United States

Michigan: Use Tax Not Due on Service Transactions Involving Use of Remote Software

Mar 30, 2015
From KPMG TaxWatch

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The Michigan Court of Claims recently addressed whether a taxpayer owed use tax on web-based software accessed by Michigan customers. The taxpayer, a Maryland-based company, engaged in online transactions with Michigan customers that were facilitated by software housed on the taxpayer’s out-of-state servers. The transactions at issue involved formatting, transmitting, and exchanging Electronic Data Interchange (EDI) documents, converting business documents into a format for EDI transmission, and providing cataloging services for synchronizing, storing, and managing EDI transmissions. It was undisputed that the taxpayer’s customers did not install or download the software. The Michigan Department of Treasury conducted a use tax audit for the 2005 through 2009 tax years and subsequently assessed the taxpayer use tax on its customers’ use of the software. The general basis for the assessment was that the taxpayer’s customers “used” the prewritten computer software when they accessed the software’s functionalities in Michigan.  The taxpayer paid the assessment in full, but immediately filed a refund action claiming that no taxable use of prewritten computer software occurred.

Under Michigan law, the definition of taxable tangible personal property includes prewritten software that is "delivered by any means.” Although the term “delivered” is not defined in the statute, the court noted that the plain-meaning of the term requires that a customer take possession or control of the software for delivery to have occurred. The software at issue was used by the taxpayer internally to provide its services. It was not handed over, left, or transferred. The court determined that there was no evidence that the taxpayer's customers ever took delivery of the software and rejected the Department’s position that “access” to software applications equated to delivery of prewritten computer software.  The court also concluded that even if the software was delivered, there was no evidence that the taxpayer’s customers exercised any right or control “incident to ownership” over the software in a manner that would constitute a taxable use under Michigan law.  Furthermore, under the Department’s reasoning, a use tax obligation could arise any time a customer inadvertently accessed the functionality of tangible personal property used to provide a service. The Department had also argued that the transactions were taxable as telecommunications services. However, this position was rejected as the definition of taxable telecommunications services specifically excluded the taxpayer’s services. The court did note that it believed sales and use tax laws have not “kept pace with the rapid technological changes” of the increasingly virtual world, but that it was confined to applying the law as written. Having determined that use tax was not owed, the court declined to address the taxpayer’s argument that the assessment violated the Internet Tax Freedom Act. This is at least the third case in which the Court of Claims has found that remotely accessed software is not subject to tax in Michigan.  The Court of Appeals has heard oral argument in one of these cases, Auto Owners Insurance. For more information on GXS, Inc. v. Dep’t of Treasury, please contact Jill Nielsen at (312)-665-2794.


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The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.