The Tennessee Department of Revenue recently issued Letter Ruling No. 23-07, which addresses questions about how sales tax could apply to online courses and related items. The Ruling is a valuable reminder of the sales tax issues for SaaS companies and others who sell a good or service through access to a web-based platform.
You or your client’s business could face a wide range of sales tax outcomes because of the potential variance in state rules and their enforcement of remotely accessed software. Below, we discuss:
- How computer software and SaaS-like products are taxed in Tennessee,
- The outcomes in the recent Letter Ruling No. 23-07,
- The comparison between Tennessee’s position on taxing computer software and other states, illustrating the multi-state sales tax challenges you may face in your business.
How Tennessee Sales Tax Applies to Computer Software and Related Purchases
Tennessee broadly taxes the sale, lease, license, and use of computer software to customers located in the state under Code Section 67-6-231. This section further explains that the “use of computer software” includes access and use where the seller retains possession. Additionally, sellers can proportionally allocate the purchase price of the software for sales tax purposes when it relates to users located outside of Tennessee. Subsection (b) also expressly states that this rule for sales tax on computer software does not impose a tax on services, such as the following:
- Information or data processing services
- Payment or transaction processing services
- Payroll processing services
- Billing and collection services
- Internet access
- Storage for data, digital codes, or computer software
- Conversion, management, or distribution of digital product services
Tennessee Letter Ruling 10-14: Sales Tax on Items Packaged with Taxable Computer Software
Many computer software transactions are not standalone transactions and often include additional items. These “bundled” transactions can create varying outcomes depending on the taxability of each item, their separability from the other items, and how you invoice (i.e., itemized or not). The Tennessee Department of Revenue explains this concept in the context of computer software in greater detail in Letter Ruling No. 14-10.
If one item is taxable in a bundled transaction and items are not itemized on the invoice, then the entire sales price is generally subject to Tennessee sales tax under Section 67-6-102(87)(vi). Tennessee also applies the “true object” test in complex cases of bundled transactions where items are taxable and exempt, but do not lend themselves to simple classification. Under this test, the Department of Revenue or court will look to the transaction’s true object. If the transaction’s true object is independently taxable, then all other essential and integral parts of the transaction are also taxable.
What the Tennessee Department of Revenue Says About the Taxability of Online Courses in Letter Ruling No. 23-07
In Letter Ruling No. 23-07, the Tennessee Department of Revenue was asked to determine the taxability of various education products for an online school. Specifically, the school provided courses for people seeking real estate licenses in Tennessee and had four items for which it sought sales tax clarity:
1. An Online Real Estate Licensing Course
Customers pay a one-time, non-itemized fee to access this online licensing course hosted through the school’s website. The course includes audio lectures, written transcripts, chapter quizzes, and a final exam. The school also grades these quizzes and exams and issues a certificate of completion. The Tennessee Department of Revenue ruled the online licensing course was taxable as the sale of remotely accessed computer software under Section 67-6-231. The Department reasoned it was comparable to prepackaged software accessed through a tangible medium, such as a DVD or compact disk.
2. A Course Textbook
The school provided a course textbook that customers could download as a PDF after payment of a one-time fee. The Department ruled the course textbook was not taxable under Sections 67-6-329(a)(3) and (d) as a textbook delivered as a digital good equivalent to its tangible form.
3. An Exam Guide Course
The exam guide course contains text-based lessons and practice exams that customers would also access through the seller’s website after payment of a one-time fee. The Department determined this product was also taxable as remotely accessed computer software. The Letter Ruling noted the course included items that would not be taxable on their own, such as instructor feedback and membership in a social media group, but that these elements were incidental to the course under the true object test.
4. A Mortgage Loan Origination Course
The seller also asked about the taxability of a future course it planned to offer for mortgage loan origination. Similar to its other online courses, it would feature access to instructor hours and access to text-based materials including chapter quizzes and final exams. The seller noted this course may include a live instruction portion that could also be accessed online. Broadly speaking, the Department stated this course would be subject to tax as computer software, but the live instruction could possibly be nontaxable since it is not a taxable service listed under Section 67-6-205. This would require proof that the live instruction could be a separately sold product from the rest of the course. Otherwise, it would become taxable under Section 67-6-102(87)(A)(iii) as services necessary to complete the true object of the sale according to the Department.
What Is the Authority of a Letter Ruling in Tennessee?
Letter Rulings from the Tennessee Department of Revenue have a unique authority for taxpayers. Technically, the Department’s ruling only applies to the taxpayer that made the request, assuming the facts are correctly stated. While Letter Rulings do not directly extend to other taxpayers with similar facts, they do provide insight into how the Tennessee Department of Revenue could decide on future tax decisions related to you, such as during an audit or assessment.
It’s also important to note that the interpretations and determinations in a Letter Ruling could change in the future. For example, the Commissioner of the Department of Revenue could revoke the ruling or the Tennessee court system could overturn it while hearing an appealed sales tax dispute.
How Other States Tax the Sale of Remotely Accessed Software
Remotely accessed software continues to be a divisive subject for sales tax purposes with some states taxing these products and other states carving an exemption. For example, states like Colorado and Mississippi exclude remotely accessed or electronically delivered software from tax because there is no transfer of tangible personal property. Other states take a position similar to Tennessee by taxing remotely accessed or transferred software, including Arizona and Pennsylvania.[3] [4]
Get Help with SaaS and Computer Software Sales Tax Issues
As web-based applications and remote access of software continues to grow, businesses that offer these products are increasingly likely to have multi-state sales tax obligations. If you or your client’s business has concerns about nexus, audit risk, or an assessment appeal, our team of sales tax professionals can help.
Schedule a free consultation today.