Michigan Department of Treasury Issued a Draft RAB on "Single Mixed Transactions" and "Bundled Transactions"
Companies are changing the way they do business. The internet and software developers are opening up new opportunities for storage and processing of data in the internet. The generic name is "cloud computing".
First taxing authorities and now politicians in Michigan are grappling with the issue of whether "cloud computing" should be subject to either the sales tax or use tax. Cloud computing, also called "software as a service," takes place on virtual servers over the Internet. In all cases software is used in the performance of some sort of service whether it is merely storage or processing of files. Cloud computing has gained credibility as an efficient and viable means of doing business as an increasing number of businesses have moved their operations to the cloud.
The Michigan Senate has passed legislation (SB 335 and SB 336) which, if enacted, would exempt from the Michigan sales tax and use tax, "prewritten computer software installed on another person's server". The two bills are stalled in the Michigan House where both the Department of Treasury and the Snyder administration have reservations.
Prewritten computer software is used in "cloud computing" as a gateway for access to storage or processing of data. Whether the transaction is the sale of a service (storage or processing of data) or the sale of software is a determination based on a factual finding of the essence of the transaction. If Senate Bills 335 and 336 were to pass, it would solve only part of the problem.
The Michigan Department of Treasury is currently debating whether companies that sell software and data accessed through the cloud are peddling a taxable good or a nontaxable service. In an audit, factors to be considered in determining taxability can include whether a license of software is granted by the agreement, how pricing is structured under the agreement, the location of the server, and to what extent the service or software is accessed from a point within state or in multiple states. Also relevant is whether the service provider has a taxable presence in the state where the customer accesses the application, and whether the customer has a taxable presence where the servers running the application are located.
The Department of Treasury has promulgated a draft Revenue Administrative Bulletin (RAB) on the taxation of "single mixed transactions" and "bundled transactions". The draft RAB proposes using the Michigan Supreme Court "incidental to service test" and consideration of six factors to determine if the transaction is the sale of a service or the sale of tangible personal property. (Catalina Marketing Sales Corporation v. Department of Treasury, Michigan Supreme Court #121673 and #121674)
In Catalina, the Supreme Court adopts the "incidental to service" test for categorizing a business relationship that involves both the provision of services and the transfer of tangible personal property as either a service or a tangible property transaction. Under this test, "sales tax will not apply to transactions where the rendering of a service is the object of the transaction, even though tangible personal property is exchanged incidentally." (85 CJS 2d, Taxation, § 2018, p 976) The "incidental to service" test looks objectively at the entire transaction to determine whether the transaction is principally a transfer of tangible personal property or a provision of a service. The sales tax is a tax on sellers for the privilege of engaging in the business of retail sales. If the consideration paid in a transaction is not paid for the transfer of the tangible property, but for the service provided, and the transfer of the tangible property is only incidental to the service provided, the transaction is not a sale at retail under MCL 205.51(b).
The court must objectively examine the totality of the transaction in determining whether it is subject to sales tax. When tangible goods or items are provided in conjunction with services, courts examine the totality of the transaction to determine its taxability. The essence of the transaction test specifically applies to those sales tax cases in which it is initially unclear whether the transaction mixes sales and services. For purposes of determining whether a transaction falls within a sales tax statute, the court considers whether the tangible personal property exclusively as the medium of transmission for an intangible product or service; if the intangible component is the true object of the sale, the intangible object does not assume the taxable character of a tangible medium. Where the item is the substance of the transaction, and the service or skill provided is merely incidental, the transaction is one for tangible personal property, to which sales tax may be applied. The focus belongs on the transaction, not the character of the participants. (68 Am Jur 2d, Sales and Use Taxes, § 62 pp 51-52)
In determining whether the transfer of tangible property was incidental to the rendering of personal or professional services, a court should examine (1) what the buyer sought as the object of the transaction, (2) what the seller or service provider is in the business of doing, (3) whether the goods were provided as a retail enterprise with a profit-making motive, (4) whether the tangible goods were available for sale without the service, (5) the extent to which intangible services have contributed to the value of the physical item that is transferred, and (6) any other factors relevant to the particular transaction.