December 10, 2024

Executive Summary / Abstract

Since the 1990’s, the Commonwealth of Pennsylvania (”PA“) has made several legislative changes to the scope of what types of software and related services should be subject to sales and use tax. These developments in the law have left taxpayers in the software, technology and information technology (”IT“) industries with more questions than answers in terms of understanding their sales and use tax obligations.

The PA Department of Revenue (the ”Department“) recently issued new guidance on its website that provides a comprehensive list of different services and the resulting tax ramifications—some of which will likely come as a surprise based on the statute and prior Department rulings.

Background

Historically, the taxability of software in PA was dictated by whether the software is canned (off-the-shelf) or customized for a particular customer, with the latter not being subject to sales or use tax. Additionally, most software-related services, such as programming, system design and data processing were generally not subject to PA sales tax based on legislative changes made in 1997. As technology evolved with software no longer being physically installed, but rather downloaded or made available via cloud resources such as SaaS, the Department continued to impose sales and use tax regardless of the method of delivery or access.

In 2016 and 2017, changes were made to the statutory definition of ”tangible personal property“ to specifically include canned software and any updates, maintenance, and support, except for separately-invoiced help desk or call center support. Since ”repairing,“ ”altering,“ and ”installing“ tangible personal property have historically been subject to PA sales and use tax, the Department took the position that those same activities should be taxable when pertaining to software.

Additionally, in a 2017 letter ruling—the Department attempted to define taxable ”support“ services and distinguish them from nontaxable software ”consulting“ services. While the Department’s ruling is somewhat helpful, practitioners and software/IT providers still faced numerous questions in terms of understanding exactly which services should be taxable or not.

The Department’s New Guidance

To help address many of the outstanding questions related to PA’s taxation of software and related services, the Department has published extensive guidance enumerating numerous services, along with definitions of those services and the resulting tax implications. The Department’s definitions and taxability conclusions can arguably be applied going back to 2016, but questions remain as to how prior sales and use tax reporting periods will be treated by the Department.

The new guidance provides the following list of key software or IT services and their resulting tax implications:

• Configuration – Enabling specific functions or options within the existing canned computer software without altering the source code or creating custom computer software (See Modification regarding source code).
  • Taxable as the alteration of tangible personal property.
• Consulting – Gathering information related to the goals and needs of the customer and linking these to software or hardware solutions. This involves analyzing a customer’s business process and requirements, in addition to documenting the customer’s needs for new or existing software or hardware.
  • Taxable as part of purchase price if sold in conjunction with the sale of tangible personal property or other taxable services, even if invoiced separately.
  • Non-taxable when the result is only a recommendation regarding the need for changes in implemented software or process and there is no transfer of tangible personal property.
• Enhancement – Improvements made to software that increase its performance, capacity, or capabilities. They can also add functions, correct defects, or update the current version of the software.
  • Taxable as the sale and/or alteration of tangible personal property if the underlying software is canned.
• Installation – Loading or re-loading an application or canned program on computer hardware through downloading or from a disk.
  • Taxable as the installation of tangible personal property whether installation is performed by the vendor of the application/canned program or a separate vendor.
• Modification – Custom computer software programming for the specific customer that adds, edits, or changes proprietary software, such as modifying source code and application programming interface (API) creation. This does not include patches or updates that fix or enhance the computer software that are made available by the vendor (See Enhancement).
  • Modifying the source code of canned computer software is taxable as the alteration of tangible personal property.
  • Modifying the source code of custom computer software is non-taxable.
  • Programming performed to add functionality to canned computer software, such as API creation, is taxable as part of purchase price if sold in conjunction with the sale of tangible personal property or other taxable services, even if invoiced separately.
  • Programming is a non-taxable service if performed on or for the development of custom computer software.
• Repair – Any action to maintain the compatibility with any other software or hardware products or correct the function or performance of canned computer software. This does not include custom programming (see Modification); however, it does include troubleshooting and the correction or adjustment of a software defect.
  • Taxable as the maintenance or repair of tangible personal property.
• Support – The providing of advice or guidance concerning otherwise taxable digital or electronic tangible personal property involving identifying the source of problems affecting the usability of the property and attempting to place the property in or restore the property to a useable state, including, but not limited to, what is commonly referred to as help desk support or call center support.
  • Taxable as the support of canned computer software.
  • Separately stated charges for help desk or call center support where the vendor does not access the software are non-taxable.
• Website Development – The process of creating, building, and maintaining websites and web applications. It can include web design, programming, and database management.
  • Taxable if the website is transferred to the customer. Both the website and the maintenance of the website are subject to Pennsylvania sales and use tax as the transfer and maintenance of tangible personal property. The tangible personal property may be canned software or any other otherwise taxable tangible personal property electronically or digitally delivered, streamed, or accessed.
  • Taxable if the service provides access to a canned software program that allows the user to develop a website using no/low code interface or html programming with or without access to stock images or art that can be incorporated into the website.
  • Nontaxable if the developer retains possession and control of the website. The creator is responsible for remitting tax on materials used or consumed in creating and maintaining the website.
  • Separately stated fees for website hosting services are nontaxable.

The Department’s guidance also indicates that separately-stated charges for training or project management services that are not part of the purchase of software or SaaS should not be subject to sales tax provided the project management services do not constitute taxable help supply services—i.e., when temporary staff/labor is provided to a customer and personnel involved work under the direction and control of the customer.

An information retrieval service, defined as ”a subscription for the right to obtain digitized products electronically that may include a search function,“ should be considered taxable as the purchase of canned software or a digital product. And finally, providing access to a database of information to customers should also be considered subject to sales or use tax—even if the customer can filter and search through the data for particular information.

Commentary & Observations

The taxability of information retrieval services remains an issue of contention between practitioners and the Department since the Department has continued to audit these services aggressively, while the legislative history suggests that lawmakers intended for this service to be nontaxable. Some interesting areas of potential opportunities for taxpayers include:

• The definition of installation requires downloading from the internet or physical installation from a disk. This should allow for any installation/onboarding/implementation charges related to SaaS to not be subject to tax.
• Since software, SaaS, data, and any related maintenance, updates and support are defined as tangible personal property under PA law, software and SaaS developers’ purchase of equipment, machinery and parts (including software and hardware) used in the development process should be eligible for sales and use tax exemption.

How We Can Help / Contact Information

Please contact Jaime Reichardt or another member of Citrin Cooperman’s State and Local Tax (SALT) Practice leadership team to discuss the contents of this article and how it may impact your business.