New Jersey’s New Rules for Software Sales Tax

New Jersey’s New Rules for Software Sales Tax

CJ Stroh, Esq
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New Jersey adopted several new regulatory changes this month that address how software related services are taxed. The prior law, which was governed by N.J.A.C. §18:24-25.6, has been repealed.

NEW GUIDANCE

The new guidance is effective December 1, 2014, and is enacted via:

  • The adoption of N.J.A.C. §18:24-25.7, which deals specifically with software maintenance contracts; and
  • What amounts to an amendment of N.J.A.C. §18:24-25.6, which now exclusively addresses the treatment of software related services.

The regulations make important distinctions that taxpayers need to be aware of for sales tax purposes. The regulations clarify the taxability of certain types of software maintenance contracts and attempt to clarify the taxability of software related services.

BACKGROUND AND CONCEPTS

In New Jersey, tangible personal property is subject to sales tax. The state’s definition of tangible personal property includes prewritten computer software, regardless of whether the software is delivered to a customer via a disc or drive, or is electronically transmitted or downloaded. Thus, prewritten computer software is subject to sales tax.

Conversely, software as a service (known as “SaaS”) is not considered tangible personal property, so it is not subject to sales tax. Software providers that offer customers remote (e.g. internet) access to their software on a per transaction basis, through a service contract, or by subscription, are SaaS providers. SaaS providers do not transfer software to their customers.

Additionally, electronically delivered software that is used for business purposes is exempt from sales tax. However, this exemption does not apply to software-related installation, maintenance, servicing, or repairs. The general position is that services to software are taxable, even if the underlying software itself is exempt from sales tax.

SOFTWARE MAINTENANCE CONTRACTS

The new regulation (N.J.A.C. §18:24-25.7) details the taxability of software maintenance contracts. Contracts that only provide upgrades and updates are treated as a sale of prewritten computer software, and are thus subject to sales tax. If however, the upgrades and updates are delivered electronically and used directly and exclusively in the conduct of the purchaser’s business, trade, or occupation the software maintenance contract is not taxable.

A software maintenance contract that includes both taxable and nontaxable/exempt products is considered a “bundled transaction.” If the taxable products are not separately itemized from the nontaxable products on the invoice or billing document, then the entire bundled transaction will be taxable unless the seller can demonstrate what portion of the contract is for nontaxable products. Reasonable and verifiable means will be needed for proof; however, separately identifying taxable and nontaxable charges on invoices is always advisable.

SOFTWARE-RELATED SERVICES

The amended regulation N.J.A.C. §18:24-25.6, points out that prewritten computer software is tangible personal property, and therefore the servicing, installing, or maintaining of software is subject to sales tax. This is the case regardless of whether the service activity is performed at the purchaser’s location, or from a seller or service provider’s remote location. This wording seems broad enough to encompass all software related services, but that is not the case. The regulation also states that the modification of prewritten computer software for a purchaser is treated as a sale of non-enumerated services and not subject to sales tax.

There has been friction in the past between certain types of software service providers and the state regarding the seemingly contradictory way taxable and non-taxable software services have been defined by New Jersey. With “software consulting” businesses that offer a mix of programming, systems analysis, design and implementations, it is often difficult to determine how the “modification” of software differs from the “servicing” of software in the eyes of the state and its auditors. Unfortunately, the new regulations fail to resolve this longstanding issue.

“Modifying” software is currently defined by the state as:

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

This definition does little to identify the differences between modifying and servicing software.

Lastly, the amended regulation covers two additional areas of software related types of services. Clerical, data entry, and accounting services that may be performed with the use of software are not considered to be the “servicing” of software, and thus are not subject to sales tax. Also, customer support services, which are defined as, “verbal and written computer software advice or guidance,” are deemed to be a non-enumerated, nontaxable service.

ACTION STEPS

Taxpayers should consult with Withum professionals to make sure they are in compliance with the new rules, and that their use tax accruals are proper.

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