Sales and use tax is an extremely complex field that is evolving every day, especially in the area of electronic information and cloud computing. Michigan law currently states that downloaded, custom software, which is a program or website specifically designed for your company, is exempt from sales tax, while downloaded, prewritten, or “as-is” software, is subject to sales tax. Unfortunately, electronic information is no longer easy to group into one of these two categories. In the most recent court rulings, Michigan is now providing guidance for the sales and use taxation of cloud computing. Cloud computing includes all the various ways that software and electronic information can be delivered to customers either via downloading or remote access.
To determine whether or not software or electronic data is subject to sales tax, Michigan is focusing on the transaction as a whole. In the court case of Catalina Marketing Sales Corporation (“Catalina”) vs. Department of the Treasury, the Department of the Treasury overturned the Michigan Tax Tribunal and Court of Appeals as they focused on just part of the transaction. Catalina is a company that contracts with manufacturer-clients to deliver a coupon or advertising message to shoppers at grocery stores. Catalina has software that analyzes the items customers are purchasing. Depending on client demands, Catalina provides either a coupon, advertisement, or no coupon at all to the end consumer in the grocery store. This is considered a mixed transaction for sales tax purposes. On one hand, there is a nontaxable service of utilizing the software to determine an outcome. On the other hand, taxable tangible personal property is generated in the form of a coupon. The Michigan Tax Tribunal and Court of Appeals applied the “real object test,” holding that because Catalina provided a coupon, or a “real object” to the consumer, the entire transaction was subject to sales and use tax. The Department of the Treasury determined this is where the lower courts ruled incorrectly, as they should have applied the “incidental to service” test. The “incidental to service” test looks at the whole transaction. With a focus on the transaction in its entirety, sales tax does not apply to any service transactions in the event tangible personal property is exchanged incidentally. In the Catalina case, the Department of Treasury found the coupons to be incidental to the whole service transaction since the main transaction is the software which determines an outcome to the consumer. As the coupon was incidental to service, the transaction was deemed to be nontaxable.
Cloud computing is a new and evolving area for states to determine sales and use taxability. Through its recent court rulings, Michigan is setting precedent for how to determine taxability with respect to software and other electronic data. Companies should review their individual cloud computing transactions to determine taxability. If a company has paid sales and use tax on any transaction that should be exempt, a refund may be available. Have a Barnes Dennig tax specialist reach out to you to answer any questions that you may have on sales and use tax, or other general tax matters.