Travis, I enjoyed our lunch yesterday. It was good to catch up. I can’t believe it’s been five years since we last worked together! While it’s been a bit of a transition, I’m enjoying my work here at Tipstar Gaming. These guys are creative geniuses. Their goal is to be the industry leader in multi-player, online gaming, and they are really pushing the envelope. They are close to releasing a new game now that is just unbelievable. It's all very hush hush, but I've seen some early versions. Think World of Warcraft meets Farmville. As you can imagine, this is an interesting place to be the "tax guy". Steve Hagy, our CEO, has spent the last several months re-evaluating our business model. He wants to get out of the business of shipping disks. His vision is to move the delivery of our gaming software to an internet platform. There’s been a lot of discussion around how best to make this happen. The IT guys have laid out a good argument for delivery via a “cloud” solution. The Operations team believes we would have more control if we kept things “in-house”. The Product Development and Marketing folks want everything yesterday. The leadership team is looking to me to provide insights on the tax issues involved. We have a meeting in a couple of weeks and would like to hear your insights and advice. Here are the “hot button” issues as I see them: • We have a good understanding of the income and indirect tax issues surrounding the retail sale of tangible personal property as that is how we have delivered our games in the past. Are there any tax issues, both from a federal and state perspective, we need to consider as we move to an internet delivery model? Will it still be considered the sale of tangible property or would it be considered a service? Can you give us a feel for any trends you are seeing on the tax side of things for other similar products? What do you think we can expect in the future?

•

Please let me know if you have any questions. I look forward to hearing your team's recommendations. Regards, Clarence Krupp Director, Tax Tipstar Gaming

Contact: Gabriel Smith Tel. 324/555-6352-40 Email: GabeSmith@Tipstar.com

FOR IMMEDIATE RELEASE

Tipstar's "Project X" to Launch at GameCon
NEWTON, Lowlands, September 1, 2011. Gamers: get ready for liftoff. Tipstar Gaming, Inc. takes the gaming community to new worlds with the launch of its newest offering at GameCon Sylvania. Tipstar Gaming, Inc. (Tipstar), Sylvania's premiere publisher of interactive software and content will introduce its newest game at GameCon Sylvania scheduled for October 21 - 25th at the Universal Convention Center in Newton, Lowlands. For the last two years, the gaming community has been abuzz as clips from Tipstar's latest offering have shown up on YouTube and gamer message boards. Few details of the much anticipated game have been released. Even its name is a closely guarded secret. "Everyone is going to be blown away." says Steve Hagy, Tipstar CEO. "Epic doesn’t begin to describe this game. Get ready to be transported." Tipstar is a worldwide leader in the development, publishing, and distribution of quality interactive entertainment software that delivers a highly satisfying entertainment experience. The company successfully competes for the leisure time and discretionary spending of consumers with other video game companies, as well as with other providers of different forms of entertainment, such as motion pictures, television, social networking, and music. Its success is built on developing longterm relationships with its gamers by delivering highly interactive, graphically rich, easy to use products. Tipstar appeals to all segments of the gaming community by offering multi-tiered monthly service plan packages allowing gamers to customize their relationship with Tipstar games at an appealing price point.* Tipstar's latest venture is into digital delivery of content and focusing on online product innovations, such as additional online content, services and social connectivity to build value enhancement with its global communities of players. Tipstar products are sold at retail locations throughout Sylvania. The company employs approximately 385 total full-time and part-time employees at its corporate headquarters in Lowlands and an additional 50 employees at its data centers in Midlands and Catawba.

*Service plan packages include minimal fees for early termination. Customers are required to pay all monthly charges regardless of service availability. Tipstar Gaming, Inc. is not responsible for customer injuries that may result from overuse of its games.

Tax Issues In Sylvania the Journal for Tax Professionals

August, 2011

How Do You Tax a Cloud?

Cloud computing is a term for anything that involves delivering hosted i th

Industry experts believe that cloud computing -- a term used to define the latest innovation in web hosted services the -has the potential to (IT) with revolutionize while information the risks technology associated

industry. Others are holding back their opinions assessing migrating data into the "clouds." That said, tax

professionals must understand the basics of cloud computing and be able to discuss the potential benefits and risks of the technology with their clients. Additionally, tax professionals should be aware of constantly evolving tax positions

Cloud computing is poised to be one of the largest revolutions in this era for the IT i d t

regarding cloud computing to better support and guide clients that provide or purchase cloud computing services. Cloud Computing In General Cloud computing is a term for anything that involves delivering hosted services over the Internet. The encompassing name "cloud computing" is derived from the cloud symbol that often is used to represent the Internet resources in flow charts and diagrams. Cloud computing has three distinct characteristics that differentiate it from traditional hosting services: (1) it is sold on demand, typically by the minute or the hour; (2) it is elastic -- users can have as much or as little of the service as they want; and (3) the service is managed fully by the provider with the user needing only a computer and an Internet connection. A cloud can be public or private. A public cloud sells to anyone with an Internet connection, while a private cloud sells access to its proprietary network or data center to a limited number of users. A service provider may use public cloud resources to create a private cloud called a virtual private cloud. Cloud Computing Services Cloud computing services generally fall into one of three categories: Infrastructure-as-aService (IaaS), Platform-as-a-Service (PaaS), and Software-as-a-Service (SaaS). Infrastructure-as-a-Service. IaaS provides virtual server instances with unique IP addresses and blocks of storage on demand. Customers use the provider's application program interface (API) to start, stop, access, and configure their virtual servers and storage. IaaS allows a company to purchase only as much capacity as needed with additional capacity available on demand. Given the pay-for-what-you-use nature of the IaaS model -- much like how electricity, fuel, or water services are billed -- IaaS often is referred to as utility computing. Platform-as-a-Service. This service is defined as a set of software and product development tools hosted on the provider's infrastructure. Developers use the provider's platform to create applications over the Internet. One limitation currently facing this type of service is

Cloud computing has three distinct characteristics that differentiate it from traditional hosting services: (1) it is sold on demand, typically by the minute or the hour; (2) it is elastic -- users can have as much or as little of the service as they want; and (3) the service is managed fully by the provider with

that there are no standards for interoperability or data portability from cloud to cloud (i.e., some providers will not allow customer-created software to be moved off their platforms). Software-as-a-Service. In the SaaS model, vendors supply hardware infrastructures, software, and a front-end portal by which the user interacts with the SaaS provider. Services include anything from web-based email and software sales or licensing to inventory control and database processing. Because the service provider hosts both the application software and the data, the customer is able to use the service from anywhere he or she has Internet access. Providers offering customers the SaaS model often are called application service providers (ASPs). These three categories within the cloud appeal to distinct user groups. Businesses that want complete control over data will migrate towards the IaaS model. Programmers, developers, and web designers will reach towards PaaS. Home or business users looking for low-cost alternatives to traditional software will gravitate to SaaS models. Taxing a cloud So how is a cloud taxed? How is the location of a cloud pinpointed for tax purposes? Just as states are getting around to amending their statutes to address the taxation of digital products, technology once again has evolved and left states racing to catch up -- in this case, racing to catch a cloud. Cloud computing is predicated on borderless global networks. If the location of a cloud cannot be pinpointed, how is it determined which state's laws apply in taxing the cloud? If a state taxes at the point of usage, what if services are free at the point of use? If tax is based on the location of the servers or the office of the cloud computing provider, will providers simply move to the lowest tax jurisdiction? How does a provider or purchaser avoid being taxed in two locations simultaneously when states apply different sourcing rules for tax purposes? Sales and use taxes. Though definitely lagging behind, states indeed are chasing the clouds. Some are chasing it through rulings. For example, in Lowlands, a taxpayer asked the Department of Taxation and Finance whether its hosted marketing service, which it performed through software, and its related services, were subject to Lowlands' sales and use taxes. Though the taxpayer thought it was performing a service, the Department concluded that the hosted marketing service constituted the sale of prewritten software. As a result, its charges were subject to sales and use tax. In a ruling in North Brunswick, the state ruled that a customer's purchase of a taxpayer's product that allowed the customer to obtain information in the taxpayer's database, including reports prepared by the taxpayer, was not subject to tax. The services provided by the taxpayer did not involve transfers of prewritten software, either in tangible or electronic form, or a license to use software on a server hosted by taxpayer or a third party. Therefore, the sale of the taxpayer's product was not subject to North Brunswick sales and use tax. This ruling is noteworthy as the state does tax SaaS transactions. However, in this case, the state, in looking at the facts, determined that a service was being provided rather than software. In Essex, an out-of-state corporation that sold software systems was not subject to Essex sales or use tax for the sale of the hosted software if the corporation did not provide its customer with a tangible format of any component of the hosted software. The corporation's monthly managed access fee for the communications connection to its data centers was subject to sales tax because it was a charge for the taxable sale of a telecommunications service. In Catawba, a provider of a Web-based reporting system consisting of a server, database, and reporting application located in Catawba was subject to Catawba sales tax on various services and rentals provided to customers. The reporting application was used by customers to enter data from remote field locations and retrieve reports from their offices in various locations across the country. Charges for reports provided to customers on a pay-per-use basis or on a long term contract were taxable as charges for data processing (as opposed to an information service) because the reports included computerized data or information manipulation and information storage. As states update their statutes to address the taxation of digital products, some are taking the opportunity to include language aimed at SaaS platforms. For example, in Midlands, the state has taken a different approach from Lowlands and North Brunswick and is amending its statutes to address cloud computing offerings rather than issuing rulings. For example, the state recently enacted HB 2075, which provides that a sale to a consumer of remote access software is a retail sale and is subject to sales or use tax unless an exemption applies. “Remote access software” includes any transaction where a charge is made to a consumer for the right to access prewritten computer software, where possession of the software is maintained by the seller or a third party.

Finally, as states consider expanding the tax base to cover a wider array of services in hopes of generating new revenue sources, they are under increased pressure to attract providers to locate and remain within their borders. For some time, a number of states have provided a sales and use tax exemption for purchases of machinery and equipment used at data centers located within the states' boundaries. Data centers, or server farms, are a vital component in the provision of cloud computing services. Favorable state tax policies in regard to data centers can influence the location of cloud computing providers. State income taxes. In addition to varying state opinions for sales and use taxes, states and taxpayers alike have been struggling on how to source cloud computing revenue from a state income tax perspective. Most states use some form of a three-factor apportionment formula to apportion income from a taxpayer’s business operations. In general, the three-factor formula is based on the ratio of payroll, property, and sales in the state to total property, payroll, and sales everywhere. The main concern for cloud computing revenue would be the sourcing of cloud computing receipts for the sales factor. Generally, receipts from the sale of tangible personal property are included in the sales factor numerator of the destination state, regardless of whether the goods are shipped by the vendor to the destination state or picked up by the customer from the seller’s business location (i.e., dock sales). States source receipts from other than the sale of tangible personal property using an “income producing activity method.” The income producing activity method provides that a sale of other than tangible personal property will be sourced to a state if the income producing activity is performed wholly within the state, or the income-producing activity is performed both in and outside the state and a greater proportion of the income producing activity is performed in the state than in any other state, based on the costs of performance. Income producing activities generally are held to include only activities directly related to the performance of services that produced the business receipts subject to apportionment. Income producing activities include activities performed by the taxpayer's employees, as well as those performed on behalf of the taxpayer, such as those conducted by independent contractors. Costs of performance mean the costs incurred to generate the receipts subject to apportionment, and include the taxpayer’s direct costs and amounts paid to an agent or independent contractor, as well as costs associated with the use of tangible and intangible personal property. In general, states follow the income classification for federal income tax purposes (i.e., if an income item is determined to be a service for federal purposes, it is a service for state apportionment purposes). However, if an item is determined to be the sale of tangible personal property, can states and taxpayers identify where an item has been delivered? To make matters even more confusing, in Catawba, the state legislature has proposed a bill that would statutorily source cloud computing service revenue on a market based approach rather than the cost of performance method. The market-sourcing method sources receipts based on the location of the customer. It is unsure if this measure will pass and if other states will consider adopting similar provisions. Conclusion Cloud computing is poised to be one of the largest revolutions in this era for the IT industry. Client service professionals need to be familiar with the basics of cloud computing to effectively discuss potential risks and benefits with their clients. From an audit perspective, various regulations require varying levels of IT security and control, and the use of cloud computing may have an adverse effect on a company's IT control for audit purposes. From a tax perspective, client service professionals must stay informed of potential changes in state tax policies regarding the tax treatment of the various cloud computing platforms. Further, tax professionals need to inform their clients of cost saving tax exemptions when client cloud computing providers are looking to expand operations.

Notice: 2011-0803 SYLVANIA TREASURY DEPARTMENT Tax Collections & Enforcement Notice of public hearing Summary: The Sylvania Income Tax Code was enacted many years ago when the primary business model involved sales between parties that were conducted locally and typically in-person. As the Sylvania economy has grown and developed, business activity has evolved from primarily regional and to some extent, national activity, to an environment where many Sylvanian businesses operate on an international scale and now in many cases, entirely electronically. The Sylvania Treasury Department has scheduled a public hearing for December 16, 2011, to discuss the characterization of income related to these new types of business transactions, specifically to determine whether such arrangements involve the provision of a service or the use of property. The government is studying how taxpayers are applying the current regulations in the new economy and whether revisions to these rules would provide more clarity to taxpayers as they evaluate the proper tax treatment of their business transactions. In advance of the hearing, the Treasury Department is requesting comments from taxpayers as to where additional clarification or modifications of these rules may be necessary. Following the hearing, the Treasury Department intends to issue proposed regulations encompassing the findings. Current Provisions: Section 27.3 of the current regulations identifies various factors taxpayers should consider in determining whether a contract should be characterized as a service arrangement or a lease for purposes of income taxation. These regulations were introduced in 1970 to standardize the criteria that should be reviewed when analyzing the provisions of an agreement. If an agreement is determined to be a lease under section 27.3, then it will be treated as a lease for all purposes of Sylvania income taxation. The Treasury Department's views on the six commonly regarded factors for determining whether a contract should be classified as a lease or a service are outlined below: 1) Physical possession - If the recipient has physical possession of the property, this is indicative of a lease. Physical possession can occur when the recipient locates the contracted property on-site at its premises or off premises but operated by the recipient's employees. 2) Control - If the recipient maintains control over the contracted property, this is indicative of a lease. Control over the property by the recipient requires a contractual right to dictate how the property is operated, marketed, maintained or improved during the contract term and is more than monitoring compliance with performance, safety or other similar general standards. 3) Possessory or economic interest - If the recipient has a possessory or economic interest in the property, this is indicative of a lease. The following factors in the agreement should be considered in determining whether the recipient has a possessory or economic interest in the property: a. use of the property during the contract by the recipient covers 75% or greater of the useful life of the property would support the notion that the transaction is a lease, whereas use of the property for 60% of less of the useful life of the property would indicate the transaction is a service; b. if the contract provides for the recipient to share in increases or decreases in value of the property, this would be indicative of a lease; c. if the contract provides potential for the recipient to share in savings in the property's operating costs, this would be indicative of a lease; or

d. if the provider bears the risk of damage or loss of the property, this would be indicative of a service. 4) Non-performance - If the recipient must continue to pay the provider regardless of the performance of the underlying property or when the recipient is responsible to cover the costs to maintain and/or repair the covered property, this is indicative of a lease. 5) Use of property - If multiple unrelated parties can use the property concurrently, this is indicative of a service arrangement. 6) Contract cancellation - If the recipient has the option to cancel the contract at any point without paying a significant penalty, this is indicative of a service arrangement. An agreement need not meet or fail all of the factors above to be treated as a service arrangement or a lease; rather a determination will be made based on the substance (versus form) of the agreement and all of the surrounding facts and circumstances. A particular factor or factors may be insignificant in the context of any given contract.

North Brunswick Department of Revenue—Letter Ruling 11-4,
April 12, 2011 On behalf of your client, ***********************************(“Taxpayer”), you have requested a letter ruling with respect to the North Brunswick sales and use tax as it applies to the Taxpayer's online services. Specifically, you request a ruling on whether such services are subject to the sales tax when sold to North Brunswick customers. The following is your representation of the facts upon which we base this ruling. I. FACTS Taxpayer is an ******* corporation that helps organizations to manage their workforce. One of the products sold by the Taxpayer is the ********************* (“Product”) which aids in the employee application gathering and selection process. The Product uses software that was developed by the Taxpayer and remains on the Taxpayer's server. Customers access the Product remotely via the Internet. No portion of the Taxpayer's software is delivered to its customers on a tangible medium, nor is any portion electronically downloaded to its customers' equipment. In addition, the Taxpayer's customer contracts do not provide a license of software or confer any rights to use the software to its customers. The Product is based on the hiring needs of the Taxpayer's customers. To set up the Product, customers provide the Taxpayer with a listing of their current employment opportunities and related job descriptions via e-mail. The Taxpayer develops a customized Internet web portal for each of its customers, which displays the employment opportunities for prospective employees. A link to the web portal that contains the job postings is placed on the websites of the Taxpayer's customers. Prospective employees use the link on the customer's web site to view the Taxpayer's internet web portal where they can search the job postings and complete and submit electronic applications. The Product includes a behavioral assessment, which is a series of questions developed by the Taxpayer that measure critical aspects of an applicant's individual characteristics that can influence whether the person is likely to succeed or fail at a particular job. The assessments are grounded on the principles of selection science and industrial psychology and are the result of large-scale research studies conducted by the Taxpayer. The Taxpayer consults with each customer to create customized assessments based on critical behaviors needed to succeed at the customer's jobs. Through the Internet portal, customers can select which behavioral assessment questions they would like posed to applicants. In addition, customers have a limited ability to add, delete and modify job postings. The Product automatically analyzes data submitted by applicants and determines which applicants meet the minimum qualifications and fit the job descriptions. Customers do not generate reports by using the Product. Rather, the results of the analysis are automatically furnished to the Taxpayer's customers in the form of online reports once the analysis of the applicants has been completed. Customers access the reports via the Internet and have the ability to search and sort information in the reports. The reports are specific to each customer and the information contained in the reports is not provided to other customers. Customers are charged for the Product based on the number of employees that have access to the Product or the number of employment locations.

II. ISSUE Whether sales to North Brunswick customers of the Taxpayer's Product, which provides employment application collection and selection services through proprietary software, are subject to the North Brunswick sales and use tax. III. RULING Sales of the Taxpayer's Product to North Brunswick customers are not subject to the North Brunswick sales and use tax. IV. LAW AND ANALYSIS North Brunswick imposes a 4% sales tax on sales of tangible personal property and telecommunication services within the Commonwealth including sales of prewritten (also called “canned” or “standardized”) software regardless of the method of delivery. Charges for prewritten software, whether it is electronically downloaded to the customer or accessed by the customer on the seller's server (including the Software as a Service business model) are generally taxable. The rules relating to tax on computer hardware and software are contained in the Computer Industry Services and Products Regulation provide the following: (3) General Rules. (a) Sales Tax. Sales in North Brunswick of computer hardware, computer equipment, and prewritten computer software, regardless of the method of delivery, and reports of standard information in tangible form are generally subject to the North Brunswick sales tax. Taxable transfers of prewritten software include sales affected in any of the following ways regardless of the method of delivery, including electronic delivery or load and leave: licenses and leases, transfers of rights to use software installed on a remote server, upgrades, and license upgrades. The vendor collects sales tax from the purchaser and pays the sales tax to the Commissioner. The sale of a license or right to use software on a server hosted by the taxpayer or a third party, as described in (3)(a), are taxable under North Brunswick sales and use tax laws. However, where there is no charge for the use of the software and the object of the transaction is acquiring a good or service other than the use of the software, sales or use tax on software does not apply. In the present case, the Taxpayer provides information services to its customers based on data it gathers from prospective employees and then provides this information to its customers in a report. Under these facts, the object of the customers' purchase of the Product is to obtain database access including reports prepared by the Taxpayer, rather than the use of the software itself. Thus, the sale of the Taxpayer's Product constitutes nontaxable services that allow customers to access information regarding prospective employee applications that the Taxpayer has gathered and screened for the customer. The Taxpayer's customers do not have the ability to operate, direct, or control the software. Rather, the Product automatically collects and screens applications and prepares reports for its customers. Although the customers have the limited ability to edit job descriptions, modify application questions, and view reports on-line, this limited functionality is not sufficient to render the transaction a sale of software. V. CONCLUSION Based on the facts provided and the reasoning above, a customer's purchase of the Product allows that customer to obtain information in the Taxpayer's database, including reports prepared by the Taxpayer. The services provided by the Taxpayer do not involve transfers of prewritten software, either in tangible or

electronic form, or a license to use software on a server hosted by Taxpayer or a third party, as described in (3)(a). The sale of the Taxpayer's Product is not subject to the North Brunswick sales and use tax.

Midlands Excise Tax Advisory NUMBER: 9002.2010 ISSUE DATE: July 24, 2010 Taxation of digital songs, movies, books, and remote access software Overview HB 2075 clarifies the taxation of the sale of digital products that are transferred electronically, including the sale of digital songs, movies, books and online games. The sale of these products has previously been subject to tax in Midlands only if the buyer took possession of the digital good by downloading it. This excise tax advisory explains how HB 2075 affects the taxation of these items. Digital goods: Audio works, audio-visual works, and books HB 2075 provides that a sale to a consumer of digital goods is a retail sale and is subject to retail sales or use tax unless an exemption applies. “Digital goods” includes, but is not limited to, the following products, when transferred electronically:
•

•

•

Digital audio works, which means works that result from the fixation of a series of musical, spoken, or other sounds, including ringtones. This includes, but is not limited to, recorded or live songs, music, readings of books or other written materials, speeches, ringtones, or other sound recordings; Digital audio-visual works, which means a series of related images that, when shown in succession, impart an impression of motion, together with accompanying sounds, if any. This includes, but is not limited to, movies, motion pictures, musical videos, news and entertainment programs and live events; and Digital books, which means works that are generally recognized in the ordinary and usual sense as books.

Remote access software: online games for a single user HB 2075 also provides that a sale to a consumer of remote access software is a retail sale and is subject to sales or use tax unless an exemption applies. “Remote access software” includes any transaction where a charge is made to a consumer for the right to access prewritten computer software, where possession of the software is maintained by the seller or a third party. Digital automated services HB 2075 also provides that a sale to a consumer of digital automated services is a retail sale and is subject to sales or use tax unless an exemption applies. “Digital automated services” includes, with certain exceptions, any service transferred electronically that uses one or more software applications. “Transferred electronically” defined “Transferred electronically” means obtained by the buyer by means other than tangible storage media.

•

It is not necessary that a copy of the product be physically transferred to the buyer. So long as the purchaser may access the product, it is considered to have been electronically transferred to the buyer.

Lowlands Department of Taxation and Finance Office of Counsel Advisory Opinion Unit Private Letter Ruling 6-11 Sales Tax June 1, 2011 STATE OF LOWLANDS COMMISSIONER OF TAXATION AND FINANCE ADVISORY OPINION Petitioner, name redacted, asks whether its hosted marketing service, which it performs through software, and its related services, are subject to Lowlands State sales and use taxes. We conclude that the hosted marketing service constitutes the sale of prewritten software and its charges for that service are subject to sales and use tax, but that its charges for optional training and consulting services are not taxable. Facts Petitioner is a Lowlands-based company that provides marketing services to clients that use email, direct mail, and other marketing channels to reach their customer bases. Petitioner's branded software and related services help clients evaluate their potential and existing customers and then plan and implement marketing campaigns. Because Petitioner maintains the software that it uses to perform the service on its own servers, Petitioner can easily apply its software to different types of clients or adapt it to existing clients' changing needs. Petitioner's clients include airlines, hotels, retail sales stores, auto rental companies and a host of other commercial and retailing establishments. Specifically, Petitioner has developed a proprietary program, called “Hosted Offering,” that allows clients to create, manage and deliver email campaigns. Clients load their own content and data via the Internet and their data are kept separate from any data belonging to other clients of Petitioner. The data remains the property of the client. The messages are sent out of Petitioner's servers/data centers in Lowlands. The data centers host all of the software developed by Petitioner and contain all of the electronic storage where the data belonging to clients is maintained. Via the web access, clients are able to monitor activity on campaigns they have sent out, run reports on these campaigns, and plan future campaigns. A client's employees use the Hosted Offering via a website that they log into. These employees may be located in any location as long as they have an Internet connection. Petitioner grants to its clients a right to use the software on its server for a designated number of interactive users. Title to the software and all its proprietary items remain with Petitioner and the proprietary program is not allowed to be downloaded to the client's computers. Petitioner does not charge any software license fee. Petitioner imposes two charges for this service. First, it imposes an initial set-up fee for establishing connectivity between the client's computers and its data centers to the data centers. The set-up process involves chiefly (a) configuring Petitioner's software to be compatible with the client's system, and (b) working with third parties to ensure that the client's e-mails are specifically identified as not being spam. Petitioner asserts a second charge that is based on the number of marketing messages that Petitioner's client

requests to send to its customers via email, text messaging or on their mobile devices. In addition to its Hosted Product, Petitioner sells related optional marketing services, for which it separately charges. These related services are only provided on-line or from Petitioner's offices and include (i) training on use of the Hosted Offering; (ii) consulting on best practices; (iii) creative services to design messages; and (iv) services to help execute campaigns by providing marketing advice using the expertise Petitioner has developed in conducting e-mail marketing campaigns. These optional services are not performed through software, but rather require Petitioner's staff to work intensively with the client's personnel. The latter three services all involve Petitioner sharing its marketing expertise to help the clients develop more effective marketing campaigns. Charges for these services are based on the type of service and are either hourly or for a fixed dollar amount. These services are primarily provided from Petitioner's offices in Lowlands, Midlands, and Catawba and delivered via the Internet. Petitioner does not provide any tangible deliverables in to any state and does not sell or provide marketing data. Invoices are based on the bill-to location of the client. Analysis Prewritten computer software is considered tangible personal property “regardless of the means by which it is conveyed to a purchaser.” Retail sales of tangible personal property are subject to sales tax. A sale includes “[a]ny transfer of title or possession or both” and includes a “license to use.” Through its Hosted Product, Petitioner grants its clients a license to use the software on its servers in order to conduct marketing campaigns via email and messages to other communication devices. While Petitioner does not assert a charge for the use of the software denominated as such, the set-up fee and the messaging charge appear to constitute consideration for the right to use the software. By providing its clients with these rights to use or control its Hosted Product for a consideration, Petitioner is making taxable sales of prewritten computer software. Thus, the “set-up” and “messaging” charges are subject to sales tax as receipts from the retail sale of pre-written software. The Sales Tax Regulations provide that, in general, “a sale is taxable at the place where the tangible personal property or service is delivered or the point at which possession is transferred by the vendor to the purchaser or his designee.” The regulations further provide that, with respect to a “license to use,” a transfer of possession has occurred if the customer obtains actual or constructive possession, or if there has been “a transfer of the right to use, or control or direct the use of tangible personal property.” “[C]onstructive possession” of software or “the right to use, or control” software is determined based on the location where the client uses or directs the use of the software and not on the location of the code embodying the software. Accordingly, the situs of Petitioner's sales for purposes of determining the proper local tax rate and jurisdiction is the location of the client's employees who use the software. If the client's employees who use the software are located both in and outside of Lowlands State, Petitioner should collect tax based on the portion of the receipt attributable to the client's employee users located in Lowlands. Petitioner may rely on information received from its client to determine the location of its client's employee users. Petitioner's separate charge for the optional service of providing training in the use of its prewritten computer software is not taxable. Petitioner's remaining optional services are in the nature of consulting services, which are not taxable under the Tax Law. NOTE: An Advisory Opinion is issued at the request of a person or entity. It is limited to the facts set forth therein and is binding on the Department only with respect to the person or entity to whom it is issued and only if the person or entity fully and accurately describes all relevant facts. An Advisory Opinion is based on the law, regulations, and Department policies in effect as of the date the Opinion is issued or for the

specific time period at issue in the Opinion.

LR5753 July 16, 2009 Dear Applicant: The facts you presented in your letter ruling request and additional documentation and information provided to Legal Counsel are as follows: Applicant is an out-of-state corporation that sells software systems to automate the trading process for sellside equity firms engaged in securities transactions. Applicant hosts the software application in Applicant's data centers and provides the software to the client as a managed service. Before implementing the software system, the Applicant and customer determine the configurations that will enable the software to function as the customer requires. Applicant next sets up dedicated communications from the customer's location to the Applicant's data centers outside of Essex in order to provide access to the software on the data center servers. Applicant leases a dedicated line from a telecommunications service provider in order to provide its customer with a T1 connection to the servers. Applicant then bills its customer for a monthly managed access fee for this communications service. The hosted software system is installed remotely. Applicant establishes servers in its data centers that its customer may access via the dedicated telecommunications lines. A component of the software system is installed on the customer's desktop PCs. This component of the software is installed by Applicant's engineer who uploads the software to the client over the dedicated telecommunication lines from the servers in the data center onto the customer's desktop PCs.
ISSUE 1:

Is Applicant's sale of the hosted software subject to sales or use tax if Applicant does not provide its customer with a tangible format of any component of the hosted software?
RESPONSE 1:

No. Applicant's sale of the hosted software is not subject to sales or use tax if Applicant does not provide its customer with a tangible format of any component of the hosted software. Essex imposes a sales tax “upon all sellers for the privilege of engaging in the business of selling tangible personal property or rendering taxable service at retail in this state” and imposes a use tax “for the privilege of storing, using or consuming within this state any article of tangible personal property[.]” Further, state statute provides: Tax applies to the sale of canned programs delivered in a tangible medium which are transferred to and retained by the purchaser. Examples of canned programs delivered in a tangible medium would include coding sheets, cards, magnetic tape, CD-ROM or other tangible electronic distribution media on which or into which canned programs have been coded, punched or otherwise recorded. Canned programs are defined as follows:

Canned programs are standardized programs purchased “off the shelf” or are programs of general application developed for sale to and use by many different customers with little or no modifications. These may include programs developed for in-house use and subsequently held or offered for sale or lease. A program may be a canned program even if it requires some modification, adaptation or testing to meet the customer's particular needs. Applicant is selling a canned software program, which is subject to sales or use tax if it is sold in a tangible format. If Applicant does not transfer or provide the canned software program in a tangible medium, however, there is no sale of tangible personal property under Section 144.020, RSMo. Therefore, Applicant's sale of hosted software is not subject to sales or use tax.
ISSUE 2:

Is Applicant's monthly managed access fee for the communications connection to Applicant's data centers subject to sales or use tax?
RESPONSE 2:

Yes. Applicant's monthly managed access fee for the communications connection to Applicant's data centers is subject to sales tax. Essex imposes a sales tax on the following: [A]ll sales of local and long distance telecommunications service to telecommunications subscribers and to others through equipment of telecommunications subscribers for the transmission of messages and conversations and upon the sale, rental or leasing of all equipment or services pertaining or incidental thereto; except that…any amounts paid for access to the Internet…shall not be considered as amounts paid for telecommunications services[.] Telecommunications service are defined as follows: [T]he transmission of information by wire, radio, optical cable, coaxial cable, electronic impulses, or other similar means. As used in this definition, “information” means knowledge or intelligence represented by any form of writing, signs, signals, pictures, sounds, or any other symbols. Providing the communications connection from Applicant's servers to the customer's location in Essex meets the definition of a telecommunications service. Consequently, Applicant's monthly managed access fee is subject to sales tax because it is a charge for the taxable sale of telecommunications service. This letter ruling is binding upon the Department of Revenue with respect to Applicant for three (3) years from the date of this letter and is subject only to statutory changes by the General Assembly and to changes in the interpretation of law by the courts or administrative tribunals. If a change occurs, the taxpayer who relies upon an outdated interpretation may be subject to additional taxes, interest and penalties, which may be imposed prospectively from the date of the change. For this reason, the interpretation set forth above should be reviewed on a regular basis. Please note that any change in or deviation from the facts as presented will render this ruling inapplicable. Sincerely, Alana M. Barragán-Scott

Catawba Letter No. 200801068L, Catawba Comptroller of Public Accounts, January 17, 2008. Sales and use: Taxability of persons and transactions: Computers, software, and services: Data process services.– A provider of a Web-based reporting system consisting of a server, database, and reporting application located in Catawba was subject to Catawba sales tax on various services and rentals provided to customers. The reporting application was used by customers to enter data from remote field locations and retrieve reports from their offices in various locations across the country. Charges for reports provided to customers on a pay-per-use basis or on a long term contract were taxable as charges for data processing (as opposed to an information service) because the reports included computerized data or information manipulation and information storage. Charges for consulting services (report design, software changes, etc.) were taxable because the services were provided in connection with the sale of taxable data processing. An exemption could be claimed for 20% of the total charge for data processing services. The entire charge for the rental of laptops to customers was subject to sales tax. Because these rentals were not integral to the data processing service, the 20% exemption extended to data processing services did not apply to the rental of the laptops. A customer could not claim a multistate benefit exemption on the laptop rentals. This exemption was only allowed for taxable services and did not apply to rentals of tangible personal property transferred to customers in Catawba. See ¶60-310. Sales and use: Taxability of persons and transactions: Information services: Web-based services.– A provider of a Web-based reporting system consisting of a server, database, and reporting application located in Catawba was subject to Catawba sales tax on various services and rentals provided to customers. The reporting application was used by customers to enter data from remote field locations and retrieve reports from their offices in various locations across the country. Charges for reports provided to customers on a pay-per-use basis or on a long term contract were taxable as charges for data processing (as opposed to an information service) because the reports included computerized data or information manipulation and information storage. See ¶60-435. Catawba Comptroller of Public Accounts 200801068L January 17, 2008 To: ************** Web-based Reporting System Dear **************: I am responding to your email regarding sales tax. Please accept my apology for the delay in my response. I am restating your facts and questions below, followed by my response. Facts Taxpayer provides a Web-based reporting system which consists of a Web server, SQL database and reporting application that is located in Catawba. The reporting application resides on the server and is

managed directly by the taxpayer. The reporting application provides data entry screens and generic reports which can be customized by the taxpayer or the client to suit each client's requirements. The reporting application is used by taxpayer's customer to enter data from remote field locations and retrieve reports from customer's offices in various locations across the country. You state that the data is proprietary in nature and therefore the taxpayer does not resell or otherwise grant access to other customers. The reporting system also provides an automated email distribution process for the customer's use. The customer is required to use a Web browser and internet connection to access the reporting application. Taxpayer does not provide internet access service. Taxpayer also rents laptop computers to the customer to facilitate data entry at the remote field locations. The customer is responsible for connecting the laptop to the internet by obtaining wireless internet services from a service provider. Per additional facts supplied by you over the phone, the taxpayer does not provide laptop rentals unless its customer also purchases the Web-based services. However, the Web-based services can be purchased without the laptop rental when the customer has his own equipment. Taxpayer's fees for the following services and rentals are billed as separate line items on the customer invoices: 1. Reports: Taxpayer typically charges on a pay-per-use basis. Each time a report is generated taxpayer charges a fee. Alternative long term contracts, typically 1 to 3 years, are billed at a fixed monthly fee for a fixed number of reports 2. Consulting (report design, software changes, etc.): This invoice description refers to the customization of data entry screens and generic reports 3. Laptop rentals: Fixed daily or monthly fee Question You ask if the stated fees as described above are subject to tax and whether the taxpayer can accept an exemption certificate from a customer claiming a multi-state benefit. RESPONSE: Your client is considered an application service provider and is providing a taxable data processing service per Catawba Rule 3.330. Additionally, Catawba Tax Code Sec. 151.0035 states that “data processing also includes the use of a computer or computer time for data processing whether the processing is performed by the provider of the computer or computer time or by the purchaser or other beneficiary of the service”. Your client's charges for reports, whether on a pay-per-use basis or on a long term contract, are taxable as data processing (as opposed to an information service) because they include computerized data or information manipulation and information storage even though the data was entered remotely by the client's customer. The consulting charges you described are considered to be a service in connection with the sale of data processing per Catawba Tax Code Sec. 151.007(a)(2) and subject to sales tax. The entire charge for the rental of laptops is subject to sales tax. Although the rental items are provided with the taxable data processing service, these charges are distinct and identifiable from the data processing charges. The rental is not integral to the data processing service and the data processing service can be performed without the provision of the rental units by your client. In other words, your client provides a data processing service and will supply a laptop at the customer's option. Hence, the twenty percent exemption extended to data processing services does not apply to the rental of tangible personal property by your client.

Whether your client may accept an exemption certificate from its customer claiming a multi-state benefit for taxable services will depend upon whether the customer meets the provisions of Rule 3.330(f). I do not have enough information about the nature of your client's customers' business to make a specific determination. That is a claim only the customer can make and your client should collect the tax until such an exemption is claimed. You may find the results of Comptroller Hearing 46,844 (STAR Document No. 200706958H) of interest as it relates to the multi-state benefit. I do want to point out that an exemption (claiming a multi-state benefit) may not be claimed on the laptop rentals. This specific exemption is only allowed for taxable services and does not apply to the rental of tangible personal property, where possession of the tangible personal property is transferred to the customer in Catawba. This opinion is based on the facts presented. If there are additional or different facts, the opinion may change. Sincerely, Elias Amaya Tax Policy Division TP letter via email: November 26, 2007 Catawba Comptroller of Public Accounts Tax Policy Division Dear Sir/Madam, On behalf of a client (taxpayer) of this firm who desires to remain anonymous, we seek advice on the Catawba Sales and Use Tax (“Sales Tax”) effect of a transaction. Our inquiry relates to whether the activities described below are non-taxable information services under 34 TEX. ADMIN. CODE. 3.342 FACTS Taxpayer provides a Web based reporting system which consists of a Web server, SQL database and reporting application that is located in Catawba. The reporting application resides on the server and managed directly by the taxpayer. The reporting application provides data entry screens and generic reports which can be customized by the taxpayer or the client to suit each client's requirements. The reporting application is used by taxpayer's customer to enter data from remote field locations and retrieve reports from customer's offices in various locations across the country. The data is proprietary in nature and therefore the taxpayer does not resell or otherwise grant access to other customers. The reporting system also provides an automated email distribution process for the customer's use. The customer is required to use a Web browser and internet connection to access the reporting application. Taxpayer does not provide internet access service. Taxpayer also rents laptop computers to the customer to facilitate data entry at the remote field locations. The customer is responsible for connecting the laptop to the internet by obtaining wireless internet services from a service provider. Taxpayer's fees for the following services and rentals are billed as separate line items on the customer invoices:

1. Reports -Taxpayer typically charges on a pay-per-use basis. Each time a report is generated taxpayer charges a fee. Alternative long term contracts, typically 1 to 3 years, are billed at a fixed monthly fee for a fixed number of reports 2. Consulting (report design, software changes, etc) This invoice description refers to the customization of data entry screens and generic reports 3. Laptop rentals Fixed daily or monthly fee RULING REQUESTED We request a ruling regarding only the taxability of charges for report generation and consulting. We recognize that the charge for the laptop computer is a rental of tangible personal property and is taxable. ANALYSIS Our contention is that the charges for report generation and consulting are non-taxable information services for the following reasons: * The application compiles information of a proprietary nature to produce reports on behalf of the customer that may not be resold to others by the taxpayer. * The services are not taxable data processing services because they do not produce records of transactions and the data entry and retrieval is performed by the customers. * The services are not taxable internet access services because they do not enable the customers to access content or other services offered over the Internet. The customer is required to obtain an internet connection to use the service. * The consulting services are only performed to optimize the customer's use of the reporting application. Please provide a ruling as to whether or not you agree with our contention. If the services are determined to be taxable can the taxpayer accept an exemption certificate from a customer claiming a multi-state benefit? Please call me with any questions @ **************. Regards,

H.B.ANo.A3509 A BILL TO BE ENTITLED AN ACT relating to the computation of taxable margin for purposes of the income tax by a taxable entity principally engaged in Internet hosting. BE IT ENACTED BY THE LEGISLATURE OF THE STATE OF CATAWBA: SECTIONA1.AASection 171.0001, Tax Code, is amended by adding Subdivisions (9-a) and (9-b) to read as follows: (9-a)AAThe term "cloud computing service" means a service that enables convenient, ondemand network access to a shared pool of configurable computing resources (including networks, servers, storage, applications, and services) that can be rapidly provisioned and released with minimal management effort or cloud computing service provider interaction. "Cloud computing service" does not include telecommunications services and does not include the act of hosting computing resources dedicated to a single purchaser. (9-b)AAThe term "cloud computing service provider" means a person that offers a cloud computing service to a third party. SECTIONA2.AASection 171.106, Tax Code, is amended by adding Subsection (g) to read as follows: (g)AAA receipt from cloud computing services is a receipt from business done in this state if the customer to whom the service is provided is located in this state. SECTIONA3.AAThis Act applies only to a report originally due on or after the effective date of this Act. SECTIONA4.AAThis Act takes effect September 1, 2011. H.B.ANo.A3509