After refusing to back down on the issue for years, the Michigan Department of Treasury (Department) issued guidance last week to taxpayers announcing a change in its policy on the sales and use taxation of remotely accessed prewritten computer software. This comes after years of litigating the issue in the Michigan courts, most recently with the precedential taxpayer victory in Auto-Owners Ins. Co. v. Dep’t of Treasury, No. 321505 (Mich. Ct. App. Oct. 27, 2015), in which the Michigan Court of Appeals held that remote access to software did not constitute delivery of tangible personal property. See our prior coverage here. The Department has announced it will apply Auto-Owners (and the numerous other favorable decisions) retroactively and thus allow for refunds for all open tax years. This is a huge victory for taxpayers; however, those that paid the tax (both purchasers and providers alike) must act promptly to coordinate and request a refund prior to the period of limitations expiring.
Implications
In issuing this guidance, the Department specifically adopts the Michigan Court of Appeals interpretation of “delivered by any means” (as required to be considered taxable prewritten computer software). Going forward, the “mere transfer of information and data that was processed using the software of the third-party businesses does not constitute ‘delivery by any means’” and is not prewritten software subject to sales and use tax. See Auto-Owners, at 7. Not only has the Department admitted defeat with respect to the delivery definition, but it also appears to have acquiesced to taxpayers’ arguments with respect to the true object test (or “incidental to services” test in Michigan). This test was first announced by the Michigan Supreme Court in Catalina Marketing, and provides that a court must objectively analyze the entire transaction using six factors and determine whether the transaction is “principally” the transfer of tangible personal property or the transfer of services with a transfer of tangible personal property that is incidental to the service.[1] In last week’s guidance, the Department states that if only a portion of a software program is electronically delivered to a customer, the “incidental to service” test will be applied to determine whether the transaction constitutes the rendition of a nontaxable service rather than the sale of tangible personal property. However, if a software program is electronically downloaded in its entirety, it remains taxable. This guidance comes in the wake of Department and the taxpayer in Thomson Reuters, Inc. v. Dep’t of Treasury stipulating to the dismissal of a Supreme Court case involving the same issues that had been appealed by the Department. In light of these developments, it appears that the Department has given up all ongoing litigation over cloud services.
Immediate Action Required for Refunds
Taxpayers who paid sales or use tax on cloud based services are entitled to receive a refund for all open periods. In Michigan, the period of limitations for filing a refund is four (4) years after the filing deadline of the original return (including extensions). See Mich. Comp. Laws Ann. § 205.30 (citing Mich. Comp. Laws Ann. § 205.27a). Because sales and use tax returns are filed periodically, typically monthly, taxpayers should act quickly to avoid missing out on a portion of their refund.[2] The Department states that a taxpayer seeking a refund of taxes paid for a product falling within the Auto-Owners opinion should file a written refund request with the Department, which should include any necessary supporting documentation. The guidance sets forth the requirements and procedure for filing a refund claim, including the address to send the claim to and return requirements.
Vendors who collected the tax from customers will need to carefully review the requirements in Michigan about customer reimbursement to determine what must be done (such as notify customers, etc.) to satisfy the state refund procedures. Customers who paid tax to vendors on these purchases must notify the vendors (not the Department) that they are owed a refund from the vendor. Specifically, Michigan statutorily provides that a cause of action against a seller for overcollected sales or use taxes does not accrue until a purchaser has provided written notice, including sufficient information to determine the validity of the request, to a seller and has given the seller 60 days to respond. See Mich. Comp. Laws Ann. §§ 205.60(2), 205.101(3). This statutory requirement will force purchasers of cloud-based services to dig deep in their records—as far back as 2012—for documentation that sales tax was paid on the transactions (and collected and paid to the state by whom) and require vendors to promptly respond to customer requests.
Practice Note
While this guidance represents a monumental victory in Michigan, we are wary that the Department may pursue alternative avenues to tax remotely accessed software in the future, such as through the Legislature. With Michigan starting its 2016 session yesterday, companion exemption bills that were introduced (but not passed) in 2015 will be carried over and are likely to be reconsidered. There have been discussions that the Department may seek an imposition through the Legislature, so vendors should monitor the 2016 session carefully.
[1] See Catalina Marketing Sales Corp. v. Dept. of Treasury. 678 N.W.2d 619 (Mich. 2004) (identifying six factors to consider when making this determination that include: (1) what the buyer sought as the object of the transaction; (2) what the seller or service provider is in the business of doing; (3) whether the goods were provided as a retail enterprise with a profit-making motive; (4) whether the tangible goods were available for sale without the service; (5) the extent to which intangible services have contributed to the value of the physical item that is transferred; and (6) any other factors relevant to the particular transaction).
[2] In Michigan, taxpayers with annual sales, use and withholding tax due of less than $750 file annually; taxpayers with between $750 and $3,600 annual tax due for the year of the same taxes file quarterly; and taxpayers with over $3,600 annual tax due for the same taxes file monthly—with the return due on the 20th of the following month.
