Response
August 20, 1993
Request
June
11, 1993
Utah
State Tax Commission
Mr.
Roger O. Tew, Commissioner
Heber
M. Wells Office Building
160
E. 300 South
Salt
Lake City, UT 84134
Dear
Mr. Tew:
Enclosed
is a Statement of Representations and Inducements on behalf of an anonymous
company referred to as XXXXX. We
respectfully request a letter ruling.
If
you have any questions, please contact me or my colleague, XXXXX, who is
working with me on this matter. She can
be reached at XXXXX.
Thank
you for your consideration.
Sincerely,
XXXXX
Statement
of Representations and Inducements
I. Background and Nature of Business
XXXXX
incorporated as a C corporation in its home state in XXXXX. Its stock is privately held. It elected S corporation status in XXXXX and
terminated its election effective XXXXX.
It has remained a C corporation ever since that time. The company maintains two sales offices; one
in its home state and one in a state other than Utah.
The
company provides services to meet the specifications of sophisticated
purchasers in a specialized industry.
These services consist of the modification and customization of in-house
software or the creation of new custom software. The company conducts a thorough and comprehensive analysis of
each client's goals and objectives. In
addition, the company must determine the size and scope of the client's
business, its computer hardware, network specifications, operating system, and
data collection, analytical and display requirements. Based on the company's evaluation and analysis, it makes real and
substantial changes to the operational coding of any relevant in-house software
or creates new software to meet a client's specific needs. The client is charged a single price for the
company's services, which are provided under a license agreement.
The
company was formed by two individuals and initially had clients in only a few
states. As the company's business
increased, its representatives occasionally traveled from the home office to
other states to solicit potential clients.
In XXXXX, the company started offering optional support agreements. These support agreements provide the client
an opportunity to attend user conferences (not necessarily held in the client's
home state), access to telephone consultation, on-site technical support, and
software enhancements. The telephone
consultation and on-site technical support are either included in the price of
the support agreement or offered for an additional charge, depending on the
type of support agreement purchased.
XXXXX
consulted with an accounting firm during its start-up period regarding the
taxability of its services. The
accounting firm advised the company that the services it provided were not subject
to sales tax in any state. Moreover, a
XXXXX sales tax audit in XXXXX that determined that the company was not subject
to sales tax reinforced the company's belief that its services were exempt. The company has never requested or received
legal advice regarding its state tax liabilities.
II. Facts Leading to Review of Tax Exposure
In
XXXXX, a new investor became the shareholder with the largest interest in the
company's stock. The new investor
serves on the board of several high technology companies. He is aware of the complex laws regarding
the taxability of software services and the lack of uniformity among the
states. Upon investing in the company,
he requested an in-depth analysis of the company's state sales tax and income
tax exposure. Moreover, as a result of
the recent publicity regarding the U.S. Supreme Court decisions in XXXXX, the
company decided to reexamine the taxability issue. The company hired a new firm to conduct the evaluation.
XXXXX
has not received a nexus questionnaire from Utah and has not been contacted for
audit.
A
comprehensive review of the company's tax exposure in Utah follows:
III. Contacts with Utah
All
of XXXXX's employees are located outside Utah.
XXXXX does not maintain an office, warehouse, stock of goods or own or
lease any real property within Utah. As
described above, however, in XXXXX the company began offering technical support
services for certain key customers in various states. The first such visit to Utah was in XXXXX; one other visit occurred
in XXXXX. Each visit lasted
approximately one day. The company had
two sales solicitation visits to Utah: one in XXXXX and one in XXXXX. Each visit lasted approximately one day.
IV. Sales/Use Tax Exposure
A. XXXXX
As
previously discussed, the company has no employees and does not maintain an
office, warehouse, stock of goods or own or lease any real property within any
state other than its home state or a state other than Utah. Its casual and nonsystematic, non-recurring
contacts with Utah do not constitute “substantial” nexus within the meaning of
Quill Corporation v. North Dakota, 112 S.Ct. 1904 (1992). These “minimum contacts” might satisfy the
Due Process Clause, “and yet lack the 'substantial nexus' with [the] State as
required by the Commerce Clause”. Id at
p. 1914. The Court has expressly
rejected a “slightest presence” standard for nexus. Id at n.8.
B. Tax Exposure
Even
if the company is deemed to have nexus, however, it has no Utah sales or use
tax liability for the following reasons.
Similar
to the law of most states, Utah distinguishes between canned and custom
software. Canned 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. 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 other than the addition of a customer name or account title
or codes. Utah Rule
R865-19-92S(A)(1),(2); Utah Code Ann. Sec. 59-12-103. For the following reasons we believe the company is exempt on its
activities in Utah.
First,
the company does not sell any software off the shelf or on an “as is”
basis. Unlike a vendor of canned
software, the company does not inventory any software or mass produce its
software. Before performing its
services, the company conducts a thorough and comprehensive analysis of each
client's objectives. Only then can the
company provide services that fit the client's specifications. Every piece of software licensed by the company
is customized to the specific and unique needs of its client.
Second,
no two clients receive identical services.
Third, although the company typically embodies its services in the form
of a disk, it can, and has, made modifications to its client's software over
the telephone. Indeed, if time were of
the essence the company could easily provide its services by using only the
telephone and not use a disk at all. In
fact, the company does from time to time forgo a disk by providing programming
instructions to its client's programmers.
Fourth,
the amount charged by the company reflects the level of its services. Fifth, many of the clients receive some
personal training in the use of the software, although not necessarily
on-site. Sixth, the company's practice
is to replace the disk at no cost should a client damage or lose its copy, a
practice that is inconsistent with vendors of canned programs.
As
the facts above demonstrate, the charge by the company is for its services and
not for the disk that typically, but not invariably, is used to embody those
services. The value of the disk is
essentially an inconsequential element in relation to the value of the service
transaction. The disk costs about $$$$$
whereas the value of the services can range from $$$$$ to $$$$$. Indeed, the clearest evidence that the disk
is essentially an inconsequential element in the service transaction is the
company's policy of providing a new disk for free to any customer who has
damaged or lost the original. No vendor
of canned software adheres to a similar policy. Moreover, the company chooses to embody its services on a disk
for convenience; in some cases it will directly program the client's computer
without using a disk or transmit a program in writing for the client's
programmers to install.
The
object of the transaction is to obtain the company's services. The first thing the company does is to
conduct an extensive and comprehensive survey of the client's requirements and
system. In addition, the use of the software
typically requires training of the customer's personnel and substantial written
documentation. Technical support by the
vendor is needed, at least initially, for the client to master the software.
In
short, the company provides customized software--not canned software. Accordingly, the company is not subject to
the Utah sales tax.
In
addition to its software services, the company provides three different types
of optional program maintenance to its customers. These charges are exempt under the Utah sales tax. Utah Rule R865-19-92S(C).
V. Income Tax Nexus and Exposure
The
infrequent trips made by XXXXX into Utah were to facilitate the use of the
custom software by the client. It is
our opinion that such activities lack the “substantial nexus” with the state of
Utah as required by the Commerce Clause.
If
Utah disagrees with the analysis regarding nexus, the company is subject to the
income tax. Even if the company is
subject to tax, however, we believe that its tax liability is zero for the
following reasons.
Utah
has adopted XXXXX. For purposes of the
apportionment formula,
Utah
Code Ann. Sec. 59-7-317 (Section 15 of UDITPA) states:
The
sales factor is a fraction, the numerator of which is the total sales of the
taxpayer in this state during the tax period, and the denominator of which is
the total sales of the taxpayer everywhere during the tax period.
Utah
Code Ann. Sec. 59-7-319 (Section 17 of UDITPA) states:
Sales,
other than sales of tangible personal property, are in this state if:
(a) the income-producing activity is performed
in this state; or
(b) the income-producing activity is performed
both in and outside this state and a greater proportion of the income-producing
activity is performed in this state than in any other state, based on costs of
performance.
The
company falls within the preceding provision because it does not sell tangible
personal property. Utah Rule
R865-6-8F. I .I.6.(b)( 1),(3)
[Multistate Tax Commission (MTC) Regulation IV. 17(2)] defines the term “income
producing activity” to mean “the transactions and activity directly engaged in
by the taxpayer in the regular course of its trade or business for the ultimate
purpose of obtaining gains or profit” including but not limited to “the
rendering of personal services by employees or the utilization of tangible and
intangible property by the taxpayer in performing a service,” as well as “the
rental, leasing, licensing, or other use of intangible personal property.”
Utah
Rule R865-6-8F.l.I.6.(e)(3) [MTC Regulation IV. 17(4)(B)(c)] contains special
rules for the allocation of receipts for the performance of personal
services. Under this regulation,
receipts are attributable to the state to the extent such services are
performed in this state. Moreover:
If
services relating to a single item of income are performed partly within and partly
without this state, the gross receipts for the performance of such services
shall be attributable to this state only if a greater proportion of the
services was performed in the state, based on costs of performance. Usually, where services are performed partly
within and partly without this state, the services performed in each state will
constitute a separate income producing activity; in such case, the gross
receipts for the performance of services attributable to this state shall be
measured by the ratio which the time spent in performing such services in this
state bears to the total time spent in performing such services
everywhere. Time spent in performing
services includes the amount of time expended in the performance of a contract
or other obligation which gives rise to such gross receipts. Personal service not directly connected with
the performance of the contract or other obligation, as for example time
expended in negotiating the contract, is excluded from the computations.
Utah
Rule R865-6-8F.1 .I.6.(c) [MTC Regulation IV. 17(3)] defines “costs of
performance” as “direct costs determined in a manner consistent with generally
accepted accounting principles and in accordance with accepted conditions or
practices in the trade or business of the taxpayer.
As
previously discussed, the company has no employees and does not maintain an
office, warehouse, stock of goods, or own or lease any real property within
Utah. The services that give rise to
XXXXX's gross receipts from Utah and the company's costs of performance occur
within the company's home state.
Therefore, because none of its gross receipts is allocable to Utah and
since the company has no payroll or property in Utah, its Utah apportionment factor
is zero and likewise its income tax liability is also zero.
The
only exception to the above analysis would involve those support agreements
under which on-site consulting occurs.
Such consulting is only one of an array of services covered by the
support agreement. All of the other
services are performed in the company's home state. At the most, the support agreement provides for one day of
on-site consulting annually.
Accordingly, the Utah receipts factor would be negligible. The costs of compliance would far outweigh
the minuscule amount of tax involved.
The company requests permission to treat this situation as de minimis.
VI. Conclusion and Request for Taxability Ruling
XXXXX
as the preceding analysis bears out, has neither an income nor a sales tax
liability in the state of Utah. The
company, therefore, requests a letter from Utah based on the above
representations that confirms the lack of any state sales, use, franchise,
income, or comparable tax liability.
August
20, 1993
Re:
Advisory Opinion - Nexus for Sales, Use or Corporation Franchise Taxes and
Taxability of Custom Software Sales
Dear
XXXXX:
Your
request (copy attached) for an advisory opinion as to whether XXXXX has a
liability to the State of Utah for sales, use, or corporation franchise tax was
referred to the Auditing Division for their analysis.
The
division's staff recommendations are as follows with regard to sales and use
tax:
1. If XXXXX meets none of the definitions of a
“retailer” as defined in Utah Code Annotated Section 59-12-102 (copy attached),
then the company is not required to be licensed for collection of sales or use
tax as indicated in U.C.A. Sections 59-12-106 and 59-12-107 (copies
attached). The description in your
letter of the company's contacts and nexus exposure does not clearly deny all
of the criteria in the referenced statutes.
It is not possible, therefore, to unequivocally offer an opinion that
the company is without sufficient nexus to require licensing and tax collection
under the Utah Sales and Use Tax Act.
2.
Utah State Tax Commission
Administrative Rule R865-19-92S defines “custom computer software” and allows
for exemption of its sale. Your
descriptions of the programs and services sold by XXXXX would indicate
qualification as exempt sales of custom computer software.
3. Consequently, regardless of the company's
XXXXX situation, XXXXX does not appear to have a liability for sales or use tax
on its sales of described software and services.
With
regard to the question of nexus and possible exposure to the Utah corporation
franchise tax for XXXXX, the division makes the following recommendations:
1. Based upon the representations made in your
letter, it is clear that XXXXX is engaged in the sale of services rather than
tangible personal property. Therefore,
the exemption from taxability provided under Public Law 86-272 does not
apply. Further, the providing of
services in Utah meets the Utah definition of “doing business” under U.C.A.
59-7-101(5).
2. We are in agreement with the analysis in
your letter concerning the attribution of sales to Utah under the XXXXX rule
that based upon your representations, only the income earned from the actual
performance of services in Utah would be includable in the Utah sales and
receipts factor and that such amount would likely create a negligible
apportionment factor and Utah tax amount.
3. Based upon the above facts which indicate
that the services provided in Utah have amounted to one employee's services for
one day or less per year, the company should be permitted to treat this
situation as “de minimis” pursuant to their request. However, XXXXX will be required to file returns in Utah at such
time when the level of activities in Utah begins to exceed those de minimis
activities described in your letter.
Further, this area involving the creation of nexus relating to sales of
services and intangibles has been targeted for further study in the Uniformity
Committee of the Multistate Tax Commission.
It is anticipated that some additional guidelines may be forthcoming in
the future that would give additional guidance and possibly have an impact on
XXXXX should they be adopted in Utah.
However, until such guidance is available or the activities in Utah
increase, we recommend that XXXXX not be subject to the Utah corporation
franchise tax.
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 appeal to the Tax Commission
for a formal hearing. The results of
that hearing would constitute a declaratory judgment and be appealable to the
Utah State Supreme Court. A Notice of
Appeal Rights and a copy of the Utah Taxpayer Bill of Rights are attached.
For
The Commission,
Joe
B. Pacheco
Commissioner
As
previously discussed, the company has no employees and does not maintain an
office, warehouse, stock of goods, or own or lease any real property within
Utah. The services that give rise to
XXXXX's gross receipts from Utah and the company's costs of performance occur
within the company's home state.
Therefore, because none of its gross receipts is allocable to Utah and
since the company has no payroll or property in Utah, its Utah apportionment
factor is zero and likewise its income tax liability is also zero.
The
only exception to the above analysis would involve those support agreements
under which on-site consulting occurs. Such
consulting is only one of an array of services covered by the support
agreement. All of the other services
are performed in the company's home state.
At the most, the support agreement provides for one day of on-site
consulting annually. Accordingly, the
Utah receipts factor would be negligible.
The costs of compliance would far outweigh the minuscule amount of tax
involved. The company requests
permission to treat this situation as de minimis.
VI. Conclusion and Request for Taxability Ruling
XXXXX
as the preceding analysis bears out, has neither an income nor a sales tax
liability in the state of Utah. The
company, therefore, requests a letter from Utah based on the above
representations that confirms the lack of any state sales, use, franchise,
income, or comparable tax liability.
August
20, 1993
Re:
Advisory Opinion - Nexus for Sales, Use or Corporation Franchise Taxes and
Taxability of Custom Software Sales
Dear
XXXXX:
Your
request (copy attached) for an advisory opinion as to whether XXXXX has a
liability to the State of Utah for sales, use, or corporation franchise tax was
referred to the Auditing Division for their analysis.
The
division's staff recommendations are as follows with regard to sales and use
tax:
1. If XXXXX meets none of the definitions of a
“retailer” as defined in Utah Code Annotated Section 59-12-102 (copy attached),
then the company is not required to be licensed for collection of sales or use
tax as indicated in U.C.A. Sections 59-12-106 and 59-12-107 (copies attached). The description in your letter of the
company's contacts and nexus exposure does not clearly deny all of the criteria
in the referenced statutes. It is not
possible, therefore, to unequivocally offer an opinion that the company is
without sufficient nexus to require licensing and tax collection under the Utah
Sales and Use Tax Act.
2. Utah State Tax Commission Administrative
Rule R865-19-92S defines “custom computer software” and allows for exemption of
its sale. Your descriptions of the
programs and services sold by XXXXX would indicate qualification as exempt
sales of custom computer software.
3. Consequently, regardless of the company's
XXXXX situation, XXXXX does not appear to have a liability for sales or use tax
on its sales of described software and services.
With
regard to the question of nexus and possible exposure to the Utah corporation
franchise tax for XXXXX, the division makes the following recommendations:
1. Based upon the representations made in your
letter, it is clear that XXXXX is engaged in the sale of services rather than
tangible personal property. Therefore,
the exemption from taxability provided under Public Law 86-272 does not
apply. Further, the providing of
services in Utah meets the Utah definition of “doing business” under U.C.A.
59-7-101(5).
2. We are in agreement with the analysis in
your letter concerning the attribution of sales to Utah under the XXXXX rule
that based upon your representations, only the income earned from the actual performance
of services in Utah would be includable in the Utah sales and receipts factor
and that such amount would likely create a negligible apportionment factor and
Utah tax amount.
3. Based upon the above facts which indicate
that the services provided in Utah have amounted to one employee's services for
one day or less per year, the company should be permitted to treat this
situation as “de minimis” pursuant to their request. However, XXXXX will be required to file returns in Utah at such
time when the level of activities in Utah begins to exceed those de minimis
activities described in your letter.
Further, this area involving the creation of nexus relating to sales of
services and intangibles has been targeted for further study in the Uniformity Committee
of the Multistate Tax Commission. It is
anticipated that some additional guidelines may be forthcoming in the future
that would give additional guidance and possibly have an impact on XXXXX should
they be adopted in Utah. However, until
such guidance is available or the activities in Utah increase, we recommend
that XXXXX not be subject to the Utah corporation franchise tax.
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 appeal to the Tax Commission
for a formal hearing. The results of
that hearing would constitute a declaratory judgment and be appealable to the
Utah State Supreme Court. A Notice of
Appeal Rights and a copy of the Utah Taxpayer Bill of Rights are attached.
For
The Commission,
Joe
B. Pacheco
Commissioner