Tennessee Issues Notices to Clarify Sales & Use Tax on Remote Access Software and Software Maintenance Contracts

In December, Tennessee released two notices that address the taxation of the most troublesome product/service in sales and use taxation: software.

Technological innovation is changing the way that companies conduct business, yet the slow development of state tax laws to address these changes can create great uncertainty for taxpayers. In December, Tennessee took a step to alleviate some of that uncertainty by issuing two Sales and Use Tax Notices that address the taxation of perhaps the most troublesome product/service in sales and use taxation: software. [1] These notices help to solve a prevalent issue with the taxation of remote access software and provide additional clarification to the state’s existing rules regarding the taxation of software maintenance contracts.

As of July 1, 2015, Tennessee joined the increasing number of states that now assess sales tax on licenses or subscription fees for remote-access software, also known as software-as-a-service (SaaS). One of the nationwide issues in taxing SaaS is what jurisdiction’s tax to assess when the actual users may be located across several different states (e.g., a business purchases software used by its employees located in various states). Vendors are often left with assessing tax on the full sales price based on where the customer is located as noted by a shipping or billing address absent better usage information provided by the purchaser at the time of sale, even though the users that access the software may be located in other states.

A few states have attempted to mitigate this issue by allowing a purchaser to provide what is known as a direct pay permit or “multiple points of use” exemption for these digital transactions. In December, Tennessee adopted a “Remotely Accessed Software Direct Pay Permit” (Form RV-F1323107) to address this issue and has provided additional guidance on its use in Sales and Use Tax Notice #15-24.

Purchasers of remotely accessed computer software can provide this direct pay permit to a vendor to prevent the collection of Tennessee sales tax by that vendor on the remote access software that will be used both within and outside of the state. Purchasers are subsequently responsible for identifying the number of licenses that will be accessed from within Tennessee and self-remitting use tax on the applicable amount of charges/license fees. A properly completed direct pay permit serves as evidence for the vendor that it is not required to collected tax on the transaction in the same manner as if the vendor had received a tax exemption certificate.

Businesses should be aware that the permit is only valid for remotely accessed software; vendors should not accept permits for software that is provided via tangible medium, download or load-and-leave. Further, the permits are only valid when they include the purchaser’s Tennessee sales and use tax account number that will be used to pay the corresponding use tax. Any purchaser that is not registered for Tennessee sales and use tax may instead provide a multi-state Streamlined Sales and Use Tax Certificate of Exemption with their federal tax identification number to claim an exemption for the percentage of users outside of Tennessee. [2] In this case, the vendor is required to collect and remit the applicable Tennessee sales tax based on the percentage of users within the state.

As of Oct. 1, 2015, Tennessee repealed the tax law covering assessment of sales tax on computer software maintenance contracts and incorporated it into the statute covering maintenance and service contracts on all tangible personal property. [3] While there have been no material changes to the treatment of software maintenance contracts, the Department of Revenue has issued Sales and Use Tax Notice #15-25 which helps to clarify the state’s positions.

Under Tennessee law, the sale or use of a mandatory or optional computer software maintenance contract is subject to tax when sold in conjunction with a taxable sale of computer software or the software covered by the contract is installed on a computer in the state. [4] Additionally, the contract is subject to tax when the location of the corresponding software is unknown but the purchaser’s residential or primary business address is located in Tennessee.

The published sales tax notice goes on to identify several positions on software maintenance contracts:

  1. The contracts are subject to both sales and use tax. If a purchaser buys a contract in another state or the vendor otherwise does not charge Tennessee sales tax on the transaction, use tax is due for the portion of the contract that covers software installed on computers in Tennessee.
  2. Separate sales of support services are not subject to tax when not sold as part of a maintenance contract. This requires the vendor to sell the support services separately, the support must not be a mandatory condition of purchasing the maintenance contract and the support services cannot include installation, repair, maintenance, updates or upgrades of the covered software.
  3. The single article limitation on local option sales tax does not apply to software maintenance contracts. In Tennessee, local option sales tax only applies up to the first $1,600 of the sales price of a single item of tangible property which does not include these contracts.
  4. Maintenance contracts covering software installed on computers located both within and outside of the state are taxable only on the Tennessee portion. The customer must provide the vendor with information on the location of the covered software installations for this to apply.
  5. No additional sales or use tax is due on repairs performed under a computer software maintenance contract. However, charges for repairs that are not covered under the contract are subject to tax.

The taxation of software licenses, SaaS and related services continues to be one of the most confusing in the sales tax area, due to the fact that these transactions are structured in a variety of ways and guidance is often lacking. Companies in the software business should be proactive in addressing the sales tax consequences of their transactions in order to minimize exposure. Aprio’s SALT team members have extensive experience in helping businesses to identify and address these issues, thereby mitigating their sales and use tax risk.

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

This article was featured in the January 2016 SALT Newsletter. To view the newsletter, click here.

[1] Sales & Use Tax Notices #15-24 and #15-25

[2] This requires the purchaser to identify to the vendor the percentage of licenses that will be accessed from within the state.

[3] Tennessee Public Chapter 273 (2015), §5 and §6

[4] A computer software maintenance contract is a contract that obligates one person to provide to another person future updates, upgrades and/or support services for computer software.

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 this matter.