Ohio Court Rules that Charges for Accounting Software are Subject to Sales Tax

By: Jess Johannesen, SALT Senior Manager

At a glance

• The main takeaway: A recent Ohio court opinion analyzed why a taxpayer’s use of an accounting software is classified as a taxable automatic data processing service rather than a nontaxable professional service.
• Assess the impact: These types of analyses can be subjective, making it complicated for taxpayers and practitioners to classify between software and services for sales tax purposes, as factors may vary from state-to-state.  
• Take the next step: Aprio’s State and Local Tax (SALT) Team can help you determine where your sales and use tax obligations align so you can remain in compliance with your state requirements.

Schedule a free consultation today to learn more!

The full story:

In today’s high technology environment, many services that used to be performed internally by employees are now being performed by automation, which may be considered taxable. In a recent Ohio Supreme Court decision, the Court rejected a bank’s argument that it was paying a provider for nontaxable professional services that were performed by computer systems.[1]

The case explained

The taxpayer in the case is a bank located in Ohio that entered into an agreement with Fiserv Solutions, Inc. (Fiserv) for various “account-processing services” provided by “the Fiserv system.” That system allows the bank to run transactions daily, and the system maintains all the bank’s accounting and financial records on an ongoing, real-time basis. The bank sought a refund for the sales tax it paid to Fiserv related to charges for access to the services provided by the Fiserv system. 

In Ohio, taxable services include, “automatic data processing, computer services, or electronic information services…for use in business when the true object of the transaction is the receipt by the consumer of [ADP], computer services, or [EIS] rather than the receipt of personal or professional services to which [ADP], computer services, or [EIS] are incidental or supplemental.”[2] 

Ohio statutes define ADP as the “processing of others” data, including data entry services together with verification thereof, or providing access to computer equipment for the purpose of processing data,” and EIS as “providing access to computer equipment for one of two purposes: examining or acquiring data stored in or accessible to the computer equipment, or placing data into the computer equipment to be retrieved by designated recipients with access to such computer equipment.”[3]

Excluded from ADP and EIS are “personal and professional services” that include “accounting and legal services such as advice on tax matters, asset management, budgetary matters, quality control, information security, and auditing and any other situation where the service provider receives data or information and studies, alters, analyzes, interprets, or adjusts such material.”[4]

In support of its refund, the bank claimed that Fiserv’s services constituted nontaxable accounting services, relying on a “replacement” theory. In other words, the bank argued that it replaced a portion of its internal accounting department and an external traditional accounting/bookkeeping firm with Fiserv’s accounting services. The bank did not dispute that Fiserv’s services constitute ADP and EIS since Fiserv receives data from the bank and the bank’s customers that is processed with Fiserv’s computers while making it available to the bank. However, under the bank’s replacement theory argument, those services are specifically excluded from sales tax because they replace accounting services that would otherwise be provided by individuals.

The court concluded

The Court rejected this argument, explaining that there is no evidence that any individuals employed by Fiserv provide the bank with an accounting-analysis service. The Court also noted that Fiserv lacked the legal authority to provide professional accounting services that required licensure. Ultimately, the Court concluded that because Fiserv did not provide accounting services that were performed by individuals, the ADP and EIS services provided were taxable services.[5] While the Court rejected the taxpayer’s refund claim pursuant to its argument above, it did send the case back to the lower court for additional consideration and argument. Specifically, the taxpayer made a second argument that since Fiserv performed some software modifications to meet the taxpayer’s needs, then the services should be viewed as a personal and professional service of software customization.[6] Since the lower court did not apply the true-object test to these services (i.e., whether some of the charges constituted nontaxable software customization versus taxable ADP/EIS), the Court sent the case back for further analysis of this issue.

The bottom line

While the terminology and provisions of this issue are specific to Ohio, this case illustrates the complexity that we see in all states regarding the distinction for sales tax purposes between software and services, and the factors that each state uses to try and draw some type of line. This is one of the most difficult issues for taxpayers and practitioners to address due to the subjective nature of the analysis – i.e., when is the customer’s use of software really a software transaction as opposed to a service transaction involving incidental use of software. Aprio’s SALT team has experience with this issue, and we can help your business remain in compliance with its sales and use tax obligations so that it does not incur unexpected tax 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.

This article was featured in the April 2022 SALT Newsletter.

For more information contact Jess Johannesen at jess.johannesen@aprio.com or call 770-353-2817 or contact Jeff Glickman at jeff.glickman@aprio.com or call 770-353-4791.

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[1] Cincinnati Fed. S. & L. Co. v. McClain, Slip Opinion No. 2022-Ohio-725, 03/15/2022.

[2] Ohio Rev. Code Ann. § 5739.01(B)(3)(e).

[3] Ohio Rev. Code Ann. § 5739.01(Y)(1).

[4] Ohio Rev. Code Ann. §§ 5739.01(Y)(1)(d) and (Y)(2)(a).

[5] If there were accounting services provided by individuals that were provided in connection with the ADS and EIS, then the “true-object” test would likely need to be applied to determine whether the transaction would be treated as nontaxable accounting services or taxable ADP/EIS.

[6] Under Ohio Rev. Code Ann. § 5739.01(Y)(2)(d), a personal and professional service includes “[d]esigning policies, procedures, and custom software for collecting business information, and determining how data should be summarized, sequenced, formatted, processed, controlled, and reported so that it will be meaningful to management.”

Disclosure

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.