Washington: Taxpayer Must Charge Sales Tax on Entire Charge for Taxable and Non-Taxable Services

December 16, 2016

A recent Washington tax determination illustrates the impact invoicing can have on the taxability of products and services.

By Jess Johannesen, SALT manager

Businesses analyze whether their products or services are subject to sales tax based upon the specific provisions of each state’s tax laws. However, businesses may overlook the fact that their invoicing practices can also impact the sales taxability of the products or services. When businesses provide multiple products or services, the sales tax liability may differ if the items are separately stated or bundled into a single charge on the invoice. A recent tax determination from Washington illustrates the sales tax impact of bundling taxable and non-taxable services in a single lump sum charge on the invoice. [1]

The taxpayer is an IT research and advisory firm, and it provides its customers with online access to a proprietary research database. In addition to the online database, the taxpayer’s customers typically package one or more additional services in order to aid in the customer’s IT decisions. These additional services generally consist of consulting (either telephonic or on-site) and invitations to attend webinars and summits/symposia. However, there are instances where customers only purchase access to the online database without any additional services. While these additional research services vary, all of the services essentially include analysts providing professional IT advice to the customer through different delivery mechanisms (in-person, telephone, webcasts, etc.).

When the taxpayer invoices its customers, a single lump sum charge for “Research Fees” includes the access to the online database as well as any of the additional research services purchased by the customer. The underlying service agreements do not separately itemize the component services provided within the research package. Instead, both the invoices and underlying contracts identify the service package, describe and detail the services rendered, and list the total amount of the Research Fee.

The issue Washington addressed was whether the Research Fee (i.e., the charge for the entire package) is subject to retail sales tax under the bundled transaction laws, which required a two-step analysis. First, the state analyzed whether any of the individual service offerings were taxable. Washington determined that the access to the online database is a taxable digital automated service. A “digital automated service” (“DAS”) is “any service transferred electronically that uses one or more software applications.” [2]

It is worth noting that the taxpayer tried to argue that its database product met the requirements of an exception to the definition of DAS for “any service that primarily involves the application of human effort by the seller, and the human effort originated after the customer requested the service.” [3] The state denied that claim, noting that the most of the human effort performed in developing the database occurred before the taxpayer purchased the DAS. Any human effort expended in continuously updating the database does not count because the taxpayer did not specifically request the updating services. As to the other services included in the package, the state concluded that they were professional services not subject to sales tax. [4]

Second, the state analyzed whether or not the transaction was a “bundled transaction.” A “bundled transaction” has to meet the following criteria: (i) the retail sale of two or more products, (ii) that are distinct and identifiable, and (iii) that are sold for one non-itemized price. [5] The only real issue was whether the products/services sold by the taxpayer were distinct and identifiable. One rule to determine this is whether each of the items sold is necessary to complete the sale of the other items. If not, then that would make the items distinct and identifiable. In this case, the fact that the taxpayer sold the research database without any of the other services proves that the items are distinct and identifiable. Therefore, the taxpayer’s Research Fee is considered a charge for a bundled transactions.

Accordingly, Washington concluded that the entire Research Fee is subject to retail sales tax because the sale of one of the component products (the research database is a taxable DAS) is individually subject to retail sales tax. If the additional services had been separately stated from the online research database service, it is likely that only the separately-stated charge for the research database would be subject to sales tax.

This ruling illustrates the importance of invoicing procedures. With the same set of research services described above, the taxpayer’s customers could appropriately be subject to less Washington sales tax if the taxpayer had changed only its invoicing and contract structure (i.e., without altering the underlying research services themselves). This could provide the taxpayer with an advantage over its competitors who may charge sales tax on the entire non-itemized charge.

Aprio can assist your company in determining whether your products and/or services are subject to sales tax in certain states, in addition to advising your company on invoicing practices to ensure the proper sales taxability. We constantly monitor these and other important state tax issues, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Jess Johannesen, SALT manager, at [email protected] or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at [email protected] for more information.

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

[1] Washington Tax Determination 14-0243, 35 WTD 426, 09/30/2016.

[2] Wash. Rev. Code §82.04.192(3)(a)

[3] Wash. Rev. Code §82.04.192(3)(b)

[4] Wash. Admin. Code §458-20-224

[5] Wash. Rev. Code §82.08.190(1)(a)

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.