Arizona Issues Letter Ruling on Taxation of SaaS

Earlier this year, Arizona issued a Taxpayer Information Ruling, in which it determined 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 and are well-known terms to businesses and consumers, yet it remains difficult to determine how these products and services fit into the sales tax laws and policies of many states. As the remote access of software has become a common business model over the past decade, many states have failed to make comprehensive updates to their sales tax statutes and lack helpful guidance in the area. As a result, many taxpayers have reached out to states for private letter rulings on the sales tax classification of their products and services.

Earlier this year, Arizona issued a Taxpayer Information Ruling, in which it determined that a SaaS subscription to a hosted website development application was 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.

Having concluded that the software is tangible personal property, the next issue was whether or not this particular activity constituted 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, manipulation occurs by typing, and for database software, manipulation involves entering search parameters.

It is critical to note that the taxability of SaaS is highly fact-dependent. 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 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.

The range of different products and services offered by SaaS providers and the lack of definitive guidance in many states makes for continuing difficulty and uncertainty in determining sales tax obligations. Furthermore, new laws or interpretations by states are periodically changing the way SaaS should be viewed for sales tax purposes. If the taxability of your SaaS offerings has not been reviewed or has not been updated in several years, HA&W’s SALT team can assist you with this analysis. In addition, we will continue to monitor state tax developments in this area and report on those in future issues of the SALT Newsletter.

Contact Jeff Glickman, partner-in-charge of HA&W’s 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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