Massachusetts software subscription fees subject to sales tax

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February 2020

Overview

The Massachusetts Supreme Court recently held that fees related to the sale of a subscription to access computer software involved the sale of tangible personal property and, therefore, were subject to sales tax. 

Although the holding is limited to sales tax, the Court’s rationale could have corporate income tax and local property tax implications. The Court’s treatment of remote access subscription fees as receipts from the transfer of pre-written software could potentially extend to treating the company charging such fees as a software developer engaged in manufacturing. If a taxpayer is deemed to be substantially engaged in manufacturing due to software development, it would be required to apply single sales factor apportionment. Moreover, if a taxpayer is deemed to be substantially engaged in manufacturing in Massachusetts, it may be eligible for the investment tax credit and may be exempt from local property tax on most types of machinery if formally classified as a manufacturing corporation.

The takeaway

Although this case involves Massachusetts sales tax, the treatment of subscription fees as sales of tangible personal property could have income tax implications.

Massachusetts requires corporations substantially engaged in manufacturing to apportion based on a single sales factor. Additionally, corporations substantially engaged in manufacturing in Massachusetts can qualify for the state’s investment tax credit and are eligible to apply for local property tax benefits. Software development is considered a manufacturing activity. 

If a taxpayer develops pre-written software offered to customers on a subscription basis that is remotely accessed by customers then, based on the rationale of this decision (assuming such software development activity is substantial), the taxpayer could be treated as a manufacturer. Corporations treated as manufacturers must use single-sales factor apportionment. If the manufacturing activity within Massachusetts is substantial, then such corporations may be eligible for an investment tax credit for qualifying purchases and might qualify for certain local property tax benefits.

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Peter Michalowski

State and Local Tax Leader, PwC US

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