Arizona Appeals Court Re-Affirms State Position on Remote Software Licensing

The Arizona Court of Appeals ruled in favor of the Department of Revenue, rejecting a refund request from an HR software company that challenged the taxation of their sales of software licenses. In line with prior decisions published by the state, the court rejected the taxpayer’s view that their software did not qualify as tangible personal property, and re-affirmed the state’s position that licenses to access cloud based software are taxable as rentals of tangible personal property under Arizona’s transaction privilege tax. The court rejected the taxpayers attempt to define the software as an intangible good, clarifying that the court decision Honeywell Information Systems Inc v. Maricopa County only applied that definition for property tax purposes, and as the provision of a service, defining the taxpayer’s customer’s use of the software as exclusive use and control over their own login to the software.

With cloud software becoming more and more the norm for users, the questions of how a state taxes cloud products and under which definitions have become a challenge to understand for taxpayers. Cloud software may qualify as a specifically taxed service, tangible personal property, a digital good, or a rental, and may require different administrative filing requirements or taxable treatment in each state depending on which definition it falls under. With many states still taxing under laws written long before the internet, and with state’s interpretations established by court or administrative rulings, navigating how to handle sales of these products remains an ongoing problem for many taxpayers.

(ADP LLC v. Arizona Department of Revenue and City Of Phoenix, 1 CA-TX 21-0009, Arizona Court of Appeals, Division One)

UPDATE: The Arizona Supreme Court has denied ADP’s Petition for Review in this case in a Minutes document dated September 12, 2023. The Court declined to hear the appeal without comment. (Minutes, Arizona Supreme Court, September 12, 2023)

Posted on September 28, 2023