Michigan: Sale of an information subscription service is not a taxable sale
On May 13, 2014, the Michigan Court of Appeals rendered an opinion of significance to businesses in the database subscription industry, and to a somewhat lesser extent, the software industry (Thompson Reuters Inc. v. Dept. of Treasury, No. 90-345 (Mich. Ct. App. May 13, 2014)). Thompson analyzed the proper treatment of sales of subscriptions to an information service for use (and, by analogy, sales) tax purposes.
Factual summary and procedural background
The plaintiff, Thompson Reuters Inc. (“Thompson”), sold information products during the relevant period. These products included CD-ROM computer software and online-research products and tools. At issue was one of these products named Checkpoint. Checkpoint is an online tax and accounting research program that provides subscribers access to information. Subscribers of Checkpoint can search and retrieve up-to-date sources, browse compiled topical information, and click on links between sources. Access to the information on Checkpoint can be accessed through a web browser.
In 2009, the defendant, the Michigan Department of Treasury (the “Department”), conducted an audit of Thompson’s business for the period April 2004 through December 2007. The Department assessed Thompson a use tax deficiency of $814,260, inclusive of interest, as a result of this audit. The Department determined that Thompson’s sale of Checkpoint subscriptions constituted the sale of taxable “prewritten computer software.”
Thompson disputed the assessment in the Michigan Court of Claims. The Court of Claims granted the Department’s motion for summary disposition. The Court of Claims reasoned that this case involved an evolution of services and because this product was taxable when it was sold in book or CD format, it remained taxable. The Court of Claims further held that the primary object in selling subscriptions was the sale of tangible personal property because what the customers wanted was “information,” which was “tangible personal property.” Thompson appealed the Court of Claims’ decision to the Court of Appeals (the “Appeals Court”).
Appeals Court analysis
The Appeals Court reviewed the Court of Claims’ decision granting summary disposition de novo (i.e., anew or considering the action for the first time without deference to the Court of Claims).
Under the Michigan Use Tax Act (UTA), use tax is generally imposed on the privilege of “using, storing, or consuming tangible personal property and is complimentary to the Michigan General Sales Tax Act, as it is designed to cover those transactions not subject to sales tax. As such, the taxes are mutually exclusive but complimentary and designed to assess an equal tax based on the purchase price of underlying property. Generally, use tax applies to tangible personal property, not to services, in Michigan. The UTA defines “tangible personal property” to include “prewritten computer software.” Computer software, under the UTA, is “a set of coded instructions designed to cause a computer or automatic data processing equipment to perform a task.”
However, there are times when a transaction involves the transfer of both tangible personal property and service. In such cases, the Michigan Supreme Court has adopted the “incidental to service test,” which is an evaluation of the entire transaction “to determine whether the transaction is principally a transfer of tangible personal property or a provision of a service." Catalina Mktg. Sales Corp. v. Dep't of Treasury, 470 Mich. 13, 24–25 (2004). In Thompson, the Appeals Court determined that any transfer of tangible personal property was incidental to the service. It reached this determination based on a number of factors, including:
Checkpoint subscribers sought access to up-to-date information relevant to their needs
Thompson’s clients sought the expert knowledge of Checkpoint’s content creators in synthesizing, compiling and organizing the materials, rendering their research more efficient
There was no evidence that even a de minimus amount of software transferred was the object of the transaction, or that customers sought to own or otherwise have responsibility for the prewritten computer software
The Checkpoint license agreement entitles users to access and use the Checkpoint program
Thompson holding and concluding thoughts
The Appeals Court ultimately found in favor of Thompson, as it determined the sale of subscriptions to Checkpoint (the transactions at issue), were primarily the provision of a service and not the transfer of tangible personal property. Therefore, the Appeals Court determined, the assessment of use tax on Thompson was improper.
One of the takeaways from this case is that it can be extremely valuable to involve tax counsel from an early stage in any tax case. Competent counsel can suggest an array of solutions, assist you in evaluating the costs and benefits of litigation, and craft a solution that fits your factual situation and needs.
In general, it remains the “wild west” on many matters of electronic commerce in the state tax arena, not to mention electronic subscription services specifically. Therefore, while a state tax department may have solidified its position on a particular matter, that position may not always be the correct or appropriate one.
Illinois: Special joint committee recommends changes to the state tax code to attract more businesses
The Tax Policy Subcommittees of the Illinois General Assembly’s Joint Revenue & Finance and State Government Administration Committees (the “Joint Committees”) recommended a number of changes to the Illinois tax code in a joint report (the “Report”) issued on May 28, 2014. Cutting the corporate income tax rate and repealing the corporate franchise tax were among the recommendations in the Report.
The Joint Committees’ purpose is to review the Illinois tax code and find ways to improve the state’s business climate. The Report offered various ways to modernize the Illinois tax code in this regard.
Although the Report analyzed many state tax policies, it recommended changes only to a small number of them. The policies that did not garner enough consensuses did not receive an official recommendation. The Report analyzed the Illinois tax code and the state’s current business climate, in addition to other states’ tax policies, in making its recommendations.
The State Corporate Income Tax recommendation
Among the many topics discussed in the Report was Illinois’ corporate income tax. Currently, the state’s corporate income tax rate is 7 percent. Starting Jan. 1, 2015, the corporate income tax rate is scheduled to decrease to 5.25 percent. Governor Pat Quinn and other Democrats, however, are starting to call for the rate to remain at 7 percent via an extension of the tax increase.
The Report recognized the competing interests exist regarding cutting the corporate income tax rate. A major issue facing such a cut, as the Report explained, is balancing of business growth and job creation with the reduction of vital services that the state would no longer be able to provide with the cut. Future debate on this matter will likely revolve around a balancing of these factors.
The Report concluded that the current rate of 7 percent could be reduced, but did not specifically recommend an alternative tax rate. The opinion of the interested parties claimed the rate should be reduced, citing competitiveness concerns.
The State Corporate Franchise Tax recommendation
Although no consensus was reached regarding how to replace revenue from the corporate franchise tax, the Report did recommend repealing the tax. The Report stated that the franchise tax was “outdated and not well administered.” This conclusion is not surprising as the corporate franchise tax is a product of an Illinois law that is over thirty-years old and the Illinois Secretary of State does not have the authority to conduct full audits of companies to determine compliance with the tax.
Although the Report did not recommend how to replace revenue from the corporate franchise tax, it contained some suggestions in the event the tax remains:
Make the corporate franchise tax apportionment formula consistent with the corporate income tax formula so that it is less burdensome on businesses striving to comply with its requirements
Allow investors to not include the treasury stocks of a corporation when determining an investor’s paid-in-capital (the corporate franchise tax is calculated based on an investor’s paid-in-capital)
Provide the state with better enforcement mechanisms to collect the corporate franchise tax
Other discussed changes to the Illinois tax code
The Report also discussed additional recommendations regarding other provisions of the Illinois tax code. Such recommendations included:
Changing the eligibility requirements to obtain the research and development income tax credit. The current tax credit is awarded to businesses that engage in qualified research activities in Illinois. One such suggested change to the eligibility requirements is to mirror them after the federal research and development income tax credit requirements.
Maintaining the earned income tax credit but making changes to it regarding when it is paid out and the potential for a refund of the tax credit. Although these changes were discussed, no consensus was reached.
Restructuring the tax code to promote investment in data centers, although there was not a consensus on specific solutions.
Considering combining the manufacturer’s purchase credit with the manufacturing, machinery, and equipment exemption.
Modernizing the sales tax to encompass service industries within the state.
Reducing initial filing fees for limited liability companies. Although no consensus was reached regarding other limited liability company fees, the Report did indicate that the Joint Committees would consider reducing them in the future.
It is not clear whether the Illinois legislature will adopt any of the recommendations or what taxes the Joint Committees will consider in the future. However, the Report may be used as an impetus for change, especially as debate over various tax rates in Illinois begins to heat up.
For additional information regarding these subjects or any other multistate tax issues, please contact:
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