New York Refuses to “Split the Baby” and Treats Integrated Service as Taxable Software
March 30, 2023
At a glance
- The main takeaway: A New York Board of Tax Appeals decision illustrates that the content of your customer service agreements and marketing materials can have a significant impact on how a state analyzes the taxability of your goods and services.
- Assess the impact: Service providers need to be aware of the sales tax ramifications that can occur based on how their customer service agreements are drafted and how they market their services.
- Take the next step: Aprio’s State and Local Tax (SALT) team can help your business understand its sales and use tax obligations to avoid incurring unexpected liabilities and penalties.
The full story:
The New York State Division of Tax Appeals recently ruled, In the Matter of the Petition of Beeline.com, Inc., that a taxpayer’s fees charged for its vendor management system (VMS) that match customers needing temporary workers with the suppliers of temporary labor was subject to sales tax.1 Despite the administrative law judge (ALJ) acknowledging that the taxpayer also provided nontaxable services, the bundling of those services with taxable prewritten software resulted in the entirety of the taxpayer’s VMS fees being subject to sales tax.
The ALJ found it much easier to reach this decision due to the taxpayer’s customer service agreements heavily emphasizing that the customer was obtaining a license to use and access the taxpayer’s VMS, which the customer service agreement defined as a “a web-based application delivered through a software-as-a-service model.”
A closer look at the case
The New York Department of Taxation and Finance (the Department) has administratively treated fees charged to access software-as-a-service (SaaS) as being subject to sales tax for several years. For a transaction to be a taxable “sale” under New York’s sales tax law, a customer must obtain title and/or possession to tangible personal property. With prewritten software being statutorily included in the definition of “tangible personal property” in New York, the additional requirement for a taxable sale to exist in the context of SaaS is that the customer needs to have possession of the software. Despite SaaS products not needing to be downloaded, the Department’s position is that a customer obtains constructive possession of the software through its right to access and use the software.
In Beeline.com, the taxpayer provided services to assist companies in procuring temporary workers and streamlining the organization and management of their temporary workforce. The testimony of the taxpayer’s CEO revealed that the taxpayer spent months and hundreds of hours gathering information about each of its customers’ labor needs, business processes and hiring workflow to tailor its services to each customer. Further, throughout the life of its service agreements, the taxpayer provided its customers with consulting and training services. The ALJ acknowledged that a number of the taxpayer’s services are not subject to New York sales tax.
However, the problem for the taxpayer was how its services were priced and the characterization of its service as a SaaS product in its customer service agreement and marketing materials. As noted above, the taxpayer charged a single bundled fee for its VMS service. Interestingly, in prior years the taxpayer itemized some of its nontaxbale services, and for those periods the Department concluded that such charges were not subject to sale tax. However, for the periods where the taxpayer bundled all its services into one price, the ALJ concluded that the entire price was subject to sales tax because the software component of the sale was “anything but incidental” to the entire package of services being provided. In short, the ALJ concluded that the software streamlined and integrated the entirety of the taxpayer’s service into one offering, and any attempt to “split the baby” would diminish the services offered by the taxpayer.
Of course, any doubt that the ALJ had in whether to potentially treat VMS as not being subject to sales tax vanished due to how the taxpayer marketed its service and how its services were described in its customer service agreements. For example, the taxpayer’s website stated that “VMS is the software that automates the hiring process” and “most VMS tools are delivered through a software-as-a-service model.” Further, the customer service agreement characterized the VMS service as being “delivered through a software-as-a-service model” and indicated the taxpayer’s customer was granted a license to use and access the VMS solution.
The ruling explained
When faced with a sale of taxable and nontaxable services bundled into one price, New York typically applies what is known as the “primary function” or “primary purpose” test in determining whether the sale is subject to tax. In applying this test, which is similar to other states’ “true object” test, New York looks to determine whether the primary function of the transaction is the taxable services or the nontaxable services. This is invariably a subjective test that can be very difficult to apply.
The ALJ that ruled over the Beeline.com case, seemingly agreed that the “primary function” test is not always a workable one. Instead of looking to the “primary function” of the sale, the ALJ seemed to conclude that both the access to the SaaS as well as the nontaxable services, provided the customer with significant value. As noted above, the ALJ could not reach the conclusion that the customer’s access to the SaaS product was incidental or inconsequential as compared to the nontaxable services. In the end, the taxpayer’s marketing materials and customer service agreements helped make the ALJ’s decision that much easier.
The bottom line
The Beeline.com decision illustrates that a company’s characterization of its service can be just as important as the true nature of the services actually being sold. A company’s website and customer service agreements that consistently label its service as being delivered through a SaaS model can easily become the determining factor in whether a state that imposes sales tax on SaaS products ultimately assess tax against the service provider. Thus, service providers need to be aware of the sales tax ramifications of how they market their services, so they can make informed decisions as to whether the collection of sales tax is required.
Aprio’s SALT team has experience addressing these types of taxability issues, and we can assist your business to ensure that it complies with its sales and use tax obligations so that it does not incur unexpected liabilities and penalties. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.
1 In the Matter of the Petition of Beeline.com, Inc., DTA No. 829516, N.Y. Division of Tax Appeals, February 9, 2023.
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About the Author
Michael assists clients with a broad range of state and local tax issues. His expertise extends to many areas of multistate taxation, including income, franchise, sales and use, and property taxes. Michael’s experience also includes representing clients at all stages of tax controversy—from audit through appellate litigation as well as advising clients on restructurings and state tax refund and planning opportunities.