Tennessee Rules That Live Online Class is Not Taxable but Self-Paced Online Class Is Taxable

A recent Tennessee ruling addressing the application of sales tax to online live and self-paced education courses highlights that the manner in which a good or service is provided has a direct impact on the taxability of that good or service.

In sales tax, taxability determinations are not only focused on what is being sold, but also the manner of form in which it is sold. For example, items of tangible personal property that had previously been subject to tax, such as software on a disc or a book, may not be subject to tax when provided in electronic form.  However, the analysis works both ways in that services that were previously not subject to tax may now be taxable when provided through a technological platform. This principle was the subject of a recent Tennessee Department of Revenue (DOR) letter ruling that addresses the application of sales tax to the taxpayer’s online classes.[1] The DOR distinguished between the taxpayer’s live instructor-led online classes and its self-study online courses.

The Taxpayer provides online courses (non-degree and unaccredited) to students who are preparing for new careers. All courses include a set curriculum, completing lessons and graded projects, electronic communications and online meetings with a mentor (this includes feedback on progress as well as extra help), online meetings with an academic counselor, and networking events. All students create online accounts. All instruction and mentor time occurs online, but the students do not download software or course content to their personal computers.

The Taxpayer offers its courses using one of two basic formats. The first format has a live instructor that leads the class through the materials, answer questions and is available during the entire class session. The second format has no live instructor and allows students to progress through the material at their own pace, although students that exceed a certain amount of time are charged additional tuition. Students who choose the second format receive the course materials through their online accounts, complete each module online and take assessments that are graded by an instructor.

The ruling explains that Tennessee taxes tangible personal property, which is defined to include prewritten computer software, regardless of how a person receives access to the software.[2] When a transaction involves taxable and nontaxable components for one non-itemized price, the state applies the true object test to determine the taxability of the transaction by identifying the crucial, essential, necessary, consequential or integral element of the transaction. If that element is separately taxable, then the entire transaction is taxable. However, a transaction will not be taxable only if its true object is not independently subject to tax and the taxable components are “merely incidental” to the true object of the transaction.

Applying the Taxpayer’s facts to the sales tax rules described above, the DOR addressed each of the two online course formats. Regarding the first format, the DOR determined that the true object of the student’s purchase is access to live instructor-led classes, which is a nontaxable service. The software platform (which is taxable as remotely accessed software) through which the student accesses those classes only facilitates course instruction, and therefore it is merely incidental to the instructor-led classes. Therefore, classes that had a live, online instructor were not subject to sales tax.

On the other hand, in examining the second format, the DOR concluded that the true object of the student’s purchase is the Taxpayer’s software platform, since the student learns the course by reading online materials and answering test questions. While the DOR recognized that the students did receive some services that were not taxable, such as live online meetings with mentors and counselors, the DOR did not view those services as crucial elements since they did not have any value without the online course itself.  Therefore, the self-study course format was subject to sales tax as the purchase of remotely accessed software.

True object cases are difficult to analyze since they ultimately involve subjective determinations. For example, it would not have been unreasonable for the DOR to conclude that regardless of the format, the students are purchasing a nontaxable educational service, and it is possible that another state might reach that conclusion. Therefore, it is important to examine the specific guidance in each state, and if it is not clear, then it may be worthwhile to request a ruling like the Taxpayer in this case did.

Aprio’s SALT team is very experienced with these sales tax issues and with preparing ruling requests. We can assist your business to ensure that it is compliant with its sales tax obligations and 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.

Contact Kristen Mantilla, SALT Associate at kristen.mantilla@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 August 2020 SALT Newsletter.

[1] Tennessee Department of Revenue Letter Ruling # 20-04, June 10, 2020.

[2] Tenn. Code Ann. §§ 67-6-102(89)(A) and 67-6-231.