For those of you who are unfamiliar with the new tax imposed on computer design and installation (including some web development activity) I am posting the latest DOR update. This is a draft for practitioner comment and I believe important information. This is the first tax on services and is quite obscure. So much so in fact that DOR has been updating the information weekly. Businesses providing these services need to decipher this information to determine if this tax applies to them or not. This tax was imposed quickly and not very well publicized. If you are in the computer design or web development business you will need to follow the course of this tax.
I. Introduction.
This Technical Information Release (TIR) is intended to supplement TIR 13-10 regarding the new tax on certain computer and software services effective July 31, 2013. It describes the principles that the Department will apply in determining the taxability of certain transactions. The new tax on computer/software services has two components which, although interrelated, are distinct and have a different scope. The provisions relating to modification, integration, enhancement, installation or configuration (hereafter “modification”) of standardized/prewritten software are discussed in Section II and the provisions relating to computer system design services are discussed in Section III. This TIR supersedes any FAQs or other informational guidance published by DOR to the extent that such prior guidance is inconsistent. The Department anticipates issuing ongoing guidance regarding the tax on computer/software services as needed to address issues and questions that arise regarding implementation of the tax.
II. Modification of Standardized/Prewritten[1][1] Software
A. In general. The Department will construe the software services tax provisions relating to modification, integration, enhancement, installation or configuration of standardized software as applying only to such services that occur in association with taxable prewritten software. Where these services do not occur in relation to taxable prewritten software, no tax on software modification services will apply.[2][2] Where however the software services do relate to taxable prewritten software, the modification services will be taxable whether or not the services may be described as the provision of custom software. The taxable prewritten software does not need to be or to have been acquired from the same vendor who provides the modification services and does not need to occur at the same time in order for the modification services to be taxable. Accordingly:
- Modification, integration, enhancement, installation or configuration of free open source software, including modification of such open source software to create a custom product for a customer, is not a taxable service, provided that no taxable prewritten software is involved or furnished and that the software is generally available for no consideration.
Example: See discussion of nontaxable website design services that utilize only open source software and a prewritten operating system, below. - Such modification services associated with prewritten software sales or licenses that are exempt from tax under the G.L. c. 64H, §§ 6(r) and (s) “manufacturing” exemptions are also exempt to the extent that the modification services relate to such exempt prewritten software. Example: An industrial plant in Massachusetts purchases customized prewritten software that is directly and exclusively used to operate machinery used for manufacturing tangible personal property to be sold. Assuming that the software otherwise meets the statutory requirements of 6(s), the customization services are exempt from sales/use tax because they relate to prewritten software that qualifies for the manufacturing exemption.
- If the modification services do enhance the functionality of taxable prewritten software, modify or configure such software, or integrate with other taxable prewritten software, they are taxable even if they involve completely custom work (e.g. , macros or plug-ins that operate in conjunction with prewritten software). Example: A software designer creates a custom plug-in for a customer that allows the customer to create a unique type of spreadsheet or report on Excel. The customer already has licensed Excel from a third party and the software designer makes no changes to the Excel code. The plug-in is transmitted to the client electronically. The charges for the plug-in are taxable because it enhances the functionality of taxable prewritten software.
- Vendors of taxable software services that modify, integrate, enhance, install, or configure taxable prewritten software may separately state charges determined in good faith for design and/or planning phases that are separate from the modification work, in which case such separately stated charges are not taxable unless a computer system design project is involved, as described in Section III of this TIR. Example: A software designer is engaged by a client to make improvements to the client’s website, which will involve custom modifications to prewritten software. Pursuant to this engagement, the designer first meets with the client to discuss problems with the website, to learn more about the client’s business and expectations, and to develop plans for a redesign. If the designer separately states the charges, using any reasonable method (e.g., hourly or a percentage of the total billing for the project), for ascertaining the client’s needs and developing a project plan, including developing mock-ups of web pages, etc., those charges are not taxable.
- Custom software projects that integrate an inconsequential level of taxable prewritten software will not thereby become taxable, so long as integration of that taxable software (or integration of multiple taxable software components) is not the object of the custom services and the total cost of the integration services relating to all such taxable software is less than 10% of the total charge for the project. (The license or sale of prewritten software itself remains taxable.)
- Custom application software that is written to run on a prewritten operating system does not become taxable due to its integration with the prewritten operating system alone.
Example: A software designer creates custom software for a client. As part of the project, the client asks to have a prewritten math or graphics library incorporated.
Generally, the integration of taxable prewritten software would be taxable, but where the value of the taxable services in integrating taxable prewritten software is inconsequential, that is, valued as less than 10% of the total charge, and the modification or enhancement of the prewritten software is not the object of the services, the software designer is not required to collect and remit tax unless the charges for the taxable services are separately stated.
B. How do these rules apply to website design services?
- If the website designer is using (in addition to custom code) only free, open source software for the project, no tax applies to the website designer’s charges to his/her customers.
- If the website designer or customer purchases, licenses, or otherwise obtains taxable prewritten software that provides a platform to create the website, the website design services are considered a taxable modification of taxable prewritten software.
- The date of the purchase, license, or other acquisition of taxable prewritten software by the website designer or customer does not affect the taxability of the website design transaction.
- The website designer may separately state charges determined in good faith for design and/or planning phases that are separate from the work that involves modifying, integrating, enhancing, installing, or configuring taxable prewritten software, in which case such separately stated charges are not taxable, except as provided in Section III.
III. Computer System Design Services
Computer system design services are defined by statute as “the planning, consulting, or designing of computer systems that integrate computer hardware, software, or communications technologies.” The services may be provided either by the vendor of one or more components of the system or by another party.
In general, the Department construes a “computer system” that “integrates hardware, software, or communication technologies” as referring to information management systems that include and integrate hardware, software, and/or communications components and that are used to support a business operation. For example, an information management system handling accounting, sales, purchasing, inventory, or similar records of a business through an integrated system involving computer servers or mainframes, data storage devices, and ERP and application software, would fall squarely within the scope of the statute. While it has become common for many types of machinery, from automobiles to robots, to incorporate dedicated computer and software components, the Department will not construe the tax as applying to design of computer hardware or software embedded in a machine or similar product.
The computer system design services that are subject to tax are planning, consulting, or design services. Consulting and evaluation services with respect to existing computer systems to identify deficiencies and needs are not subject to tax. In the context of computer system projects following the Project Management Body of Knowledge (PMBOK) or similar project management methodologies, taxable planning, consulting, or design services would equate to services provided to the customer by a prime contractor, integrator, or other vendor during the Origination, Initiation, and Planning stages of the project, but not to services in the Execution and Control or Closure stages.
Implementation of a computer system will often involve additional taxable components, beyond planning, consulting or design services. Hardware and prewritten software components are
generally subject to tax, as are the services of modifying, integrating, enhancing, installing or configuring prewritten software, as described in Section II of this TIR.
WORKING DRAFT FOR PRACTITIONER COMMENT 8/20/13
[1][1] DOR is aware of some confusion regarding the use of terms such as “prewritten” or “standardized” software in the tax statutes and regulations. As explained in the existing DOR regulations on Computer Industry Services and Products, 830 CMR 64H.1.3(2), the terms “prewritten,” “canned,” or “standardized” software are interchangeable. In general, these terms all refer to commercially available software, not designed or developed to the specifications of a particular user, the sale of which is subject to Massachusetts sales/use tax under G.L. c. 64H, 64I and was previously subject to tax prior to the July 31, 2013 effective date of the amendments in St. 2013, c. 46 (imposing tax on computer/software services) that are the subject of this TIR.
[2][2] This provision assumes that the pricing of a combination of prewritten software and modification services, if acquired contemporaneously from the same vendor, is set in good faith, and not for tax avoidance purposes. For example, a vendor of prewritten software and software modification services who charges a fee for license of such software in the normal course of business may not, for tax purposes, characterize the transaction as comprised of a “free” software license, with all charges attributable to associated software modification service. In such a situation, the prewritten software should be viewed as taxable software and the entire charge for the prewritten software and software modification services would be subject to tax, regardless of the parties’ characterizations.
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