United States

Arizona: Charges for Access to an Online Database Subject to Rental Transaction Privilege Tax

Feb 22, 2016
From KPMG TaxWatch

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The Director of the Arizona Department of Revenue recently affirmed an Administrative Law Judge (ALJ) decision holding that a taxpayer was subject to personal property rental transaction privilege tax on receipts from providing access to an online research database. The personal property rental transaction privilege tax is imposed on the gross income of a business derived from leasing or renting tangible personal property. The taxpayer at issue sold access to an online research database on a subscription basis. Subscribing customers could independently browse the database, run searches for information, download and print articles, and create flowcharts and spreadsheets. Following an audit, the Department assessed state and city transaction privilege tax on the taxpayer’s subscription income from Arizona customers. After an ALJ upheld the assessment, the Director of the Department of Revenue agreed to review.

The Director observed at the outset that the taxpayer provided access to an online research library and that this access was made possible by software hosted on the taxpayer’s servers. Software is tangible personal property and, in the Director’s view, the taxpayer provided customers the use of the software for consideration. The taxpayer argued that, if it was renting its software for consideration, it was also providing a service, and the tests for a “mixed transaction” should be applied. Arizona applies two such tests. Under the “common understanding” test, whether a mixed transaction is taxable is determined by whether it is commonly understood that a business is engaged in selling products or rendering services. The Director determined that there was no evidence of a common understanding of the taxpayer’s business. Under the “dominant purpose” test, the courts look to whether a customer’s “dominant purpose” for entering into a transaction was to obtain a product or service. The Director determined that the dominant purpose that customers subscribe to the taxpayer’s database was to be able to browse and search for information. The customers did not pay for customized research, but for the ability to locate research articles that met their search queries, and to independently arrange the content as printed text, flowcharts or spreadsheets through the use of the taxpayer’s software. The taxpayer’s customers, the Director noted, had sufficient use and control over the software when they accessed and manipulated the taxpayer’s data base content for the transactions to qualify as rental transactions under the personal property rental classification. The assessment was therefore upheld. For more information on Director’s order, or more generally, the application of Arizona’s transaction privilege tax to database access, 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.