Based on a decision issued by the Texas Comptroller, certain out-of-state companies that license software products to customers in Texas are required to collect sales tax on those licenses, even if they have no actual presence in the state. The Comptroller’s decision (Decision No. 106632), which was issued on September 19, 2014, takes a rather expansive view of the concept of what constitutes a “physical presence” for purposes of state sales tax collection requirements.
For sales tax purposes, the U.S. Supreme Court held in 1992 that a state cannot require a company to collect its sales tax unless the company has a physical presence in the state. States have responded by issuing rulings and passing statutes and regulations that put various spins on what constitutes a physical presence, but the recently issued ruling by Texas arguably pushes the “physical presence” concept for sales tax purposes further than ever before.
The software provider named in the case delivered its software electronically to Texas customers over the Internet, and the customers subsequently downloaded the software onto their computers. Despite having no location, property, or employees in the state, the Comptroller concluded that the software provider had a physical presence in Texas because it retained certain property rights to the software that was downloaded by Texas users. The software license agreements provided that the licensor retained title, ownership, and the copyrights to the licensed products. The customers were limited to a non-transferable right to use of the software, which is typical for software licensing agreements. It is also important to note that Texas, like most other states, considers software to be tangible personal property for sales tax purposes. Thus, according to the Comptroller, the retention of property rights in the software (i.e., tangible personal property) downloaded in Texas was sufficient grounds for establishing a physical presence in the state.
This decision, for now, does not impact providers of software-as-a-service (SaaS) with Texas customers. Texas considers SaaS to be “Internet Hosting,” which under the state’s sales tax law does not create a presence in the state for purposes of having a sales tax collection obligation. However, Texas users of such services are still required to remit use tax on SaaS. Thus, a software provider’s sales tax collection obligation in Texas seemingly hinges on the manner in which it provides its products to customers.
The application of a state’s sales tax to software products and services varies significantly and is changing constantly. If you have any questions about sales tax, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6200.