Any company that has purchased software over the last four years, or is contemplating the purchase of new software, may have an opportunity to reduce their sales tax burden on those purchases based on a number of factors. Software, especially if used in multiple jurisdictions, may be taxed based on where the software is installed, or where the users of the software reside, or, depending on how the software is received, not taxed at all. Factors that should be examined include:
- Whether the software canned or custom.
- Where the software is physically located.
- Who has access to the software and where they are located.
- How the software is delivered. Whether it is hard copy, electronically or load and leave.
- Whether the software is accessed through the cloud.
Taxability of software transactions varies by state. For example, both Ohio and Pennsylvania tax software based on where it is used and not where the software is installed. This means that software located out of state could be subject to Ohio or Pennsylvania tax if there are users of that software located in-state.
Alternatively, if software is purchased and installed in Ohio or Pennsylvania, but users reside out of state, a portion of the taxable purchase price can be allocated out of Ohio or Pennsylvania.
For example: a Pennsylvania-based company purchases software that is installed on a server in Pennsylvania. The purchase price of the software is $100,000. One-third of the company’s employees reside in Pennsylvania, one-third are in Ohio, and one-third are in Kentucky. All employees have access to the software.
Based on this fact pattern, tax is owed to Ohio and Pennsylvania on $66,666 ($33,333 to each state). No tax is owed to Kentucky. However, our experience with clients has shown that software vendors will tax the entire transaction based on where the software is installed, unless instructed otherwise. In this case, the software vendor will typically charge Pennsylvania tax on $100,000. Both Ohio and Pennsylvania have mechanisms, through the use of exemption certificates, to notify vendors of the proper amount of tax that should be charged for each state.
If you have any questions about the potential sales tax implications of software transactions, please contact Bill Vohsing at (614)586-7147.
© 2012 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.
This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.