The Maryland Comptroller’s Office on June 3 and July 14 released revised versions of Tax Tip #29, updating the Comptroller’s interpretation of the digital products sales tax provisions amended by S.B. 787 enacted on May 30. The legislation (and therefore the Comptroller’s revised guidance) applies retroactively to the March 14, 2021, effective date of the digital products sales tax.
Action item: Sellers and purchasers should analyze the Comptroller’s revised guidance as to whether they should change their taxability determinations, revisit their contracting and invoicing practices, and potentially seek refunds of tax paid under the Comptroller’s original guidance. When S.B. 787 was pending enactment, the Comptroller’s Office stated, “If the legislature makes any retroactive changes to tax collected and remitted under this law, the Comptroller will ensure refund claims are processed as appropriate.”
The Comptroller’s Office has indicated that it will provide a mechanism for seeking refunds due to the law change and change in interpretation. The Comptroller’s Office also has indicated that it will further update the Tax Tip “periodically.”
The revised Tax Tip #29 reflects both revisions to the law enacted in S.B. 787 and changes in approach to the issue of digital products taxation by the Comptroller’s Office. The following highlights some of the major revisions but is not intended to be a comprehensive review of the revised guidance or the amendments enacted in S.B. 787. See PwC’s Insight on S.B. 787 and PwC’s Insight on the Comptroller’s original guidance for further details.
The revised Tax Tip #29 deletes the “non-exclusive list of digital products the sale of which is subject to the sales and use tax if obtained and delivered by electronic means[.]” The Comptroller’s original guidance had significantly expanded the statutory list of items considered digital products, with the resulting list being more comprehensive than in any other state.
The revised guidance moves some of the “digital products” from the former “non-exclusive list” to separate sections of the document and provides detail and the Comptroller’s rationale. Many of the categories of taxable digital products generally are in line with the approach taken in other states. For example, there is a new section on the taxation of “a book, e-book magazine, newspaper, periodical or similar product...whether delivered electronically or in tangible form.”
The revised guidance also maintains the position that the sales and use tax applies to the sale of “customer lists, mailing lists, medical records, and similar products.”
Observation: The revised guidance adopts the concept that otherwise nontaxable services do not become taxable services merely because they involve delivery of a digital product. For example, the revised guidance recognizes that a contract with an advertising agency may involve components of both non-taxable services and the production of a product that is either tangible personal property or a digital product.
However, certain categories remain from the original guidance that seem to expand on the statutory language. For example, the revised guidance provides that a digital product includes “a chat room, discussion, weblog, or any other venue that permits users to communicate electronically in real time.” The law provides that a “digital product” includes “a newspaper, magazine, periodical, chat room discussion, weblog, or any other similar product that is transferred electronically.” The revised guidance appears to take the position that a digital product includes electronic communications.
One controversial aspect of the original guidance was its extension to software, including Software as a Service (SaaS). Like the pre-amended law, S.B. 787 does not explicitly include “software” under the “digital products” definition. However, S.B. 787 amends a provision in existing law excluding “custom computer software services” from sales and use tax. The amendments specify that the exclusion applies if the custom computer software is created for use by a specific person or contains standard or proprietary routines “requiring” significant creative input to customize, “configure, or modify” the procedures and programs “that are necessary to perform the functions required for the software to operate as intended.” [quoted text added by S.B. 787]
The revised guidance implements these changes by stating that customized, configured, or modified software “is software that does not operate immediately as required by the buyer (i.e., ‘out of the box’) and includes enterprise software[.]” SaaS remains taxable under the Comptroller’s interpretation unless the exclusion for customized software applies. The revised guidance includes a long list of business software uses that might qualify for the exclusion and 11 examples.
Observation: The examples provide clear-cut statements of nontaxability, such as where the software requires “substantial configuration” to operate as intended. The same software functionality is deemed taxable where it involves “a simpler software plan geared to individuals or a limited number of users in Maryland that does not require configuration to use.” While the examples reflect the “custom software” amendments in S.B. 787, they may not help taxpayers seeking to apply these general concepts to their specific facts.
The revised guidance states that vendors are relieved of the obligation to collect and remit tax upon receiving notice from the buyer that it or a third party will customize, configure, or modify the software as required by the buyer. Likewise, the vendor’s duty to collect and remit tax is waived if it performs the customization, configuration, or modification on behalf of the buyer.
Observation: The revised guidance (unlike a regulation) is not binding on the Comptroller, and vendors may need to defend their software taxability decisions upon audit notwithstanding receiving the specified notification from their customers.
A digital code is defined as a number, symbol, alphanumeric sequence, barcode, or similar code that provides a buyer with a right to obtain one or more digital products. A digital code may be obtained by any means, including in tangible form or electronically. A digital code does not include a gift certificate or gift card with a monetary value that may be redeemable for an item other than a digital product, however.
The revised guidance provides examples of how these statutory provisions are to be implemented by the Comptroller. In one example, a sale of a gift card at a retail store “is subject to the sales and use tax because it is a sale of a digital code that only entitled the customer to purchase digital products” -- in this case, “to purchase and download prerecorded music from another vendor’s website.” The redemption of the gift card for prerecorded music is not considered subject to tax.
Another example employs the same facts, except that the gift card can be used to purchase goods and download video games at another vendor’s website. Because the gift card is redeemable for an item other than a digital product, the sale of the gift card at the retail store is not subject to sales and use tax (and presumably the goods -- if taxable -- and downloaded video games would be deemed subject to tax when the gift card is redeemed).
Observation: Retailers will need to determine how to charge tax at the point of sale of both the digital code and the items purchased with the digital code, with the taxability of the former dictating the taxability of the latter.
The guidance states that the sales and use tax does not apply to “a personal, professional or insurance service that is not a taxable service but involves a sale of a
digital code or a digital product as an inconsequential element for which no separate charge is made.” In one example, an employment placement firm conducts reference checks on an employment applicant and sends a report to the prospective employer on that applicant’s references. “As this is not one of the enumerated services that is subject to Maryland sales and use tax, the charge for the service and delivery of the report in either digital form or tangible form is not subject to tax.”
The guidance separately treats what it considers “bundled transactions,” where two or more (not inconsequential) items are not separately stated and are sold for one price. In such cases, the entire charge for a bundled transaction that involves a digital product and a nontaxable service or nontaxable tangible personal property is deemed subject to sales and use tax.
The guidance’s section regarding photography and videography illustrates the concept of separately stating charges in seeking to avoid a fully taxable bundled transaction. In one example, a photography and video company charges a company solely operating in Maryland $10,000 for taking photos and videos of its products and providing draft proofs for approval “with no obligation to purchase the photos or digital product[.]” The photography and video company will charge $2,000 to produce the final digital graphic images, photos, or videos to be utilized on website and social media advertising to customers in Maryland. In this case, only the $2,000 charge is subject to Maryland’s sales and use tax.
The revised guidance notes that the retail sale of a digital code or a digital product is presumed to be made in the state in which the “customer tax address” is located. The guidance provides a hierarchy for determining the customer tax address, including:
In one example, the purchaser is headquartered in Maryland, but its purchase order indicates the “that the particular purchaser is Buyer's division located in Colorado and Buyer's purchase order further contains a ‘Ship To’ address for the Buyer's division located in Colorado.” The purchaser’s primary use location is not known by the vendor. In this circumstance, although the SaaS transaction does not qualify as customized software, the transaction is not considered a retail sale in Maryland and the vendor is not required to collect and remit sales and use tax.
The revised guidance also provides, “if a digital code or digital product will be used [by] a buyer’s employees or equipment in multiple states, the sale is subject to Maryland sales and use tax to the extent used by employees or equipment in Maryland.” In such cases of multiple points of use, the buyer “must determine the percentage of employees or equipment in and outside of Maryland using a reasonable methodology and notify the vendor [of] the percentage of use in Maryland.”
If the vendor receives a written statement from the buyer at the time of sale, the vendor “may charge Maryland sales and use tax based on the percentage of use in Maryland.” However, the guidance states, if the vendor does not receive such a statement, it must charge sales tax under the general sourcing hierarchy, and the purchaser may seek a refund based on the percentage of use outside of Maryland.
Observation: The guidance does not allow purchasers to remit use tax based on their in-state use, but instead requires sellers to collect tax based on written representations from the purchaser (or, without such representations, under the general sourcing hierarchy).
The guidance provides three examples of the application of the sales and use tax on digital products that took effect on March 14, 2021:
Maryland’s revised guidance represents the latest chapter in a saga which began with the Comptroller’s original digital products sales tax guidance issued on March 11, 2021, just three days before the March 14 effective date of the new tax. That guidance prompted the amendments enacted in S.B. 787, which in turn left many questions unanswered. The revised guidance provides answers to some of these questions, including in the most recent revisions addressing documentation and sourcing to multiple points of use.
Partner, PwC US