What is the True Object Test for Technology Companies
Technology companies face many hurdles in this new eCommerce economy, including how to classify a product or service that is sold. Is it tangible personal property (“TPP”) or is it a service? This simple question may seem easy to answer until you dive into the nuances that determine how your product is classified. This is known in the sales and use tax world as the True Object Test. In other words; how will the various states classify your particular product; as a service or as TPP?
Of course the answer to that question is the most common response given in the sales tax world… it depends on the state. Specifically, it depends on the state into which you sell. Most states have a single set of rules, regulations and statutes that govern how a particular good or service will be taxed. For example, Texas has very few exemptions when it comes to technology goods and services. With the exception of the 80% taxable rule for certain data processing services, most goods and services one would consider in the realm of technology are going to be taxable. These include electronically downloaded software, Software as a Service (“SaaS”) and many others. Texas considers these to be a transfer of TPP and therefore subject to sales and use tax. California, on the other hand, generally does not tax SaaS or electronically downloaded software; they consider these to be nontaxable services.
Texas and California have differing opinions about the “true object” of the transaction. In Texas it is the purchasing of a good, while California has determined it is the purchasing of a service. So which is right? Unfortunately, both are correct. Each state has the flexibility to determine how to tax any variety of goods and services. So before making a decision on whether to include or exclude tax on a sales invoice, every company needs to make sure they know how a state is going to tax that particular good or service.
To further complicate the issue, some states, such as Colorado, allow Home Rule Cities to write their own sales and use tax regulations. A city’s interpretation may differ from the state’s interpretation.
For traditional sellers of TPP, the True Object Test is not too difficult of a task. However, in this new and ever expanding world of eCommerce, technology companies face a tougher challenge when it comes to determining the true object of a transaction for purposes of taxing correctly. Not taxing correctly can be costly both in time and money. If the state considers your offering to be taxable and you did not collect tax when you sold it, your company will still be responsible for paying the tax (money). Sometimes a state discovers your company is not taxing properly while auditing your customer and reviewing their purchases. Their next step might be to begin auditing your company to see if this is a pattern with all your sales. Now resources are being spent to defend an audit (time) and you’re likely to end up owing the back taxes, plus penalty and interest.
For more information on how new sales tax regulations impact technology companies, read this article:
So what’s a technology company to do? First and foremost; do your homework on the front end. It will save time and money on the back end. Sure, it might cost you a little up front to get a taxability study or matrix done but ensuring you are properly taxing will almost certainly save you in the long run.
At Cherry Bekaert, our sales tax group is often brought in after the fact and sees the devastating consequences of not handling taxability issues correctly. Take the proactive approach toward fiscally responsible sales tax compliance. For more information, visit our website.