This blog was last updated on August 10, 2023
Businesses use software for everything, and for many companies, the aggregate cost of all their software licenses represents an enormous expense. When purchasers of business software acquire or renew their license, negotiations around the total price of the solution are often rigorous and sometimes even contentious. This is understandable as cost containment is a key component in any company’s overall profitability strategy. However, software purchasers often give little or no attention to the sales tax implications of their acquisition, even though it is possible that fundamental tax minimization strategies could yield substantial savings. An example of such a strategy is Multiple Points of Use (MPU).
Complexity creates an opportunity
The sales tax rules around software are complex. In years past, when software was purchased on magnetic media, the tax ramifications were straightforward. The disk where the software resided was considered tangible personal property and tax was due based on the delivery location. Those days are long gone. Today, software is frequently purchased through an electronic download or accessed in the cloud under a Software as a Service (SaaS) model. In this world, tax is properly due at the location where the software is used and enjoyed. Although states have now had years to adapt their sales tax rules to these modern technologies, not all states have chosen to do so, meaning that in some states, SaaS and/or downloaded software remain tax exempt. Further, over the last few years a handful of states have enacted specific exemptions for business-to-business (B2B) software based on a growing philosophy surrounding expanded exemptions for common business inputs.
In total, 24 states fully exempt B2B SaaS software. In Illinois, B2B SaaS is exempt everywhere but the city of Chicago. In Mississippi, pursuant to a recent law change, it’s exempt unless both the server upon which the software resides, and the customer are located in Mississippi. Further, in Connecticut it’s subject to tax at the special reduced rate of 1%. In Texas, it’s taxable but only at 80% of the sales price. For a full list of states where SaaS is exempt, check out our complimentary white paper on sales tax in the software industry.
It’s this disparity in tax treatment that creates possible tax savings through Multiple Points of Use rules.
What is Multiple Points of Use?
For companies with multiple locations and the growing acceptance of remote work, it’s increasingly likely that business software will be contemporaneously used by employees in multiple geographies. A handful of states overtly acknowledge this business reality through a Multiple Points of Use exemption. Fundamentally, this exemption allows software buyers to pay tax commensurate with its proportional utilization in each applicable state.
A handful of states overtly recognize this exemption through specific rules and exemption certificate language, allowing the buyer to completely take control of their tax remittance responsibility. They include Massachusetts, Minnesota, Ohio and Washington. For example, Massachusetts specifically notes Multiple Points of Use on its exemption certificate, Form ST-12, and provides detailed guidance in Regulation 830 CMR 64H 1.3 – Computer Industry Services and Products. Under the Massachusetts rules:
- Upon receipt of an exemption certificate claiming MPU, the seller is relieved of all obligation to collect the applicable tax.
- A purchaser delivering an exemption certificate claiming MPU may use any reasonable, but consistent and uniform method of apportionment that is supported by their books and records.
- A purchaser delivering an exemption certificate claiming MPU reports and pays the appropriate tax to each jurisdiction where concurrent use occurs.
- The exemption certificate claiming MPU remains in effect for all future sales eligible for apportionment by the seller to the purchaser until it is revoked in writing.
The Commonwealth also provides a handful of examples of what constitutes “reasonable, consistent, and uniform methods of apportionment,” including an approach based on number of computer terminals or licensed users in each jurisdiction where the software will be used. On the flip side, Massachusetts holds that apportionment cannot be based on the location of the servers where the software is installed.
Example: A Massachusetts company licensing a cloud-based CRM solution who concurrently uses that solution in their home offices as well as in regional locations in Minnesota and Georgia can, at the time of sale, provide their supplier with Form ST-12 with Box #9 checked for MPU. By so doing, the seller will no longer charge tax, but the buyer becomes obligated to reasonably apportion their utilization amongst the three states and self-assess any applicable tax in Massachusetts.
With respect to apportionment, if there are 100 total licensed users, 30 of whom are in Massachusetts, the taxpayer could reasonably self-assess tax based on 30% of the sales price. Of course, by so doing the buyer obligates themselves to self-assess any applicable tax to Georgia or Minnesota, but since neither state taxes SaaS software, no further tax is due.
The devil is in the details
Other states have similar rules but be on alert: there can be important and meaningful differences. In Texas, purchasers of “data processing services” are permitted to provide their suppliers with an exemption certificate claiming MPU and self-assess applicable Texas tax based on “any reasonable method for allocation that is supported by business records.” While this option applies to SaaS software, which Texas taxes as a data processing service, it would not apply to downloaded software, which is taxed under other rules.
States such as New York, Pennsylvania, Tennessee and Utah all have rules that allow software buyers to provide their suppliers with information around how software should be apportioned for the purpose of determining the correct sales tax liability. However, in these cases the requirements specify that the seller must charge any applicable in-state sales tax rather than have the buyer self-assess. Of course, to the extent that software can be apportioned to jurisdictions where it is not taxable or where the applicable tax rate may be lower, the benefit of MPU remains the same.
Do your research
While strategically utilizing an MPU exemption can create substantial sales tax savings, be sure to do your homework before moving forward. Understand the states in which the software you are buying will be used, how software is taxed in those states and whether the MPU exemption is recognized. If MPU is allowed, review any guidance discussing permissible or impermissible allocation approaches.
If the software is subject to a periodic license renewal, keep your research up to date. Not only could your “reasonable allocation” change as your company evolves, but the tax rules surrounding software are far from static. For example, in just the last couple years the tax rules around software materially changed in states like Kentucky, Mississippi and Maryland.
Be prepared to show your work
The rubber hits the road for any sales tax exemption when an auditor comes knocking. Be prepared to show how you effectuated your allocation and stand ready to produce documentary evidence that supports your decision. For example, if your software contract specifies that you are being granted a certain number of end-user licenses, be sure your allocation accounts for all those licenses. If it says you have the right to use the software in specific geographies, be sure your allocation only includes those places. An aggressive auditor will look for reasons to allocate more of the software cost to their state, and having your answers prepared in advance maximizes your ability to sway the auditor as to the reasonableness of your approach.
Take Action
Still have questions about the complex world of sales tax in the software industry? Read our white paper to learn more.
