On September 19, 2014, the Texas Comptroller issued its decision 106,632. On the surface, the issues seemed fairly routine. A Utah taxpayer was audited and assessed tax on sales of downloaded software. The decision outlines many procedural issues but the most startling point of the ruling is the conclusion reached by the Hearing Officer that the Utah vendor had nexus with the state of Texas by virtue of the presence in Texas of software that had been downloaded onto servers located in the state. https://www.salestaxstrategies.com/sales-tax-audit-defense.html
The company did not send salesmen into the state to solicit sales and it did not conduct other types of training or support services in the state. The decision states: “The substantial physical presence requirement is determined by the character of the rights and interest Petitioner retained in the software and digital images download by users located in Texas.” Because Texas deems downloaded software to be tangible personal property and because the taxpayer (Petitioner) only grants a limited set of rights to the user and retains other rights for itself, that the Petitioner is deemed to own personal property in the state of Texas. That’s right, the state of Texas has now concluded that software residing on the servers of another to which the licensing company has retained some intellectual property rights thereto, is deemed to be the ‘ownership’ of property in the state of Texas and creates nexus for the company.
The decision went on to say that based on the volume of business the company had in the state that there was “substantial physical presence”-not just a minimal physical presence in the state. Granted, the taxpayer did not object to the assertion that the downloaded software was tangible personal property, so part of their problem may be a self-inflicted by not vigorously objecting to the characterization of their intangible property as being tangible.
Regardless of the taxpayer’s error, this is a very frightening outcome and a dramatic advancement of the theory of nexus for sales tax purposes. For remote sellers of software they would be forced to abandon their intellectual property rights of the software sold or be forced into a sales tax compliance position that, heretofore, has not be promoted by any other state. Just because downloaded software is taxed as “tangible personal property” does not make it “tangible personal property”. There is nothing physical about software that is received electronically and exists only in an electronic state on a computer. If more states pursue this dramatic and unprecedented advancement of nexus, software vendors across the country should be in fear of audits and assessments.
Ned Lenhart, CPA