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Taxation of Software Downloads: Software as a Service

Sep 16, 2016
By: Craig A. Cookle

Too often the sales and use tax considerations of licensing software are overlooked when entering into the licensing agreement, only to find out years down the road that the transaction is under scrutiny in a state sales and use tax audit. In December 2014, we brought you the article, Sales Tax and Technology Solutions: Accepting the “Mission Impossible.” The article focused on 10 tips to consider up front that would help you navigate the complex sales tax world of technology solutions. 

The previous blog post focused on the taxability of canned software. This post will discuss software as a service.  Software as a Service (SaaS), or “cloud computing,” is software that is licensed on a subscription distribution model in which a third-party provider hosts the applications and makes them available to customers over the Internet. In this situation, the purchaser that licenses the software will access the software via a user ID and password. The software does not reside on the purchaser’s computer or the company’s server. The key element of SaaS is that it is hosted and maintained by a third party. If your company licenses software and places it on a server that you lease from another provider and you are responsible for the maintenance and upkeep of the software, this would likely not be considered SaaS.


States are slowly coming out with positions on whether this is subject to state sales and use tax or not. The taxability of the SaaS arrangement varies by state. Illinois has not come out with any formal guidance on this topic at this time but has indicated that the state is working on it. Michigan has attempted to tax SaaS under its interpretation of Sec. 205.92b(o) that “prewritten computer software” means computer software, including prewritten upgrades, that is delivered by any means. However, two courts have ruled against SaaS being exempt (Thomson Reuters, Inc. v. Michigan Dept. of Treas., No. 313825, 2014 BL 134598 [Mich. Ct. App. May 13, 2014]; Auto-Owners Ins. Co. v. Michigan Dept. of Treas., No. 12-000082- MT [Mich. Ct. Cl. March 20, 2014]). There has been discussion in Michigan about introducing legislation that would tax this arrangement going forward. Minnesota has not issued any formal guidance on this matter at this time but informally has not imposed sales tax on this arrangement as long as there is a true SaaS arrangement (described above). Wisconsin takes the position that SaaS is not subject to sales or use tax; this guidance was issued in a formal tax release several years ago.


It’s becoming more common that software providers are offering their software subscriptions through a SaaS model. Therefore, it is important that the software license agreement reflect the arrangement as cloud computing or SaaS. Typically, the billing invoice does not indicate whether software resides on the company’s server or is a hosted application, and this is the reason most auditors will initially take the position that this software is subject to sales tax. A state auditor will often request to see a copy of the software license agreement to verify the arrangement is SaaS. The key items the auditor will look for are how the software is accessed (i.e., user ID and password) and who is responsible for all maintenance costs of the software.

The next blog post will focus on Infrastructure as a Service.



Craig A. Cookle, CPA
Partner, Tax
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