The New York State Department of Taxation and Finance (Department) has just released Tax Bulletin TB-ST-128 (Tax Bulletin), addressing how the state’s sales tax applies to sales of computer software and related services.  The Tax Bulletin does not broach new ground, though it does offer a formal expression of the Department’s position that the provision of remote access to prewritten software is subject to sales tax.

The Tax Bulletin provides standard and accepted statements with respect to the taxability of prewritten and custom software, specifying that the former is taxable regardless of the means delivered (i.e., by physical medium or by electronic transmission) and that the latter is not subject to tax.  “Prewritten software” is software that is not designed and developed to the specifications of a particular purchaser.  “Custom software” is software that is designed and developed to the specifications of a particular purchaser and sold to that particular purchaser.  Sales of custom software to anyone other than the particular purchaser are subject to tax, though the purchaser is allowed to transfer custom software tax-free to certain affiliated entities.  The sale of software upgrades is treated similarly to the sale of software; therefore, prewritten upgrades are subject to tax, while custom upgrades generally are not.

The Tax Bulletin further explains that services related to software, including prewritten software, such as training, consulting and repair services, are generally not subject to tax, provided that any charges for such services are reasonable and separately stated from charges for the software.  Software maintenance agreements may include taxable components (such as prewritten software upgrades) and nontaxable components (such as repair services); if the charges for the various components are not reasonable and separately stated in documentation provided to the customer, the entire agreement may be subject to tax.

The Tax Bulletin’s raison d’etre appears to be to give the Department the opportunity to formally publish its long-standing position that the provision of remote access to prewritten software is subject to sales tax.  The Department’s position is based on its conclusion that “[w]hen a purchaser remotely accesses software over the Internet, the seller has transferred possession of the software because the purchaser gains constructive possession of the software and the right to use or control the software.”  Further, the Department applies unique sourcing rules to the sale of remote access to software, providing that “[t]he situs of the sale for purposes of determining the proper local tax rate and jurisdiction is the location from which the purchaser uses or directs the use of the software, not the location of the code embodying the software.”

The Department’s position with respect to the taxability of sales of remote access to prewritten software does not comport with New York authorities.  In New York, for a taxable sale to occur, possession or control of the taxable good must be transferred to the customer.  Under controlling law, that possession must be “exclusive” and for more than a fleeting moment, and control must mean actual control.  The Department appears to be aware of these authorities, but rather than provide substantive analysis of the type of possession or control over remotely accessed software that is transferred to customers, the Department merely concludes (without support) that sufficient possession or control over remotely accessed software has been transferred in order to subject the transaction to tax.  However, in the authors’ experience, the requisite level of possession or control over software is not transferred to the customer in the vast majority of remote access transactions.  In fact, in In re Sungard Securities Finance LLC, DTA No. 824336 (N.Y. Div. Tax App. 2014), a New York administrative law judge recently came to the conclusion that such possession or control over software was not transferred in what appeared to be a typical remote access transaction.  The provision of remote access to software is better viewed as the provision of a service, not the transfer of property.  Nevertheless, the Department appears to double down on its position in the Tax Bulletin.

Further, even if the Department’s basic position that the provision of remote access to prewritten software constitutes a taxable transfer of that software were correct, the sourcing rules it applies to such transactions are not supported by law.  In New York, sales of property are sourced to where the taxable property is delivered.  The Department concludes that customers are receiving possession or control over the remotely accessed software, but then concludes that “the location of the code embodying the software” is not relevant in determining where that property is delivered.  Instead, the Department applies sourcing rules typically reserved for sales of services to these transactions.  The sale of remote access to software is either the sale of property sourced to where the property is delivered or the sale of a nontaxable service; the Department cannot have it both ways.