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Information retrieval systems allow vendors to store data electronically and charge customers a fee to access and retrieve the information. In this article, Reed Smith LLP's Lee A. Zoeller, Robert E. Weyman, Christine M. Hanhausen, and Michael I. Lurie discuss a recent Pennsylvania Department of Revenue letter ruling that applies sales tax to these systems.
By Lee A. Zoeller, Robert E. Weyman, Christine M. Hanhausen, and Michael I. Lurie
Lee Zoeller is chair of Reed Smith's State Tax Group of more than 30 lawyers which is nationally renowned for helping corporations save significant state taxes. Robert Weyman is counsel in the State Tax Group. Rob assists clients with income, sales, and gross receipts tax issues around the country. Christine Hanhausen is part of the State Tax Group in Philadelphia. Christine focuses her practice n Pennsylvania and New Jersey Income Tax and Sales and Use Tax issues. Michael Lurie has been a member of Reed Smith's State Tax Group since 2013. Michael currently focuses his practice on Pennsylvania, Virginia, and New Jersey taxes, and unclaimed property.
Twenty years ago, the Pennsylvania Legislature repealed Pennsylvania's sales tax on information retrieval services. The tax on information retrieval services was never reenacted, but a new letter ruling (Letter Ruling SUT-17-002) from the Pennsylvania Department of Revenue (“Department”) nevertheless argues that these services are taxable once again. The Department's ruling echoes the arguments made by the Michigan Department of Treasury several years ago when Michigan unsuccessfully attempted to impose sales tax on information retrieval services.
This article provides an overview of the Department's guidance prior to issuing SUT-17-002, an analysis of the letter ruling, a brief history of Pennsylvania's tax on information retrieval services, and suggested next steps for taxpayers in light of the Department's position in the letter ruling.
In 2015, the Department publicly stated in a Q&A that “[i]nformation retrieval services, where the vendor maintains a database which the purchaser may search for information, are not subject to tax as the purchaser is buying access to that database or information.” The following year, the Legislature enacted Act 84 of 2016, which expanded Pennsylvania's sales tax base by amending the definition of “tangible personal property” to include 10 enumerated digital products, including: books; canned software; “otherwise taxable printed matter”; and “otherwise taxable tangible personal property” that is electronically or digitally delivered, streamed, or accessed. Information retrieval services and information services, however, were not included in Act 84's enumerated list of digital products.
When issuing its initial guidance regarding the scope of the tax on digital products, the Department published an FAQ listing the digital products that the Department viewed as taxable under Act 84. The FAQ described commonly purchased items that that the Department viewed as taxable digital products (such as e-books, digital video, digital audio, apps and games, and photographs), as well as some less commonly purchased taxable digital products (including e-greeting cards and ringtones). Notably absent from the FAQ was any reference to the tax being imposed on information services or information retrieval services.
Additionally, the Department's revenue estimate of Act 84 did not take information retrieval services into account. The Department estimated that the change to the definition of tangible personal property in Act 84 would generate $46.9 million of revenue in 2016–17. In reaching this $46.9 million revenue estimate, the Department included additional revenue attributable to digital downloads of books and music ($18.61 million), streaming video and audio ($19.75 million), and satellite radio ($8.55 million). However, the Department did not include additional revenue attributable to information retrieval services.
Given the statutory language of Act 84, the Department's own initial guidance, and the revenue estimate, Pennsylvania taxpayers had little reason to expect that the Department would view Act 84 as imposing tax on information retrieval services.
The letter ruling describes a vendor that performs a subscription service that allows purchasers to log onto a website and search statutes, court decisions, regulations, and a variety of secondary sources. A purchaser can enter search commands, which are transmitted to the vendor's server. Software on the vendor's server processes the search query and provides the purchaser with responsive information. Given the Department's prior guidance, it came as a surprise to many when the Department concludes that the vendor's “information retrieval product” is subject to sales tax.
First, the Department concluded that providing purchasers with access to an online search function constituted a taxable sale of software. The Department reasoned that when a purchaser used the search function, they were exercising power and control over the canned software on the vendor's server and this constituted taxable “access” to canned software, even though the software was on a server outside of Pennsylvania. This position regarding access to canned software is consistent with the Department's May 31, 2012 letter ruling on cloud computing. This reasoning is also similar to the position that the Michigan Department of Treasury took when it unsuccessfully argued that access to information services constituted a taxable transfer of software.
Second, the Department concluded that even when a purchaser used the service simply to access content like statutes, cases, regulations and journals (rather than using search tools), the service is still taxable. The Department reasoned that when the service was used in this way, it constituted the equivalent of electronically accessing a book or “otherwise taxable tangible personal property” and, thus, was subject to tax under Act 84.
The Department's ruling may cause some readers to have a feeling of déjà vu. In 1991, Pennsylvania's General Assembly enacted a statute that explicitly taxed a litany of computer services, including information retrieval services.
The tax on computer services did not fare well the first time. Maryland ran an ad in a Pennsylvania newspaper, advertising “Come to Maryland! Unlike Pennsylvania, the Free State doesn't add 6 percent to the cost of computer services.” Legislators on both sides of the aisle soon realized that the tax on computer services was “a job-killing tax on the high technology industry in the Commonwealth of Pennsylvania” and “a particularly counterproductive and noncompetitive tax.” After just six years, the legislature ended the experiment of imposing its sales tax on computer services–including information retrieval services–by repealing the tax in 1997.
In the twenty years since the tax on computer services was repealed, the legislature has not explicitly reinstated sales tax on information retrieval services. In its ruling, the Department construes Act 84 as implying that information retrieval services are once again subject to tax. But this construction ignores the fundamental canon of Pennsylvania law that “a later statute shall not be construed to … repeal an earlier statute unless the two statutes are irreconcilable.”
Taxpayers should closely review all sales and purchases of information retrieval services and any other services that permit a purchaser to electronically interface with a vendor's software. Based on the reasoning applied in SUT-17-002, the Department could treat other services as taxable sales of software, including:
To the extent a vendor has been charging Pennsylvania sales or use tax on any of these services, purchasers may have refund opportunities on the basis that the service is not subject to tax. There are strong arguments that sale of an information retrieval service does not constitute a sale of software, and that the Legislature did not intend Act 84 to result in a backdoor reinstatement of the tax on computer services.
In the alternative, even if the service constitutes taxable access to canned software, all or a portion of the transaction could be sourced outside of Pennsylvania, based on the locations where the “service” is “used.” We would note that this sourcing rule is based on the Department's May 31, 2012 ruling concluding that remote access of software at a Pennsylvania location is taxable in Pennsylvania even if the software is located outside Pennsylvania. That determination is subject to challenge on the basis that there is not a taxable use of the software in Pennsylvania. A successful challenge to the May 31, 2012 ruling would undermine the letter ruling concluding that information retrieval services are subject to tax as well.
Taxpayers may want to consider the potential exposure that would result if the Department were to apply the reasoning adopted in the letter ruling to all purchases made during periods open under the statute of limitations. The first rationale in the letter ruling concluding that the information retrieval services were subject to tax (i.e., that access to a database constitutes access to canned software) does not depend on the enactment of Act 84. Since May of 2012, the Department's position has been that electronic access to canned software is taxable. Thus, the Department's rationale in the letter ruling may directly contradict the Department's 2015 interpretation that information retrieval services were not taxable, and taxpayers that relied on the 2015 guidance could have exposure if the rationale in the letter ruling is applied retroactively.
In our experience, some Pennsylvania auditors are already assessing tax on purchases of services of this type for periods prior to Act 84, and the letter ruling could embolden auditors to take that approach. Any taxpayer that is assessed for these types of services prior to Act 84 should strongly consider filing a petition for reassessment.
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