Taxpayer is a business which conducts business in Indiana
and outside Indiana. Taxpayer supplies its customers with telephone, computer
software, and information services. Taxpayer is registered for sales tax and
withholding tax.
The Indiana Department of Revenue ("Department")
conducted an audit review of Taxpayer's business records. The audit resulted in
the assessment of additional sales/use tax.
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Taxpayer argues that it should be given credit for the
amount of tax paid on five invoices. The invoices were issued by Business
Furniture LLC and CDW Computer Center ("CDW"). Taxpayer explains that
the "sole purpose of these purchases was to acquire tangible personal
property that was to be solely used outside Indiana." In support of its
contention that the five invoices were not subject to tax, Taxpayer cites to IC
§ 6-2.5-3-2(e) which states:
(e) Notwithstanding any other provision of this section, the
use tax is not imposed on the keeping, retaining, or exercising of any right or
power over tangible personal property, if:
(1) the property is delivered into Indiana by or for the
purchaser of the property;
(2) the property is delivered in Indiana for the sole
purpose of being processed, printed, fabricated, or manufactured into, attached
to, or incorporated into other tangible personal property; and
(3) the property is subsequently transported out of state
for use solely outside Indiana.
Taxpayer is correct in part. IC § 6-2.5-3-2(e) provides a
"temporary storage" exemption from use tax when the tangible personal
property is purchased from an out-of-state vendor, shipped to an Indiana
location, but then subsequently "transported out of state for use solely
outside Indiana."
In the case of its purchases from Business Furniture LLC,
Taxpayer was assessed tax on purchases from this Indiana vendor which were
either shipped or delivered to Taxpayer's Indiana facility but then later sent
to out-of-state locations. Taxpayer predicates its protest on IC § 6-2.5-3-2(e)
arguing that its temporary storage of personal property in Indiana did not give
rise to a taxable exercise of ownership because Taxpayer's personal property –
bought from Business Furniture LLC – was temporarily retained in Indiana for
subsequent use outside of Indiana. As a result, Taxpayer argues, the items were
exempt under IC § 6-2.5-3-2(e).
Taxpayer operates from an incorrect premise. The items
Taxpayer purchased from Business Furniture LLC were subject to sales tax and
sales tax was properly paid; however, the exemption Taxpayer seeks is
inapplicable to items bought from an Indiana vendor, temporarily stored in
Indiana, and then shipped to out-of-state locations. IC § 6-2.5-3-2(e) is
inapplicable under Taxpayer's circumstances because there is no "temporary
storage" exemption for sales tax.
Taxpayer purchased items from a company called CDW which is
a company located in Illinois. Taxpayer explains that the items were not
subject to tax because the "temporary storage exemption" operates to
exempt the transactions and because the items were destined for a location in
New Jersey. In support of that contention, Taxpayer points to its underlying
company purchase order. The following notation is found at the bottom of the
purchase order:
PO Comments
1401 SV HUS
3755X & New Jersey DC
[Individual Name]
Taxpayer maintains that the notation "3755X & New
Jersey DC" is sufficient to establish that the items purchased from CDW
were destined for a New Jersey location. The Department must disagree with
Taxpayer's assertion because the notation is ambiguous. Other than the
notation, Taxpayer has provided nothing which establishes that the tangible
personal property was shipped to and used at one of Taxpayer's out-of-state
locations. Under Indiana law IC § 6-8.1-5-1(c) imposes upon a taxpayer the
burden of establishing that the proposed assessment is wrong; the purchase
order notation is insufficient to meet that burden.
Taxpayer was assessed tax on the sale of software to a
financial institution. Taxpayer maintains that the software was eventually
resold to a third-party which presented the financial institution an exemption
certificate. The exemption certificate asserts that the transaction between the
financial institution and the third-party is exempt because the third-party
will again resell the software back to the financial institution. Taxpayer
believes that the transaction between itself and the financial institution
should, therefore, be exempt.
Under IC § 6-2.5-8-8(a), "A person... who makes a
purchase in a transaction which is exempt from the state gross retail tax and
use taxes, may issue an exemption certificate to the seller instead of paying
the tax." Once the purchaser provides the exemption certificate, the
retail merchant is under no obligation to collect sales tax on the transaction.
IC § 6-2.5-8-8(a) states that, "A seller accepting a proper exemption
certificate under this section has no duty to collect or remit the state gross
retail or use tax on that purchase."
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Taxpayer relies on the exemption certificate which purports
to establish that third-party could purchase from financial institution the
computer software for purposes of reselling the software back to financial
institution. Taxpayer argues that this documentation is sufficient to establish
that its sale of the software to financial institution is exempt because the
financial institution intended to resell the software. Specifically, Taxpayer
explains that its "sale was to [third-party] and not [financial
institution] and [third-party] resold or leases the software to [financial
institution].
The circular transaction – Taxpayer to financial institution
to third-party to financial institution – notwithstanding, the original
transaction at issue was between Taxpayer and financial institution. Was
Taxpayer entitled to rely on the nature of the down-stream transactions to
overcome its responsibility to collect sales tax from financial institution? IC
§ 6-2.5-2-1(b) imposes on retail merchants – in this case Taxpayer – the
responsibility to collect sales tax as "an agent for the state."
Without an exemption certificate from the entity which purchased the software,
Taxpayer was obligated to collect and remit the tax.
The audit assessed sales tax on the price Taxpayer paid to a
company here designated as "Vendor I". Taxpayer disagrees with the
assessment on three different grounds. Taxpayer first argues a different entity
will ultimately pay use tax on these same transactions. Taxpayer explains that
it has "provided unequivocal proof" that any Indiana sales tax due on
invoices issued by "Vendor I" from 2008 through 2010 will be paid to
the Department through an audit of "Vendor I".
In addition, Taxpayer argues that the price it paid to
"Vendor I" does not represent the purchase of tangible personal
property. Taxpayer explains:
[Taxpayer] has engaged [Vendor I] to provide Infrastructure
as a Service. [Taxpayer] purchases processing storage, networks, and other
fundamental computing resources from [Vendor I]. This is to enable [Taxpayer]
to increase/decrease our IT needs as our company grows. [Taxpayer does] not
receive any physical property from [Vendor I]. The master service agreement and
the invoices are attached for our review. We do not receive any tangible
personal property from [Vendor I]. We do not have any software licenses with
[Vendor I]. Since we do not believe the invoices from [Vendor I] should be
subject to sales/use tax.
Taxpayer makes a third argument related to the nature of the
transaction between itself and "Vendor I" by which Taxpayer acquired
pre-written software. Taxpayer argues that the price it paid allows it to
access the pre-written software by means of "cloud computing" and
that the pre-written software is therefore not subject to tax.
The first issue is whether Taxpayer can avoid the assessment
on the ground that a different, unrelated entity may be subject to tax on the same
transactions. As noted above, Indiana imposes an excise tax called "the
state gross retail tax" on retail transactions made in Indiana. IC §
6-2.5-2-1(a). An entity such as Taxpayer which acquires property in a retail
transaction is liable for the sales tax on the transaction. IC § 6-2.5-2-1(b).
Indiana law does not contain a provision which enables a purchaser of tangible
personal property to avoid tax on retail transactions on the ground that the
same tangible personal property might be taxed in either an upstream or
downstream transaction. If Taxpayer engaged in a taxable transaction under the
sales/use tax regime, Taxpayer is presumptively subject to the tax.
Taxpayer's secondary argument is that it engaged
"Vendor I" to provide exempt services. As noted immediately above, IC
§ 6-2.5-2-1(a) imposes sales tax on retail transactions made in Indiana. IC §
6-2.5-1-2 defines a retail transaction as "a transaction of a retail
merchant that constitutes selling at retail as described in IC § 6-2.5-4-1...
or that is described in any other section of IC § 6-2.5-4." IC §
6-2.5-4-1(a) provides that "[a] person is a retail merchant making a
retail transaction when he engages in selling at retail." IC §
6-2.5-4-1(b) further explains that a person sells at retail when he "(1)
acquires tangible personal property for the purpose of resale; and (2)
transfers that property to another person for consideration." As Taxpayer
correctly concludes, if the subject transaction does not involve the
acquisition of tangible personal property, the transaction is not subject to
sales tax because there is no "retail transaction."
Taxpayer has provided copies of its "Master Service
Agreement" with "Vendor I" and the invoices it received from
"Vendor I". Taxpayer is correct in that its business relationship
with "Vendor I" does require "Vendor I" to provide services
to Taxpayer. The "Master Service Agreement" states that,
"[Vendor I] agrees to provide the services as provided for in and subject
of the Agreement...." However, the invoices establish that "Vendor
I" is also selling Taxpayer tangible personal property such as cabinets,
computer servers, and computer software.
The Department agrees with Taxpayer to the extent that
"Vendor I" is selling Taxpayer exempt services. However, the Department
is unable to agree with Taxpayer's assertion that "We do not receive any
tangible personal property from [Vendor I]." A cursory review indicates
that Taxpayer bought and paid for such items as a "processing node,"
"Microsoft server," "cabinet," "MS Basic DR,"
"External WAN switch port," "2x4 Core Processor,"
Colocation Cabinet," and "Microsoft Virtual Machine." These
items represent taxable tangible personal property subject to the sales tax. As
provided in IC § 6-2.5-1-27:
"Tangible personal property" means personal
property that: (1) can be seen, weighed, measured, felt, or touched; or (2) is
in any other manner perceptible to the senses. The term includes electricity,
water, gas, steam, and prewritten computer software.
However the "Vendor I" invoices also contain
separately stated specific costs for items which are clearly
"services" such as "storage," "24x7 support," and
"Managed Services." The audit division is requested to review the
"Vendor I" invoices and remove from the assessment those amounts
clearly attributable to Taxpayer's acquisition of exempt services.
The third argument is that the pre-written software is
accessed by means of "cloud computing" and that its purchase from
"Vendor I" of the software is therefore exempt. Taxpayer explains
that "cloud computing is a model for enabling ubiquitous, convenient,
on-demand network access to a share pool of configurable resources.... that can
be rapidly provisioned and released with minimal management effort or service
provider interaction."
"Cloud computing" is defined as, "[A] type of
computing based on sharing computing resources rather than having local servers
or personal devices to handle applications." Dictionary.com's 21st Century
Lexicon, http://dictionary.reference.com/browse/cloud+computing (last visited
December 09, 2012). Taxpayer explains that "any tangible personal
property... which is necessary to providing prewritten computer software via
"cloud computing" should be excluded from Indiana sales tax."
Taxpayer also believes that tangible personal property acquired by means of
"cloud computing" services for its customers is exempt pursuant to IC
§ 6-2.5-5-3(b) which provides:
Except as provided in subsection (c), transactions involving
manufacturing machinery, tools, and equipment are exempt from the state gross
retail tax if the person acquiring that property acquires it for direct use in
the direct production, manufacture, fabrication, assembly, extraction, mining,
processing, refining, or finishing of other tangible personal property.
Taxpayer's third argument is somewhat unclear but – for
purposes of this Letter of Findings – the Department will assume that Taxpayer
does not believe the pre-written software is subject to sales tax because it
does not acquire possession of the software. IC § 6-2.5-4-1 defines
"retail transactions" as follows:
(a) A person is a retail merchant making a retail
transaction when he engages in selling at retail.
(b) A person is engaged in selling at retail when, in the
ordinary course of his regularly conducted trade or business, he:
(1) acquires tangible personal property for the purpose of
resale; and
(2) transfers that property to another person for
consideration.
(c) For purposes of determining what constitutes selling at
retail, it does not matter whether:
(1) the property is transferred in the same form as when it
was acquired;
(2) the property is transferred alone or in conjunction with
other property or services; or
(3) the property is transferred conditionally or otherwise.
Taxpayer purchased "canned" computer software such
as "Microsoft Virtual Machine" from Vendor I. If the computer program
was conveyed on a physical medium such as a disk, then it would clearly
constitute tangible personal property regardless of whether it could have been
conveyed by other means. The fact that the software can be transferred by means
of various media, i.e., from tape to disk, or tape to hard drive, or even that
it can be transferred over the Internet, does not take away from the fact that
the software is recorded and stored in physical form upon a physical object. As
the purchaser and user of canned computer software, Taxpayer is acquiring more
than insubstantial knowledge or an intangible right; rather, Taxpayer is
acquiring an electronic copy of a computer program that is stored on hardware,
takes up space on a hard drive, and can be physically perceived by checking the
computer's files for its absence or presence. The software remains on the
computer and operates a program each time it is used. The Department is unable
to agree with the Taxpayer's argument that the location of this software rather
than its deemed acquisition and ultimate use determines the tax consequences of
a transaction in which Taxpayer acquired an ownership interest in the canned
software. Presumably, the software is accessed by means of the "Cloud
computing" because it facilitates the functions performed by "Vendor
I". However, that does not change the fact that Taxpayer bought and paid
for canned software and that the mere invocation of "cloud computing"
does not necessarily serve as a password or catch phrase which determines
substantive tax consequences.
Taxpayer also suggests that the canned software and tangible
personal property are exempt because these items are directly used in the
direct production of tangible personal property pursuant to 45 IAC
2.2-5-8(b) which states in relevant part:
The state gross retail tax does not apply to sales of
manufacturing machinery, tools, and equipment to be directly used by the
purchaser in the direct production, manufacture, fabrication, assembly, or
finishing of tangible personal property.
In the case of the canned software and tangible personal
property acquired from "Vendor I", the argument is not well
developed; Taxpayer has not provided information which establishes that
Taxpayer uses the property for "direct use in the direct production,
manufacture, fabrication, assembly, extraction, mining, processing, refining,
or finishing of other tangible personal property."
Taxpayer purchased computer software and hardware including
servers. Taxpayer states that it uses these items to provide services to its
customers. Taxpayer explains that, "The software is installed and then
integrated into the server[s] in order to be accessed by customers through the
cloud."
To that end, Taxpayer provided sample customer agreements
along with sample customer invoices. The documentation establishes that
Taxpayer provides a myriad of services to its customers. Taxpayer assists its
customers in developing automated phone menus, developing efficient means by
which to route incoming phone calls to the appropriate phone attendant or
service provider, developing phone "trees," developing supervisory
functions, and providing training to its customers employees.
Taxpayer argues that its purchases of "Computer
Hardware, Software and related maintenance [equipment] used in providing
[Software as a Service]" should be exempt under IC § 6-2.5-5-3(b). That
provision states:
Except as provided in subsection (c), transactions involving
manufacturing machinery, tools, and equipment are exempt from the state gross
retail tax if the person acquiring that property acquires it for direct use in
the direct production, manufacture, fabrication, assembly, extraction, mining,
processing, refining, or finishing of other tangible personal property.
The Department's regulation restates the general principle
but reinforces a distinctive caveat. 45 IAC
2.2-5-8 provides:
(a) In general, all purchases of tangible personal property
by persons engaged in the direct production, manufacture, fabrication,
assembly, or finishing of tangible personal property are taxable. The exemption
provided in this regulation extends only to manufacturing machinery, tools, and
equipment directly used by the purchaser in direct production. It does not
apply to material consumed in production or to materials incorporated into
tangible personal property produced.
(b) The state gross retail tax does not apply to sales of
manufacturing machinery, tools, and equipment to be directly used by the
purchaser in the direct production, manufacture, fabrication, assembly, or
finishing of tangible personal property.
(c) The state gross retail tax does not apply to purchases
of manufacturing machinery, tools, and equipment to be directly used by the
purchaser in the production process provided that such machinery, tools, and
equipment are directly used in the production process; i.e., they have an
immediate effect on the article being produced. Property has an immediate effect
on the article being produced if it is an essential and integral part of an
integrated process which produces tangible personal property. (Emphasis added).
The regulation sets out the requirement that in order to
claim the exemption, the machinery, tools, and equipment must be directly
involved in the production of "tangible personal property." As the
Tax Court explained in Mechanics Laundry & Supply v. Dept. of Revenue, 650
N.E.2d 1223, 1228 (Ind. Tax Ct. 1995), "Without the production of goods
or, to use the language of the statute, 'other tangible personal property,' the
equipment exemption does not apply." (See also Indianapolis Fruit v. Dept.
of State Revenue, 691 N.E.2d 1379, 1384 (Ind. Tax Ct. 1998), "[T]here is
one iron-clad rule: without production there can be no exemption.").
Other than the assertion that Taxpayer produces
"software offerings" for its customers, there is insufficient
information to establish that Taxpayer's own software or servers are have
"an immediate effect" on the software Taxpayer provides its
customers.
Although agreeing with the basic premise that the computer
software constitutes "tangible personal property" under the sales tax
regime, the Department is unable to agree that either Taxpayer's software or
servers have an active and direct effect on the software Taxpayer presumably
provides its customers. (A "server" is simply a device "that
manages centralized data storage or net communications resources." The
American Heritage Science Dictionary, http://dictionary.reference.com/browse/server
(last visited December 09, 2012)). Taxpayer provides its customers various
services, and the exemption to which Taxpayer resorts requires the production
of tangible personal property. Taxpayer has not met its burden under IC §
6-8.1-5-1(c) of establishing that the original assessment was wrong.
