Indiana to clarify sales tax status of software as a service in 2019

Update 6.18.2018: SB 257 has been enacted. Effective July 1, 2018, Indiana sales tax applies to the sale, rental, lease, or licensing for consideration the right to use prewritten compuer software delivered electronically.

However, the purchase, rental, lease, or licensing of the right to remotely access prewritten computer software over the internet, over private or public networks, or through wireless media is not considered to be a transaction in which prewritten computer software is delivered electronically, and does not consititute a retail transaction.

Does Indiana sales tax apply to sales of software as a service? In general, tax law tends to evolve more slowly than technology. And despite the state’s repeated efforts to clarify how cloud computing services are taxed, much uncertainty remains.

With any luck, that will soon change. In his 2018 State of the State address, Governor Eric Holcomb said, “With your help, we’re clarifying the sales tax exempt status of software as a service in 2019.”

Past efforts to clarify tax policy

In late 2016, the Indiana Department of Revenue determined that sales of certain electronically transferred products (e.g., books, music, videos), prewritten computer software, and software purchased to be stored in a tangible medium were taxable.

About Software as a Service (SaaS), Platform as a Service (PaaS), and Infrastructure as a Service (IaaS), the department was much less clear. It declared SaaS “may or may not be subject to tax”; the taxability of PaaS “depends on the nature of the software rights”; and IaaS transactions were sometimes taxable and sometimes exempt.

A few months later, in March 2017, the department made another determination that confused as much as it clarified: “While the cloud-based software does not subject Company’s mobile messaging service to Indiana sales and use tax, the fact that the service is a ‘telecommunication service’ does subject the service to Indiana sales and use tax.”

Opinion on the issue is divided in Indiana. While some want the tax revenue from taxing these services, others feel there are greater benefits to exempting these sales. Gov. Holcomb is of the latter opinion. He pointed out in his state address that 29 states already exempt sales of software services, and stressed that exempting software as a service is “critical to our ability to continue to recruit … dynamic companies.”

Governors don’t always get what they want, but legislation seeking to exempt remotely accessed prewritten computer software has already been introduced.

Clarification forthcoming

According to the Senate Bill 257’s fiscal note, current law doesn’t address the taxability of software remotely accessed via the internet, “either using a hosted computer or server or cloud computing.” Under SB 257, tax would continue to apply to sales of prewritten computer software that is either:

• Delivered electronically (downloaded), or
• Remotely accessed but also available in a physical medium or delivered electronically.

However, the measure would exempt sales of prewritten computer software that is:

• Remotely accessed, or
  
• Remotely accessed but also available in a physical medium or delivered electronically, if the software is provided exclusively in connection with a service and is an essential part of that service.
  

The Indiana Department of Revenue estimates the state would have lost at least $5 million in FY 2018 had the proposed policy been in place at that time.

The taxability of cloud computing services: a vexing problem

Many states struggle with the taxability of software as a service. Their sales tax laws were written to account for tangibles, not intangibles — sales of most services are still exempt in most states. Bloomberg BNA calls the taxability of cloud computing services a “vexing” problem for states and notes, “states’ classifications and sourcing of cloud transactions are not always consistent.”

Cloud computing services such as those offered by Avalara help facilitate sales and use tax compliance in all states. https://www.avalara.com/us/en/learn/sales-tax.html