Sales Taxation of Cloud-Based Software with Multiple Points of Use
Increasingly, those responsible for the procurement of software in an organization purchase multiple copies of software or licenses that are hosted and accessed via the ‘cloud.’ Typically, the host is located in a main office or central purchasing department in one state, and the software is then distributed or made available for use in offices in several other states, including use from home offices or by remote employees. This model of centralized purchasing for eventual distribution to other locations creates a dilemma and opportunity for sales and use tax analysis – first, should tax be paid to the state where the purchase is initially made or the state where the software is eventually used, and second, is the software in question taxable in the relevant state?
The Taxing State
Most states refer to such software as “multiple point of use” or MPU software. MPU software is generally exempt from sales tax provided that the purchaser presents the seller with an MPU exemption certificate as proof of the intended use. After the tax-free purchase transaction, the buyer is responsible for allocating the cost of the software to the states where it will be used, and then paying use tax to those states. Use tax is closely related to sales tax – typically applied to the same taxable items at the same rate. The use tax return is filed by the purchaser of the item, and the tax is paid to the state where the item is used, rather than being invoiced, collected and remitted by the seller to the state where the delivery of the good or service takes place.
Allocating the price among states where MPU software is used can be done using a variety of reasonable methods. In most cases, allocation based on the number of licenses used in each state or number of employees using the software in each state is the simplest and most practical method.
Is the MPU Software Taxable?
Once a business determines how much of the total purchase price to allocate to various states, the next step is to determine if the states in question tax the particular type of software at issue. Nearly all states that have a sales and use tax impose the tax on software transferred on a tangible medium such as a CD or DVD. However, many do not tax downloaded or cloud-based software, known as software-as-a-service or SaaS in sales tax parlance. For more information on this topic, please refer to our recent articles on sales taxation of SaaS here and here.
Benefits to the Taxpayer
Applying the MPU software rules to your business offers several tax-saving opportunities. If your main office is in a high tax state or a state that taxes cloud-based software, but you have operations in other states with more favorable tax rules, you can allocate a portion of your software purchases to other states and pay tax at a reduced rate or perhaps avoid tax entirely on a portion of your purchase. Similarly, if you were unaware of the MPU rules and recently made a significant software purchase on which you paid sales tax in full in the state of purchase, some states will allow you to apply the MPU rules after the fact and obtain a refund for the portion of the software that was destined for out of state use. The unfortunate corollary to this opportunity is that states may expect you to remit use tax on software you use in state even if you purchased it elsewhere, and could raise this issue on audit and demand tax payment.
Please note that this tax planning opportunity only covers purchases of software, and may not be applicable to central purchasing of other taxable goods. If you have questions or are wondering if your business could benefit from application of the MPU rules to a recent or planned software purchase, please contact Dan Gayer, Merrill Barter, Chris DeRosa, or your BNN advisor for a detailed analysis of your specific situation.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.