How Texas sales tax affects technology companies

As many companies transition operations from California to Texas, they have found different sales tax rules with respect to software and software as a service (SaaS). While California does not tax software that is conveyed solely electronically or through the cloud (with no physical medium), Texas treats software as taxable tangible personal property and SaaS as taxable data processing services. Software and SaaS providers in Texas, and in a growing number of other states, have significant sales and use tax reporting requirements as well as opportunities for sales and use tax savings and refunds. Understanding the Texas requirements can help companies better evaluate the costs associated with moving their operations.

Because Texas statutes define software as tangible personal property, the sourcing rules, sales price determinations, and software development exemptions all are affected. The Texas comptroller typically attempts to assess tax in full for software downloaded to a server in Texas. For software that resides outside of the state, Texas will attempt to tax it to the extent remote users are in Texas. On the other hand, because software is tangible personal property, software developers are considered manufacturers, and Texas provides a variety of manufacturing exemptions that can reduce a software developer’s sales tax costs.

Furthermore, services associated with the software that are provided by the seller, such as installation, implementation, modification, and maintenance, typically are treated as part of the sales price and tax base of the software. However, if a third party provides these associated services, they typically are not subject to tax. Therefore, software companies should consult with a tax adviser about whether having a separate legal entity provide services might reduce Texas sales tax.

SaaS is treated as a taxable data processing service in Texas

Because the Texas comptroller considers SaaS to be a taxable data processing service, specific challenges and opportunities exist for SaaS providers and users. The comptroller considers SaaS to be the remote access of software provided by another (Comptroller PLR 20180724152951, March 3, 2020). As a data processing service, SaaS is sourced based on the customer’s service benefit location. If the provider and customer are in Texas, the comptroller will presume that Texas tax is due. Customers that have segments of their business inside and outside of Texas can issue the provider a multistate benefit exemption certificate. If the SaaS provider receives a properly completed certificate, it does not need to collect any Texas sales tax. The customer would calculate its own tax based on any reasonable method. Texas also provides a 20% exemption for SaaS.

Depending on the facts and circumstances, reducing the Texas sales tax on SaaS could be possible. For instance, data processing service providers can purchase tax free for resale any tangible personal property when the care, custody, and control transfers to their customer. Additionally, SaaS providers that purchase services that are intended to be transferred as an integral part of the services provided to customers also might be eligible for refunds of Texas sales tax paid on these purchases. SaaS providers also might be eligible for Texas sales tax refunds on cloud-based platform services, data hosting and transmission services, telecommunication services, and other services integral to SaaS. Every refund is dependent on specific facts and circumstances in addition to available documentation. While comptroller auditors are not necessarily tasked with identifying and quantifying these refunds, it typically is advantageous to pursue these refunds while under audit. SaaS providers that qualify for these exemptions also can issue a resale certificate to their vendors in lieu of sales tax.

Looking forward

Software, software-related services, and SaaS providers and customers face many challenges associated with sales and use tax. However, several exemptions could reduce the sales tax amount required to be paid or increase the opportunities for refunds. Providers and users should determine if these tax-savings opportunities are available and mitigate future audit risk by engaging in a thorough evaluation of these types of purchases and sales.