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The Tennessee Department of Revenue (the Department) recently issued Revenue Letter Ruling #13-12 (the Ruling). In the Ruling, the Department addressed the application of the Tennessee Retailers’ Sales Tax Act (the Act) to various cloud computing services.


The taxpayer in the Ruling (Taxpayer) offers information technology infrastructure services to customers online. The services offered allow customers to access applications and platforms, server bandwidth and storage capacity without significant information technology capital investment. The Taxpayer does not own any data centers. It only uses large data centers and very small clusters of servers provided by affiliated companies. None of the centers or sites are located in Tennessee. In summary, the Taxpayer’s “cloud” computing services include remote storage and virtual computing.


The remote storage service allows customers to store, backup, retrieve, and maintain content data, applications and software on the Taxpayer’s servers. Customers can use this service at any time over the Internet using certain software development kits and a management console made available by the Taxpayer free of charge, but the customer may use the storage service without utilizing these tools. The customers retain ownership of the information uploaded to the Taxpayer’s servers.


The virtual computing service allows users to perform activities typically performed on a server, such as running application, monitoring computers and computer usage and hosting web domains. Customers tailor their service based on their computing needs and allocate sufficient processing and memory optimal for their operating system and applications the customer plans to use. Taxpayer provides its customers free application programming interfaces and software development kits. These forms of assistance are entirely optional to the customer. The customer can use either an open source operating system free of charge (and one that is freely available on the Internet) or opt to use a third-party operating system. Regardless of choice, the operating system runs on the Taxpayer’s servers and is not downloadable by the customer for the customer’s own use. The customer’s use of the operating system is only in connection with its use of the virtual computing services, and no licenses or software are sold by the Taxpayer.


The fee for each of the remote storage services and virtual computing services includes both a base fee, which is based largely on time and availability (e.g., like a monthly cell phone fee for a certain plan), and an incidental usage charge, which is based on the Taxpayer’s customer’s activity on the Taxpayer’s network. No fees were based on the use of the transmission infrastructure necessary to provide the services. Thus, “both the Taxpayer and its customers must obtain and pay their own telecommunications access and usage fees to their respective telecommunications service providers outside of and independent from the Taxpayer’s service transaction.”


In order to understand sales taxes in Tennessee, there are a number of definitions one must know. Under the Act, the retail sale in Tennessee of tangible personal property and specifically enumerated services is subject to sales tax, unless there is an applicable exemption. “Retail sale” is defined under the Act as “any sale, lease or rental for any purpose other than for resale, sublease or subrent.” “Sale” means “any transfer of title or possession, or both, exchange, barter, lease or rental, conditional or otherwise, in any manner or by any means whatsoever of tangible personal property for a consideration.” “Tangible personal property” includes “property that can be seen, weighed, measured, felt, or touched, or that is in any other manner perceptible to the senses.” Tangible personal property further includes “prewritten computer software,” defined as “computer software, including prewritten upgrades, that is not designed and developed by the author or other creator to the specification of a specific purchaser.” However, the sale or use of intangible intellectual property is not subject to Tennessee sales and use tax unless stored on a tangible storage media.


One of the items explicitly taxable is “[t]he retail sale, lease, licensing, or use of computer software in this state, including prewritten and custom computer software...regardless of whether the software is delivered electronically, delivered by use of tangible storage media, loaded or programmed into a computer, created on the premises of the consumer, or otherwise provided.”


“Computer software” is “a set of coded instructions designed to cause a perform a task.” Computer software is “delivered electronically” if delivered “by means other than tangible storage media.”


Sales taxes are also applicable to retail sales of services specifically enumerated in the Act. One such service is the furnishing of “intrastate, interstate or international telecommunication services.” However, data processing is excluded from telecommunication services.


There are two ways in which non-enumerated services may be taxed. One such way that a nontaxable service or item may be subject to taxation is when charges for the nontaxable service or item are included in the sales price of a taxable good or service. The other way is where the service is intertwined with the sale of taxable tangible personal property.


Without going through the entire lengthy legal analysis contained in the Ruling, the Department ultimately ruled that none of the remote storage service, the virtual computing service or the Taxpayer’s fees were subject to Tennessee sales and use taxes. This finding was based primarily on the grounds that none of the non-customized software was subject to a fee, the noncustomized software was not sold to any customers, the Taxpayer was not providing telecommunication services, and the Taxpayer’s services or software were never embodied in or intertwined with a tangible medium that is by itself subject to Tennessee sales tax.


Note that letter rulings are binding on the Department only with respect to the taxpayer being addressed in the ruling.

Click here to read the text of Revenue Letter Ruling #13-12 and to read the Department’s legal analysis.