Pennsylvania: Department of Revenue addresses sales and use tax issues
Sales and use tax applicable to computer software
In a February 9, 2017, Pennsylvania Department of Revenue (Department) Sales and Use Tax Letter Ruling (Ruling), the Department clarified its position on the extent to which the state’s sales and use tax applies to support services for canned computer software. The Department ultimately concluded that all support services are subject to the tax when they are “transferred in a sale at retail or made use of after being obtained in a purchase at retail.”
In its discussion, the Department first noted that Pennsylvania’s 6 percent tax applies to the retail sale, or use of, tangible personal property, and some services. Included in the definition of “sale” is the granting of a license to use or consume the property, regardless of the means of the transfer, and regardless of whether the granting of the license is absolute or conditional.
In addition, a retail sale also covers payment for services that alter the tangible personal property. Beyond this, citing case and statutory law, the Ruling pointed out that canned computer software has long been considered tangible personal property.
In 2016, lawmakers updated the statutory definition of tangible personal property to expressly include particular items, like video, books, applications, games, music, audio, and canned software, notwithstanding the function performed by the canned software, and regardless of whether the canned software is purchased singly, by subscription, or in any other manner. Additionally, with this 2016 update, the list of items subject to the sales and use tax now includes “maintenance, updates and support.”
With this Ruling, the Department gives notice that it now “considers the Legislature’s express inclusion of the ‘maintenance, updates and support’ language within the definition of tangible personal property to operate as rendering all such services to canned computer software as being subject to tax.” Accordingly:
when a vendor who is providing support to software is afforded any access to the software itself, the vendor is rendering taxable support. This includes electronic or remote access as well as direct physical access to the software. It also includes any updates, upgrades, enhancements, patches, modules, and/or other modifications to canned software, whether provided and billed separately, or in conjunction with such support.
Helpfully, the Ruling offers the following examples of taxable events:
- A vendor providing support via a remote desktop where they access and alter the software directly;
- A vendor providing telephone support where they troubleshoot/discuss the issue with the customer and subsequently provide a patch or module to fix the issue;
- A vendor distributing upgrades, patches, and/or modules to its customers;
- A customer sending a copy of the software program to a vendor who accesses, uses, or alters and then returns the corrected version of the software;
- A vendor providing telephone support in the form of a call-in help-desk providing direction as to the use, correction, or manipulation of the software;
- A vendor providing training with respect to the use, correction, or manipulation of the software.
To further clarify what would constitute a taxable event, “support” includes any and all support services to canned computer software, all types of technical support, consulting, and training for the canned software, regardless of whether sold by tangible media or not.
Requests for sales tax refunds could trigger an audit
Bloomberg reported that it obtained a copy of a draft bulletin (draft) in which the Department states that it is changing the procedures for handling “large and complex sales and use tax refund petitions.” Should the Department actually implement the bulletin, which it has not done yet, it would address “large refund requests” through the field audit process.
To justify the audits, the Department provided the following “advantages for both taxpayer and the Department:”
- Overpayments would offset audit liability, potentially reducing the amounts of interest and penalties due;
- A field audit could limit the number of transactions required to be reviewed at all appellate levels;
- A field audit would identify particular areas of liabilities and overpayments, to help the taxpayer “take corrective action to improve compliance;”
- A taxpayer can provide on-site evidence, allowing an auditor to make an informed decision regarding the proper application of the sales and use tax;
- Consolidation of liability and overpayment issues into a field audit would enable “the appellate process to handle both issues simultaneously.”
The draft declares that audits “will encompass at least the same periods within the three-year refund window, and may extend to additional periods” if the taxpayer waives the statute of limitations on assessments. A taxpayer could challenge a denial of a refund within six months of the mailing date of the notice of assessment, or within three years of the actual payment of the tax, whichever is later.
The Department reserves the right to conduct the field audit in the first place at its discretion.
Tax professionals are not happy. Bloomberg reported that some have concerns that, “[i]f finalized as written, the bulletin could lengthen wait times for refunds and dissuade skittish taxpayers from filing refund petitions at all.” Another said that “[i]n the taxpayer’s view, it is a retaliatory audit provision…This will put a dampening effect on filing refund claims.” Yet a third opined that “[t]he proposal seems to be ‘a bit of a scare tactic for the wary taxpayer who would not want to subject [himself] to an audit.’”
The three-year waiting period is another sore spot. Another one of Bloomberg’s professionals asserted that “[r]efund requests that get converted to audits could take as long as one to three years to resolve, delaying a taxpayer’s refund. Under the current setup, it takes companies about six months to get a refund petition processed.
Other questions Bloomberg identified include:
- How long would the audits take?
- Would the bulletin give the Department more time to issue an assessment, while the taxpayer still only has three years to file a refund claim?
- Procedurally, will there be any issues relating to the periods of time a taxpayer has to file an appeal with the Board of Finance and Revenue?
The Pennsylvania Institute of Certified Public Accountants (PICPA) even went so far as to send a letter to the Department in late December, expressing its “serious reservations about the proposal from both a practical and legal standpoint.”
PICPA claimed that the draft “seems to contravene, or at a minimum muddy, existing statute in this area.” Among the group’s worries are confusing timing rules, refund delays, and what would constitute “large and complex sales and use tax refund petitions.”
Ultimately, the PICPA wonders, “[g]iven that the Department will likely eventually audit a taxpayer with a large refund appeal anyway, is the draft Bulletin necessary?”