February 14, 2010 01:12 AM UTC

Sales tax on software - oncoming train wreck

• 16 Comments
• by: DavidThi808

First off, I think we should bring in most tax revenues through a progressive income tax and limit sales tax to cases where we want to reduce consumption (cigarette taxes) or the tax goes to direct use of the good (gasoline tax). Second, if we are going to have sales taxes (and we are), then I don’t think anyone should get a free ride – so I support the concept of taxing software sales.

With that said, this impacts me personally as my company sells software. I’m not concerned with adding a tax to the sale as our customers are not price sensitive. What I am concerned with is the hassle as I don’t want to have to have employees spend a ton of time administering this, and I don’t want to force out customers to spend a lot of time telling us where they are using the software we sell them. We are all very hassle sensitive.  

Under the proposed software sales tax, can the state tell me how to tax the sale? The following are all real cases that my company has seen, either selling or buying software.

1. In the car (as a passenger) I buy a program for my iPhone. I make the purchase in Boulder but by the time it’s downloaded we are in Denver. And I first use it South of Denver on our way to Colorado Springs. Which City/County gets the sales tax?
2. My company purchased a site license to a program used to create our documentation. It is used by 2 employees, one in Boulder and one in New Hampshire. Both downloaded a copy. Neither knows which one used it first. And at the time of purchase they would not have been able to predict who would use it first. Note that we did not buy 2 copies – we bought a single site license. Which state gets the sales tax.
3. We are an IBM partner. One option we have is to pay $795.00/year and we then get all IBM software for free. One year we never used any software – was that still a sale as it was never installed & run on a computer in Colorado? In this case would we pay the sales tax the first time we actually get a free copy – and in that case only if the first use was in Colorado?
4. We sell to customers in Colorado where at the time of sale they do not know where the software will first be installed. In the case of one 65K sales I asked and they think it was installed first in Colorado on a virtual machine, but then shipped to China to run on servers there. So it was never run in Colorado. Is it where first installed or first run?
5. We sell floating developer licenses. We have a customer where they have some developers here in Colorado and the rest in China. Sometimes all the licenses are used by developers in Colorado, sometimes all in China, and usually it’s about 2/3 China and 1/3 here. And at the time of purchase they have no way of knowing who will use it first.
6. Potential customers download our software, install it, and try it. When they decide to purchase we then ship them a new license key to replace the demo key. So upon purchase they are not downloading or installing any software, just a key. Is that a software sale?
7. We have a customer that has a large presence in Boulder. We sold to a group in New Jersey, to be used in Poland, and paid for out of Chicago. But the Boulder facility may (they aren’t sure) use the system with our software, but probably running on servers in New Jersey.
8. We have customers who put our software on Amazon’s cloud system. They don’t know what state the software first runs on, not does Amazon. A customer in England could have our software first running in Colorado while one in Colorado may never have it running here.
9. We have customers pay us to add specific functionality to our program. So it’s professional services in that they are paying us to do something specific. But the end results is that we ship them a new version of our commercial product as the feature is added to the commercial product. Is that a software sale or professional services?
10. We sell annual support & updates to our customers. This is a combined deal where they get both for the price. As the updates is the new version of the commercial software, is that taxable? And if so, what percentage of the support & updates as the support part is not software?
11. If a customer downloads our software from a server in Asia, does it count as a sale from Colorado?
12. We use SalesForce for our salespeople. Their software runs on servers in California and we access it via our web browsers. As the software does not get installed here, do we owe Colorado taxes on that purchase? What if they use JavaScript in their web pages so that it then does run code in our browser from their server?
13. If I buy commercially available web page templates, is that software? It’s html which are page layout commands but it is not a program that runs.
14. There are electronic books with embedded flash in them – is that software?
15. Multiple Kindle books can be tied to the same account so all members of a family can read a book purchased once. If my daughter in Chicago gets a Kindle we’ll tie her to our account. If I buy a book that she reads first – which state gets the sales tax? What if I buy it for her?

Before making this law, you need to have clear answers for the above. We have sales prices on the order of 50K – 250K so the Department of Revenue is going to want any money due to it. But if the above questions do not have a clear answer, we will be left waiting in most (not some – most) cases to have DoR determine what is owed to who.

The other thing is I see this creating a barrier to closing a sale – and that will harm us (and other Colorado companies). If we tell a potential customer they need to break out their purchase and identify which components will first be used in Colorado and where – that’s the kind of requirement that will always slow a sale. And will sometimes lose one. (Needless to say, if we lose a 250K deal, that’s one less person we hire.)

On top of that, we have to determine what taxing districts within the state a given sale falls in. How do we determine if a Boulder address is within the city limits? In addition, this guarantees we will not open a sales office in DTC (something we have considered) because the last thing we need is a second jurisdiction we have to figure out local taxes for.

Keep in mind we’re a small company. There are literally thousands of others like us here in Colorado. We are all coming out of the recession and trying to focus all of our time and effort and growing our companies (and that adds jobs). You need to give as a simple straightforward way to determine the correct sales tax.

And to double down on this clusterfuck, there is the proposal to require companies in other states to report to Colorado based on sales. Can Colorado even tell them the criteria to determine what is included? (I bought a book on my Kindle when I was in Arizona, read it in Arizona, and deleted it when done – still in Arizona. The book was never on my system in Colorado. How can Amazon track that?) Senator Brophy has a good post on this – including the little issue of the state learning what you are buying (that inflatable sheep was a gag gift – I swear!).

I understand the need to increase revenues. I agree that it is fair for software companies to pay their fair share. But software is not buying a physical thing at a physical location. It is the purchase of an amorphous object that can then first be used in multiple locations.

The legislature needs to get this figured out before dumping it on us. Otherwise it will cost Colorado companies sales (and jobs).

first published at Sales tax on software

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