Is a cloud service that remotely runs a customers telephone system taxable as prewritten software in New York?

Plain-English summary

A company sells a cloud collaboration service that supports a customers existing telephone system by remote means. Its software — running on the companys out-of-state servers — instructs the customers own equipment to process and route calls, handle voicemail, video, presence, audio/web conferencing, and mobility. No calls are actually routed through the providers system; customers never download the software. The provider bills a start-up fee (to modify its software to interact with the customers system) and a monthly per-user license fee. It asked whether the service is taxable, and how its hardware and software purchases are treated.

The Office of Counsel concluded the service is taxable prewritten software:

• Prewritten software is taxable tangible personal property regardless of the delivery medium (Tax Law sections 1101(b)(6), 1105(a)), and a sale includes a license to use (section 1105(b)(5)). Software is prewritten if not designed and developed to a specific purchasers specifications (section 1101(b)(14)).
• Because customers have the right to use, control, and direct the use of the software to run their phone systems, they obtain constructive possession (20 NYCRR 526.7(e)(4)). The location of the code is irrelevant (TSB-A-08(62)S) — so the charges are taxable even though the servers are out of state.
• Situs / local rate: the provider should collect tax on the portion of receipts attributable to customer telephone systems located in New York, and may rely on customer-provided location information.
• Start-up fee = custom software: because it modifies the software to the customers specifications, it is non-taxable custom software if the charge is reasonable and separately stated.
• Purchases: the providers hardware is not subject to NY tax if not delivered to or used in New York; software bought exclusively for resale to customers is exempt with a properly completed resale certificate.

What this means for you

Cloud / SaaS and unified-communications providers

If your customers can use, direct, or control your prewritten software — even remotely, with the code on your own servers — New York treats it as a taxable sale of software via constructive possession. Calling it a service or keeping the servers out of state does not change the result.

Source by the customers location

Tax is sourced to where the software is used — here, the location of the customers telephone systems. Collect based on the New York share and keep the customer-supplied location info supporting your allocation.

Separate your customization charges

Charges to modify software to a specific customers specs are non-taxable custom software — but only if reasonable and separately stated. Bundle them into the taxable license fee and they lose that treatment.

Watch your own purchases

Hardware used outside New York isnt taxed here; software you buy purely to resell to customers is exempt with a resale certificate.

Common questions

Q: The software lives on the providers out-of-state servers and is never downloaded. Why is it taxable in New York?
A: Customers get constructive possession by having the right to use, control, and direct the software. The location of the code is irrelevant, so the receipts are taxable and sourced to the customers New York systems.

Q: Is the start-up fee taxable?
A: No, if it is a reasonable, separately stated charge for modifying the software to the customers specifications — that is non-taxable custom software.

Q: How does the provider know how much to tax?
A: It collects on the share of receipts for customer telephone systems located in New York and may rely on location information the customers provide.

Q: Can I rely on this opinion?
A: It binds the Department only as to the petitioner. Use it as guidance and confirm your own facts.

Citations and references

• Tax Law section 1101(b)(6) (tangible personal property includes prewritten software)
• Tax Law section 1101(b)(14) (definition of prewritten software; separately-stated custom modification carve-out)
• Tax Law section 1105(a) (tax on sales of tangible personal property)
• Tax Law section 1105(b)(5) (definition of sale includes license to use)
• 20 NYCRR 526.7(e)(4) (constructive possession: right to use, control, or direct use)
• TSB-A-08(62)S (location of the code is irrelevant)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_2017.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a17_9s.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-17(9)S
Sales Tax
July 6, 2017

Office of Counsel
STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S130314A

The Department of Taxation and Finance received a Petition for Advisory Opinion from
REDACTED REDACTED REDACTED REDACED REDACTED REDACTED (“Petitioner”).
Petitioner asks whether its “Cloud Collaboration Service” (“Product”) is subject to sales tax and
whether it owes any sales or use tax on its purchase of hardware and software.
We conclude that Petitioner’s service constitutes prewritten software, the sale of which is
subject to New York State and local sales taxes. Petitioner’s hardware will not be subject to sales
or use tax if it is not delivered or used in New York. If Petitioner purchases software in New York
that is intended exclusively for resale to its customers, such purchases would be exempt from sales
tax.
Facts
Petitioner sells Product, which supports by remote means a customer’s telecommunication
system. The crux of Petitioner’s service is to assist the customer’s own telecommunication system
in the processing and routing of communications. Specifically, Product is an alternative to the
customer using its own software and related hardware to support its telecommunication system.
Petitioner owns, leases or licenses the hardware and software used to provide Product. This
software is installed on Petitioner’s servers located outside New York. Petitioner’s customers do
not download any software owned or licensed by Petitioner. The hardware components used to
provide these services are also located outside New York. Petitioner’s customers are responsible
for providing connectivity of sufficient bandwidth between the customer’s location and
Petitioner’s data center, as well as connectivity to the Internet and the Public Switched Telephone
Network (“PSTN”). The PSTN or other connections can reside throughout the customer locations
and are terminated into Petitioner’ data center through customer-owned gateways managed by
Petitioner. Customers remain the “customer of record” with third-party providers of PSTN,
Internet access or other transmission services.
Petitioner’s Product does not provide the ability to transmit messages or information across
any telephone, Internet or other network lines. Rather, Product enhances the functionality of the
customer’s own telephone system by providing instructions to the customer’s equipment for the
processing and routing of incoming and outgoing communications.
Petitioner’s Product includes the following capabilities:

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TSB-A-17(9)S
Sales Tax
July 6, 2017

1.
Voice -- Petitioner’s server communicates with the customer’s gateway device (i.e.
the customer’s own switch) to provide instructions for the processing and routing of
incoming and ongoing calls to or from the customer’s phone extensions. No calls are
routed to Petitioner’s server. That is, no end-to-end communication is ever routed through
Petitioner’s system. For example, when a customer’s telecommunication system receives
and incoming telephone call, Petitioner’s applications will direct the customer’s
telecommunication system (including the customer’s switch) to route the call to the
appropriate internal extension without the call ever leaving the customer’s
telecommunication system. This system also supports a customer’s other forms of
communication to IP end-points, media processing devices, VoIP gateways, mobile
devices, and multiple media applications.
2.
Video – This component is provided through Petitioner’s servers in the same
manner as, and performs functions similar to, the Voice component. This component
provides instructions to the customer’s own computer and telecommunication systems for
capturing, recording, processing, storing, transmitting, and reconstructing a sequence of
images.
3.
Messaging – This component directs the customer’s gateway device to send an
incoming call to voice mail if a customer’s phone extension does not answer. The voice
messages are then stored on Petitioner’s servers and are available for the user to access at
his or her convenience.
4.
Presence – This component provides users the ability to determine when colleagues
are available to communicate. The customer’s own communication equipment accesses an
application on Petitioner’s server to utilize the presence capabilities.
5.
Audio Conferencing – This component supports the customer’s own audio
conferencing capabilities. It is provided in the same manner as, and performs functions
similar to, the Voice component.
6.
Web Conferencing – This component employs a third-party application that permits
desktop sharing through a web browser with phone conferencing and video. The
application resides on Petitioner’s server, and provides instructions to the customer’s own
computer and telecommunication systems for the handling of web conferencing.
7.
Mobility Services – This component supports a customer’s mobile devices through
a third-party application. Mobile customers utilizing this application can place and receive
calls over their own business’s wireless local area network and telephony infrastructure,
using Petitioner’s server to instruct the customer’s own telecommunication system in the
routing of calls. No end-to-end communications is ever routed through Petitioner’s server.
Petitioner bills customers that purchase Product a startup fee that includes the cost of
modifying Petitioner’s software to enable it to interact with and direct the customer’s

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TSB-A-17(9)S
Sales Tax
July 6, 2017

telecommunication system. Petitioner also bills a monthly user license fee for Product, which is
calculated based on the number of users. The “Service Descriptions” for Product state that the
monthly fee includes “virtual server instance charges, required storage charges, rack space charges,
power and cooling charges as well as monitoring and management charges, most moves-addschanges and major version upgrades.
Analysis
We conclude that Petitioner’s charges for Product constitute receipts from the sale of
prewritten software. Sales tax is imposed on receipts from the sale of tangible personal property,
including prewritten software, “regardless of the medium by means of which the software is
conveyed to the purchaser.” Tax Law § 1101(b)(6); see also Tax Law § 1105(a). Prewritten
computer software is any computer software that is not designed and developed by the author or
other creator to the specifications of a specific purchaser. Tax Law § 1101(b)(14). Prewritten
software remains prewritten software, even if modified or enhanced to the specifications of a
specific purchaser, except to the extent that there is a reasonable, separately-stated charge for such
modification or enhancement. Id.
“Sale” is defined as “[a]ny transfer of title or possession or both, exchange or barter, rental,
lease or license to use or consume (including with respect to computer software, merely the right to
reproduce) or otherwise, in any manner or by any means whatsoever for a consideration, or any
agreement therefor.” Tax Law § 1105(b)(5). Sales and Use Tax Regulation 526.7 provides
generally that “a sale is taxable at the place where the tangible personal property or service is
delivered or the point at which possession is transferred by the vendor to the purchaser or his
designee.” Regulation 526.7(e)(4) further provides that, with respect to a “license to use, “a
transfer of possession has occurred if there is actual or constructive possession, or if there has been
a transfer of “the right to use, or control, or direct the use of tangible personal property.” The
location of the code embodying the software is irrelevant, because the software can be used just as
effectively by the customer even though the customer never receives the code on a tangible
medium or by download. See TSB-A-08(62)S.
The essence of Petitioner’s Product is software. Petitioner’s Product facilitates the
operation of a customer’s telecommunications system by allowing the customer to remotely access
its software. This software then “instructs” the customer’s own equipment to perform various
functions, such as instructing the customer’s switching apparatus on how to route a telephone call
or to direct a call to voice mail if the user does not answer.
Petitioner’s receipts from Product constitute receipts from the sale of prewritten computer
software because its customers have the right to use, control, and direct the use of, Petitioner’s
software to facilitate the operation of the customers’ telecommunication systems. A customer
contracts with Petitioner to modify Petitioner’s software to allow it to interact with the customer’s
telecommunication system and to instruct the customer’s telecommunication equipment to perform
various functions. By contracting with Petitioner to purchase a license to use Product, the
customer is directing the use of Petitioner’s software to interact with its telecommunications

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system. Thus, the customer obtains constructive possession of the software. See 20 NYCRR
526.7(e)(4).
The situs of a software license for purposes of determining the proper local tax rate and
jurisdiction is the location associated with the license to use. See TSB-A-12(3)S; TSB-A-03(5)S.
Petitioner should collect tax based on the portion of the receipts attributable to its customers’
telecommunications systems located in New York. Id. For this purpose, Petitioner may rely on
information received from its customers about the location of their telecommunication systems.
See Tax Law §§ 1132(c)(1); 1142(4).
Petitioner’s start-up charges are separate from the charges for the license to use its
software. Because these charges are for modifying Petitioner’s software to enable it to interact
with and direct the customer’s telecommunication system, they constitute receipts from custom
software and are not subject to sales tax, as long as the charge for the customization is reasonable
and separately stated on the invoice or billing statement provided to the customer. See TSB-M93(3)S –State and Local Sales and Compensating Use Taxes Imposed on Certain Sales of
Computer Software: TSB-A-09(44)S; TB-ST-128.
Petitioner is the retail purchaser of the hardware that it uses to provide Product. Petitioner
will not owe sales or use tax on its purchases of such hardware if the hardware is not delivered to
or used by Petitioner within New York State. To the extent that Petitioner purchases software in
New York that is intended exclusively for resale to its customer, those purchases would be exempt
from sales tax as long as the Petitioner is registered for sales tax purposes and timely furnishes the
vendor with a properly completed resale certificate.

DATED: July 6, 2017

/S/
DEBORAH R. LIEBMAN
Deputy Counsel

NOTE:

An Advisory Opinion is issued at the request of a person or entity. It is limited to the
facts set forth therein and is binding on the Department only with respect to the person
or entity to whom it is issued and only if the person or entity fully and accurately
describes all relevant facts. An Advisory Opinion is based on the law, regulations, and
Department policies in effect as of the date the Opinion is issued or for the specific time
period at issue in the Opinion. The information provided in this document does not
cover every situation and is not intended to replace the law or change its meaning.