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TN Sales and Use Tax Law Changed for Software Effective in July

September 22, 2015

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Posted by: Peter Marcum

TN Sales and Use Tax Law Changed for Software Effective in July

From the State of Tennessee website:

Generally, if you make retail sales, leases, or rentals in Tennessee of any goods, computer software, warranty contracts, or certain services and amusements, you should register for the sales tax. You, as the retailer, are liable for the tax, but you may collect it from your customers. The sales tax applies to the sales price, which includes the entire amount the customer must pay for the item purchased.

A person must also register to report and pay use tax on purchases of tangible personal property, computer software and specified digital products that they cause to be imported for use in Tennessee. The use tax applies to the purchase price of the imported item, which includes the entire amount the customer must pay for the item. 

As products evolved from physical to virtual, the various state governments have struggled to redefine what gets taxed and when, in regards to software. And now there is a new law in TN that attempts to remove the difficulty in deciding when a software product is taxed.

Previously, the law discussed a product being downloaded onto a customer computer. This is a throwback to the days when a company purchased a program literally in a box with a CD that downloaded the product onto the user computer.  To put it mildly, the law was very confusing. Think QuickBooks downloaded onto your computer versus Cloud QuickBooks where you log onto the software online. There was no real cloud software in the near past, so the old law talked about a download. And there were no SaaS solutions, where nothing is downloaded, and everything is accessed online.

The TN legislature changed the law effective July of 2015. We spent a lot of time and effort on this, as DevDigital at that time was enjoying an audit on all of the above from the Department of Revenue, for a time previous to the new law. There was some spirited discussion between our accountants, LBMC, and the Department representatives. Everything ended up fine for us, but the new law means custom or SaaS software has to be taxed in TN. Depending………Here is what we learned and believe………literally the auditors asked us to tell people about the new law.

If you are located in TN as a software reseller or custom shop, which means you have an office here, or your company is registered in TN, here is a breakdown of what is expected...

First, if you create or sell software and do not have a Sales and Use Tax permit, you need one, and now we have one. (REMEMBER THE WORD USE).

If you have a SaaS product, any clients with a TN address have to be taxed at the state, plus local rate. So, we have gone through all our clients and defined that in our accounting software. However, hosting is exempt, so if it is 75 software and 25 hosting, totaling 100 a month, only 75 is taxable, hosting is NOT TAXED. On our big music SaaS products we store lots of their data, so we will be breaking out some small hosting charge.

If a client for that product is out of state, then you do not have to tax them for TN. We defined this also in our billing one by one.

The same for custom software, if they are in TN, you have to charge tax, and report it to the state. We mainly create custom work, and this for sure has affected us and caused some bills to go up. Hosting is exempt, and some “labor” is exempt. This has led to redoing parts of our billing line items, to separate exempt and not exempt, and more clearly showing that in original contracts and invoices for our work. Old contracts we have to live with.

If the client is out of state, there is no tax. We spent a lot of time on if the client is out of state, but the server is in TN, is it taxable? We have been told that it is not. However, we have friends who are moving their servers out of state, including to North GA. I could write a long paragraph on which states tax custom product and which states do not. We are told that GA does not tax custom software on servers in GA.

Now there is a caveat, where we are creating custom software, but the client is going to resell it, or try and license it as a SaaS product. We have some serious clients in this category; so, we are informing all such clients that if they fill out a certificate for resale, we will not tax them. But we have to have the form filled out, so that we have this certification on file, if needed.

So, we have redefined locations and our billing items to make sure we are doing things right, and this was a fair amount of work for our accounting.

Now for the USE part of SALES AND USE TAX. We are still working on this one. We subscribe to 10-15 services for all kinds of things we need. We are figuring out if those companies are charging us for sales tax in TN, otherwise we are being assessed a USE tax by the state of TN. Most of the time a charge simply appears at the bank, and this has been a lot of work, tracking them all down, and some do change us, we have to find them all, or simply pay. Also, if it was a SaaS product, why would we pay a USE tax previous to July 2015? But we are dutifully going through them all.

Lastly all other purchases, and I mean all. We buy office products online, from several vendors, and have looked up every invoice. If we bought a server or memory or drives online, we are having to show we did or did not pay USE tax on every purchase. Essentially, we have gone through every purchase that has been made in the last three years. Some of those are exempt also, depending. But we have had to do them all and prove it.

So, the last part, if you are a customer and purchase custom software from an out of state vendor, and you are in TN, you owe a USE tax in TN. There is a complicated formula having to do with locations in and out of state that can mitigate some of the tax.

As time goes on, there will be more rulings and explanations on all of the above. This is our understanding, and I promise others can come to a different conclusion on the nuances of the new law, so talk to your accountants. While we do not like all of the paperwork, and do not want to charge more, we realize TN does not have an income tax, and they have to collect money in other ways. And this is complicated for legislators; we have talked to some who are friends and there is confusion. Heck, it’s complicated for us, and we are in the business. I hope this helps some, email me if I can share more details.

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Mark Cleveland

September 24, 2015

This is absolutely fascinating. I will forward to my friends who are in one or more of the potentially impacted forms of business/use/consumer status you've reviewed here. Thank you for putting so much effort into thoughtful communication like this.

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