Sales Tax Treatment of a Computer Sales and Consulting Firm
A recent Advisory Opinion issued by the State Department of Taxation and Finance considered sales and use tax questions raised by a computer sales and consulting firm that sells, installs and maintains computer hardware and software and also provides customer support. (TSB-A-98(73)S, November 5, 1998)
The specific questions posed by STS Systems, Ltd were: 1) whether its point of sale system ("POS") maintenance agreements qualify for exemption under Tax Law 1115(o), which exempts otherwise taxable services that are performed on computer hardware; 2) what criteria are used to determine whether computer software support charges are "reasonable" (if a software maintenance agreement provides for the sale of both taxable and nontaxable elements, the entire charge is taxable unless the separate charge for the nontaxable element is "reasonable"); 3) whether the 'hardware help desk' telephone support services are subject to sales tax; 4) whether charges to customers for reimbursement for travel expenses are subject to sales tax; and 5) whether restocking charges for canceled orders are subject to sales tax.
The guiding principles cited in answer to these questions are as follows: (a) if both taxable and exempt items are included as a lump sum on an invoice, the entire amount is subject to tax; (b) if there is a separately stated charge on the invoice for the nontaxable elements and such charge is reasonable, sales tax does not apply and; and (c) pre-written software is subject to sales tax while software designed and developed to the specifications of a specific purchaser is exempt. Thus, the answers to these questions require examination of the agreements and standard contracts used by the company and an analysis of how STS bills for the goods and services it provides.
The POS maintenance agreement submitted by STS entitles the customer to upgrades and enhancements provided during a specific coverage period. The software upgrades will be considered pre-written software unless designed specifically for the user. To the extent these upgrades and enhancements are tangible personal property, the receipts will be subject to sales and compensating use tax.
Extended maintenance and support services are also available from STS. Extended maintenance is for services provided outside the period or scope of the other maintenance agreement and the related invoices separately state the charge for hardware and software support. Since the exemption found in Tax Law Search7RH1115(o) does not apply to charges for computer hardware support, these upgrades or enhancements are subject to tax. If the amount of the POS maintenance agreement is billed in a lump sum without separately stating the nontaxable items, the entire amount will be subject to tax. If the charges for software support are reasonable and separately stated on the invoice or attachment thereto, the receipts from extended maintenance and repair services performed on computer software are exempt from sales and use taxes.
The Advisory Opinion does not set forth criteria for establishing a "reasonable charge" nor is that term defined in the statute or regulations. However, the Opinion states that if a taxpayer's charges are comparable to standard industry rates for similar services and the balance of the charge for the tangible personal property sold in conjunction with the software support is similarly comparable to industry standards, the charge will be deemed reasonable.
The Opinion analogizes the "hardware help desk" telephone support to other maintenance agreements or service contracts and finds them taxable under Reg. Sec. 527.5(c).
Receipts for reimbursed travel expenses are subject to sales tax provided the receipts from the related services are taxable. Thus, because receipts from hardware support services are taxable (as noted above) reimbursed travel expenses associated with hardware support would be subject to sales tax.
The restocking charge upon cancellation of an order prior to shipment is not subject to sales tax. The Opinion bases this conclusion on the fact that the equipment on order has not entered New York and is not transferred by the seller to its customer and therefore, "no incidence of tax arises."
Observations:The answers set forth in the Advisory Opinion are not particularly surprising, in that they apply longstanding rules to new types of transactions. The mix of hardware and software in the computer industry makes for new and interesting sales and use tax problems under a statute designed in the 1930's and 1940's for an economy based on the manufacture and sale of tangible personal property.
The Advisory Opinion also makes clear the perils taxpayers face when taxable and nontaxable sales are bundled in one invoice. The risk of subjecting the entire amount of the sale to tax -- even though only a small part may be taxable -- is a substantial problem facing many businesses.