Response March 19,
1993
Request
January 12, 1993
XXXXX
Dear XXXXX:
We are writing on
behalf of our client ("Taxpayer") to request a ruling (opinion) from
the State. We seek this ruling to determine the income and/or franchise tax
consequences under the facts outlined below. The Taxpayer is anticipating
operations in your state and needs to know whether they are subject to income
and franchise tax in the State.
Facts
The Taxpayer offers
its customers a service which provides access (referred to as a “gateway”) to
many third party databases. The Taxpayer does not own the databases but has
agreements with the owners of the various databases whereby the Taxpayer has
access to these databases and can provide that access to the Taxpayer's
customers (see attached exhibit).
To access the service,
the customer must enter into a Service Agreement (“Agreement”) with the
Taxpayer. The customer requests information by connecting to the Taxpayer's
gateway via the XXXXX public data network. the Taxpayer's gateway then routes
the customer's request to the appropriate database back through the XXXXX
public data network. Consequently, all the information is transmitted over the
telephone lines. As part of the Agreement, the customer may be provided with
software (via a software license agreement) to allow access to the Taxpayer's
gateway. The Taxpayer at all times retains ownership of the software. The
software licensed is standard (“canned”), thus is not customized for any
individual customer.
Service Fees - The
customer is billed monthly based on the number of information requests made and
for the time connected to the gateway. A minimum monthly fee is charged if the
actual usage charge is lower than $$$$$. The majority of customers do not incur
this minimum fee. The customer does not incur long distance charges since they
need only dial a local number or an 800 number, owned by XXXXX, to access the
XXXXX public data network. The charges for XXXXX network usage and the charges
for the information retrieved from the databases are allocated and billed
directly to the customer based on usage. Service fees generate significantly
greater revenue than any of the other fees. All other fees combined will only
represent a very small percent (from l%-5%) of total revenues.
Establishment Fee -
Each customer pays a one time fee of $$$$$ in order to establish the service.
Software License Fee -
For personal computer users, there is no fee. Mainframe licenses range up to
$$$$$. The Taxpayer expects to sell very few (maximum 1 to 2 each year in a
given state) mainframe licenses to customers. In addition mainframe users may
purchase a standard software maintenance agreement whereby the customer receives
software upgrades (if any) and telephone support. The upgrades are not shipped
from your state nor is the telephone support located within your state.
The Taxpayer is
located outside of your state and does not have any property, other than the
licensed software, or payroll in your state. The Taxpayer does not have any
leased property or leased telephone lines in the state.
The taxpayer does
expect to have a traveling sales force in the near future. The purpose of this
sales force would be to engage in the solicitation for sales. The sales people
would not have any authority to accept orders, only the home office out of
state would have this authority. For sales to personal computer users, the
sales person would complete the sale over the telephone from out of state. The
sales to main frame users would require on site visits to solicit for the sale.
In any event, the sales person would not exceed the authority permitted in
Public Law 86-272 relating to sales of tangible personal property.
Questions
(1) If the Taxpayer
does not have any traveling sales people in your state, are they subject to
income (franchise) tax based on the presence of licensed software in the state?
(2) Would the answer
to (1) above be different if they did have traveling sales people in your
state?
(3) If the Taxpayer is
subject to income (franchise) tax, are they considered a seller of tangible
personal property (sale of canned software) or a service business, since the
primary revenue is from the use of the database or maintenance agreements and
not the sale of the software?
(4) If the Taxpayer is
subject to income (franchise) tax, what apportionment methodology should be
used (i.e. three factor, single gross receipts factor, or another method).
(5) If the Taxpayer is
not subject to income (franchise) tax and does not have traveling sales people
in your state, is the presence of licensed software in your state sufficient
nexus to require the Taxpayer to qualify to do business in your state?
(6) Would the answer
to (5) above be different if they did have traveling sales people in your
state?
Discussion and
Analysis
The Due Process and
Commerce Clauses of the United States Constitution and Federal law (Public Law 86-272)
prevent states from subjecting a corporation to taxation unless the corporation
has sufficient nexus with that state. The Supreme Court enunciated the modern
Commerce Clause test for determining whether a state tax is unconstitutional in
Complete Auto Transit Inc. v. Brady. 430 U. S . 274 (1974). The Court held that a state tax will be
upheld against Commerce Clause scrutiny “when the tax is applied to an activity
with a substantial nexus with the taxing State, is fairly apportioned, does not
discriminate against interstate commerce, and is fairly related to the services
provided by the state.”
The court expressly
rejected a “'slightest presence' standard of constitutional nexus” again in National
Geographic Society v. California Board of Equalization, 430 U.S. 551, 556
(1977).
In Quill
Corporation v. North Dakota. No. 91-194, Supreme Court of the United
States, May 26, 1992, the Court upheld the “substantial nexus” standard for
licensed software in the state. Quill licensed a computer software program
to some of its customers in the state that enabled them to check Quill's
current inventories and prices and to place orders directly. The Court noted
“Quill's interests in the licensed software does not affect our analysis of the
due process issue and does not comprise the “substantial nexus” required by the
Commerce Clause.” The Court concluded that “title to “a few floppy diskettes”
present in a State might constitute some minimal nexus,” but " Quill's
licensing of software in this case does not meet the “substantial nexus”
requirement of the Commerce clause.”
Based on the above
cases, it is clear the Supreme Court has determined that substantial nexus is
required in order for the State to subject the corporation to an income tax
under the Commerce Clause. In Quill, the Court expressly stated that the
holding of title to licensed software in the State does not meet the
“substantial nexus” requirement of the Commerce Clause.
Therefore, to the
extent the doing business statutes attempt to impose an income (franchise) tax
on the taxpayer, we believe they are inapplicable as they relate to the
licensing of software by the taxpayer since they are in conflict with numerous
decisions by the Supreme Court.
Thank you for your
assistance with this matter. Please respond to the address below.
XXXXX
If you have any
questions please do not hesitate to call me directly at XXXXX.
Very truly yours,
XXXXX
TO: XXXXX, Director
FROM: XXXXX, Secretary
DATE:XXXXX
SUBJECT: Request for Ruling - No. 93-002DJ
Attached is a request
for information and/or ruling from XXXXX of XXXXX. Will you please review the request of XXXXX to determine the
income and/or franchise tax consequences of a taxpayer who is anticipating
operations in Utah and needs to know whether they are subject to income and
franchise tax in the state.
Please prepare the
response for signature by the Commission as per the guidelines established by
them.
Thank you.
XXXXX
Dear XXXXX:
Your request for an
advisory opinion regarding whether a taxpayer engaging in the providing of data
base services referred to as a “gateway” is subject to the Utah corporation
franchise tax was referred to the Auditing Division for their analysis.
The division staff has
recommended the following:
It is necessary at the
outset to distinguish between limitations imposed by Public Law 86-272 and the
constitutional limitations imposed.
Public Law 86-272 places limitations on the taxing power of the states
with regard to the sale of tangible personal property within the state. The leasing, renting, licensing or other
disposition of tangible personal property, intangible or any other type of
property is not immune from taxation by reason of P.O. 86-272. Therefore, the ownership of licensed
software in Utah would not qualify for exemption under P.L. 86-272 since such
ownership does not constitute the sale of tangible personal property.
The Commerce Clause
under the Complete Auto Transit test does require that a taxpayer have a
substantial nexus with the state before the state may impose its tax. It is this test to which the U.S. Supreme
Court referred in Quill Corporation v. North Dakota when it stated that
“title to a few floppy diskettes present in the State...does not meet the
‘substantial nexus’ requirement of the Commerce Clause”. However, the Quill case was a sales tax case
which was reliant on previous sales tax case law including the XXXXX case. There are major differences in nexus
determinations between corporate tax and sales tax. The telecommunications industry is a unique industry which is
extremely interactive in nature.
Therefore, “a substantial nexus” could be found to exist in this
industry through delivery into the state of the service through the local
exchange.
The questions you
posed in your letter are restated with a corresponding answer below:
(1) If the taxpayer does not have any traveling
sales people in your state, are they subject to income (franchise) tax based on
the presence of licensed software in the state?
Yes. A mainframe license in the amounts discussed
in your letter would constitute sufficient property to the “substantial nexus”
test in our view. In addition, the
unique and interactive nature of the telecommunications industry and the
taxpayer’s use of the local exchanges would be sufficient to create nexus for
the company.
Further, it appears
that the activity that would potentially generate the majority of Utah tax
liability, if any, is the service fees charged to the Utah customer for access
to the “gateway” databases. Public Law
86-272 does not exempt the company from taxation on these service fees either
since they are not a sales of tangible personal property. However, the Utah statute does not presently
require the inclusion of these fees in the Utah sales numerator since the
services are provided from outside the state.
Therefore, at this point in time, the Utah law would only require
inclusion of the minimal amounts of tangible property in the property numerator
and nothing in the sales numerator which would not appear to create much of a
tax burden for the present.
2) Would the answer to (1) above be different
if they did have traveling sales people in your state?
No. The company would still be subject to tax
and required to include the property in the Utah property numerator. However, if the activities of the traveling
sales people exceeded “solicitation”, such activities would create nexus
standing alone and the Utah portion of the employee’s wages would be includable
in the Utah wage numerator.
(3) If the taxpayer is subject to income
(franchise tax, are they considered a seller of tangible personal property
(sales of canned software) or a service business, since the primary revenue is from
the use of the database or maintenance agreements and not the sale of the
software?
The taxpayer appears
to be primarily engaged in a service business.
The use of the database or maintenance agreements are services. To the extent the taxpayer sells, rents or
leases its canned software, it would also be engaged in the sale, renting or
leasing of tangible personal property.
(4) If the Taxpayer is subject to income
(franchise) tax, what apportionment methodology should be used? (i.e. three factor, single gross receipts
factor, or another method).
The XXXXX three-factor
formula is the law in Utah. As stated
above, under current statutes and rules, Utah would not include the fees from
the services provided in the Utah sales numerator. Utah would require the inclusion of any tangible property (canned
software) owned by the taxpayer which is physically located in this state.
(5) If the Taxpayer is not subject to income
(franchise) tax and does not have traveling sales people in your state, is the
presence of licensed software in your state sufficient nexus to require the
Taxpayer to qualify to do business in your state?
This question appears
to be inapplicable since we have stated that the taxpayer is subject to income
(franchise) tax based on the facts presented.
However, the Utah corporation franchise tax law does not include any
provisions requiring a corporation to qualify in this state although a
nonqualified corporation which is doing business in the state is required to
file a tax return and pay taxes. The
taxpayer should inquire of the Utah Department of Commerce if it has additional
questions regarding qualification requirements in Utah.
(6) Would the answer to (5) above be different
if they did have traveling sales people in your state?
No.
Based upon the facts
presented in your letter, we are in agreement with the Auditing Division’s
recommendations. Obviously, if there
are deviations from these facts, this opinion may be negated.
If you do not agree with
this determination, you may file an appeal before the Commission in a formal
hearing. Any adverse ruling would also
be appealable to the Utah Supreme Court.
A notice of appeal rights and a copy of the Utah Taxpayer Bill of Rights
are attached.
In contacting with the
Tax Commission, if special accommodations are needed in accordance with the
Americans with Disabilities Act, please call (801) 530-6920, (801) 530-6077 or
TDD (801) 530-6269 allowing three working days notice.
For the Commission,
Joe B. Pacheco,
Commissioner