Tennessee Addresses the Distinction Between Taxable Software and Nontaxable Services

January 31, 2023

By: Camille Gregory, SALT Senior Associate

At a glance

  • The main takeaway: Tennessee issued a revenue ruling explaining the distinction between a license of computer software and the sale of nontaxable services. 
  • Assess the impact: Analyzing a transaction for sales and use tax is more complex than simply understanding what is and isn’t taxable. There is also the subjective issue of determining what “It” is, which may vary from state-to-state.
  • Take the next step: Aprio’s State and Local Tax (SALT) team can help you identify and analyze the taxability of your services to keep your business in compliance with its sales and use tax obligations. 

Schedule a free consultation today to learn more!

The full story: 

The Tennessee Department of Revenue (Department) issued a letter ruling stating that tax should be paid on a subscription-based product (product), which allows users to create and manage advertisements for rental properties. The seller (taxpayer) argued that the product should not be taxed because it is an advertising service. The Department considered the product to be taxable computer software.

The product allows users to create advertisements for rental properties and publish those advertisements to sites, such as Facebook, Google and Craigslist. The product consolidates leads onto a user dashboard, allowing customers to communicate with potential renters to schedule tours, follow up with interested renters and ultimately negotiate the lease of the apartment, or other rental space. Many of these communications are automated by the product, including initial response emails and scheduling prompts for tours. The product also provides automated live-chat functionality and a text message auto-response feature to maximize engagement with rental prospects and assist in increasing lease renewal rates. Finally, there is also a marketing function that provides users the ability to track leads and evaluate the effectiveness of different advertising platforms. 

The ruling explained

The taxpayer argued that although the product involves access to and use of computer software, its primary function is the provision of nontaxable advertising services.[1] Tennessee defines advertising services as: services rendered by an advertising agency to promote a product, service, or idea.[2] However, the ruling declared that the product was taxable computer software. Specifically, the ruling states that:

“[T]he Taxpayer does not assume an active role in assisting its Users to generate advertising content. Rather, the Taxpayer provides software that facilitates its Users’ creation and management of their own advertising content. Furthermore, the Product is being used by the Users for this software functionality. Thus, the Taxpayer’s Product is appropriately characterized as computer software that Users purchase to generate their own advertisements, manage rental property listings, and interact with potential renters, not as an advertising service.” 

This ruling illustrates an important distinction used by states to analyze whether a transaction should be treated as a license of computer software or a service (even when the service provider may use software to provide the service). For example, there is a difference between an attorney providing legal services by preparing a legal document and a person using computer software that helps that person create that same legal document. The former is a legal service (which is almost universally nontaxable) while the latter is the license of computer software (which may or may not be taxable depending on the state).[3]

The bottom line

Analyzing a transaction for sales and use tax purposes involves not only understanding what is and isn’t taxable, but also the more complex and subjective issue of determining what “It” is. Aprio’s SALT team has experience identifying and analyzing these issues, and we can help your business remain in compliance with its sales and use tax obligations, so that you do 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.

[1] “Advertising Services” are defined in Tenn. Code Ann. § 67-6-102(3)(A).
[2] Id.
[3] In cases where there may be some combination of the two, states may apply a “true object” or “primary purpose” test to determine how to characterize the transaction.