Michigan Characterizes Cloud Computing as Nontaxable Service

Michigan has held that a taxpayer’s purchases of cloud computing services are not subject to use tax because transactions involving remote access to a third-party provider’s technology infrastructure are properly characterized as nontaxable services and not the sale of prewritten software. The taxpayer hired third parties to provide services, including web-conferencing, web-hosting, payment processing, and online legal research, and information. The court found that these transactions did not qualify as the sale of prewritten software because the providers did not surrender possession and control of the software to the taxpayer. In addition, when the relevant statute was amended in 2004 to add “prewritten software … delivered by any means” as tangible personal property, the legislature likely did not contemplate the nature of cloud computing transactions because remote access to a third party’s technological infrastructure was not commonly in use at the time by consumers. Even if prewritten software was delivered to the taxpayer, the requisite “use” of the software was not made by the taxpayer. Per the Use Tax Act, the taxpayer must “exercise a right or power over the property incident to ownership….” The taxpayer had no such control over the software, hence use tax should not be applied. The only evidence of control on the taxpayer’s part involved the ability to control outcomes by inputting data. Finally, even if prewritten software was delivered to and used by the taxpayer, the use was merely incidental to the services rendered by the third-party providers and would not subject the overall transactions to use tax. The taxpayer sought out services, not software, in these transactions. The third-party providers were in the business of providing services as opposed to selling or licensing software. Additionally, the value of the software was incidental to the services accompanying it. This decision exempts Software as a Service (SaaS) when executed by a services agreement. If this type of agreement were a software license agreement instead, it would appear to be taxable. This case may be appealed in the future. For an update on this news item, click here. (Auto-owners Insurance Company v. Department of Treasury, State of Michigan Court of Claims, March 20, 2014)

Posted on May 6, 2014