This Week in State Tax

The Louisiana Department of Revenue (Department) adopted a final rule clarifying sales and use tax exemptions for digital tools, effective October 20, 2026. Digital tools include digital products, computer software, prewritten computer software access services, and information services. The rule addresses exemptions for digital tools used in commercial production and healthcare, as well as self-created digital products, and identifies uses and purchases that do not qualify for exemption.

For the commercial production exemption, direct use requires applying or incorporating a digital tool into the creation, development, or production of a final product or service for sale to a customer. Tools used to manage business operations or improve efficiency or productivity, including accounting, inventory management, project management, communication, and analytical software, do not qualify. The rule also provides examples of exempt digital products created solely for the creator’s business needs and which are not the type offered for sale by that person, including in-house workflow automation tools, proprietary content management systems, internal brand style guides, and training videos. Digital tools purchased to create those products remain taxable. For example, an employee training video is exempt, but prewritten computer software access services purchased to create the video are taxable.

For the healthcare exemption, the rule defines licensed healthcare facilities and providers to include institutions and individual practitioners licensed by the Louisiana Department of Health or Louisiana State Board of Medical Examiners to deliver medical, dental, behavioral health, or related clinical services. Qualifying tools used to store or transmit healthcare information or diagnose or treat a medical condition include tools that monitor and protect the transmission and storage of patient healthcare information.

Please contact Randall Serpas and Patrick Loynes with questions about the Louisiana Department of Revenue’s Exemption for Digital Tools Regulation. 

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The South Carolina Court of Appeals recently issued two decisions addressing how companies must source service and intangible income for corporate income and bank tax purposes. In both cases, the court upheld Administrative Law Court (ALC) determinations that a company’s income-producing activity occurs within South Carolina when its services relate to a transaction with a cardholder, merchant, or borrower located in the state, rejecting taxpayer arguments that the relevant activity is confined to out-of-state processing, decisioning, or servicing functions. Both panels relied heavily on the court’s 2017 decision in DIRECTV, Inc. & Subsidiaries v. South Carolina Department of Revenue, which sourced a satellite provider’s income to the location where it delivered its signal to subscribers.

In Mastercard, the taxpayer, the operator of a worldwide credit card network, generated revenue by charging fees based on the number of credit and debit transactions from branded cards and the gross dollar volume of those transactions. The transactions were initiated when cardholders presented branded credit or debit cards to merchants as payment for goods and services. The taxpayer argued that none of its gross receipts should be sourced to South Carolina because its payment processing and related services were performed outside the state and its customers were financial institutions, not cardholders or merchants. Specifically, it characterized its income-producing activity as the “final act” of delivering authorization messages to the Mastercard Interface Processors (MIPs) at its financial institution customers’ facilities or processing facilities, with all MIPs located outside South Carolina.

Although the court rejected the Department’s position and subsequent ALC’s finding that cardholders were the taxpayer’s true customers, it held that the taxpayer’s income-producing activity was providing a network that enabled cashless transactions at South Carolina merchants. The court explained that neither the state’s income-producing activity sourcing methodology nor its previous decision in DIRECTV requires sourcing based solely on which party technically pays for the service; instead, the inquiry focuses on the activity that actually earns the revenue. The court also upheld the Department’s proxy methodology as a reasonable approximation of South Carolina receipts, using the state’s share of U.S. transaction dollar volume for assessment fees and transaction counts for processing fees, with other fees and rebates and incentives allocated proportionately. Moreover, sourcing based on its financial institution customers’ South Carolina billing addresses would capture only a fraction of the income generated by transactions in the state, including purchases by out-of-state cardholders.

In U.S. Bank, the taxpayer originally excluded mortgage interest; servicing fees; gains from pooled mortgage sales to government-sponsored entities such as Fannie Mae; and credit card interest, fees, and interchange income from its South Carolina receipts for purposes of its bank tax apportionment factor. The court upheld the ALC’s sourcing determinations but reclassified credit card interest and fees as service income. For mortgage servicing fees, the court upheld the ALC’s finding that the services were directed into South Carolina and inextricably tied to mortgages secured by property in the state, even though the employees performing those services were located elsewhere. The court also held that mortgage interest constituted receipts from the use of intangible property, while mortgage sale gains constituted net gains from the sale of intangible property used in a trade or business rather than sales of inventory. Both were sourced to South Carolina because the mortgages were used at the location of the real property securing them. For credit card interest and fees, the court re-classified the receipts as service income rather than intangible-property income. Despite that change, the court upheld South Carolina sourcing because customers paid for the extension of credit and their in-state card use generated income, while activities such as administering rewards programs and facilitating balance transfers were preparatory or ancillary. Finally, the court upheld South Carolina sourcing of interchange and merchant fees because the initiation and ultimate funding of transactions at South Carolina merchants generated the bank’s income, notwithstanding out-of-state routing, processing, and funding functions.

The court upheld the challenged penalties in both cases. In Mastercard, the taxpayer conceded that it had sufficient nexus with South Carolina to require filing returns, supporting the failure-to-file penalties regardless of whether its income was earned in the state. The ALC had already waived penalties for failure to pay due to the taxpayer’s good faith reliance on DirectTV. In U.S. Bank, the court upheld the remaining substantial-understatement penalties because excluding the disputed receipts did not reasonably approximate the bank’s South Carolina business activity and the bank failed to establish substantial authority or reasonable cause, as acting in good faith did not constitute reasonable cause. Please contact Jeana Parker with questions about Mastercard Int’l Inc. v. Dep’t of Rev. and U.S. Bank N.A. v. Dep’t of Rev.

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The Washington Department of Revenue (“Department”) recently published a 2023 decision of the Administrative Review and Hearings Division (“Division”) addressing whether a taxpayer’s filming, recording, and production of television programming for its parent company should be taxed as sales of digital goods or professional services. The taxpayer, a wholly owned subsidiary, filmed and recorded games and produced finished content under a services agreement to meet the programming needs of its parent company. The taxpayer asserted that the programming content constituted digital audiovisual works and therefore digital goods whose sales were subject to retail sales tax and retailing business and occupation (B&O) tax, rather than the service and other activities B&O tax. The Department disagreed, concluding that the taxpayer provided professional services excluded from the definition of digital goods and the services were subject to the service and other activities B&O tax, which carried a higher tax rate during the audit period. Following an audit covering January 1, 2012, through December 31, 2015, the Department assessed the service and other activities B&O tax, reversed small business credits, and imposed penalties and interest. The taxpayer petitioned the Division for reconsideration.

The Division explained that, under Washington regulations, professional or personal services represented in electronic form are excluded from the definition of a digital good when the service primarily involves human effort and the human effort originates after the customer requests the service. The Division concluded that the taxpayer’s finished programming content, including audio commentary, was not a digital good despite its electronic transmission because its production primarily involved human effort performed after the parent requested the filming under the services agreement. Accordingly, the taxpayer’s activities satisfied both criteria for the professional services exclusion, and its income was subject to the service and other activities B&O tax rather than retailing B&O tax. The taxpayer’s petition for reconsideration was denied.

Contact Michele Baisler with questions about Determination No. 22-0244R.

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The Wisconsin Tax Appeals Commission (“Commission”) has held that payments two affiliated insurance companies made under aircraft and software sale-leaseback agreements were subject to Wisconsin sales tax. The Commission rejected the taxpayers' argument that the transactions were, in substance, refinancing arrangements. In 2011, the taxpayers sold an aircraft and some internally developed software to an equipment finance company. The taxpayers leased the assets back from the finance company for rent, with an option to buy the assets at the end of each lease term. A clause in each agreement said that, for federal, state, and local sales and income tax purposes, the parties would treat the deal as a loan secured by the assets, with the taxpayers still treated as owners. The Wisconsin Department of Revenue assessed sales tax on the lease payments for tax years 2015 through 2018.

The taxpayers argued that the substance of the transactions should control. They pointed to provisions that called the assets collateral, said the transfers were made only to give the lender a security interest, and based rent on the value of the property. The Department of Revenue argued that the agreements were leases in name and function, and met the definition of a lease under Wisconsin law. The Commission sided with the Department of Revenue. It relied on its earlier decision in Ladish Co., Inc. v. Wisconsin Department of Revenue, under which the Department may look past the form of a transaction to its substance, but a taxpayer is held to the transaction’s express terms and cannot demand recharacterization when that form is unfavorable. The Commission said the agreements appeared to be drafted to support conflicting readings. It added that accepting the taxpayers' position would encourage unclear contracts and leave the Department of Revenue with an analysis that would be nearly impossible to administer. The Commission also noted that a contract clause stating the parties' intended tax treatment does not bind the Department of Revenue, which was not a party to the agreements.

The Commission found the taxpayers' substance argument unpersuasive. The agreements repeatedly referred to lessors, lessees, and rent. Also, the agreements allowed the taxpayers to return or buy the assets at the end of the term, which would make little sense if the taxpayers still owned them. In addition, the taxpayers had stipulated that sales occurred, and neither party offered evidence of how the transactions actually worked after the agreements were signed. The Commission acknowledged federal tax precedent holding that a transfer of legal title alone does not make a transaction a sale. However, it stressed that federal authority is persuasive but not controlling on questions of Wisconsin law. Finding no statutory exception for sale-leaseback transactions, the Commission concluded that a valid sale-leaseback occurred and the payments were taxable.

For questions regarding CMFG Life Insurance Co. v. Wisconsin Department of Revenue, please contact John Vann.

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