United States: New Jersey Proposes Rules To Clarify Sales Tax Treatment Of Software Services

On April 21, the New Jersey Division of Taxation issued proposed amendments, repeals and new rules which are intended to clarify the Division's position on the taxability of software-related services.1 The Division has provided a 60-day period, ending June 20, for interested parties to comment on the proposed rules and amendments.

The proposed amendments are not intended to change the current sales tax treatment of computer software and software-related services. The clarification provided by the amendments and new rules would ease the existing confusion within the software industry as to how to properly impose sales tax. Purchasers of software and software services would also benefit from clear and understandable guidance. Highlights of the proposed changes include:

  • Specifically defining the following terms: "customer support services," "modifying," "installing" and "servicing" of software;
  • Specifically exempting from taxation "modifying" and "customer support services;" and
  • Clarifying the taxability of software maintenance contracts.

Background

Under the current law, sales of prewritten software, which includes software delivered electronically and in tangible form, fall within the definition of "tangible personal property." A New Jersey statute imposes sales tax on receipts from maintaining, servicing, installing or repairing tangible personal property.2 Since prewritten software is considered tangible personal property, the installation, servicing, repairing or maintaining of prewritten software is also taxable. However, there is confusion in the industry regarding certain software services and whether they should be considered one of the statutorily enumerated services (i.e. installation, servicing, repairing or maintaining) and be held taxable or characterized as "modifying" or some other form of "customer support service," which are not specifically enumerated as taxable under the statute.

Proposed Amendments

Under the proposed rule amendments, the Division would define or re-define the following:

"Customer support services" means verbal and written computer software advice or guidance (for example, provided via the Internet or telephone).

"Installing" software means the act of loading an executable file, whether tangible or electronic, containing a prewritten computer software application or program onto a device or equipment. The mere act of electronic delivery does not constitute installation.

"Modifying" software means any action, other than installing or servicing software, performed to enhance, improve, or customize software, regardless of whether the computer code is changed.

"Servicing" software means any action to maintain the compatibility of computer software with other hardware and software products and performing other corrective services that do not involve changing computer code.3

With the above terms further defined, the Division then proposes changes to the rule which discusses the taxability of "modifying" and "customer support services."4 The proposed language specifically indicates that "modifying" and "customer support services" are treated as a sale of non-enumerated services which are not subject to sales tax. The updated regulation would also provide specific examples of "modifying" and "customer support services."

The Division also has proposed to add a new rule which would provide additional guidance on the taxability of software maintenance contracts.5 Notably, a software maintenance contract would be considered partially non-taxable, even if the taxable and non-taxable services are bundled together on the face of the invoice, if the seller of the services can present reasonable and verifiable support for the non-taxable component.

Commentary

The proposed amendments to the rules would provide sellers and purchasers with additional and broader definitions and examples of software services. The updated definitions for "installing" and "servicing" will also help those in the industry better understand when their services are taxable. The definitions for "modifying" and "customer support services" more clearly identify the services the Division will consider to be non-taxable.

Without these proposed rule modifications, it is often difficult to determine the taxability of software-related services. Even with these proposed amendments, the taxability of a transaction may not be evident simply by reviewing the invoices in question. Frequently, these consulting services are billed by the hour, or include generic wording such as "software consulting." Sellers and purchasers will still need to understand the specifics behind what the "software consulting" represents. However, once they do, it should be easier to label them under one of the defined categories. At this point, the amendments are proposals subject to public comment and possible future revisions. Therefore, the rules that eventually are promulgated may differ from the proposed rules.

Footnotes

1 Specifically, N.J. ADMIN. CODE § 18:24-25.1, which currently provides definitions, would be replaced by a new scope provision. A new section, N.J. ADMIN. CODE § 18:24-25.1A, would be added to provide definitions. Existing N.J. ADMIN. CODE § 18:24-25.6, which covers the treatment of maintenance contracts and software-related services, would be replaced with a new N.J. ADMIN. CODE § 18:24-25.7, which addresses software maintenance contracts. Finally, a new N.J. ADMIN. CODE § 18:24-25.6 would be added to cover the treatment of software-related services. 2 N.J. REV. STAT. § 54:32B-3(b)(2). 3 Proposed N.J. ADMIN. CODE § 18:24-25.1A. 4 Proposed N.J. ADMIN. CODE § 18:24-25.6. 5 Proposed N.J. ADMIN. CODE § 18:24-25.7.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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