, new laws or interpretations by states are periodically changing the way SaaS should be viewed for sales tax purposes.

Has the taxability of your SaaS offerings been reviewed recently? If not, let us help you with your analysis. Our team monitors state tax developments in this area so that we can provide the most up-to-date advice and keep you taking the right actions for your business.

Contact Jeff Glickman, partner-in-charge of SALT practice, at for more information.

[1] Arizona Taxpayer Information Ruling LR15-005, May 14, 2015. The transaction privilege tax is a transaction tax that is very similar to other states’ sales taxes. The primary difference is that the burden of the tax is initially placed on the seller, although the tax may still be passed on to purchasers.

[2] See Georgia Letter Ruling SUT-2014-01, Feb. 20, 2014.

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