Sales Taxation of Software as a Service: A (Relatively) New Frontier

Stepping away from Tax Reform for a moment, we’d like to briefly shift our focus to an important topic that has repeatedly surfaced with our friends in the tech industry: the taxability of Software as a Service (“SaaS”).

SaaS taxation is one of the most common (and complex) issues facing companies and tax jurisdictions today. As a general rule, states (and some municipalities) impose a sales tax on the sale or lease of tangible personal property. Most services (though not all), on the other hand, are exempt from sales tax. Traditionally, prewritten software has been treated by states as tangible personal property, and as such, the sale or lease of such software to an end user was generally subject to sales tax.

In the SaaS model, a seller provides online access to hosted software for use by customers. No actual transfer of possession occurs. Instead, the seller is economically providing a service to the buyer. Further, many sellers also provide other services connected to the hosted software platform, many of which, when considered alone, would constitute services that are not subject to sales tax.

In an attempt to tax hosted software, states have generally attempted to include “application software” in the state’s definition of tangible personal property subject to sales tax. While many states have relied on interpretations of long-standing rules to subject SaaS and other hosted product offerings to sales tax, others have passed new legislation to specifically tax web-based technology products. For example, in 2009 Washington enacted legislation which specifically taxes among other digital products, “remote access software,” such as SaaS and products which meet the definition of the state’s newly created “Digital Automated Service” category. Accordingly, states which assert tax on SaaS and/or hosted product offerings generally do so under one or more of the following classifications:…

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