TWIST - This Week in State Tax

Welcome to TWIST for the week of January 10th, featuring Sarah McGahan from the Washington National Tax State and Local Tax practice.

Happy New Year! This is the first TWIST of 2022. The first development we are covering today is a case from the Oregon Supreme Court holding that a VoIP service provider was required to collect the state’s E911 tax for the tax period at issue, which pre-dated the Wayfair decision. The court rejected the taxpayer’s arguments that it was not purposefully availing itself of the Oregon market when it did not target Oregon customers specifically. The taxpayer developed marketing plans and employed business strategies intended to reach Oregon residents (and residents of other states), shipped products directly into Oregon, and engaged retailers to sell its products in Oregon. In the court’s view, these efforts to attract Oregon customers and the services provided in Oregon to those customers established its purposeful availment of the Oregon market. Further, the court rejected the taxpayer’s position that it needed to have an extensive virtual presence to establish Commerce Clause nexus.

In Pennsylvania, the Commonwealth court concluded that a taxpayer was not a manufacturer for purposes of the sales and use tax exemption when it created prepackaged frozen meals. Although the taxpayer took individual food products and transformed them into prepackaged, ready-to-use, full meals, this process did not result in the kind of substantive change necessary to the starting products to qualify for the manufacturing exemption. The court, however, ruled in the taxpayer’s favor as to whether it was purchasing taxable help supply services.

In a recent Letter Ruling, the Tennessee Department of Revenue concluded that certain separately stated fees associated with the sale of platform computer software were subject to sales and use tax. The Department concluded at the outset that the true object of the transactions at issue was for customers to obtain access to the platform software. The fees, although separately stated, were either necessary to complete the sale or essential and integral to the sale of software and were therefore subject to Tennessee sales tax.

Finally, in Texas, an appeals court concluded that a taxpayer was entitled to a sales and use tax exemption for electricity used at its manufacturing plant. The taxpayer produced cash register tapes that were sold to grocery stores, restaurants, and retail stores for use in their point-of-sale machines. The Comptroller had argued that because the taxpayer printed third-party advertising on one side of certain cash register tapes, it was not engaged in manufacturing with respect to those tapes. The court rejected this argument, as the manufacturing exemption statute unambiguously provides that the imprinting of tangible personal property for sale is manufacturing and does not make a distinction about the type of content that may be printed on the tangible personal property.

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Oregon: VoIP Provider Required to Collect State E-911 Tax

The Oregon Supreme Court recently affirmed a Tax Court decision holding that a VoIP service provider was required to collect and remit the state’s E911 tax imposed on VoIP lines. The taxpayer did not collect the E911 tax from Oregon customers or remit the tax during the relevant tax period, which covered January 2013 through March 2016.  Before the court, the taxpayer argued that it did not have the requisite contacts under the Due Process Clause or sufficient nexus under the Commerce Clause to be required to collect and remit the tax. During the relevant time, the taxpayer had no physical presence in Oregon. The number of VoIP lines provided to Oregon customers during the tax period ranged from 6,633 to 13,467 and the service billings for those lines generated $2.2 million in revenue over the 39-month audit period.

The Oregon Supreme Court first addressed the taxpayer’s argument that it did not purposefully avail itself of the Oregon market and therefore lacked the minimum contacts necessary to establish Due Process Clause nexus. The taxpayer’s position was that it was not purposefully availing itself of Oregon’s market because its marketing efforts were not targeted specifically at Oregon customers. However, in the court’s view, the efforts to target customers in other states in addition to Oregon did not affect or diminish the constitutional significance of the taxpayer’s effort to target customers in Oregon. The taxpayer developed marketing plans and employed business strategies intended to reach Oregon residents (and residents of other states), shipped products directly into Oregon, and engaged retailers to sell its products in Oregon. These efforts to attract Oregon customers and the services provided in Oregon to those customers established its purposeful availment of the Oregon market.

The court next addressed the taxpayer’s Commerce Clause argument, which was based on the Wayfair decision although the tax years at issue predated Wayfair. The taxpayer appeared to be arguing that in assessing the extent of a company’s economic activity in a state it was not enough to simply establish that a company did more than $100,000 of sales or had more than 200 transactions with in-state customers. In addition, the taxpayer argued that “a court may not conclude that an out-of-state company satisfies the substantial nexus requirement without finding that the company maintains an extensive virtual presence.”   The court rejected both arguments, stating that a company that earned far greater revenue and engaged in far more transactions than involved in Wayfair must be deemed to have also availed itself of the substantial privilege of carrying on business in Oregon. And, while the taxpayers in Wayfair undoubtedly had an extensive virtual presence, the court noted that the U.S. Supreme Court did not articulate that as a specific requirement for establishing nexus. And the taxpayer offered no explanation as to why it would make sense to impose such a requirement when a nexus is otherwise established through sales, marketing, and service delivery efforts. Please contact Vinh Tran with questions on OOMA, Inc. v. Oregon Dep’t of Revenue.

Pennsylvania: Commonwealth Court Addresses Scope of Manufacturing Exemption; Taxability of Help Supply Services

The Pennsylvania Commonwealth Court recently addressed whether a taxpayer was a manufacturer and whether it owed sales tax on purchases of help supply services. The taxpayer at issue was engaged in assembling and selling pre-cooked frozen meals. To create its products, the taxpayer purchased food components and packaging materials, blended the components into meals, packaged them into various types of containers, and then froze the meals. The issue before the court was whether the taxpayer was engaged in manufacturing such that it was entitled the manufacturing sales and use tax exemption on its purchases of machinery, equipment and associated repair parts. The taxpayer also argued that it had not purchased taxable help supply services. After the taxpayer lost its appeals before the Appeals Board and the Board of Finance & Revenue, the case came before the Commonwealth Court.

The Court first addressed whether the taxpayer was manufacturing when it created it prepackaged frozen meals. The Department argued that the taxpayer was not a manufacturer because there was no change in the form, composition, or character of the pre-cooked frozen food ingredients when the taxpayer packaged them into a frozen meal. The taxpayer, on the other hand, maintained that case law makes it clear that "there does not have to be a change in the composition of the components making up a product for the activity to be considered manufacturing" and that by taking "various materials and converting them into prepackaged food products ready for distribution and consumption," it was engaged in manufacturing. The Commonwealth Court noted at the outset that both parties had provided it with a “plethora” of cases to compare and contrast and that the distinctions in the case are often narrow and required the court to engage in a detailed, fact-intensive review.  In doing so, the court concluded that the taxpayer was not a “manufacturer” as contemplated under the manufacturing exemption. Although the taxpayer took individual food products and transformed them into prepackaged, ready-to-use meals, this process did not result in the kind of substantive change necessary to the ingredients to qualify for the manufacturing exemption. In the court’s view, the taxpayer’s operations were similar to the operations of other businesses that were determined not to be manufacturers because their processes did not result in a pronounced and lasting change to the starting materials. The court next addressed whether the taxpayer purchased taxable help supply services when it contracted with various vendors for contract laborers. Under Pennsylvania law, a taxable help supply service is when a vendor provides an individual to a purchaser and the individual is an employee of the vendor, but the work performed by the individual is under the supervision of the purchaser. The issue in the case centered on whether the taxpayer was supervising the employees at issue. The court concluded that the taxpayer's largely unrebutted affidavits supported its position that its contractors worked independently on the plant floor with very little hands-on oversight by the taxpayer. While the taxpayer retained responsibility for overall quality control and operations, there was no evidence that the level of direction necessary for the third-party labor services to be considered taxable help supply services was present. Accordingly, the court determined the taxpayer did not owe sales tax on its purchases. Please contact Mark Balistrieri with questions on Quality Driven Copack, Inc., Petitioner v. Commonwealth of Pennsylvania.

Tennessee: Fees Associated with the Sale of Software are Taxable

In a recent Letter Ruling, the Tennessee Department of Revenue addressed whether separately stated fees associated with the sale of computer software were subject to sales and use tax. The taxpayer was an information technology company that sold access to its software platform. The sales included three separately stated fees: a platform fee, an implementation fee, and a content fee. The mandatory platform fee covered the access and use of the computer software, and it was not disputed that this fee was taxable as access to software.  The implementation fee covered mandatory onboarding necessary for integrating the platform into a customer’s system and included training provided by the taxpayer. The content fee was a charge for access to the taxpayer’s proprietary content. The taxpayer requested a ruling on the taxability of only the implementation and content fees.

Under Tennessee law, retail sales of tangible personal property and computer software are subject to sales and use tax unless an exemption applies. Tennessee also imposes sales tax on those services specifically enumerated by statute as taxable. The sale of access to and use of computer software in the state is subject to sales and use tax regardless of the chosen method of delivery.  When transactions involve the sale of a combination of items and services and taxable and nontaxable components are included, if the true object or the transaction is subject to tax, the entire transaction is subject to sales tax.

The Department concluded at the outset that the true object of the transactions at issue was for customers to obtain access to the platform software. The fees, although separately stated, were either necessary to complete the sale or essential and integral to the sale of software and/or remote access to and use of software; they were therefore subject to Tennessee sales tax. The ruling also addressed the optional software training.  The training would be nontaxable if it was optional and separately stated from the sale of the taxable product. In the instant case, the training was optional, but it was not separately stated from the overall implementation fee, which was deemed part of the sales price. Please contact Justin Stringfield with questions on Tennessee Letter Ruling #21-10.

Texas: Printing Advertisements on Cash Register Tapes was Manufacturing

A Texas Court of Appeals recently addressed whether a taxpayer was entitled to a sales and use tax exemption for electricity used at its manufacturing plant. The taxpayer produced cash register tapes that were sold to grocery stores, restaurants, and retail stores for use in their point-of-sale machines.  The cash register tapes were either blank or had third party or customer-specific advertising printed on one side. The taxpayer conducted a study of electricity used at its facility and concluded that 66.74 percent of the electricity consumed at the plant was used to power exempt manufacturing equipment and to light, heat, or cool the manufacturing area. Based on that study, the taxpayer requested a refund of sales tax paid on the electricity. The Comptroller denied the refund on the basis that the taxpayer was not manufacturing when it printed third-party advertisements on the cash register tapes and that the taxpayer’s customers contracted for the side of the tape without the third-party advertising. In the Comptroller’s view, the electricity study was flawed because it intermingled the electricity used in manufacturing tapes with third-party advertising and the other types of tapes. The appeals court rejected the Comptroller’s position. Texas Tax Code Section 151.318(t) unambiguously provides that the imprinting of tangible personal property for sale is manufacturing. The statute does not make a distinction about the type of content that may be printed on the tangible personal property. Further, in the court’s view, the Comptroller ignored the fact that the taxpayer’s agreements with customers gave the taxpayer the right to sell advertising and imprint it on the reverse side of register tapes and gave customers complete control over the type of third-party advertising that may be printed on the reverse side of register tapes. The court concluded that the taxpayer established that to fulfill its agreements with its customers, its equipment was "necessary and essential" to the actual manufacture of the register tapes it sold. Please contact Sarah Vergel De Dios with questions on RTU, Inc. v. Hegar.