United States: Massachusetts Department Of Revenue Addresses Sales Taxation Of Employee Recognition Program Charges

On January 8, 2016, the Massachusetts Department of Revenue ruled that a company was not subject to Massachusetts sales and use tax on charges for the consulting, startup, and Web site design associated with its online employee recognition and rewards program and related program management services. Additionally, the Department ruled that transaction fees charged by the company, and gift cards rewarded under the program, were not subject to sales and use tax. However, sales of merchandise redeemed with certificates through the employee recognition Web site were subject to sales and use tax.1

Background

The company, an online program provider, allows its customers' employees to recognize and reward each other based on performance, employment milestones, and/or behaviors that demonstrate company values. The company's subsidiary, located in Massachusetts, works with customers' human resources departments to create unique employee rewards programs (ERPs). The company provides the following services for the startup of the ERPs: (1) consulting services to create a rewards program that meets the customer's specific needs for an ERP; (2) creating, configuring and maintaining a customer-tailored recognition and rewards Web site that is used to administer the ERP program; and (3) training customers' employees for effective use of the Web site.

The company's service agreement grants its customers a "non-exclusive, non-transferrable right and license to use and access the website and the related software for its administration and fulfillment of any Program." The ERP Web site is hosted by and links to the company's online marketplace platform. The company's customers and their employees access the Web site either through the customers' human resources portal, or by logging into the program. The Web site is used to participate in the rewards program, and to retrieve custom reports on the effectiveness of the program. Customers have the opportunity to authorize the granting of various abilities within the Web site to their employees, including participation, nomination and approval privileges. The company then uploads the employee names onto the Web site and grants the appropriate authority to the designated employees.

Customers also may request modification of the reward value or content on the Web site, which changes are uploaded to the Web site by the company. Customers do not have the ability to control the program platform, self-implement, change or manipulate any functionality of the Web site or change parameters of the rewards program. Only the company has that power, and the company frequently contacts their customers to ensure the Web sites are updated and maintained. However, customers do have the power to run reports on how the program is being used, and the nature of rewards transactions.

The company also manages the marketplace Web site to which the customers' employees have access for browsing or tracking orders. In doing so, the company retains the power to run the Web site, acting on the instruction of the customers to make changes to the merchandise in the marketplace and process employee nominations. After the company notifies employees via email that they have been nominated or rewarded by a customer employee, the company electronically issues reward points (company certificates) to employees who have earned them. The company certificates may be redeemed for gift cards or merchandise from the company's marketplace Web site. Customers are charged the U.S. dollar value of the company certificates plus transaction fees, which constitute a percentage of the value of each company certificate issued.

The company's subsidiary, acting as the company's U.S. purchasing agent, purchases the merchandise at wholesale and provides a resale certificate to its suppliers. When employees purchase items, the company has its suppliers drop ship the merchandise to the employee when the company certificates are redeemed. The price of the merchandise (including shipping, handling and sales tax) is set by the company and is displayed on its marketplace Web site. With respect to the gift cards, the company purchases them at a retailer's store and sells the cards on its marketplace Web site for the actual value plus shipping and handling. The company holds the gift cards in inventory, and when the company certificates are redeemed, the subsidiary ships the gift card directly to the employee.

Employee Recognition Programs and Associated Transaction Fees

Massachusetts imposes a 6.25 percent sales tax on sales of telecommunication services and tangible personal property, including the sales of prewritten computer software, regardless of the method of delivery. 2 The Department acknowledged in its ruling that there is some use of the software for purposes of monitoring the program, nominating employees for rewards, and purchasing merchandise with company certificates. However, such software use ultimately was incidental to the true object of the transaction, which is to provide a non-taxable service. Because the true object of the company's transaction is for customers to obtain a non-taxable service (managing an online ERP), the Department determined that transaction fees associated with running the program, and specifically the fees associated with the reward or redemption of company certificates, were not subject to the sales and use tax.

Merchandise Purchased Through ERP

Generally, a resale certificate relieves a vendor of the burden of proving that a sale is not taxable, only if the purchaser is engaged in the business of selling the property at retail or if the purchaser is unable to determine at the time of purchase whether the property will be sold or used for some other purpose. 3 Additionally, if a service enterprise sells tangible personal property in the regular course of business, it is a retailer with respect to such sales and is required to collect the sales tax from the customer. 4

As previously noted, the company is in the business of establishing and managing ERPs, rather than selling tangible personal property. The company purchases and resells merchandise in the ordinary course of its business of providing services. These merchandise sales are separately charged from the ERP service and Massachusetts sales tax is collected by the company from the employee upon the purchase of merchandise through the company certificate. The Department ruled that as long as the charges for merchandise were separately stated from the charges for ERP services, and the collected sales tax was remitted to the Department, the company's treatment of these transactions was appropriate.

Treatment of Gift Cards

The Department also confirmed that the company's sales tax treatment of gift cards was correct. The company purchased the gift cards, and later sold the gift cards to employees in exchange for company certificates. Upon redemption of the gift cards by a vendor, sales tax was collected by the vendor with respect to the taxable items being purchased. 5

Commentary

The Department historically has maintained a very aggressive taxable position in instances where it appeared a sales transaction included some use of cloud computing/software as a service (SaaS) functionality by the customer. That said, it has been over two and a half years since the Department has ruled that a specific SaaS offering was subject to sales and use tax. 6 Based on this recent trend of taxpayer success in this area, one may question whether Massachusetts still intends to aggressively tax transactions that include some element of SaaS where a right and license to use and access software is transferred. Massachusetts has still maintained in taxpayer audits and other published guidance that charges for SaaS are generally subject to tax. However, based on recent Massachusetts letter rulings, it appears the Department is moving away from an aggressive taxable SaaS position, and towards what appears to be a more taxpayer friendly non-taxable "true object of the transaction" test.

The present case also illustrates the need for SaaS vendors and customers to document in their contracts "what the true object of the transaction is for." Here, the Department paid particular attention to all of the services that the company provides, which trumped any potential taxable transfer of access to software. Taxpayers should also try and avoid, if possible, use of the language "transfer of a license" in their contracts as Massachusetts auditors generally attempt to place these transactions in a taxable SaaS category.

The Department's letter also is notable in the application of the state's sales and use tax reseller rules to a service provider. Generally, a service provider is the consumer of any tangible property that is purchased. In such instance, sales tax must either be paid to the provider's vendor or use tax must be self-assessed and remitted to the state. The Department noted that the company is in the business of establishing and managing employee rewards programs, not in the business of selling tangible personal property as a vendor. However, since the company purchases and resells merchandise to its customers in the ordinary course of its service business, and the merchandise is charged to the customers separately from the ERP service, the Department was comfortable with the arrangement. When engaging in service transactions where tangible personal property is also transferred, companies must ensure that any charges for sales of property are separately stated from charges to customers for services provided. If the invoice does not bifurcate the property and services, then the Department may apply the state's bundled transaction rules and subject the entire transaction to sales and use tax, even the nontaxable service portion.

Footnotes

1 Letter Ruling 16-1, Massachusetts Department of Revenue, January 8, 2016.

2 MASS. GEN. LAWS ch. 64H, § 2; MASS. REGS. CODE tit. 830, § 64H.1.3.(3).

MASS. GEN. LAWS ch. 64H, § 8.

4 MASS. REGS. CODE tit. 830, § 64H.1.1.(4).

5 Letter Ruling 81-4, Massachusetts Department of Revenue, January 5, 1981.

6 Letter Ruling 13-5, Massachusetts Department of Revenue, June 4, 2013.

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