TIR 13-10 Issued; Additional Regulations and Letter Rulings Urgently Needed
On Wednesday, July 24, 2013, the Massachusetts Legislature overrode Governor Patrick’s veto and enacted a 6.25 percent sales tax on computer-system design/software services. The new tax is part of the new $800 million transportation bill. The new tax becomes effective on Wednesday, July 31, 2013.
The new law taxes “the modification, integration, enhancement, installation or configuration of standardized software.” M.G.L. c. 64H § 1 (new definition of “services” subject to sales and use tax) (effective July 31, 2013). The scope of the new tax on software modification services is reasonably well-defined. TIR 13-10—which provides guidance on the new law—states that “the new provisions serve as overlapping descriptions generally intending to tax software services that modify, enable or adapt prewritten software to meet the business or technical requirements of a particular purchaser and to operate on the purchaser’s computer systems, regardless of how those services are described or billed to the customer.” TIR 13-10: Sales and Use Tax on Computer Software Services Law Changes Effective July 31, 2013 (emphasis added).
The new law also taxes “the planning, consulting or designing of computer systems that integrate computer hardware, software or communication technologies” where these services are provided by a “vendor or a third party.” M.G.L. c. 64H § 1 (new definition of “Computer system design services” subject to sales and use tax) (effective July 31, 2013). Unlike the new statutory language relating to computer software, the provisions regarding “computer system design services” are inherently ambiguous and TIR 13-10 fails to explain exactly how they will work. For example, TIR 13-10 fails to address the following points:
Suppose a taxpayer purchases software along with a computer, monitor, printer and keyboard. If an outside vendor installs the software and connects the cables for the hardware, does the installation of the software and cabling of the hardware now constitute taxable “consulting” services that “integrate” hardware and software? Or would these services be considered consulting and evaluation services “not directly related to a particular systems integration project involving the sale of computer hardware or software.” TIR 13-10, Part II.
The new computer systems design tax seems to apply to the “planning” and “design” of server systems that allow PCs to “talk” with each other and use software and data stored on the server. Arguably, these server systems “integrate hardware, software or communication technologies.” Does it make a difference whether the computer server is owned by the customer or is owned by an unrelated third-party (i.e., “cloud computing”)?
Suppose the new computer systems design tax applies to cloud computing (i.e., a third party provides access to computer software through a shared program accessible via the internet) and the server where the program resides is located outside Massachusetts. Is the out-of-state vendor liable for the Massachusetts sales tax on design services on the basis that the out-of-state vendor is providing computer design services to Massachusetts businesses and thus has “economic nexus” with Massachusetts?
The computer systems design tax does not apply unless the services are provided by a “vendor or a third party.” Thus, if a business uses an employee to design computer systems, the tax does not apply. But it is unclear whether the new tax applies if the business uses an employee (chief communications officer) and one or more independent contractors to design computer systems. Does it matter if the independent contractor is treated as an “employee” for payroll tax and workers’ compensation purposes? Furthermore, should the Department of Revenue be concerned about the potentially discriminatory impact that this new tax might have on small businesses that are unable to maintain in-house IT departments?
The inherent ambiguities in portions of the new law jeopardize those who sell computers and computer design/modification services, placing them in a cruel dilemma. Vendors who mistakenly collect a sales tax on computer design/modification services will find themselves at a significant competitive disadvantage vis a vis those vendors who do not collect the tax.
Vendors who fail to collect a valid sales tax may find themselves in an even worse situation. Vendors are required, by law, to include sales taxes on their invoices and to collect and remit sales taxes in a timely fashion, whether or not the tax is collected at the point of sale from the purchaser. As a practical matter, vendors who do not collect the sales tax “up front” (i.e., at the point of sale) may find it impossible to collect the tax at a later time. Meanwhile, the president, board of directors, and chief financial officers might find themselves personally responsible for any unpaid sales taxes on services including penalties and interest on the unpaid tax and penalties. These unpaid taxes, penalties and interest add up quickly. Computer design sales of $1.6 million translates into $100,000 in sales taxes without considering penalties and interest. Indeed, proponents of the tax expect the tax to bring in about $161 million in new tax revenue on an annual basis.
Therefore, vendors may want to consider the following options:
Send informal comments and suggestions to the Massachusetts Department of Revenue. TIR 13-10 encourages taxpayers to submit “comments or suggestions regarding the application of sales and use taxes to . . . computer/software services.” The Department of Revenue also anticipates that there will be “opportunity for public comment on a working draft of the regulation amendment before it is formally proposed.”
Come together as an industry and present the Massachusetts Department of Revenue (“MDOR”) with a proposed regulation. The MDOR will likely welcome this type of intervention. The problem with this approach is that it takes time and there is no guarantee that the computer design industry will be able to coalesce around an agreed-upon regulation.
Request individual letter rulings from the MDOR. Vendors may choose—with the assistance of general counsel or outside counsel—to request a private letter ruling from the Massachusetts Department of Revenue based on the facts and circumstances of individual cases.
What are letter rulings? They are rulings issued by the Massachusetts Department of Revenue to a particular taxpayer. There is no filing fee involved in requesting a ruling. The professional fees, however, can be substantial. Technically, the ruling protects only the taxpayer that applies for the ruling. Normally, however, the Massachusetts Department of Revenue will treat all similarly situated taxpayers equally as long as all have acted in good faith.
Why might a taxpayer opt for requesting a private letter ruling instead of submitting an industry-approved draft regulation to the Massachusetts Department of Revenue? First, letter rulings are tailored to the specific needs of the requesting taxpayer and do not consider the tax consequences to the requestor’s competitors. Second, ruling requests (unlike drafting proposed regulations) can be crafted, drafted and filed fairly quickly. Third, the professional fees associated with requesting private letter rulings are often quite reasonable when weighed against the requestor’s competitive and financial exposures, as outlined above. For all these reasons, requesting a private letter ruling may be preferable to submitting an industry-approved draft regulation to the Massachusetts Department of Revenue.
Morris Robinson, CPA, LL.M., is Managing Director at M. Robinson & Company, P.C., a boutique tax firm in downtown Boston focused on the resolution of federal, state, and international tax controversies for corporations, small businesses, and individuals. M. Robinson & Company is available to provide complimentary 30 minute initial consultations regarding the process for requesting private letter rulings from the IRS and/or Massachusetts Department of Revenue and the likelihood of success for such a ruling according to the particular facts and circumstances of your company’s case.
This blog post was originally published at http://masstaxlawyers.wordpress.com/2013/07/29/%EF%BB%BFcomputer-system-designsoftware-services-now-taxed-at-6-25-effective-july-31-2013/