Streamlined sales tax: debate continues on MPU purchases and the digital goods definition.

A year ago, the Streamlined Sales and Use Tax Agreement (SSUTA) developed under the Streamlined Sales Tax Project (SSTP) became effective, when at least 10 states encompassing at least 20% of the U.S. population (based on the 2000 Federal census) modified their sales and use tax provisions and procedures to conform to it. The SSUTA represents years of effort by states and the business community, working together, to simplify and modernize sales and use tax laws and administration. Twenty-one states have enacted legislation to conform.

Currently, 13 states are considered "full member" states (i.e., their laws, rules, regulations and policies are currently in substantial compliance with the SSUTA (although there is an annual re-certification requirement)); these are Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, New Jersey, North Carolina, North Dakota, Oklahoma, South Dakota and West Virginia. Seven other states (Arkansas, Nevada, Ohio, Tennessee, Vermont, Utah and Wyoming) have "associate member" status; these states either have enacted some, but not all, of the provisions required to be in full compliance with the SSUTA or legislation enacting the required changes is not yet effective. Vermont, which is an associate-member state, and Rhode Island, which is not, expect to become full-member states starting in 2007.

Work in Progress

While these states have enacted legislation conforming (in whole or part) their sales and use tax laws, rules, regulations and policies, the SSUTA itself continues to be a work in progress. The process of developing a model agreement that (1) adheres to the stated goals of simplification and modernization, (2) allows state tax administrators to garner the support of state legislators and (3) provides a framework that the business community can tolerate, has been challenging. On the one hand, the cooperation of state governments and the business community, in working together to create a simplified and uniform sales tax system, has been one of the project's greatest successes. On the other hand, the progress made toward creating a simplified and uniform sales tax system has been hindered by having so many players with such vastly different interests involved in the policymaking process.

In the year since the SSUTA became effective, work has continued on a number of outstanding issues that have plagued the simplification process from its infancy. Two important, and cutting-edge, issues that have been the subject of ongoing recent debate between the State and Local Advisory Council (SLAC) and the Business Advisory Council are the (1) SSUTA's "multiple points of use" (MPU) provisions and (2) potential adoption of a "digital goods" definition.

MPU

The MPU provisions are intended to address how a purchase (such as digital goods, computer software or services), that can and will be used concurrently in more than one taxing jurisdiction, should be sourced to determine the proper remittance of sales and use tax. For example, a purchaser acquires electronically delivered computer software and installs it on a server located in California, while its employees access and use the software from multiple business locations in various jurisdictions. The question is how to "source" the sale of that product (i.e., to which jurisdictions should sales/ use tax be remitted?).The SSUTA currently contains two different MPU provisions (in Section 312).The "current version" of SSUTA Section 312 is effective through Dec. 31, 2007. A "revised version" becomes effective on Jan. 1, 2008; to remain in compliance with the SSUTA, a member state must adopt the revised version by that date.

Exemption Form: In the situation described above, current SSUTA Section 312 provides that a purchaser that does not hold a direct-pay permit must provide the seller with an MPU Exemption Form. The purchaser then will be responsible for (1) determining an appropriate method of apportioning sales/use tax to those jurisdictions in which the software will be available for use and (2) remitting sales/use tax to those jurisdictions. On receipt of the form, the seller is relieved of its obligation to collect and remit tax.

Use of the form does not affect the taxability of a transaction, nor does it enable the purchaser to avoid remitting the appropriate sales/use tax. The form simply is intended to reallocate the burden of determining the proper apportionment of tax away from the seller and onto the purchaser, which presumably maintains sufficient business records to support the apportionment of sales/use tax to multiple jurisdictions.

Current vs. revised SSUTA Section 312: Revised SSUTA Section 312 is similar to the original, with several significant additional provisions and more nuanced modifications. It requires a business purchaser (as opposed to simply a purchaser, under the original version) that is not a holder of a direct-pay permit and knows at the time of its purchase of a digital good, computer software or a service that it will be concurrently available for use in more than one jurisdiction, to deliver to the seller an "exemption certificate claiming MPU" While current SSUTA Section 312 requires delivery of an MPU exemption form only for computer software delivered electronically, the revised version also applies to computer software delivered by "load and leave" or in tangible form. However, revised SSUTA Section 312 does not apply to computer software received in person by the purchaser at a seller's business location.

Similar to the current version, the revised version provides that, when the purchaser delivers an exemption certificate claiming MPU, the seller is relived of its obligation to collect, pay or remit the applicable tax; the purchaser is obligated to pay the appropriate sales/use tax to those jurisdictions in which concurrent use is available. The purchaser is still responsible for determining a reasonable (yet consistent and uniform) method of apportioning the sales/use tax. The tax due is to be calculated as if the apportioned amount of the digital good, computer software or service had been delivered to each jurisdiction to which the sale is apportioned.

A subtle (but potentially important) difference exists in the purchaser's records that must support the method of apportionment. Under current SSUTA Section 312, the business records at the time of the sale must support the purchaser's apportionment. Under the revised version, the records at the time the sales/use tax is reported must be used. In certain instances (such as a change in business circumstances), the lag time between the sale and the time sales/use tax is reported could result in a different apportionment.

Unlike current SSUTA Section 312, the revised version addresses a seller's actions when it is known that the product will be concurrently available for use in more than one jurisdiction, but the purchaser does not provide an exemption certificate claiming MPU. The seller either can (1) work with the purchaser to produce the correct apportionment, then collect and remit sales/use tax to the appropriate jurisdictions based on that apportionment; or (2) collect and remit the tax based on the regular destination-sourcing rules for tangible personal property contained in SSUTA Section 310. If a seller chooses the former of these options and accepts in good faith the purchaser's certification as to the apportionment's accuracy, it is relieved of any further obligation to collect any sales/use tax.

Both versions of SSUTA Section 312 provide that an exemption certificate claiming MPU or an MPU Exemption Form remains in effect for all future sales by the seller to the purchaser (except as to the specific apportionment used) until revoked in writing.

Interpretation: At its last meeting in Bismarck, ND, on Aug. 28-30, 2006, the Streamlined Sales Tax Governing Board approved an interpretation request submitted by the Software Finance and Tax Executives Council of the undefined term "concurrently available for use" contained in SSUTA Section 312. An interpretation of SSUTA provisions has the same force as the SSUTA itself; this interpretation essentially clarified that the phrase includes situations in which a copy of software loaded onto a purchaser's server in one state is accessed and used by a purchaser's employees located in multiple business locations. Additionally, the term applies when software is not physically delivered to the purchaser, but resides at all times on the seller's network and the purchaser and its employees can access and use such software. This interpretation dramatically changed the landscape as to the types of transactions for which a purchaser would be required to provide a seller with an MPU Exemption Form or certificate, as there is no requirement that software be delivered to a user--it is sufficient that a user simply access the software from another party's location.

Outstanding Issues

While the MPU provisions are intended to relieve the burden on sellers that know that a product or service will be concurrently available for use in more than one jurisdiction, there are a number of issues that have been identified with respect to them. Many of these issues relate to the burdens placed on purchasers under the SSUTA, including:

1. How do the provisions apply when a purchaser is going to be using the product concurrently in member states (i.e., those that have MPU provisions) and nonmember states (i.e., those that do not)?

2. If a certificate chiming MPU is not provided and the sale is sourced by the seller using the regular (i.e., SSUTA Section 310) sourcing rules, it appears that the purchaser still will owe use tax in the various jurisdictions in which concurrent use occurs. In this situation:

* Will there be a credit mechanism (in the jurisdiction of use) or a refund mechanism (in the jurisdiction to which the tax originally was paid) to prevent multiple taxation?

* Will the use tax owed to the various states in which the item is concurrently used constantly change, based on the relative "mix" of the purchaser's use in the various jurisdictions?

3. If a certificate claiming MPU is not provided and the sale is sourced by the seller using the regular (i.e., SSUTA Section 310) sourcing roles, Hill states have the power to force the seller to determine an apportionment on audit?

4. Both versions of SSUTA Section 312 apply to "a service" that will be concurrently available for use in multiple jurisdictions. The business community has expressed concern about this broad application and has indicated a desire to limit the scope of the provisions to information-technology-related services.

5. Both versions of SSUTA Section 312 require the use of a "reasonable" method of apportionment. How will this requirement ultimately be interpreted? What burden of proof will be acceptable?

6. The revised version of SSUTA Section 312, unlike the current version, applies to a "business purchaser." How will this term be defined?

As noted, these are just some of the issues identified under the MPU provisions. At the SLAC meeting held in Columbus, OH, on Oct. 4-5, 2006, it became clear that both states and businesses, while supporting the provisions' general premise, agreed that current SSUTA Section 312 is not workable. In fact, state representatives indicated that they were not sure what to do with the MPU provisions and would gladly welcome additional input and proposals from the business community. However, a broad consensus did not appear to arise from any group on the best way to revise the provisions and make them acceptable across the board.

Working group: The business community has established a working group that plans to revise a SSUTA Section 312 amendment that was previously proposed by Utah. Among other things, the revised amendment will likely provide that the use of the MPU provisions by a purchaser should be optional, not required. The working group hopes to have the revised amendment drafted in time to be eligible for a vote at the Governing Board meeting scheduled for December 2006. The states also suggested the possibility of drafting a motion to allow them to conform to either version of the MPU provisions (rather than just the revised version) and still be considered in compliance with the SSUTA.

This proposal would enable states that have adopted only the current version of SSUTA Section 312 to avoid having to enact additional legislation until all the issues are resolved. The motion would prevent state representatives from repeatedly going back to their state legislatures with changes that must be made to remain in compliance with the SSUTA.

Digital Goods

In addition to trying to work out issues with the MPU provisions, states and businesses continue to struggle to develop a definition of "digital goods" or "digital products" while the need for such a definition continues to grow considerably, as more products are delivered electronically. Because the SSUTA does not control the taxability of any item or service, the inclusion of a digital goods definition in the SSUTA would not dictate the manner in which a member state must treat such goods. A member state would remain free to tax or exempt such goods as it sees fit. However, it would be required to use any digital goods definition contained in the SSUTA to impose sales/use tax on products that fit the definition.

Rather than drafting a broad definition meant to encompass all digital goods (or digital products--debate still exists over the terminology), the current draft definitions have a narrow scope that generally encompasses three types of goods commonly purchased in digital form: books, music and video. Even if those definitions are adopted, member states still would be flee to treat "other digital goods" (i.e., those that fall outside the defined categories) in any manner they desire. However, the main point of contention between the states and the business community is whether a state would be able to tax "other digital goods" simply by interpreting its definition of tangible personal property to include these items. For example, a member state's definition of tangible personal property has been defined by a state court to include a downloaded customer list. That member state may use the definition of tangible personal property to impose tax on the "other digital goods" that fall outside the narrow draft definitions. The business community would prefer that member states consider using a separate definition or category for "other digital goods--one that falls outside the definition of tangible personal property--on which a statute specifically imposing a tax can be enacted if so desired.

Problems: Various issues have surfaced during the development of a digital goods definition that illustrate the complexity of trying to apply traditional sales/use tax rules to digital goods situations. For example, when a person goes to the store and purchases a new compact disk, it is clear that he or she has physically taken possession of the product and a taxable sale has occurred. However, if a person pays a subscription fee to download a new song and has a right to listen to it as long as his or her subscription is current, but cannot transfer it, it is not clear whether this is a sale or rental. In other words, when dealing with digital products that are delivered electronically, at what point has a purchaser permanently acquired the product?

During the SLAC meeting in Columbus, it appeared that some progress was made in reaching a definition of digital goods that will be acceptable to both the states and the business community. Business groups are going to work on revising the current draft definitions to address their concerns as to a state taxing other digital goods under its tangible personal property definition. As with the MPU provisions, it is hoped that a draft amendment to the SSUTA involving the digital goods definition will be eligible for a vote at the Governing Board meeting in December 2006.

Conclusion

Whether the MPU issues and the ongoing debate over the adoption of a definition of digital goods will be resolved at December's Governing Board meeting remains to be seen. As with the other issues that the parties involved in the SSTP effort have struggled with in the past, any resolution will require a careful balancing of business interests with states' rights, and compromise on both sides. The good news is that the collaboration of governments and businesses has continued to flourish, despite the many roadblocks to simplification. The bad news is that many paralyzing issues (MPU and digital goods among them) continue to drag out the simplification process and affect the momentum needed to get more states to conform to the SSUTA.

Editor: Scott Salmon, CPA, M.Acc. Partner KPMG LLP Washington, DC

Authors: Sarah McGahan, J.D., LL.M. Senior Associate KPMG LLP Washington, DC

Mr. Salmon chairs the AICPA Tax Division's State & Local Taxation Technical Resource Panel. Far more information about this column, contact Ms. McGahan at [e-mail].