On September 24, the Mississippi Department of Revenue filed a proposed amendment to its sales tax regulation on Computer Equipment, Software and Services.  This amendment appears to reverse longstanding sales and use tax policy with respect to remote internet-based computer services, and could result in a significant non-legislative tax increase on Mississippi businesses.  The notice filed with the Secretary of State did not schedule a public hearing, and the amended regulation is set to go into effect in thirty days on October 24.  All taxpayers concerned about this potential shift in tax policy or the important issues identified below should immediately contact the Department and request a public hearing on the proposed changes.

The most prominent change within this amendment is to expand the regulatory definition of “computer software” to define items such as cloud computing, software as a service (SaaS), platform as a service (PaaS) and infrastructure as a service (IaaS).  The most significant and consequential change, however, may be the deletion of the existing use tax rule declaring as nontaxable any software located on an out-of-state server when accessed via the internet.  The practical effect of this deletion is that the Department will now consider as taxable many previously non-taxable internet based services provided or hosted entirely outside Mississippi when utilized by a Mississippi user.

The proposed regulation raises but fails to address numerous important questions related to the practical application of this new policy, and it will be very important that the Department hold a public hearing to explore these issues further.

Statutory background

Mississippi imposes its sales tax on “computer software sales and services.”  For sales tax purposes, computer software is not specifically defined and is not included within the definition of tangible personal property,[1] but is taxable by direct statutory reference as it is included in the list of miscellaneous businesses typically referred to as taxable services.[2]

In contrast, the use tax statutes specifically include “computer software programs” in the definition of tangible personal property, but computer software services are not referenced.[3]  The exclusion of computer services from that definition in the use tax code is consistent with Mississippi’s historic position that the use tax generally does not encompass services acquired from and performed by out-of-state providers.

The Department’s existing use tax regulation provides that “software maintained on a server located outside the state and accessible for use only via the Internet is not taxable.”[4]  Accordingly, under current law an in-state user accessing online software and database services via the internet is not equated with the importation of property into the state so as to trigger a use tax obligation.  The Department’s proposed amendment appears specifically designed to change that existing policy and render many of these cross-border web-based transactions taxable.

Proposed Changes

Mississippi’s regulation on computer programs and services is antiquated and reflects an outdated model where most software was purchased and delivered via some physical media and installed locally on a computer.  With the expansion of internet-based software delivery and cloud- or SaaS-type applications, it has become increasingly difficult to apply Mississippi’s “old” law to these new technologies and ways of doing business.  To that end, the amended regulation provides new definitions for numerous types of modern internet-based products and services.

101 Computer Software Sales and Services

1. Definitions
2. “Computer Software” means any computer data, program or routine, or any set of one or more programs or routines, which are used or intended to cause one or more computers, pieces of computer-related peripheral equipment, automatic processing equipment, or any combination thereof, to perform a task or set of tasks. Computer software may be contained in or on magnetic tapes, discs or other tangible or electronic media or downloaded online.
3. “Cloud Computing” describes the delivery of computing resources, including software applications, development tools, storage, and servers over the Internet. The term includes the software as a service model (SaaS), platform as a service model (PaaS), infrastructure as a service model (IaaS), and similar service models.
4. “Software as a Service” is software hosted and maintained by a third-party provider and delivered to customers over the internet as a service. The provider hosts and maintains the databases and code necessary for the application to run, and the application is run on the provider’s servers.
5. “Platform as a Service” is a cloud computing model where a third-party provider delivers hardware and software tools to users over the internet. The provider hosts the hardware and software on its own infrastructure.
6. “Infrastructure as a Service” is a cloud computing model that delivers fundamental computing, network, and storage resources to consumers on-demand, over the internet.

The regulation also adds new language providing that design and creation of a web page and other undefined “certain services” are taxable if they are “delivered through SaaS, PaaS, IaaS and other cloud computing models.”  This new provision recognizes that software is no longer acquired solely by purchasing it in some physical media and uploading or installing it on a local computer as reflected in the existing regulation, and that many physical components of a system may be located remotely rather than on site as historically would have been common.  The new language, however, evidences an intent to expand the sales tax base to tax computer-related services occurring beyond the state’s borders if they involve any of these modern platforms.

Equally important, the amendment removes an existing sentence in the use tax portion of the regulation providing that “software maintained on a server located outside the state and accessible for use only via the Internet is not taxable.”[5]  If implemented, this change appears to represent a fundamental shift in tax policy and presumably will empower the Department to assess sales and use tax on computer services performed or hosted entirely out-of-state if they are accessed from inside Mississippi via the Internet.

Important Unanswered Questions

The proposed amendments raise a host of unanswered questions and the risk of numerous unintended (or perhaps intended) consequences that should be addressed now rather than on an ad hoc basis in upcoming audits.

• Are these changes retroactive? Because these policy changes do not appear to be tied to any legislative changes specifically concerning computer software, we do not have the benefit of statutory transition provisions that traditionally have clarified whether the changes apply only prospectively or retroactively to open periods.  Consistent with Department practices in other contexts, a concern exists that the Department may attempt to apply these changes to tax periods preceding the formal adoption of the amended regulation.
• Who is responsible for the tax? The local user of these internet services will almost certainly be liable for any use taxes that arise under the new rules, on par with the traditional importation of taxable property into the state.  Under the state’s new marketplace seller legislation, however, it appears the provider may also qualify as a “remote seller” and be liable for collecting the tax.  The statutes, however, appear to provide no credit mechanism to prevent double taxation if the seller does not collect the tax and the Department audits both the seller and user as both parties could be held liable for the tax.  Based on prior audit experience, this statutory flaw (or perhaps feature) will almost certainly result in disputes over which party is ultimately responsible for the tax and whether the Department is entitled to collect simultaneously from both parties by hiding behind the confidentiality statutes.
• What portion of a centralized software license or service is taxable in Mississippi? Multistate organizations often secure a single centralized license agreement for software utilized via the internet by employees both within and outside Mississippi.  Under the current regulation the remote use of that software via the internet should be nontaxable, but the amended regulation does not address how the Department will determine what portion of that centralized license fee will be taxable under this new policy.  Options might include a determination based on the simple number of in-state licensees or users, but this might produce a very different result than an approach based on actual use or if only certain portions of the core software are used by in-state employees.  Additional guidance on this topic will be critical for accurate compliance.
• How will the “value” of unpaid intercompany technology services be determined? Other organizations may provide software or data services to affiliates from remote locations (e.g., a centralized database or a dedicated IT affiliate) and may not charge those affiliates for using those services.  Given that the new policy appears to view this remote access on par with the importation of tangible personal property into the state, those services presumably could be subject to use tax based on the “value” of that property at the time of “importation.”  The regulation does not address whether uncompensated intercompany web-based services are taxable or, if so, how that value might be determined.
• Will intercompany charges be subject to “arm’s length” adjustments if the Department views them as inadequate? If a charge is made between affiliates for any intercompany software or data services, a question exists whether the Department intends to audit the adequacy of that charge and potentially adjust it to an “arm’s length” amount based on the reference to the “value” of imported property in the use tax statutes.  The regulation is silent on this key compliance issue.
• How might the regulation impact the traditional charge-out of general administrative overhead expenses? The authors are aware of situations where the Department has attempted to levy use tax on internal intercompany charges for administrative overhead.  In a common situation, a multistate organization will allocate to local operating units certain administrative costs that were budgeted or incurred by internal cost centers located exclusively outside the state.  These costs often include, along with multiple unrelated costs, software and similar licenses that might have been taxable had they been acquired and used directly by an in-state cost center.  The proposed regulation presents a significant risk that these types of common intercompany cost allocations could be scrutinized heavily in future audits.
• What are the “certain services” that the regulation could now consider taxable? The existing sales tax regulation already addressed web page design and creation, stating that those services could be taxable “regardless of the location of the hosting server,” but that language may have presumed the existence of someone in-state who was performing the actual services.  The new reference to additional “certain services” that could be taxable is very vague and raises the question whether the amended regulation will be asserted to treat as taxable otherwise nontaxable services simply due to the means of delivery via SaaS, PaaS, IaaS and other cloud computing models.
• Will the traditional sales tax credit apply when use tax accrues? When a taxpayer imports previously-used property into the state, the use tax applies based on the value of the property at the time of importation but a partial credit generally is offered for any sales tax originally paid to another jurisdiction on that same property.  The regulation is silent as to whether and how that credit will apply in the net-based software context.
• The presumed nontaxability of “exported” software appears vague and ambiguous. The amended regulation will provide that software will not be taxable in Mississippi if it is “transmitted by the Internet to a destination outside the State of Mississippi where the first use” by the purchaser occurs outside the state.  This appears to be an attempt to place these items on par with the sale and export of traditional tangible personal property, but the means of delivery of these different types of property varies significantly.  Initially, it should not be assumed that the Department will view an outbound “transmission” of software or online services the same as an inbound transmission by an in-state user.  Additionally, it is unclear what constitutes a “transmission” as this is the only context in the statute or regulation where this specific word is used and the Department has not provided a definition.  This provision will most likely be viewed as an exemption, so any ambiguities will be construed against the taxpayer.

The above examples are only a sampling of the myriad risks and uncertainties posed by this proposed regulation, and taxpayers are encouraged to request a formal public hearing to raise these and any additional concerns directly with the Department prior to the planned effective date of the changes.

[1] Miss. Code Ann. Section 27-65-3

[2] Miss. Code Ann. Section 27-65-23

[3] Miss. Code Ann. Section 27-67-3(i)

[4] Miss. Admin. Code 35.IV.5.06

[5] Miss. Admin. Code 35.IV.5.06(300)