At a Glance...
The Pennsylvania Department of Revenue has issued a letter ruling advising a vendor that its information retrieval service is subject to Pennsylvania sales tax. The rationale underlying the letter ruling echoes the arguments made by the Michigan Department of Treasury several years ago when Michigan made an unsuccessful attempt to impose sales tax on information retrieval services. Pennsylvania taxpayers should review the new ruling closely because the Department's position, if applied consistently, could result in the imposition of Pennsylvania sales and use tax on a wide variety of information services, and other services accessed over the web by Pennsylvania customers.
In 1997, the Pennsylvania Legislature ended its six-year experiment with imposing its sales tax on computer services—including information retrieval services—by repealing the tax.1 In the 20 years since the tax on computer services was repealed, the Legislature has not explicitly reinstated a sales tax on information retrieval services.
However, in a recently issued letter ruling, Letter Ruling SUT-17-002 ("SUT-17-002"), the Pennsylvania Department of Revenue (the "Department") concludes that the Legislature implicitly reinstated the sales tax on information retrieval services when it expanded the sales tax to apply to specified digital products. Specifically, the ruling advises that a vendor's sales of information retrieval services are taxable as sales of access to canned software and other digital goods under Act 84 of 2016 ("Act 84"), which took effect August 1, 2016. However, the Department's rationale for treating information retrieval services as taxable, as expressed in the ruling, leaves open the possibility that the Department will ultimately take the position that these services and other web-accessed services were already taxable in Pennsylvania prior to the effective date of Act 84.
Act 84—Imposition of Tax on Digital Products
By way of background, Act 84 expanded Pennsylvania's sales tax base by amending the definition of "tangible personal property" to include 10 enumerated digital products, in particular: books; canned software; and "otherwise taxable printed matter" or "otherwise taxable tangible personal property" that is electronically or digitally delivered, streamed or accessed.2 Information retrieval and information services, however, were not included in Act 84's list of digital products.
When issuing its initial guidance regarding the scope of the tax on digital products, the Department published an FAQ listing the digital products that the Department viewed as taxable under Act 84.3 The FAQ described commonly purchased items that the Department viewed as taxable digital products (such as e-books, digital video, digital audio, apps and games, and photographs), as well as some less commonly purchased taxable digital products (including e greeting cards and ringtones). Notably absent from the FAQ was any reference to the tax being imposed on information services or information retrieval.
Given the statutory language of Act 84 and the Department's own initial guidance, Pennsylvania taxpayers had little reason to expect that the Legislature viewed Act 84 as reinstating the tax on information retrieval services, which had been explicitly repealed in 1997.
The Letter Ruling
SUT-17-002 was recently issued to a vendor providing electronic access to "information retrieval products." The ruling concludes that this access is subject to Pennsylvania sales and use tax as a sale of tangible personal property, notwithstanding the fact that this type of access was previously classified as a nontaxable computer service.4
The vendor that requested SUT-17-002 described its service as a subscription service that allows purchasers to log onto a website and search statutes, court decisions, regulations, and a variety of secondary sources. A purchaser can enter search commands, which are transmitted to the vendor's server. Software on the vendor's server processes the search query and provides the purchaser with responsive information.
The Department found that this service was taxable for two reasons.
First, the Department concluded that providing purchasers with access to an online search function constituted a taxable sale of software. The Department reasoned that when a purchaser used the search function, they were exercising power and control over the canned software on the vendor's server, and this constituted taxable "access" to canned software. This reasoning is similar to the position that the Michigan Department of Treasury took in a group of cases a few years ago, in which the Department of Treasury unsuccessfully argued that access to information services constituted a taxable transfer of software.5
This first rationale is particularly troubling because it has implications for tax periods prior to August 1, 2016. Since 2012, the Department has taken the position that when a customer located in Pennsylvania pays to use software hosted on a server located outside Pennsylvania, the transaction is subject to Pennsylvania sales or use tax.6 SUT-17-002 would seem to open the possibility that electronic access to information services could be subject to sales and use tax, and open to assessment, back to 2012.
Second, the Department concluded that even when a purchaser used the service simply to access content like statutes, cases, regulations and journals (rather than using search tools), the service is still taxable. The Department reasons that when the service was used in this way, it constituted the equivalent of electronically accessing a book or "otherwise taxable tangible personal property" and, thus, was subject to tax under Act 84.7
Taxpayers should closely review all sales and purchases of information retrieval services and any other services that permit a purchaser to electronically interface with a vendor's software. Based on the reasoning applied in SUT-17-002, the Department could treat other services as taxable sales of software, including:
- Web-accessed information services
- Software as a service transactions, even if the true object of the transaction is to provide a service
- Web design services, where the vendor is hosting the website that is produced
To the extent a vendor has been charging Pennsylvania sales or use tax on an information service, or other nontaxable service, purchasers may have refund opportunities on the basis that the service is not subject to tax. In the alternative, purchasers may also be able to take the position that, even if the service constitutes taxable access to canned software, all or a portion of the transaction should be sourced outside of Pennsylvania, based on the locations where the service is used.
Taxpayers should also consider the potential exposure that would result if the Department were to apply the reasoning adopted in SUT-17-002 to all purchases made during periods open under the statute of limitations. The Department could expand the reasoning in SUT-17-002 to argue that all sales of electronic information retrieval services used in Pennsylvania since 2012 are subject to sales tax as remote-access software. In our experience, auditors are already assessing tax on purchases of services of this type, and the issuance of SUT-17-002 is likely to embolden auditors taking that approach.
Finally, we should note that SUT-17-002 has not been posted on the Department's website and the Department could still modify its analysis. Earlier this year, the Department issued a letter ruling regarding the taxability of software consulting services that startled the taxpayer community.8 (See our prior alert here.) After further review, the Department revised that ruling to narrow its determination.
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This article is presented for informational purposes only and is not intended to constitute legal advice.