New York Sales Tax Ruling: Taxpayer’s Document Management System Classified as Taxable Software

By: Jess Johannesen, SALT Director

At a glance 

• The main takeaway: A New York taxpayer’s cloud-based document management services was determined to be taxable prewritten software and not nontaxable data storage and security services.
• Assess the impact: Sales tax laws do not evolve as quickly as new technology and services, making it difficult to understand and apply state sales tax guidance on technology-related products/services.
• Take the next step: Aprio’s State and Local Tax (SALT) team has experience analyzing a variety of taxability considerations and can provide guidance on how to stay in compliance with your sales tax obligations.  

Schedule a free consultation today to learn more!  

In a recently published New York Division of Tax Appeals decision, an Administrative Law Judge (ALJ) determined that the New York Department of Taxation and Finance properly classified a company’s (Company) cloud-based document management service offering as taxable prewritten software.[1]

A closer look at the Company’s cloud-based services

The Company’s cloud-based services were provided primarily to law firms as well as to financial and accounting firms as a comprehensive document management system that included document storage and security, integrated workflow tools, and other optional add-on services.

During a routine sales tax audit, the Company was providing requested documentation and argued that its product was a nontaxable data storage and security service.[2] However, the ALJ determined that customers were instead purchasing the Company’s software which facilitated the desired services. In particular, the ALJ noted that, once installed, the software performs the work at the direction of the customer. In other words, the ALJ highlighted that the software is not merely a conduit for communication to deliver a service provided by the Company, but instead the software is the core element of the Company’s platform and none of the service functions could be accomplished without the Company’s development and the customer’s use of the software.

Beyond the document management system’s functionality, the ALJ also focused on the Company’s contracts, which included provisions consistent with software contracts, such as intellectual property protections, licensing provisions, and fees charged on a per user basis. When addressing the Company’s contracts, the ALJ noted that additional services were sold as part of a mixed bundle with the core software. Specifically, each contract contained an exhibit in which the fees were bundled together. When a bundle of taxable and nontaxable products/services are sold together for one charge, the entire charge becomes taxable. The Company argued that even if its sales were taxable as computer software, its revenues should be apportioned by user location since some users were inside New York and others were outside of the state.

Understanding the ALJ’s ruling

Historically, the Company filed its sales tax returns and determined the source of the sale based upon the customers’ billing addresses without regard to specific user location. However, to successfully apportion sales tax based on the location of the user, this methodology would need to be applied to all customers in order to capture users in New York that did not have a New York billing address. The auditor requested that the Company provide statements from its customers that would provide a breakdown of users located in and outside of New York. However, the Company never provided this type of documentation. As such, the existing approach was maintained where New York sales tax was charged based on the New York billing addresses without the benefit of any user location apportionment.

This ruling illustrates several factors that the ALJ focused on when determining that the Company’s services were taxable as software:

1. Customers’ use of software to facilitate a desired service,
2. The features and functionality of the platform, and
3. Contractual terms akin to those commonly in software contracts. 

Businesses need to be aware of audit issues that may arise related to the apportionment of revenues based on user location. During an audit, the state will likely require that all in-state users be included in the tax base, not just those associated with customers with a New York billing address. This may create a significant impact on taxable revenues in the future.

The bottom line

With the constant evolution of technology and the economy, new products and services are developed every day as well as new ways to deliver existing products and services. Unfortunately, sales tax laws and sales tax guidance does not evolve as quickly, so it is important to analyze new offerings to evaluate how states may classify such offerings for sales tax purposes.

Aprio’s SALT team has experience working with businesses to analyze these types of taxability considerations and provide guidance to stay in compliance with sales tax obligations in order to avoid 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 NetVoyage Corp. aka NetDocuments.com, N.Y. Div. Tax App., Admin. Law Judge Deter. No. 850246, 04/24/2025.

[2] It is worth noting that certain security or protective services, including cybersecurity services, may be subject to New York sales tax.  The ALJ did not address this issue in the ruling, presumably because it concluded that the Company’s offering was software.