A recent court decision in SAP America, Inc. v. Commissioner of Revenue, State of Tennessee, involves a dispute over whether a taxpayer is subject to Tennessee’s Business Tax Act.
The court ruled selling and licensing of software isn’t taxable under Tennessee’s Business Tax Act, and the impacts of this decision are extensive. Businesses in the software industry should review their sales and licensing models, as well as any related services they provide, to assess potential impacts on their tax obligations in Tennessee.
Business Tax Act
The Business Tax Act imposes a tax on businesses that make sales of either tangible personal property or services in Tennessee. It doesn’t apply to businesses that sell intangible personal property.
The taxpayer in the SAP America case was a company that licenses enterprise software and provides optional online training, cloud consulting, and cloud hosting services. The question the court needed to answer was whether the licensing of software constituted the sale of tangible or intangible property. This distinction would determine whether the taxpayer’s business is subject to Tennessee’s Business Tax Act.
The court concluded that software is intangible property that is not subject to taxation under the Business Tax Act. The court explained its goal was to carry out legislative intent without broadening or restricting the statute beyond its intended scope. Using this guiding principle, the court determined that if the Tennessee legislature wanted to subject the sale of intangible property—specifically the licensing of software—to the Business Tax Act, it would have.
The court started its analysis at the Commercial Union Bank v. Tidwell case. In that case, the issue was whether the sale of computer software was subject to Tennessee sales tax. The Tennessee Supreme Court specifically held that in the context of Tennessee’s sales tax, the sale of computer software was the sale of intangible personal property.
The SAP America court explained that the Tennessee legislature amended the sales tax statute to treat computer software as a sale of tangible personal property after the ruling in Commercial Union.
However, the legislature didn’t address the issue in the context of the business tax. The court explained that the legislature has amended the sales tax statute several times since Commercial Union and has specifically provided that computer software is subject to sales tax equal to the tax rate for tangible personal property. The court noted that the Business Tax Act doesn’t contain a similar provision.
Sales or Service
The court also pointed out that Commercial Union held that pre-cloud computing software was not tangible property. Following this, the legislature stepped in and amended the Retailers’ Sales Tax Act to add that computer software is tangible property subject to sales tax. No similar amendments were made to the Business Tax Act.
Tennessee also argued that software sales should be considered a service under the Business Tax Act, based on the Standard Industrial Classification (SIC) Index. However, the taxpayer countered the SIC Index is only used to determine specific exemptions in the Act, not to determine if the business provides a service. The Court cited Auto Glass Co. of Memphis Inc. v. Gerregano in agreeing with the taxpayer.
In that case, it was argued that an auto glass company should be classified as a service provider because the SIC Index classified it as such. But the court noted that the SIC Index is only used to determine exemptions under a specific section of the Act, not to classify businesses. Relying on this, the court in the current case found the state's argument to be without merit.
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For more information related to Tennessee’s Business Tax Act or any tax obligations in Tennessee, contact your Moss Adams professional.
Additional Resources
Special thanks to Ben Macomber, tax staff, for his contributions to this article.