97-1310

Sales and Use

BEFORE THE UTAH STATE TAX COMMISSION

____________________________________

PETITIONER, ) FINDINGS OF FACT,

) CONCLUSIONS OF LAW,

) AND FINAL DECISION

Petitioner, )

) Appeal No. 97-1310

v. )

)

AUDITING DIVISION OF ) Tax Type: Sales and Use

THE UTAH STATE TAX )

COMMISSION, )

) Judge: Hendrickson

Respondent. )

_____________________________________

Presiding:

Pam Henderickson, Commissioner

Joe B. Pacheco, Commissioner

Appearances:

For Petitioner: PETITIONER REP, Associate General Counsel, COMPANY A, counsel for Petitioner

For Respondent: Susan L. Barnum, Office of the Attorney General, counsel for Respondent

Clark L. Snelson, Office of the Attorney General, counsel for Respondent

STATEMENT OF THE CASE

This matter came before the Utah State Tax Commission for a Formal Hearing, which was held on two dates, September 10, 1998, and November 17, 1998. Based upon the evidence and testimony presented at the hearing, the Tax Commission hereby makes its:

FINDINGS OF FACT

The Audit Period and Audit Assessments

1. The tax in question is sales and use tax.

2. The audit period at issue is January 1, 1994, through December 31, 1996.

3. After audit, Respondent issued a preliminary notice to Petitioner, PETITIONER ("PETITIONER"), dated May 16, 1997, assessing $$$$$ in additional tax and imposing $$$$$ in interest. PETITIONER paid the total preliminary assessment of $$$$$ on June 10, 1997.

4. On July 17, 1997, the Respondent issued a statutory notice to PETITIONER, which reflected the final assessment and included an adjustment to the tax assessed on the preliminary notice. The statutory notice assessed $$$$$ in additional tax and imposed $$$$$ in interest for a total final assessment of $$$$$. The statutory notice also indicated that a $$$$$ refund of excess tax paid and accrued interest was due to PETITIONER as a result of its payment of June 10, 1997.

5. On August 12, 1997, PETITIONER filed a Petition for Redetermination. While the statutory notice included assessments of sales tax on various transactions, many were not disputed. At dispute in this appeal are the tax assessments imposed on the computer software fees that PETITIONER paid to COMPANY B ("COMPANY B") and to COMPANY C ("COMPANY C") during the audit period. The assessments on the fees paid to COMPANY B and COMPANY C represent the majority of the assessment imposed by the statutory notice.

PETITIONER's Role in the Medicare Program

6. PETITIONER is a private health service insurance corporation located in Utah that insures employees of employers within the State and individuals who purchase health insurance on an individual or association basis.

7. The Health Care Financing Administration ("HCFA") is the federal agency that administers and regulates the Medicare program, promulgated in Title XVIII of the Social Security Act.

8. To process the large number of Medicare claims that are submitted for payment, HCFA contracts with insurance companies, such as COMPANY D plans or other claims administrators, to process and pay claims within each state. There are approximately sixty-five Medicare contractors within the United States to process Medicare claims.

9. In addition to its business as a private health service insurance corporation, PETITIONER has entered into two contracts with HCFA to administer portions of the Medicare program in Utah. One contract designates PETITIONER as an "Intermediary" to administer the Medicare Part A program (hospital and facility claims) in the State of Utah. The second contract designates PETITIONER as a "Carrier" to administer the Medicare Part B program (physician and other practitioner claims) in the State of Utah.

10. Under its contracts with HCFA, PETITIONER has the responsibility to process and pay the Medicare claims submitted under both programs. When a provider within the State of Utah provides care to a Medicare beneficiary, the provider submits a medical claim for the provider's service to PETITIONER for payment. If PETITIONER determines that the claim is to be paid, it writes a check to the provider drawn on a checking account into which federal funds are deposited to cover the Medicare payments.

11. PETITIONER's costs to administer the Medicare A and B programs are reimbursed by HCFA. While PETITIONER need not get approval from HCFA for each specific purchase or payment it makes to administer the programs, it is required to submit a yearly budget of its estimated administrative expenses to HCFA, which is reviewed and approved by HCFA. Then, on a biweekly basis, HCFA transfers electronically the approved budget amount into PETITIONER's checking account for its use to pay the costs of administering Medicare. At the end of the fiscal year, HCFA and PETITIONER reconcile PETITIONER's expenses versus HCFA's payments for administration costs.

PETITIONER's Computer Software Maintenance Contracts

12. There are two computer software systems nationwide that are used by Intermediaries to process Medicare Part A claims. There are four computer software systems nationwide that are used by Carriers to process Medicare Part B claims. HCFA has approved the use of these systems for its Carriers and Intermediaries.

13. To process and pay the Medicare claims to providers, PETITIONER uses two computer software programs. During the audit period, PETITIONER used the COMPANY B computer software program ("Part A system") to process and pay the Medicare Part A claims (hospital and other facilities). It also used the COMPANY C computer software program ("Part B system") to process and pay the Medicare Part B claims (physician and other practitioners).

14. During the audit period, PETITIONER had a contract with COMPANY B to maintain the Part A system and a contract with COMPANY C to maintain the Part B system. These contracts were approved by HCFA prior to PETITIONER entering into them. In both cases, PETITIONER is part of a shared maintenance group consisting of other Medicare carriers and intermediaries who also use these systems.

15. The COMPANY B Part A system and the COMPANY C Part B system were both developed and in use by other Medicare contractors prior to PETITIONER contracting for the installation and maintenance of the software programs.

16. The contract between PETITIONER and COMPANY B provides as follow:

This Agreement for Maintenance Services ... on the STATE Medicare A System is made and entered into by and between COMPANY B, ... and the undersigned customer, PETITIONER, (hereinafter called the "Customer").

17. The contract between PETITIONER and COMPANY C provides as follows:

This System Upgrade License and Shared Maintenance Agreement ... is by and between COMPANY C ("COMPANY C"), ... and PETITIONER ..., a Federal Medicare carrier...

18. In its contracts with COMPANY B and COMPANY C, PETITIONER does not identify itself as a purchasing agent for the HCFA.

19. PETITIONER paid maintenance fees to COMPANY B and COMPANY C on a regular basis as part of its obligation under the contracts, under which the vendors agreed to keep the computer software systems properly maintained and to make any necessary adjustments to the computer programs. It is the Auditing Division's assessment of use tax on these maintenance fees that is in dispute.

20. The transactions at issue in this case were not made on purchase orders that indicated the purchase was made by or on behalf of the federal government or that the federal government was responsible for the purchase price. Should PETITIONER not make its contractual maintenance fee payments to either COMPANY B or COMPANY C, HCFA would not intervene and pay the fees (testimony of XXXXX from HCFA).

APPLICABLE LAW

1. Utah Code Ann. '59-12-103 (1996) provides that a sales or use tax is due on certain transactions and states in relevant part the following:

There is levied a tax on the purchaser for the amount paid or charged for the following:

(a) retail sales of tangible personal property made within the state;...

(g) services for repairs or renovations of tangible personal property or services to install tangible personal property in connection with other tangible property; ...[and]

(l) tangible personal property stored, used, or consumed in this state.[1]

2. Utah Admin. R. 865-19S-54(B)(1) provides that sales to Afederal agencies and instrumentalities@ are exempt. A sale made to a federal agency or instrumentality is considered exempt when made in accordance with Utah Admin. R. 865-19S-41 (1994)[2], which states in relevant part the following:

A. Sales to the United States government are exempt if federal law or the United States Constitution prohibits the collection of sales or use tax.

B. In cases where the United States government pays for merchandise or services with funds held in trust for nonexempt individuals or organizations, sales tax must be charged.

C. Sales made directly to the United States Government or any authorized instrumentality thereof are not taxable, provided such sales are ordered upon a prescribed governmental purchase order form and are paid for directly to the seller by warrant on government funds...

3. While governmental agencies may be exempt from taxation, sales made to governmental facilities managers or supply contractors are generally not exempt. Utah Admin. R 865-19S-91 (ARule 91") provides guidance in determining whether or not such transactions are exempt from taxation. Rule 91 was amended several times during the audit period. When the audit period commenced, the rule provided in relevant part as follows:

A. Sales of tangible personal property or services as defined in Utah Code Ann. Section 59‑12‑102 and 59‑12‑103 to federal, state, or municipal government facilities managers or supply contractors are subject to sales or use tax if the manager or contractor uses or consumes the property. Tax is due even though a contract vests title in the government and even if direct payment is made by the government to a vendor.

B. The United States Constitution prohibits a state from imposing a tax directly on the federal government, but a tax, the entire burden of which falls upon the United States, is not invalid for that reason alone, if it is levied against someone other than the United States.

C. In order to receive immunity from the imposition of sales or use tax, the purchasing entity must actually be the government, or so closely connected with the government that the two cannot realistically be viewed as separate entities. It must be clear that the government intends the contractor or manager to be its agent. A contract to perform services as a project manager or product supplier does not, in and of itself, create an agency relationship.

On October 1, 1994, subsection (B) of the above rule was deleted, and on February 13, 1995, subsection (C) of the above rule was deleted. The two subsections were deleted because they contained what was considered unnecessary language. Lastly, on October 22, 1996,[3] Rule 91 was again amended to state in relevant part the following:

A. Sales of tangible personal property or services as defined in Sections 59‑12‑102 and 59‑ 12‑103 to federal, state, or municipal government facilities managers or supply contractors, who are not employees or agents of that government entity, are subject to sales or use tax if the manager or contractor uses or consumes the property. Tax is due even though a contract vests title in the government.

B. A person qualifies as an agent for purchasing on behalf of a government entity if the person and the government entity enter into a contract that includes the following conditions:

1. The person is officially designated as the government entity=s purchasing agent by resolution of the government entity;

2. The person identifies himself as a purchasing agent for the government entity;

3. The purchase is made on purchase orders that indicate the purchase is made by or on behalf of the government entity and the government entity is responsible for the purchase price;

4. The transaction is approved by the government entity; and

5. Title passes directly to the government entity upon purchase.

6. If the government entity makes a direct payment to the vendor for the tangible personal property or services, the sale is made to the government entity and not to the facilities manager or the supply contractor. In that case, the sale is not subject to sales tax.

7. Sales or leases of canned computer software are subject to sales and use tax, while sales or leases of custom computer software are not. To administer the taxation of software, Utah Admin. R. 865-19S-92[4] (ARule 92") provides in relevant part the following:

A. Definitions:

1. "Canned computer software" or "prewritten computer software" means a program or set of programs that can be purchased and used without modification and has not been prepared at the special request of the purchaser to meet their particular needs.

2. "Custom computer software" means a program or set of programs designed and written specifically for a particular user. The program must be customer ordered and can incorporate preexisting routines, utilities or similar program components. The addition of a customer name or account titles or codes will not constitute a custom program.

...

B. The sale, rental or lease of canned or prewritten computer software constitutes a sale of tangible personal property and is subject to the sales or use tax. Payments under a license agreement are taxable as a lease or rental of the software package. Charges for program maintenance, consultation in connection with a sale or lease, enhancements, or upgrading of canned or prewritten software are taxable.

C. The sale, rental or lease of custom computer software is exempt from the sales or use tax, regardless of the form in which the program is transferred. Charges for services such as program maintenance, consultation in connection with a sale or lease, enhancements, or upgrading of custom software are not taxable.

D. Charges for services to modify or adapt canned computer software or prewritten computer software to a purchaser=s needs or equipment are not taxable if the charges are separately stated and identified.

CONCLUSIONS OF LAW

PETITIONER claims there are two reasons why the maintenance fees it paid to COMPANY B and COMPANY C are not subject to Utah=s sales and use tax. First, it claims that the imposition of tax on these fees would be a direct tax on the federal government and is therefore constitutionally impermissible. Second, it claims that the computer software programs upon which these fees were paid are "custom" computer software programs, and, accordingly, any maintenance on these programs would be considered a nontaxable service.

A. Direct Tax on the Federal Government.

Utah Admin. R. 865-19S-54 acknowledges that the State of Utah may not directly impose a tax on the federal government by providing that sales to the federal government and its instrumentalities are exempt from sales and use tax. Though PETITIONER is a private corporation that contracts with HCFA to administer Medicare claims, it asserts that it should be considered an agent that stands in the United States Government's shoes when it makes purchases to fulfill its HCFA contracts. In the alternative, should PETITIONER not be so closely integrated with the federal government as to share its sovereign tax immunity, PETITIONER argues that the maintenance fees at issue should be considered fees paid by the federal government, not by itself, and consequently, immune to taxation.

Purchase by Agent or Instrumentality. The United States Supreme Court stated in United States v. New Mexico, 455 U.S. 720, 102 S.Ct. 1373, 1382-83 (1982), that the federal government's tax:

immunity may not be conferred simply because the tax has an effect on the United States, or even because the Federal Government shoulders the entire economic burden of the levy... [and] that tax immunity is appropriate in only one circumstance: when the levy falls on the United States itself, or on an agency or instrumentality so closely connected to the Government that the two cannot realistically be viewed as separate entities, as least insofar as the activity being taxed is concerned....Thus, a finding of constitutional tax immunity requires something more than the invocation of traditional agency notions: to resist the State's taxing power, a private taxpayer must actually "stand in the Government's shoes."[citation omitted]....[However,] a state tax is impermissible when the taxed entity is "so intimately connected with the exercise of a power or the performance of a duty" by the Government that taxation of it would be "'a direct interference with the functions of government itself'".

In New Mexico, the Court held that three privately owned federal contractors who operated a government owned atomic energy research facility on behalf of the federal government were not exempt from New Mexico's sales and use tax. One of these contractors received no fee under its contract, but was guaranteed royalty-free, irrevocable licenses for any communication-related discoveries or inventions developed by its employees during the course of the contract. In addition, the company was completely reimbursed for salary outlays and other expenditures. The second and third contractors received both their costs and a fixed annual fee under their contracts. Under all the contracts, title to all tangible personal property purchased by the contractors passed directly from the vendor to the United States Government. Two of the three companies were required to submit an annual voucher of expenditures for government approval. The contracts also gave the government control over each contractor's property management procedures.

The contractors placed orders with third-party suppliers in their own names and identified themselves as the buyers. Each contract also provided an "advanced funding" procedure to meet contractor costs, where the contractor would pay creditors and employees with drafts drawn on a special bank account in which United States Treasury funds were deposited. Prior to the commencement of the litigation, the contracts with the federal government did not refer to the contractors as "agents." Two years after litigation commenced, the contracts were modified to state that each contractor "acts as an agent of the Government for certain purposes." Yet, the United States denied any intent to "formally and directly designate the contractors as agents." New Mexico at 1378-79.

Given this situation, the Court determined that the issue was Awhether the contractors [could] realistically be considered entities independent of the United States. If so, a tax on them [could not] be viewed as a tax on the United States.@ New Mexico at 1385. The Court pointed out that the contractors were privately owned corporations, that government officials did not run the day-to-day activities, and that the government did not have any ownership interests. As a result, the Court did not view the contractors as "constituent parts" of the federal government. Instead, the Court held that A[t]he congruence of professional interests between the contractors and the Government [was] not complete; their relationships with the Government [had] been created for limited and carefully defined purposes.@ New Mexico at 1386 .

While HCFA must approve the contracts entered into by PETITIONER and its computer software providers, PETITIONER need not receive advance government approval for each purchase made or expense paid. While an annual budget review process serves to provide the government some control over expenses, the government does not run the day-to-day operations of PETITIONER. PETITIONER maintains a substantial independent role in making purchases and budgeting to fulfill its contract with HCFA. In addition, XXXXX from the HCFA states that the federal government would not be responsible to pay PETITIONER=s computer software maintenance fees due to COMPANY B or COMPANY C should PETITIONER renege on these contractual obligations. Nor does title to the software programs pass to the federal government. For these reasons, the Commission determines that PETITIONER=s role as a purchaser or user of the computer software maintenance is sufficiently distinct from the government so that PETITIONER should not be considered an agent or instrumentality of the United States for tax immunity purposes.[5]

The case at issue may also be distinguished from a line of cases, including tort cases, involving Medicare claims and payments that have held that Medicare carriers and intermediaries are entitled to immunity from suit under the doctrine of sovereign immunity. In Petersen v. Weinberger, 508 F.2d 45 (5th Cir. 1975), the plaintiff sued Blue Cross/Blue Shield of Texas, a Medicare carrier, for actions arising out of its administering Medicare benefits. The Court held that Blue Cross/Blue Shield of Texas was a Medicare fiscal intermediary who acted as an agent at the sole discretion of the Secretary of Health, Education, and Welfare pursuant to 42 U.S.C.A. ''1395h and 1395u. The Court stated that, in this situation, it was the United States who was the real party in interest. Under the doctrine of sovereign immunity, the Court determined that the district court lacked jurisdiction over the Medicare carrier. Petersen at 51-52.

In United States v. Blue Cross Blue Shield of Alabama, Inc., 1998 WL 339553 (11th Cir. 1998), the Court, citing a Senate Report from the Congress that enacted Medicare in 1965, stated that the role of a fiscal intermediary is to act on the behalf of the Secretary:

Fiscal intermediaries, such as BCBS [Alabama], function much like an administrative agency. They "act on behalf of the Secretary, carrying on for [her] the governmental administrative responsibilities imposed by the [Medicare Act]." Sen. Rep. No. 404 (1965) reprinted in 1965 U.S.C.C.A.N. 1943, 1995 (adding that "[t]he Secretary, however, would be the real party in interest in administration of the program").[6]

The Court further stated that:

In recognition of their administrative role, the Medicare regulations require that contracts with fiscal intermediaries "contain clauses providing for indemnification with respect to actions taken on behalf of HCFA," ... and the federal courts have extended the doctrine of sovereign immunity to them. ... Rather than impose liability on fiscal intermediaries for the vast amounts of federal money their agents certify and disburse to Medicare providers, a task delegated by the HCFA, Congress established provisions providing for recoupment of overpayments from the actual recipients of the funds.

The Court confirmed that the Medicare carrier is subject to sovereign immunity on an issue that involves the carrier=s processing and payment of Medicare claims, a task delegated by HCFA. Nevertheless, the Court also pointed out that "[f]iscal intermediary immunity from liability to the United States for payments certified and disbursed by its officers in the normal course of business also does not preclude the government from seeking recourse against recalcitrant intermediaries." Blue Cross Blue Shield of Alabama, at 13. Accordingly, Medicare carriers do not enjoy unlimited immunity for their actions. See also, Livingston v. Blue Cross and Blue Shield of Alabama, 788 F.Supp. 545, 548 (S.D.Ala. 1992) (ASovereign immunity protects the government from financial liability....This Court does not read these cases to extend blanket immunity to Medicare fiscal intermediaries. Rather, a more logical conclusion is that the fiscal intermediary is entitled to sovereign immunity to the extent that the government is exposed to financial risk").

Furthermore, the Court in Blue Cross Blue Shield of Alabama at 13 stated that Medicare regulations require that contracts with fiscal intermediaries contain clauses providing for indemnification with respect to actions taken on behalf of HCFA, and as a consequence, federal courts have responded by extending the doctrine of sovereign immunity to the intermediaries. Extending sovereign immunity to the Medicare carriers holds them harmless for the actions they take and decisions they make in implementing the government's Medicare claim policies. However, liabilities that arise from processing and paying Medicare claims in an allegedly improper or incorrect manner can be distinguished from the liabilities that involve the Medicare carrier=s administrative costs.

PETITIONER=s administrative costs are liabilities that arise out of its fulfilling its contract with HCFA. Thus, they are completely analogous to the taxable costs in United States v. New Mexico. They are not liabilities that arise out of PETITIONER's distribution of government trust funds to beneficiaries, that have given rise to limited sovereign immunity. The imposition of sales tax on administrative costs is not the type of "financial risk" for which the courts have allowed the United States' sovereign immunity to extend to a Medicare carrier.

Purchase by Government. Whether or not PETITIONER is considered an agent or instrumentality of the United States for tax immunity purposes, PETITIONER claims that it is the United States Government and not PETITIONER that is actually purchasing the computer software maintenance at issue. PETITIONER purports that the decisions reached in U.S. v. Kabeisman, 970 F.2d 739 (10th Cir. 1992) and United States v. Lohman, 74 F.3d 863 (8th Cir. 1996) support this claim.

In Kabeisman, a contract existed between a private contractor and the United States Government, where the contractor had to use gasoline and diesel fuel to run various equipment to fulfill its contractual duties. The State of Wyoming imposed state and local taxes on the contractor, claiming that the contractor should pay taxes on the fuel. Critical to the outcome of this case was the Court's determination of which party was the actual purchaser of the fuel. In this case, the contractor communicated its fuel needs to the Defense Fuel Supply Center, an agency of the Department of Defense, which purchased gasoline and fuel oil for federal agencies. This agency purchased the fuel products through normal government procurement channels, and the agency itself was liable for any nonpayment for the products. However, it was the contractor who paid for the fuel with its own checks drawn on a special checking account set up by the government. Under these circumstances, the Court held that it was the federal government who had bought the fuel, and thus, its purchase was immune from state and local taxation. The Court differentiated this case from the New Mexico decision because in New Mexico, the contractors placed orders with third parties in their own names and identified themselves as being the purchasers. Kabeisman at 732.

In the issue before the Commission, the purchase of computer software maintenance from COMPANY B and COMPANY C can also be differentiated in a similar manner from the purchases in Kabeisman. Here, PETITIONER is the party that entered into the contract with the maintenance providers, while the federal agency, HCFA, did not actually negotiate and enter into these contracts. Furthermore, HCFA has no liability for payment of the maintenance fees should PETITIONER not pay them, unlike the situation in Kabeisman where the federal agency was liable for the nonpayment of the petroleum products.

In Lohman, the federal government chose an electricity vendor to supply electricity to a specific government facility. It negotiated future electrical rates with the supplier and executed an indefinite delivery contract with the supplier. The federal government then contracted with a private contractor to operate the government facility and serve as the government's "paymaster," where the contractor had a contractual obligation to pay for the electricity under its contract with the federal government. Lohman at 868. The State of Missouri imposed sales tax on the contractor for the sale of this electricity, but the Court concluded that the federal government, not the private contractor, was the purchaser of the electricity, and thus, the sale of this electricity was immune from state and local taxation.

In Lohman, the federal government had a direct contract with the vendor and the private contractor did not. The Court found that these facts differentiated it from New Mexico, where the situation was reversed; i.e., the private contractor had a direct contract with the vendor and the federal government did not. The facts before the Commission concerning PETITIONER more closely match the New Mexico scenario, because PETITIONER has a direct contract with the vendor, while no evidence is supplied to suggest that the federal government does. Accordingly, the Commission concludes that neither Kabeisman nor Lohman support a finding that the United States Government, instead of PETITIONER, is the purchaser of the computer software maintenance at issue.

Utah Regulations. We have determined that the sale or use of the computer software maintenance was made to PETITIONER in its role as a private contractor and was not made to the federal government or to an instrumentality of the federal government. When a government project manager or supply contractor is the purchaser of tangible personal property, Rule 91 provides guidance as to whether the transaction is taxable. While Rule 91 was amended several times during the audit period, subsection (A) of the rule provided during the entire audit period that a sale is subject to sales or use tax if the Acontractor uses or consumes the property.@ PETITIONER contracted with COMPANY B and COMPANY C to use their computer software systems so that it could fulfill its contractual duties with HCFA. Because it also purchased maintenance for these systems, it is clear to us that PETITIONER is the party that used or consumed this maintenance. Accordingly, sales or use tax is appropriately imposed in this situation because it was the contractor, PETITIONER, who used or consumed the taxable product or service.

Prior to February 13, 1995, subsection (C)[7] of Rule 91 provided that when the purchasing agent is Aso closely connected with the government that the two cannot realistically be viewed as separate entities@ and A[i]t is clear that the government intends the contractor or manager to be its agent,@ tax immunity is available on the transaction. This is language consistent with the concepts expressed in New Mexico. We have already determined that PETITIONER does not meet the criteria necessary to receive tax immunity as set forth in New Mexico. Accordingly, PETITIONER does not meet the criteria necessary to receive tax immunity under subsection (C).

On October 22, 1996, near the end of the audit period, a new subsection (B) was added to Rule 91 that listed five criteria that must be met before a contractor would be deemed an agent of the government and, thus, be subject to tax immunity on its purchases. Among these criteria are the requirements that the contractor be Aofficially designated as the government entity=s purchasing agent by resolution of the government entity,@ that the contractor Aidentify himself as a purchasing agent for the government entity,@ and Athe purchase is made on purchase orders that indicate the purchase is made by or on behalf of the government entity and the government entity is responsible for the purchase price.@ It does not appear from the evidence that the first two criteria have been met. In any event, we know from XXXXX's testimony that the government entity in the case, HCFA, disclaims any responsibility for the purchase price of the computer software maintenance at issue. Thus, the third requirement is clearly not met.[8] For these reasons, PETITIONER has not qualified under the new subsection (B) as an agent for purchasing on behalf of a government entity, and, accordingly, its purchases do not qualify for tax immunity.

Also, on October 22, 1996, a new subsection (C) was added to Rule 91 that provided that A[i]f the government entity makes a direct payment to the vendor for the tangible personal property or services, the sale is made to the government entity and not to the facilities manager or the supply contractor. In that case, the sale is not subject to sales tax.@ The government does not make any direct payment to either COMPANY B or COMPANY C for the computer software maintenance they provide to PETITIONER. While the federal government does transfer funds into a special account from which PETITIONER pays its expenses, it is PETITIONER that drafts a check in its own name to the maintenance providers and PETITIONER that is solely responsible for the payment to the maintenance providers. This arrangement does not constitute a direct payment by the federal government. As a result, the purchase of the software maintenance does not qualify for tax immunity under the new subsection (C) either.

B. Custom Versus Canned Computer Software

PETITIONER next claims that the computer software systems it purchases from COMPANY B and COMPANY C are custom computer software. As subsection (C) of Rule 92 provides that charges for program maintenance of custom computer software are not taxable, a determination of whether the computer software systems provided to PETITIONER by COMPANY B and COMPANY C are canned or custom computer software is critical.

Rule 92 distinguishes between custom and canned computer software as follows:

A.1. "Canned computer software" or "prewritten computer software" means a program or set of programs that can be purchased and used without modification and has not been prepared at the special request of the purchaser to meet their particular needs.

A.2. "Custom computer software" means a program or set of programs designed and written specifically for a particular user. The program must be customer ordered and can incorporate preexisting routines, utilities or similar program components. The addition of a customer name or account titles or codes will not constitute a custom program.

The Utah Supreme Court has upheld such a distinction for taxation purposes, stating that the A[t]axability of programs turns on the type and amount of the personal services used in devising a computer program, in particular, whether the program is customized or not. Computer programs may be taxed, depending on whether they are Acanned@ or customized.@ Mark O. Haroldsen, Inc. v. State Tax Commission, 805 P.2d 176 (Utah 1990). The Court further explained in Haroldsen that this distinction is consistent with the Aessence of the transaction@ test. This test focuses on whether the services provided are merely incidental to an essentially personal property transaction or whether the property provided is merely incidental to an essentially service transaction. See BJ-Titan Services v. Utah State Tax Comm=n, 842 P.2d 822 (Utah 1992).

PETITIONER makes several claims why the computer software systems at issue should be considered custom computer software. First, it claims that the computer software systems are designed and written for only one customer - Medicare. Second, it claims that the two computer software systems were further customized for use by PETITIONER, and as they could not have been used by PETITIONER without modification, they are custom computer software. Third, a previous audit of PETITIONER by the Auditing Division did not assess any tax on PETITIONER because of its maintenance agreements with COMPANY B and COMPANY C. PETITIONER argues that the Auditing Division should be bound by this previous audit.

One Customer Argument. PETITIONER claims that the computer software systems at issue in this case are designed and written for only one customer - the Medicare System. It argues that the computer software systems have no value to any entity other than the Medicare System. However, the Commission is not persuaded by this argument.

There are approximately 65 Medicare carriers and intermediaries in the United States that use six computer software systems to process and pay Medicare claims. Each of these 65 private contractors obtain value from the computer software systems because the systems enable them to fulfill their contracts with the federal government. PETITIONER has separately contracted with COMPANY B and COMPANY C to use their two systems. In addition, the federal government is not solely responsible for the maintenance costs associated with these software systems because PETITIONER and the other intermediaries and carriers who use these systems are part of a shared maintenance group responsible for the maintenance costs. Moreover, PETITIONER is responsible only for its "share" of the maintenance. Thus, the maintenance is clearly being performed for a larger group of customers.[9] For these reasons, we do not consider that the federal government is the sole customer of the two systems at issue in this case. Instead, each of the Medicare carriers and intermediaries that contract with COMPANY B or COMPANY C is a separate customer of that system provider. Consequently, as the computer software systems at issue were developed and in use by other Medicare carriers or intermediaries prior to the time PETITIONER contracted to use them, these systems were not written specifically for PETITIONER as a unique customer either. Accordingly, the systems are not custom computer software as defined in subsection (A)(2) of Rule 92.

Further Customization. Second, PETITIONER claims that the two systems at issue are custom computer software because each system was further customized for PETITIONER=s use after it contracted with the two providers. PETITIONER states that it could not have used the two systems had they not been modified. It claims that substantial system support and maintenance were required to implement and customize the systems for use in the PETITIONER computing environment.

In the case of the COMPANY B Part A system, PETITIONER states that it made a separate payment of $$$$$ to the provider to install and customize that system on the PETITIONER computer. In the case of the COMPANY C Part B system, PETITIONER states that substantial system support, installation, and adjustment was necessary to install and run that system on the PETITIONER computer. During the audit period in question, an employee of COMPANY C worked full-time and on-site at PETITIONER to meet the specific programming needs.

The Commission, in Utah State Tax Commission Advisory Opinion 93-015DJ (1993), determined that computer software was canned computer software where the software was written in conformance to general industry specifications rather than strictly in conformance to the standards of a particular customer, even though: (1) the customer met with the software provider to identify environment and application requirements; (2) the software provider used a configurator application to specifically identify the customer environment; (3) the licensed program consisted essentially of a set of preexisting routines or programs, although custom routines, while not common, might also be required; and (4) installation was performed by the software provider, including a Afinal tailoring@ to the customer=s specific environment. The Commission recognized that the cost to adapt and configure software to specific customer environments may be costly, but indicated that this fact did not change Asoftware that has been essentially prewritten@ from being considered Acanned@ software.

While it is apparent that there are substantial installation, configuration, and data conversion costs associated with PETITIONER=s use of the two computer software systems at issue, the existence of these costs does not change a purchase of Acanned@ computer software into a purchase of Acustom@ computer software. Instead, the primary consideration is whether the software is mass produced and available to a broad marketplace (e.g., the Medicare carrier and intermediary marketplace) or whether the software is written specifically for a specific user.

There is no evidence to suggest that the systems for which PETITIONER actually contracted and received were significantly different from the systems received by other carriers and intermediaries that contracted with COMPANY B or COMPANY C. Although each carrier or intermediary may have unique evaluation, installation, training, and conversion costs, to implement the same computer software system, this fact does not make the computer software Acustom.@ Under such circumstances, the computer software would still be considered Acanned.@ (Pursuant to subsection (D), any charges for services to modify or adapt that canned computer software would not be taxable if separately stated and identified.) Accordingly, the fact that the two computer software systems at issue were modified for use in the PETITIONER computer environment is not determinative of whether that software is deemed canned or custom. From the evidence before us, we determine that the two computer software systems at issue are canned computer software.

Equitable Estoppel. Third, during an audit of PETITIONER for the years 1988 through 1990, an auditor from Auditing Division did not assess any tax to PETITIONER against the COMPANY C maintenance agreement because that auditor felt the COMPNAY C system was custom software (as stated in the April 24, 1998, letter from Susan Barnum, Exhibit P-9). PETITIONER argues that this action led it to believe that it was not necessary to pay sales or use tax on the maintenance fees to either COMPANY B or COMPANY C and that the Auditing Division should be bound by its auditor=s previous decision. As the Commission has determined that both software systems used by PETITIONER are canned computer software, we must now determine if the prior Auditing Division decision gives rise to equitable estoppel that would preclude us from properly enforcing the tax laws during the audit period and into the future.

As set forth in Orton v. Utah State Tax Commission, 864 P.2d 904 (Utah. App. 1993), the elements necessary to invoke equitable estoppel are:

(1) a statement, admission, act, or failure to act by one party inconsistent with a claim later asserted;

(2) reasonable action or inaction by the other party taken on the basis of the first party's statement, admission, act, or failure to act; and

(3) injury to the second party that would result from allowing the first party to contradict or repudiate such statement, admission, act, or failure to act.

In applying equitable estoppel, the Court in Orton pointed out that "it is well settled that equitable estoppel is only assertible against the State or its institutions in unusual situations in which it is plainly apparent that failing to apply the rule would result in manifest injustice." Holland v. Career Serv. Review Bd., 856 P.2d 678 (Utah App. 1993)(citing Anderson v. Public Serv. Comm'n, 839 P.2d 822 (Utah 1992); Utah State Univ. v. Sutro & Co., 646 P.2d 715 (Utah 1982); Celebrity Club, Inc. v. Utah Liquor Control Comm'n, 602 P.2d 689(Utah 1979); Eldredge v. Utah State Retirement Bd., 795 P.2d 671(Utah App. 1990)). AIn such cases, >the critical inquiry is whether it appears that the facts may be found with such certainty, and the injustice to be suffered is of sufficient gravity, to invoke the exception.=@ Id. (quoting Utah State Univ., 646 P.2d at 720) (citations omitted).

Further, where an employee of the Tax Commission gives a taxpayer incorrect information based on inadequate facts, O'Rourke v. Utah State Tax Commission, 830 P.2d 230 (Utah 1992) holds that "sound public policy precludes the assertion of estoppel against the Commission...@ (citing Heckler v. Community Health Serv., 467 U.S. 51, 104 S. Ct. 2218 (1984); Morton Int'l v. Utah State Tax Comm'n, 814 P.2d 581 (Utah 1991)). To hold otherwise would allow any Tax Commission auditor the authority to personally amend the tax laws of this state. This is a power, however, that is clearly reserved to the legislature.

In the audit of PETITIONER for the period 1988 through 1990, an employee of the Auditing Division made the decision that the COMPANY C computer software system was custom computer software. Thus, no tax was assessed on that specific audit=s statutory notice for COMPANY C maintenance fees, and the issue was never brought before the Commission in the hearing process. Nevertheless, based on that auditor=s decision, PETITIONER has not paid sales or use tax on its maintenance fees to COMPANY B or to COMPANY C.

It is clear from the case law, however, that equitable estoppel is appropriate only Ain unusual situations@ that would Aresult in manifest injustice@ or if the Ainjustice to be suffered is of sufficient gravity.@ We do not feel that the injustice in this case, if any, rises to these extreme levels. We have determined that PETITIONER should have paid sales or use tax on the maintenance fees it paid to COMPANY B and COMPANY C because these systems were canned computer software. The only Ainjustice@ arising from the auditor=s prior differing opinion is that PETITIONER did not have to pay sales or use prior to 1994, the beginning of the audit period at issue in this case. PETITIONER has not suffered because of the prior decision of the auditor. Rather, it has benefitted from it because it should have been paying any sales or use tax all along. Accordingly, equitable estoppel is not warranted in these circumstances.[10]

DECISION AND ORDER

Based upon the foregoing, the Tax Commission finds: (1) that the software maintenance payments made to COMPANY B and COMPANY C were not made by the federal government, an instrumentality of the federal government, or a contractor who is so closely connected with the government that the two cannot realistically be viewed as separate entities; (2) that the criteria provided in Rule 91 that would qualify a transaction for tax immunity have not been met in relation to PETITIONER's payment of the maintenance fees; (3) that the maintenance fees that PETITIONER paid to COMPANY B and COMPANY C to maintain the systems at issue are taxable because the underlying computer software systems are canned computer software; and (4) that equitable estoppel is not applicable in this case. For these reasons, the computer software maintenance fees at issue in this case are subject to Utah=s sale and use tax. It is so ordered.

BY ORDER OF THE UTAH STATE TAX COMMISSION:

The Commission has reviewed this case and the undersigned concur in this decision.

DATED this 10^th day of August , 1999.

Richard B. McKeown Pam Hendrickson

Chairman Commissioner

R. Bruce Johnson Palmer DePaulis

Commissioner Commissioner

[1] While subsections (g) and (l) of '59-12-103 were renumbered during the audit period, the language of the subsections did not change during the audit period.

[2] The stated relevant parts of Rule 865-19S-41 remained unchanged during the audit period. However, in April, 1997, subsection (C) was amended to read:

C. Sales made directly to the United States government or any authorized instrumentality thereof are not taxable, provided the sale is paid for directly by the federal government. If an employee of the federal government pays for the purchase with his own funds and is reimbursed by the federal government, that sale is not made to the federal government and does not qualify for the exemption.

[3] The amended version of Rule 865-19S-91 that follows is the version enacted on October 22, 1996, except that it also includes one final amendment that was made on November 30, 1996, where the word Aand@ was inserted at the end of subsection (B)(4).

[4] This version of the rule remained unchanged during the audit period. Though it was not an explicit part of Rule 92 during the audit period, language was added to the rule in January, 1997, to clarify that canned computer software is considered tangible personal property for purposes of taxation.

[5] Various courts have found that certain entities are instrumentalities of the United States, such as: the American Red Cross, which was created by an act of Congress (Department of Employment v. United States, 385 U.S. 355 (1966)); private corporations acquired by the Federal Savings and Loan Insurance Corporation (AFSLIC@), where those corporations are owned by the federal agency, the Boards of Directors of both corporations are made up of FSLIC officials, and the FSLIC has contracted with an individual to manage the two corporations on a day-to-day basis (FSLIC v. State of Minnesota, 608 F. Supp. 185 (U.S.D.Ct., 3rd Div., 1985)); and federally-chartered credit unions organized under the Federal Credit Union Act, 12 U.S.C. '1752 et seq., which specifically exempts the credit unions from state and local taxation (U.S. v. State of Mich., 851 F.2d 803 (6th Cir. 1988). As PETITIONER is neither created by an act of Congress, owned or operated by a federal agency, nor specifically exempted by federal law from state or local taxation, it is differentiated from these federal instrumentalities.

[6] See also Matranga v. Travelers Ins. Co., 563 F.2d 677, 677-78 (5th Cir. 1977) (justifying extension of the doctrine of sovereign immunity because the United States is the real party in interest); Anderson v. Occidental Life Ins. Co. Of Ca., 727 F.2d 855, 856 (9th Cir. 1984) (AThe United States is the real party in interest in actions against Medicare carriers because recovery would come from the federal treasury@).

[7] This subsection was numbered subsection (C) until October 1, 1994, when it was renumbered as subsection (B). On February 13, 1995, the subsection was deleted from the rule.

[8] As all five criteria must be met before tax immunity is available, failure to meet any one of the criteria disqualifies the purchaser from tax immunity. As we have determined that three of the criteria have not been met, we need not address the other two.

[9] If Blue Cross of Utah=s contention were accurate, there would presumably be one contract between HCFA and each software provider which each carrier and intermediary could then benefit from.

[10] We also note that reliance on a single auditor=s view, rather than a formal opinion of the Commission, may not be reasonable in any event. Reliance on an auditor=s failure to discover a deficiency is even more problematic.