Aug 24, 2015
From KPMG TaxWatch
The Arizona Department of Revenue recently concluded that a company offering certain website design and hosting services was subject to Arizona Transaction Privilege Tax, or “TPT.” The taxpayer provided customers access to web-based software tools that allowed the customers to create their own websites. The software and offerings ranged from a basic, free level that allowed the development of a “static” web site to increasingly sophisticated software tools and services that, for graduated fees, would allow taxpayers to deploy more robust sites, such as complete e-commerce solutions. The taxpayer also sold domain names and offered its customers the option of purchasing third-party applications and digital stock photography for use on their websites. The taxpayer requested a ruling as to whether its gross receipts derived from the monthly fees were subject to TPT under the personal property rental classification.
Under Arizona law, TPT is imposed on the gross proceeds derived from the business of leasing or renting tangible personal property. The Department first determined that the web-based software accessed by the taxpayer’s customers constituted tangible personal property. Both Arizona and other courts, the Department noted, have held that software constitutes tangible personal property regardless of whether it is delivered in tangible form or located remotely on servers. Next, the Department considered whether the taxpayer was in the business of leasing or renting the software. In its view, the pivotal question was whether the taxpayer’s customers gained sufficient control and use of the software so that they had constructive possession. Observing that manipulation of software can establish its constructive possession, the Department noted that the taxpayer’s customers manipulated the software when they used it to design websites specifically to suit their business needs. The Department concluded that the taxpayer was in the business of leasing or renting tangible personal property and that receipts derived from Arizona customers were subject to TPT.
Finally, the ruling addressed the computation of the tax base. Besides gross receipts earned directly from renting tangible personal property, the TPT base includes all associated fees and charges. In addition to the monthly fees for access to software, the taxpayer received payment processing fees, charges for digital stock photography and access to third-party applications, and domain name registration fees. For charges to be excluded from the TPT base, they must come from a line of business separate from the rental of tangible personal property. The charges for processing, digital stock photography, and access to third-party applications were too inconsequential to be considered a separate line of business. The taxpayer maintained that its domain name registration receipts came from a separate line of business because they made up a significant portion of the taxpayer’s total revenues. In an earlier Arizona case addressing when receipts are from a separate line of business, the court had held that “the proper focus is not on the dollars, but on the percentage of business represented by those dollars.” Here, the taxpayer could not readily ascertain what percentage of its receipts were from domain name registration services, and the Department consequently ruled that these receipts must also be included in the tax base. For more information on this ruling, please contact Brandon Fulmer at 214-840-2497.
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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.
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.