Rhode Island Provides Guidance on Taxability of Technology Services

Rhode Island ruled that storage service, computing service and data transfer fees are not subject to sales tax because no software is licensed or downloaded.

By Tina Chunn, SALT senior manager

As technology and technology-related services continue to evolve, states receive frequent requests to clarify the taxability of such services for sales tax purposes. In some cases, these technology services use web-hosted software and are determined to be software as a service, which may be taxed as a software license. However, in other cases, technology services are not so easily identifiable or classified for sales tax purposes. Adding to this complexity is the trend to allow certain technology services to be included as part of a bundle of various service offerings. On March 31, 2017, Rhode Island issued two rulings pertaining to such emerging technology-based services.

The first ruling request addresses the taxability of an online e-retailer’s membership subscription fee that provides premium benefits to members. [1] The membership benefits include: (1) free two-day shipping and other discounted shipping; (2) video streaming; (3) free e-books and (4) access to video game content. [2]

The taxpayer argued that the fee is not taxable as it is the transfer of an intangible right to access certain benefits, the use of which is unknown to the taxpayer and customer at the time of service. However, Rhode Island found that the membership is a “bundled transaction,” since it is the sale of two or more items for one non-itemized price. The state then notes that one of the membership benefits is access to video games available through downloaded content which are considered taxable prewritten computer software. Therefore, the bundled transaction contains taxable and non-taxable elements.

Ultimately, the taxability depends on the “true object of the transaction,” and if the taxable elements are inconsequential to the entire transaction, then the transaction would be non-taxable. Since the use of any particular benefit at the time of the subscription was unknown, the taxpayer was unable to prove that the video game benefit was inconsequential, and thus, the state concluded that the entire membership fee was taxable.

The second ruling request explains the taxability of cloud computing services and related fees. [3] The taxpayer provides information technology infrastructure services to its customers. These services allow customers to access storage capacity and computing power through the Internet without having to spend capital on their own equipment and personnel.

The taxpayer’s services include storage service and computing service (using open source or third-party operating system software options). The storage service allows the customers to store and retrieve content, data, applications and software on the taxpayer’s servers through remote access to its computing infrastructure via the Internet. Its computing services allow customers to obtain remote access to computing capacity to perform a variety of activities, including, but not limited to, running applications, monitoring computers and computer usage, and hosting web domains (commonly referred to as infrastructure as a service or “IaaS”). Access to an operating system (open source or third-party) is provided to direct computing power. However, customers do not receive a license to use the operating system, do not receive a physical copy of any software and cannot electronically download the operating system software for their own use with either option.

Fees for the storage and computing services are charged using both a base fee, determined by the amount of gigabytes or computing power used in a given month, and incidental usage fees (data transfer fees) based on activity while using the service. Data transfer fees are based on customer’s requests on where to store, move or access their own data with the taxpayer’s network. Specifically, these requests would include such services as adding files, moving files among regions or availability zones, and retrieving data.

Rhode Island ruled that the storage service, computing service and data transfer fees are not subject to Rhode Island sales tax. Specifically, for the storage service, no software is downloaded and the service is similar to a data processing and information service. With regard to the computing services, the state noted that while an operating system does qualify as prewritten computer software, the taxpayer does not separately license, sell, or transfer any software. The operating software can only be used in conjunction with the computing service. Even if it were determined that the computing service involved the sales of a vendor’s platform to host software (SaaS), such a service is not considered taxable in Rhode island as the software is not downloaded. Finally, data transfer fees are a means to track a customer’s usage of a storage or computing service and are not a taxable service.

These rulings demonstrate that taxability of emerging technologies is based on how a particular state classifies the transaction, and such treatment may differ among states. Aprio’s SALT team is experienced at reviewing these transactions and assisting our clients in making determinations on a state-by-state basis so that they ensure compliance with state sales tax rules. We aid our clients in understanding the sales and use tax treatment of their product and service offerings and the sales and use tax transactions in each jurisdiction. We constantly monitor these and other important state tax issues and will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Tina Chunn at tina.chunn@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the May 2017 SALT Newsletter. You can view the full newsletter here.

[1] Rhode Island Ruling Request No. 2017-01, 03/31/2017.

[2] Although we cannot verify the taxpayer that submitted the ruling request, the list of services provided is similar to those offered to Amazon Prime members. Other benefits include: (1) e-book lending, (2) discount pricing, (3) advance purchases,  (4) music channels and (5) photo, video and file storage.

[3] Rhode Island Ruling Request No. 2017-02, 03/31/2017.

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.