Sales And Use Tax For Cloud Computing, Software, Apps, And Other .

Sales and Use Tax for Digital Products and Services— Potential Nexus Issues Where value is law. Joseph N. Endres, Esq. Hodgson Russ LLP 140 Pearl Street, Suite 100 Buffalo, New York 14202 Phone: (716) 848-1504 Fax: (716) 819-4711 jendres@hodgsonruss.com 2013 Hodgson Russ LLP www.hodgsonruss.com Doc. # 11629792

Nexus First question: Nexus, what is it? 1. Nexus is a fancy word for “connection.” In order for a state to require an out-of-state seller to collect its sales tax, there must be a requisite level of connection between the state and the seller. Quill v. North Dakota, 504 U.S. 298 (1992) The “Bright Line” Test: Physical Presence Do you have any people or property in the state? Offices Employees or independent contractors Inventories Other property – servers and Texas 30 Where value is law.

Nexus Continued Just because you have “Nexus” with a state, doesn’t mean you have a sales tax exposure. 1. Not all states tax digital goods. You have to know the rules in each state. Unfortunately the rules are complex and in flux! For example, California exempts digital goods. New York taxes digitally accessed or transferred software, but exempts other digital products such as music, pictures, etc. States that tax digital products, other than software: AL, AR, AZ, CO, CT (but at a lower rate), HI, ID, IN, IL, KY, LA, ME, MN (as of 7/1/13), MS, NC, NE, NJ, NM, OH (as of 1/1/14), SD, TN, TX, UT, VT, WA, WI, WY. 31 Where value is law.

Nexus Continued Can a third party’s activity in a state confer nexus on an out-of-state seller? 1. Yes. Affiliate or Click-Through Nexus! Scripto, Inc. v. Carson, 362 U.S. 207 (1960) Tyler Pipe Industries, Inc. v. Washington Dep’t of Revenue, 483 U.S. 232 (1987) 2. Several states now impose some sort of click-through or affiliate nexus, including Arkansas, California, Colorado, Connecticut, Georgia, Illinois, New York, North Carolina, Oklahoma, Rhode Island, South Dakota, Tennessee, Texas and Vermont. 32 Where value is law.

Nexus Continued The “Click-Through” or Affiliate Nexus laws are likely here to stay, though some have been invalidated recently in certain states. 1. This month the Supreme Court refused to hear a challenge to New York’s Affiliate Nexus laws. 2. In October, the state's highest court found Illinois' Internet sales tax void and unenforceable because it conflicts with a federal law that temporarily blocked new state or federal taxes aimed at online retailers or Internet providers, the first court in the country to take that stance. So it doesn’t look like a unified solution is going to come from the courts. What about Congress? 33 Where value is law.

Nexus Continued The Marketplace Fairness Act of 2013 1. The Marketplace Fairness Act grants states the authority to compel online and catalog retailers ("remote sellers"), no matter where they are located, to collect sales tax at the time of a transaction - exactly like local retailers are already required to do. 2. However, States are only granted this authority after they have simplified their sales tax laws. Big retailers have supported the legislation fervently, including Walmart, Amazon, BestBuy, Bed, Bath and Beyond, Barnes and Noble, Target, and Staples, among others 34 Where value is law.

Nexus Continued States have two options to simplify their sales tax codes: 1. A state can join the twenty-four states that have already voluntarily adopted the simplification measures of the Streamlined Sales and Use Tax Agreement (SSUTA), which has been developed over the last eleven years by forty-four states and more than eighty-five businesses with the goal of making sales tax collection easy. Any state which is in compliance with the SSUTA and has achieved Full Member status as a SSUTA implementing state will have collection authority on the first day of the calendar quarter that is at least 90 days after enactment. 2. Alternatively, states can meet essentially five simplification mandates listed in the bill. States that choose this option must agree to: Notify retailers in advance of any rate changes within the state Designate a single state organization to handle sales tax registrations, filings, and audits Establish a uniform sales tax base for use throughout the state Use destination sourcing to determine sales tax rates for out-of-state purchases (a purchase made by a consumer in California from a retailer in Ohio is taxed at the California rate, and the sales tax collected is remitted to California to fund projects and services there) Provide free software for managing sales tax compliance, and hold retailers harmless for any errors that result from relying on state-provided systems and data 35 Where value is law.

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Sales and Use Tax for Digital Products and Services— Sourcing Issues Where value is law. Joseph N. Endres, Esq. Hodgson Russ LLP 140 Pearl Street, Suite 100 Buffalo, New York 14202 Phone: (716) 848-1504 Fax: (716) 819-4711 jendres@hodgsonruss.com 2013 Hodgson Russ LLP www.hodgsonruss.com Doc. # 11629792

Sourcing Issues What state’s tax rules apply? 1. General Rule: For software and digital goods, the state where the end user is located typically controls but be careful! 2. But what happens when users are located across various states? Or what if a service is performed for a business with locations in multiple jurisdictions (e.g., software-based accounting services, accounts payable, payroll, etc.)? Principal place of business approach. Reasonable estimates of user locations. 38 Where value is law.

Sourcing Issues Multiple Points-of-Use (“MPU”) Exemption Certificates 1. A handful of states allow purchasers to provide sellers MPU Exemption Certificates when certain requirements are met. 2. For example, in order for the exemption to apply, most states require that the software be transferred or accessed digitally and that the software be used by the customer in multiple jurisdictions. These certificates can be a very effective way for a seller to limit its compliance obligation. A seller that receives the exemption certificate is relieved of its obligation to collect tax on the transaction. Rather, the purchaser is obligated to remit the tax to the state once it determines where the software is used by its employees. 39 Where value is law.

Sourcing Issues Multiple Points-of-Use (“MPU”) Exemption Certificates 1. The following states have some type of MPU exemption: Colorado, Massachusetts, Minnesota (but only after mid2013), Ohio and Washington 2. Unfortunately, several states that previously offered the exemption but later repealed it: Indiana , Iowa, Kansas, Kentucky, Nebraska, New Jersey, North Dakota, South Dakota. 3. Some states will still accept the MPU certificates informally. 4. NY accepts information from the purchaser regarding use. 40 Where value is law.

Sourcing Issues Practical advice for sellers 1. Establish policy and procedure for sourcing sales transactions e.g., SSTA sourcing hierarchy 2. Implement a rule for each product (SKU) sold 3. Information, information, information! Identify the best available information for sourcing purposes. 4. Maintain excellent record keeping with respect to exemption certificates. Keep both a hard copy and a digital copy. 41 Where value is law.

Digital Products STREAMLINED SALES TAX UPDATE 2013 Sutherland Asbill & Brennan LLP

Streamlined Digital Products Sourcing Background SSUTA §§ 309, 310, 311 (sourcing) and SSUTA §§ 332, 333, and Library of Definitions (digital products) Formation of the Digital Products Sourcing Workgroup Issues Location of “receipt” SSUTA § 310 Collecting and maintaining buyer address information Sourcing allocation Origin sourcing 43 2013 Sutherland Asbill & Brennan LLP

Streamlined (cont’d) Options for the Workgroup: 1. Develop stand-along Issue Paper; or 2. Develop Issue Paper with Interpretive Rule Draft Issue Paper available on www.streamlinedsalestax.org 44 2013 Sutherland Asbill & Brennan LLP

Digital Products STATE-BY-STATE LEGISLATIVE AND REGULATORY UPDATE 2013 Sutherland Asbill & Brennan LLP

Digital Products LEGISLATIVE UPDATE 2013 Sutherland Asbill & Brennan LLP

Maine Legislation Explained as a codification of existing administrative practice, Maine enacted legislation that imposes sales tax on “products transferred electronically.” See MRS 36 §§ 1752(9-E), 1811 (eff. 6/23/2013). “Products transferred electronically” means “a digital product transferred to the purchaser electronically the sale of which in nondigital physical form would be subject to tax under this Part as a sale of tangible personal property.” 47 2013 Sutherland Asbill & Brennan LLP

Maine (cont’d) Sourcing Rules “A product transferred electronically is sold in this State if: the product is delivered electronically to a purchaser located in this State, the product is received by the purchaser at the seller’s location in this State, a Maine billing address is provided by the purchaser in connection with the transaction or a Maine billing address is indicated in the seller’s business records” 48 2013 Sutherland Asbill & Brennan LLP

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Minnesota Legislation Minnesota imposes sales or use tax on “specified digital products” or “other digital products.” Minn. Stat. § 297A.61, Subd. 3(l) (eff. 6/30/2013); see also Minnesota Sales Tax Fact Sheet No. 177, 07/01/2013. Tax applies to sales of specified digital products or other digital products to an “end user” with rights of permanent use (downloaded) or less than permanent use (streaming), and regardless of whether rights or use are conditioned upon payment by the purchaser is a taxable retail sale (subscriptions). Minn. Stat. § 297A.61, Subd. 4(o). 50 2013 Sutherland Asbill & Brennan LLP

Minnesota (cont’d) Digital Codes Minnesota follows the Streamlined Sales and Use Tax Agreement’s rules related to digital codes. “Digital code” means a code which provides a purchaser with a right to obtain one or more specified digital products or other digital products. A digital code may be transferred electronically (e-mail) or it may be transferred on a tangible medium (plastic card). Minn. Stat. § 297A.61, Subd. 53. When a digital code has been purchased that relates to specified digital products or other digital products, tax applies at the time of purchase of the code – not the subsequent receipt of or access to the related specified digital products or other digital products is not a retail sale. Minn. Stat. § 297A.61, Subd. 4(o). 51 2013 Sutherland Asbill & Brennan LLP

Minnesota (cont’d) A digital code is not a code that represents a stored monetary value that is deducted from a total as it is used by the purchaser, and it is not a code that represents a redeemable card, gift card, or gift certificate that entitles the holder to select a digital product of an indicated cash value. The end user of a digital code is any purchaser except one who receives the contractual right to redistribute a digital product which is the subject of the transaction. Minn. Stat. § 297A.61, Subd. 53. 52 2013 Sutherland Asbill & Brennan LLP

Minnesota (cont’d) “Digital audiovisual works” means a series of related images which, when shown in succession, impart an impression of motion, together with accompanying sounds, if any, that are transferred electronically. Digital audiovisual works includes such items as motion pictures, movies, musical videos, news and entertainment, and live events. Digital audiovisual works does not include video greeting cards sent by electronic mail. Unless the context provides otherwise, in the sales and use tax law audiovisual works includes the digital code, or a subscription to or access to a digital code, for receiving, accessing, or otherwise obtaining digital audiovisual works. Minn. Stat. § 297A.61, Subd. 51. 53 2013 Sutherland Asbill & Brennan LLP

Minnesota (cont’d) “Digital books” means any literary works, other than digital audiovisual works or digital audio works, expressed in words, numbers, or other verbal or numerical symbols or indicia so long as the product is generally recognized in the ordinary and usual sense as a “book.” It includes works of fiction and nonfiction and short stories. It does not include periodicals, magazines, newspapers, or other news or information products, chat rooms, or weblogs. Unless the context provides otherwise, in the sales and use tax law digital books includes the digital code, or a subscription to or access to a digital code, for receiving, accessing, or otherwise obtaining digital books. Minn. Stat. § 297A.61, Subd. 52. 54 2013 Sutherland Asbill & Brennan LLP

Minnesota (cont’d) Definitions In general, Minnesota adopts the Streamlined Sales and Use Tax Agreement’s “specified digital products” definitions, but with more specificity, and separately defines “other digital products” in a unique manner. “Specified digital products” means “digital audio” works,” “digital audiovisual works,” and “digital books” that are transferred electronically to a customer. Minn. Stat. §297A.61, Subd. 55. “Other digital products” means the following items when transferred electronically: (1) greeting cards; and (2) online video or electronic games. Minn. Stat. § 297A.61, Subd. 54. 55 2013 Sutherland Asbill & Brennan LLP

Minnesota (cont’d) “Digital audio works” means works that result from a fixation of a series of musical, spoken, or other sounds, that are transferred electronically. Digital audio works includes such items as the following, which may either be prerecorded or live: songs, music, readings of books or other written materials, speeches, ring tones, or other sound recordings. Digital audio works does not include audio greeting cards sent by electronic mail. Unless the context provides otherwise, in the sales and use tax law, digital audio works includes the digital code, or a subscription to or access to a digital code, for receiving, accessing, or otherwise obtaining digital audio works. Minn. Stat. § 297A.61, Subd. 50. 56 2013 Sutherland Asbill & Brennan LLP

Ohio Legislation Ohio will impose sales or use tax on “specified digital products.” See ORC § 5739.01(B)(12) (eff. 1/1/2014). Tax applies when a specified digital product is provided for permanent (downloaded) or less than permanent use (streaming), and regardless of whether continued payments are required (subscriptions). 57 2013 Sutherland Asbill & Brennan LLP

Ohio (cont’d) As a full member in the Streamlined Sales and Use Tax Agreement, Ohio adopted the Agreement’s “specified digital products” definitions and operating rules. See ORC § 5739.01(B)(12) (QQQ). Note – Ohio does not statutorily define “digital code,” but in order to remain compliant with the Agreement, Ohio will be required to follow the rules in Section 332 related to the purchase such codes. 58 “Specified digital product” means an electronically transferred digital audiovisual work, digital audio work, or digital book. “Electronically transferred” means obtained by the purchaser by means other than tangible storage media. 2013 Sutherland Asbill & Brennan LLP

Ohio (cont’d) “Digital audiovisual work” means a series of related images that, when shown in succession, impart an impression of motion, together with accompanying sounds, if any. “Digital audio work” means a work that results from the fixation of a series of musical, spoken, or other sounds, including digitized sound files that are downloaded onto a device and that may be used to alert the customer with respect to a communication. “Digital book” means a work that is generally recognized in the ordinary and usual sense as a book. 59 2013 Sutherland Asbill & Brennan LLP

Massachusetts Repeal Less than two months after enacting a tax on computer design and software services (eff. 7/31/2013), Massachusetts repealed the new tax with the passage of HB 3662 (eff. 9/27/2013). “Computer system design services” were defined as “the planning, consulting, or designing of computer systems that integrate computer hardware, software, or communication technologies and are provided by a vendor or a third party.” MA also briefly taxed other software-related services including: “the modification, integration, enhancement, installation or configuration of standardized software,” but excluding “data access, data processing or information management services.” Mass. St. 2013 c. 46; Mass. G.L. c. 63 § 38(f), c. 64H § 1. 60 2013 Sutherland Asbill & Brennan LLP

Massachusetts (cont’d) Under HB 3662, a taxpayer that collected and remitted the software tax to the DOR may claim a refund for the full amount paid by filing an application for abatement by 12/31/2013. A taxpayer must refund all relevant amounts to its customers within 30 days of receiving the refund. A taxpayer who previously collected but did not remit such funds to the DOR must make “reasonable efforts” to refund such amounts to its customers. 61 2013 Sutherland Asbill & Brennan LLP

New York State Proposal Draft tax reform legislation under consideration by Governor Cuomo (drafted by the Department of Taxation and Finance) includes the impose of sales and use tax on the sale of, license to use, or granting of remote access to digital products in the state, according to hierarchical sourcing rules. 62 2013 Sutherland Asbill & Brennan LLP

New York State Proposal (cont’d) Draft defines “digital product” as any property or service, or combination thereof, of whatever nature delivered to the purchaser through the use of wire, cable, fiber-optic, laser, microwave, radio wa

Massachusetts Dept. of Revenue Letter Ruling 11-4, (April 12, 2011) Massachusetts Dept. of Revenue Letter Ruling 12-5 (May 7, 2012) Massachusetts Dept. of Revenue Letter Ruling 12-10 (Sept. 12, 2012) Massachusetts Dept. of Revenue Letter Ruling 12-13 (Nov. 9, 2012) Massachusetts Dept. of Revenue Letter Ruling 13-2 (March 11, 2013)