Massachusetts Department Of Revenue Issues Letter Ruling Holding Certain On-Line Services Not Subject To Sales Or Use Tax

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On April 12, 2011, the Massachusetts Department of Revenue issued Letter Ruling 11-4 holding that a product providing a customer access to information from a Taxpayer’s database is not subject to sales or use tax where the services provided do not involve transfers of prewritten software or a license to use software on a server hosted by the Taxpayer or a third party.

The Massachusetts Department of Revenue (“DOR”) issued Letter Ruling 11-4 addressing the issue of whether Massachusetts customers of a Taxpayer’s product, which provides employment application collection and selection services through proprietary software, are subject to Massachusetts sales and use tax.  The DOR held that sales of the taxpayer’s products to Massachusetts customers are not subject to the Massachusetts sales and use tax.  Massachusetts imposes a 6.25% sales tax on sales of tangible personal property and telecommunication services within the state including sales of prewritten (canned) software regardless of the method of delivery.  Also, the sale of a license or right to use software on a server hosted by a taxpayer or third party is taxable.  However, where there is no charge for the use of the software and the object of the transaction is acquiring the good or service other than the use of the software, sales or use tax on software does not apply.  See 830 CMR 64H.1.3(14)(a); LR 10-1.  In the instant matter, the provision of information services to customers based on data gathered from prospective employees and provided in a report by a taxpayer to its customers is not subject to tax.  The object of the customer’s purchase of the product is to obtain database access including reports prepared by the taxpayer, rather than use of the software itself.  The taxpayer customers do not have the ability to operate, direct, or control the software.  The DOR concluded that the services provided by the taxpayer do not involve transfers of prewritten software or a license to use software on a server hosted by taxpayer or a third party and therefore are not subject to sales and use tax.

The taxation of on-line services is evolving in many jurisdictions.  Jurisdictions without specific statutory or regulatory authority addressing such services look to existing provisions for information, telecommunication, data processing or software services in attempts to include some on-line services within their scope.  As the above ruling indicates, under existing sales and use tax principles such as true object of the transaction or primary purpose tests such efforts may not succeed.  However, every jurisdiction has is own statutory provisions and tests so one needs to review them in the context of the specific facts relating to the online game or other social media services.