During the audit, the Department found instances where Taxpayer had purchased software "maintenance agreements" without paying sales tax at the time of purchase, and assessed used tax on the purchases.
Taxpayer maintains that since the software "maintenance agreements" do not contain a provision which guaranteed that Taxpayer would automatically receive software updates and upgrades, the software "maintenance agreements" are not subject to Indiana sales/use tax.
…
A timeline of the history of various warranties, maintenance contracts, and the Department's interpretations governing those agreements is useful. In 2002, the Department published Sales Tax Information Bulletin 2 (May 2002). Under this information bulletin, software maintenance agreements and other tangible personal property warranties were generally presumed not to be subject to tax. This was consistent with pre-2002 Department practice and remained the Department's policy until August 2006.
In August 2006, the Department issued Letter of Findings 05-0438. This Letter of Findings reversed the Department's historical position on software maintenance agreements, but on a going-forward basis. Thus, effective in August 2006, the Department's stance was that software maintenance agreements were presumed to provide tangible personal property and thus taxable unless the taxpayer provided evidence to the contrary. However, for maintenance agreements and warranties for other tangible personal property, these agreements still were presumed not to be subject to tax.
During the intervening months from August 2006 to December 2006, the Department reversed its historical position on all maintenance contracts and warranties and concluded that such contracts were presumed to be subject to tax. To reflect the revised presumptive treatment, the Department issued Sales Tax Information Bulletin 2 (December 2006). Sales Tax Information Bulletin 2 (December 2006) was published on the Department's own internet site but was not published in the Indiana Register. The lack of publication in the Indiana Register was not discovered until the summer of 2010.
The effect of not publishing Sales Tax Information Bulletin 2 (December 2006) was that the Department's position from August 2006 was unchanged until proper publication of Sales Tax Information Bulletin 2 (December 2006) in August 2010. Thus, from December 2006 to August 2010, the Department's stance was unchanged from the August 2006 stance because the Department had not published the revised stance.
Nevertheless, the Department assessed the taxpayers in Letter of Findings 04-20100606 and Letter of Findings 04-20100311 as if Sales Tax Information Bulletin 2 (December 2006) had been properly published. These Letters of Findings reflected the Department's interpretation as of August 2006, in which the Department had not extended the reasoning of Letter of Findings 05-0438 beyond software maintenance agreements. However, the taxability of software maintenance agreements remained a narrow exception to the presumed nontaxability of other tangible personal property maintenance agreements. Taxpayer's case involves software maintenance agreements, not other tangible personal property.
…
Taxpayer makes the general assertion that certain of its purchases that are used in its "kitting" activities are not subject to use tax because the purchases would qualify for the manufacturing equipment exemption under IC § 6-2.5-5-3. Taxpayer further maintains that in the situations where it does not purchase the cell phones and accessories it uses in the "kitting" activities, Taxpayer qualifies for the manufacturing exemption as an industrial processor as found in 45 IAC 2.2-5-10.
…
As to the substance of Taxpayer's protest, the Department's regulations emphasize that the tangible personal property that are the "raw materials" of a manufacturing/processing/refining process must be substantially changed in their "form, composition, or character" such that the resulting tangible personal property is a different product having a distinctive "name, character, and use." The resulting product must be substantially different from the component materials used.
…
Based upon the documentation submitted, Taxpayer does not perform operations on the property that cause a "substantial change" in "form, composition, or character" to the component materials it used. While the Department recognizes that the cell phones undergo some changes–particularly the addition of software to cell phones and the assembly of cell phones from component parts–Taxpayer's process itself does not result in an end product "substantially different" from the original component products necessary to permit tax exemption. Thus, Taxpayer's "kitting" activities constitute the performance of a service that does not constitute the "substantial change" in "form, composition, or character" as contemplated by statute or regulation. Therefore, Taxpayer's protest to the imposition of use tax on its purchases involved in its "kitting" activities is denied.
