On Monday, December 1, the New Jersey Division of Taxation will release its final regulations concerning the sales tax treatment of software and related services. (Click here for an advance copy.) The new rules represent a significant change from historical practice. So taxpayers should work with their vendors to conform to the new rules and review their use tax accruals accordingly. Taxpayers should also review prior purchases for refund opportunities. (New Jersey’s limitations period for refunds is four years.)
New Jersey statute defines tangible personal property to include canned software regardless of whether it’s delivered on disk or electronically. Remotely accessed software (e.g., software as a service, or “SaaS”) is not considered tangible personal property. And New Jersey exempts electronically delivered software used for business purposes. But the exemption doesn’t apply to software-related installation, maintenance, servicing, or repairs—even if the underlying software is delivered electronically. Rather, the Division has taken the position that services to software are taxable even if the software itself is exempt.
Based on the Division’s prior guidance, many taxpayers were broadly paying sales tax on all software-related services other than custom programming and help-desk support. The new regulations will enable taxpayers to purchase additional types of services without having to pay New Jersey sales tax.
In drafting the long-awaited regulations, the Division worked with the business community to address taxpayer concerns and provide certainty. Some of the most taxpayer-friendly provisions are highlighted below:
- Software can be considered nontaxable “custom software” even if it includes prewritten functions or routines. Previously, custom software was narrowly defined to mean software created, written, and designed for the exclusive use of a specific customer.
- Taxable installation services are limited to loading executable files and do not include the mere act of electronic delivery. This is a significant policy change: previously, services that involved enabling or configuring new software were considered taxable installation services.
- The new rules codify certain Division policies and practices. In particular, the new rules clarify that “servicing software” (which is taxable) is limited to maintaining compatibility and corrective services where the underlying code isn’t changed. The new rules also clarify that data entry is a nontaxable professional service.
- If a taxpayer can show that a software maintenance contract includes nontaxable components, it won’t have to pay tax on that portion of the contract—even if the taxable and nontaxable items are not separately itemized.
Despite these changes, the new regulations specifically provide that they are “intended to clarify” existing policy. As a result, the new rules should be applied retroactively. This will provide taxpayers with helpful support for refund claims and defending against audit assessments.
If you are interested in more information on the new regulations on the sales tax treatment of software and related services, and the potential impact on your business, please contact one of the authors of this alert, or the Reed Smith attorney with whom you normally work. For more information on Reed Smith’s New Jersey tax practice, visit www.reedsmith.com/njtax.
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Client Alert 2014-313