Is a Tennessee technology consultant's work taxable — setting up a temporary 'virtual lab' to test software, and backing up a customer's data — when no software is sold to the customer?

Plain-English summary

A Tennessee technology-consulting firm helps customers pick, test, configure, install, and integrate new computer software and hardware into their existing systems. Before a customer commits to an often-expensive configuration, the firm sets up a temporary "virtual lab" — on the customer's hardware or its own — temporarily loads trial-version or firm-owned software, copies in some of the customer's data, and demonstrates how the setup would work. It also backs up the customer's data to its own servers first, to guard against data loss. No software is sold or transferred to the customer during this testing phase. The firm asked whether three of these activities are taxable. The Department said no to all three.

The framework. Tennessee's Retailers' Sales Tax Act taxes (1) retail sales of tangible personal property, including computer software (taxable however delivered, § 67-6-231(a)), and (2) a short list of specifically enumerated services. One enumerated service is "the installing of computer software" for a charge (§ 67-6-205(c)(6)). But consulting, designing, testing, and training are not enumerated, so they aren't taxable on their own. A non-enumerated service only becomes taxable if it's bundled into the price of a taxable item, or is a "crucial/essential/integral" part of a transaction that sells taxable property (the Crescent line).

Virtual lab (Questions 1 & 2) — NOT taxable, whether on the customer's or the firm's hardware.

• No software changes hands. A taxable software sale needs a transfer of title, possession, or control to the customer. The firm keeps the license (no title transfer), and the software is placed only for the firm's own demonstration and then removed — the customer never gets to use, access, or control it, so the customer never has "possession." ("Possession" isn't defined in the Act, so the Department used its ordinary meaning — dominion or exclusive control — Bryant v. Genco, Ford v. Oklahoma Tax Comm'n.)
• It isn't "installation." The only enumerated service in play is "installing computer software," but the Department held that temporarily setting up your own software for your own use and then removing it in a single event is not "installation" under the term's ordinary meaning ("to set up something for use or service" — Eusco v. Huddleston; Cent. Me. Power v. Johnson).
• Even if it were installation, the "true object" is consulting. Tennessee uses a "true object" / "primary purpose" test (Qualcomm v. Chumley). The customer is buying consulting — figuring out its software needs against its own data — and the temporary software input is merely incidental to that service. So the charge isn't taxable.
• No taxable goods are sold alongside it, and the Crescent "crucial/essential/integral" analysis isn't needed because no tangible personal property is sold with the service.

Data backup (Question 3) — NOT taxable. When the firm copies the customer's data to its servers, nothing taxable is transferred to the customer — the only thing moving is the customer's own data, from the customer to the firm. Data backup isn't an enumerated service, nothing taxable is bundled with it, and again no Crescent analysis is needed.

One thing the ruling did not bless: these three answers are about the testing/demonstration and backup phase, where no software is sold. The facts note that if the customer decides to proceed, the firm often buys the software and licenses and installs it for the customer. That later step is a separate transaction — and selling software, and charging to install it, are exactly the kinds of things Tennessee does tax. (Recordkeeping reminder: even for nontaxable services, dealers must keep sales/purchase records for at least three years, § 67-6-523.)

What this means for you

IT consultants, integrators, and managed-service providers

Pure consulting, analysis, testing, and demonstration work — including spinning up a temporary lab on your or the client's hardware with your own/trial software and tearing it down — is not taxable in Tennessee, as long as you don't transfer software to the client and don't bundle it with a taxable sale. The taxable events come later: when you actually sell software to the client or charge to install software (an enumerated taxable service). Invoice the consulting/testing phase separately from any eventual software sale and installation so the nontaxable work stays cleanly nontaxable.

The line that matters: did software change hands, and was it "installed"?

Two questions decide it. First, did the client get title, possession, or control of software? Loading software for your own demo and removing it isn't a transfer of possession. Second, did you "install" software for a charge? A momentary, self-serve setup-and-teardown isn't "installation" — but setting software up for the client's ongoing use is, and that's taxable (§ 67-6-205(c)(6)).

Accountants and tax professionals

Only enumerated services are taxable (Ryder Truck Rental; Covington Pike Toyota); software installation is enumerated (§ 67-6-205(c)(6)), consulting/testing/training are not. No taxable transfer of software occurs without title/possession/control (§ 67-6-102(78)(A), (78)(K); § 67-6-231(a)); "possession" gets its ordinary meaning (Bryant v. Genco; Beare Co.). "Installing" likewise gets its ordinary meaning (Eusco), and a temporary self-use setup/teardown isn't it. Backstop: even if the input were installation, the true-object test (Qualcomm v. Chumley; Commerce Union Bank v. Tidwell) makes the software merely incidental to the consulting service. Bundling (§ 67-6-102(79)(A)) and the Crescent "crucial/essential/integral" test don't apply because no taxable property is sold with the service. Companion software/services rulings in the corpus: the bundled-lease LR 13-09 and the cloud/data-processing rulings RR 13-03, LR 13-12, LR 13-15.

Common questions

Q: Is IT/software consulting taxable in Tennessee?
A: Generally no. Consulting, analysis, testing, and demonstration aren't among Tennessee's specifically enumerated taxable services, so they aren't taxable on their own (as long as no taxable software sale is bundled in).

Q: We loaded our software onto the client's computer to demo it — is that a taxable "installation"?
A: Not on these facts. The Department held that temporarily setting up your own (or trial) software for your own demonstration and then removing it isn't "installation," and the client never got possession or control of the software. Setting software up for the client's ongoing use, for a charge, is a different story — that's a taxable enumerated service.

Q: Is charging to back up a customer's data taxable?
A: No. Backing up the customer's data to your servers transfers nothing taxable to the customer — only the customer's own data moves — and data backup isn't an enumerated service.

Q: So when does the consultant actually charge sales tax?
A: When it sells software to the customer, and when it charges to install software for the customer's use (§ 67-6-205(c)(6); § 67-6-231(a)) — the steps that come after the nontaxable testing/demo phase covered here.

Q: Can I rely on this letter ruling?
A: No. A Tennessee letter ruling binds the Department only as to the specific taxpayer and facts, and can be revoked or modified. Confirm your own situation with a tax professional.

Citations and references

Tennessee statutes (Tenn. Code Ann.; Retailers' Sales Tax Act, §§ 67-6-101 to -907):

• § 67-6-205(c)(6) ("installing of computer software" for a charge — an enumerated taxable service); § 67-6-205 (sales tax applies only to enumerated services)
• § 67-6-231(a) (sale, lease, licensing, or use of computer software is taxable regardless of delivery method)
• § 67-6-102(78)(A) ("sale" — transfer of title/possession of TPP); § 67-6-102(78)(C) (a "sale" includes furnishing taxed things/services); § 67-6-102(78)(K) (a "sale" includes transferring/programming/loading software onto a computer)
• § 67-6-102(68) ("prewritten computer software"); § 67-6-102(18) ("computer software"); § 67-6-102(89)(A) (tangible personal property); § 67-6-102(24) ("delivered electronically")
• § 67-6-102(79)(A), (A)(iii) ("sales price" — bundling; no deduction for services necessary to complete the sale); § 67-6-102(76) ("retail sale")
• § 67-6-523 (dealers must keep sales/purchase records for at least three years)

Tennessee (and persuasive out-of-state) cases cited by the ruling:

• Ryder Truck Rental, Inc. v. Huddleston, 1994 WL 420911 (Tenn. Ct. App. 1994); Covington Pike Toyota, Inc. v. Cardwell, 829 S.W.2d 132 (Tenn. 1992) (only enumerated services are taxable)
• Eusco, Inc. v. Huddleston, 835 S.W.2d 576 (Tenn. 1992) (undefined statutory terms get their ordinary meaning — "installing"); Cent. Me. Power Co. v. Johnson, 263 A.2d 713 (Me. 1970) ("install" = "to set up for use or service")
• Qualcomm Inc. v. Chumley, 2007 WL 2827513 (Tenn. Ct. App. 2007) ("true object" / "primary purpose" test); Commerce Union Bank v. Tidwell, 538 S.W.2d 405 (Tenn. 1976) (a "merely incidental" transfer isn't taxed)
• Bryant v. Genco Stamping & Mfg. Co., 33 S.W.3d 761 (Tenn. 2000); Tenn. Farmers Assur. Co. v. Chumley, 197 S.W.3d 767 (Tenn. Ct. App. 2006); Beare Co. v. Tenn. Dep't of Revenue, 858 S.W.2d 906 (Tenn. 1993); Ford v. Oklahoma Tax Comm'n, 285 P.2d 436 (Okla. 1955) (ordinary meaning of "possession" — dominion/exclusive control)
• Crescent Amusement Co. v. Carson, 213 S.W.2d 27 (Tenn. 1948); Thomas Nelson, Inc. v. Olsen, 723 S.W.2d 621 (Tenn. 1987); AT&T v. Johnson, 2002 WL 31247083 (Tenn. Ct. App. 2002); Rivergate Toyota, Inc. v. Huddleston, 1998 WL 83720 (Tenn. Ct. App. 1998); Nashville Mobilphone Co. v. Woods, 655 S.W.2d 934 (Tenn. 1983) (the Crescent "crucial/essential/integral" line and "merely incidental")

Source

• Landing page: https://www.tn.gov/revenue/tax-resources/legal-resources/tax-rulings.html
• Original PDF: https://www.tn.gov/content/dam/tn/revenue/documents/rulings/sales/13-21.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
LETTER RULING # 13-21

Letter rulings are binding on the Department only with respect to the individual taxpayer
being addressed in the ruling. This ruling is based on the particular facts and
circumstances presented, and is an interpretation of the law at a specific point in time. The
law may have changed since this ruling was issued, possibly rendering it obsolete. The
presentation of this ruling in a redacted form is provided solely for informational purposes,
and is not intended as a statement of Departmental policy. Taxpayers should consult with a
tax professional before relying on any aspect of this ruling.

SUBJECT

The application of the Tennessee sales and use tax to computer software consulting services.

SCOPE

This letter ruling is an interpretation and application of the tax law as it relates to a specific set of
existing facts furnished to the Department by the taxpayer. The rulings herein are binding upon
the Department, and are applicable only to the individual taxpayer being addressed.

This letter ruling may be revoked or modified by the Commissioner at any time. Such revocation
or modification shall be effective retroactively unless the following conditions are met, in which
case the revocation shall be prospective only:

(A) The taxpayer must not have misstated or omitted material facts involved in
the transaction;

(B) Facts that develop later must not be materially different from the facts upon
which the ruling was based;

(C) The applicable law must not have been changed or amended;

(D) The ruling must have been issued originally with respect to a prospective or
proposed transaction; and

(E) The taxpayer directly involved must have acted in good faith in relying upon
the ruling; and a retroactive revocation of the ruling must inure to the taxpayer’s
detriment.

FACTS

[TAXPAYER] (the “Taxpayer”) is a Tennessee [ENTITY] with its principal place of business in
[CITY], Tennessee. The Taxpayer provides technology consulting services, including the
analysis, testing, installation, configuration, and integration of new computer software and
hardware into the customer’s existing system.

A customer wishing to implement new software functionality will consult with the Taxpayer to
determine the software and hardware configuration that best meets the customer’s needs. Often,
the recommended configuration involves significant cost. Therefore, before the customer
commits to full installation and integration of the software and hardware into its existing
systems, the Taxpayer tests the recommended configuration to ensure proper functionality.

The Taxpayer begins by backing up the customer’s data files to the Taxpayer’s servers anytime it
will be manipulating the customer’s data to ensure there is no data loss that results from the
Taxpayer’s services. The Taxpayer then proceeds to begin testing, which requires that the
Taxpayer set up a virtual lab, either by using the customer’s hardware or the Taxpayer’s
hardware. To conduct the testing, the Taxpayer must temporarily install and configure the
recommended software. Once the recommended software is configured, data from the
customer’s system is copied into the virtual lab for testing and demonstration purposes. No
software is purchased for, or transferred to the customer at this time. Instead, at the testing phase,
the Taxpayer uses licensed trial version software or software owned by the Taxpayer. After the
testing is completed, the Taxpayer will remove any software installed in a virtual lab created
using the customer’s hardware.

After testing and demonstration of the configuration, the Taxpayer provides the customer with
price estimates for the installation and integration of the recommended software and hardware.
If the customer chooses not to move forward, the relationship ends, and the Taxpayer provides
the customer with an itemized invoice for services rendered.

If the customer wants to proceed, it enters into a contract with the Taxpayer for the installation
and integration of the recommended software and hardware. The Taxpayer will most often
purchase the necessary software and license it to the customer. However, depending on the cost
and the customer’s preference, sometimes the customer will buy the software from a third-party
vendor. In either case, as provided by contract, the Taxpayer will install and integrate the
software into the customer’s existing data system. The Taxpayer provides the customer with an
itemized invoice for services rendered.

RULINGS

1. When the Taxpayer creates a virtual lab and, for testing or demonstration purposes,
   inputs its own software or a trial version for which it has a license onto the customer’s
   computer hardware, is the charge subject to the Tennessee sales and use tax?

Ruling: No, when the Taxpayer creates a virtual lab and, for testing or demonstration
purposes, temporarily inputs its own software or a trial version for which it has a license
onto the customer’s computer hardware, the charge is not subject to the Tennessee sales
and use tax.

2. When the Taxpayer creates a virtual lab and, for testing or demonstration purposes,
   inputs its own software or a trial version for which it has a license onto the Taxpayer’s
   computer hardware, is the charge subject to the Tennessee sales and use tax?

Ruling: No, when the Taxpayer creates a virtual lab and, for testing or demonstration
purposes, temporarily inputs its own software or a trial version for which it has a license

onto the Taxpayer’s computer hardware, the charge is not subject to the Tennessee sales
and use tax.

3. Does the Tennessee sales and use tax apply when the Taxpayer backs up the customer’s
   data to the Taxpayer’s servers?

Ruling: No, the Tennessee sales and use tax does not apply when the Taxpayer backs up
the customer’s data to the Taxpayer’s servers.

ANALYSIS

Under the Retailers’ Sales Tax Act,’ the retail sale in Tennessee of tangible personal property
and specifically enumerated services is subject to the sales tax, unless an exemption applies.

“Retail sale” is defined as “any sale, lease, or rental for any purpose other than for resale,
sublease, or subrent.”” TENN. CODE ANN. § 67-6-102(78)(A) (2013) defines “sale” in pertinent
part to mean “any transfer of title or possession, or both, exchange, barter, lease or rental,
conditional or otherwise, in any manner or by any means whatsoever of tangible personal
property for a consideration.” “Tangible personal property” includes “property that can be seen,
weighed, measured, felt, or touched, or that is in any other manner perceptible to the senses.”°
Tangible personal property also includes “prewritten computer software,” which is defined in
TENN. CODE ANN. § 67-6-102(68) in pertinent part as “computer software,“ including prewritten
upgrades, that is not designed and developed by the author or other creator to the specifications
of a specific purchaser.”” Conversely, the sale of intangible intellectual property is generally not
subject to the Tennessee sales and use tax, unless delivered via a tangible storage medium.

In addition to the transfer of tangible personal property, the term “sale” also includes “the
furnishing of any of the things or services” taxable under the Retailers’ Sales Tax Act.’ One of

' Tennessee Retailers’ Sales Tax Act, ch. 3, 88 1-18, 1947 Tenn. Pub. Acts 22, 22-54 (codified as amended at TENN.
CODE ANN. 88 67-6-101 to -907 (2013)).

• TENN. CODE ANN. § 67-6-102(76) (2013).
  3 TENN. CODE ANN. § 67-6-102(89)(A).

“ Computer software” is defined for Tennessee sales and use tax purposes as “a set of coded instructions designed to
cause a computer . . . to perform a task.” TENN. CODE ANN. § 67-6-102(18).

° TENN. CODE ANN. § 67-6-102(68) further provides that “‘[p]rewritten computer software’ or a prewritten portion
of the computer software that is modified or enhanced to any degree, where the modification or enhancement is
designed and developed to the specifications of a specific purchaser, remains prewritten computer software.” Note,
however, that “where there is a reasonable, separately stated charge or an invoice or other statement of the price
given to the purchaser for the modification or enhancement, the modification or enhancement shall not constitute
prewritten computer software.” TENN. CODE ANN. § 67-6-102(68).

° Compare Crescent Amusement Co. v. Carson, 213 S.W.2d 27, 29 (Tenn. 1948) (rental films are taxable tangible
personal property), with Commerce Union Bank v. Tidwell, 538 S.W.2d 405, 407 (Tenn. 1976) (finding a tangible

method of data transfer “merely incidental” to the underlying transaction, and thus not subject to sales and use tax).

’ TENN. CODE ANN. § 67-6-102(78)(C).

the “things” specifically taxable is the “retail sale, lease, licensing or use of computer software in
this state, including prewritten and custom computer software . . . regardless of whether the
software is delivered electronically, delivered by use of tangible storage media, loaded or
programmed into a computer, created on the premises of the consumer or otherwise provided.”®

The sales tax also applies to retail sales of services specifically enumerated in the Retailers’
Sales Tax Act.” One such enumerated service is “the installing of computer software, where a
charge is made for the installation, whether or not the installation is made as an incident to the
sale of . . . computer software, and whether or not any . . . computer software is transferred in
conjunction with the installation service.”'° Conversely, the Retailers’ Sales Tax Act does not
specifically enumerate consulting, designing, testing, and training services;'’ such services are
therefore not in and of themselves subject to taxation.

There are two ways that non-enumerated services, however, may be included in the sales price of
a given transaction, despite not being directly subject to tax. First, an otherwise nontaxable
service or item may be subject to taxation when charges for the service or item are included in
the sales price of a taxable good or service. Specifically, TENN. CODE ANN. § 67-6-102(79)(A)
provides in pertinent part that the sales price of a good or service equals the “total amount of
consideration . . . for which personal property or services are sold,” without deduction for the
seller’s cost of goods sold, labor or service costs, and other expenses. Thus, if taxable goods or
services and nontaxable goods or services are sold together for a single charge, the entire charge
is generally subject to taxation, with the bundled sales price as the measure of the tax.”

The second manner in which a non-enumerated service may be included in the sales price of a
transaction is where the service is intertwined with the sale of taxable tangible personal property.
The definition of “sales price” provides in pertinent part that there will be no deductions for
“labor or service” costs incurred by the seller and also includes “[c]harges by the seller for any

° TENN. CODE ANN. § 67-6-231(a) (2013). The term “sale” specifically includes the transfer of computer software,
including the creation of computer software on the premises of the consumer and any programming, transferring, or
loading of computer software onto a computer. TENN. CODE ANN. § 67-6-102(78)(K). Computer software is
“delivered electronically” if delivered “by means other than tangible storage media.” TENN. CODE ANN. § 67-6-
102(24).

° The Retailers’ Sales Tax Act imposes the sales tax only on services specifically enumerated in the Act. See, e.g.,
TENN. CODE ANN. § 67-2-205 (2013); Covington Pike Toyota, Inc. v. Cardwell, 829 S.W.2d 132, 135 (Tenn. 1992);
Ryder Truck Rental, Inc. v. Huddleston, No. 91-3382-II, 1994 WL 420911, at *3 (Tenn. Ct. App. Aug. 12, 1994)
(sales tax does not apply to all services; rather, it only applies to retail sales of services specifically enumerated by
the statute).

10 TENN. CODE ANN. § 67-6-205(c)(6) (2013).

"! See, e.g., TENN. CODE ANN. § 67-6-205.

2 See Tomkats Catering, Inc. v. Johnson, No. M2000-03107-COA-R3-CV, 2001 WL 1090516, at *2 (Tenn. Ct.
App. Sept. 19, 2001); cf. TENN. CODE ANN. § 67-6-102(79)(A)(vi) (“Sales price” includes “[t]he value of exempt

personal property given to the purchaser where taxable and exempt personal property have been bundled together
and sold by the seller as a single product or piece of merchandise.”).

services necessary to complete the sale.”'’ Thus, when the sale of a non-enumerated service is a

necessary part of the sale of a taxable good or service, the charges for that service are included in
the sales price and subject to the sales tax.

Accordingly, the Taxpayer’s charges will be subject to the Tennessee sales and use tax if the
charges relate to: 1) the sale of tangible personal property or computer software in Tennessee;
2) the furnishing of a taxable service in Tennessee; 3) the furnishing of an otherwise nontaxable
good or service that is bundled with a taxable good or service; or 4) the furnishing of a non-
enumerated service that necessary to complete the sale of a taxable good or service.

1. & 2. Virtual Lab

When the Taxpayer creates a virtual lab and, for testing or demonstration purposes, temporarily
inputs software onto the customer’s computer hardware or the Taxpayer’s own hardware, the
charge is not subject to the Tennessee sales and use tax.

First, no sale of tangible personal property, including prewritten computer software, occurs when
the Taxpayer sets up a virtual lab and temporarily inputs software onto its own computer
hardware or the customer’s hardware, and then removes that software when the consultation is
complete.

As discussed above, “sale” is defined in pertinent part as “any transfer of title or possession, or
both . . . of tangible personal property for a consideration,” “ and includes “any transfer of title or
possession . . . of computer software for consideration .. . and any programming, transferring or
loading of computer software into a computer.”'° A sale also includes “the furnishing of any of
the things or services” taxable under the Retailers’ Sales Tax Act, 16 including “[t]he retail sale,

'S TENN. CODE ANN. § 67-6-102(79)(A)(iii). A line of cases, beginning with Crescent Amusement Co. v. Carson,
213 S.W.2d 27 (Tenn. 1948), expand this concept, establishing that where a sale of a non-enumerated service is
accompanied by tangible personal property that is a “crucial,” “essential,” or “integral” element of the transaction,
the sales price will include the entire cost of the transaction, including the value of the non-enumerated service, see,
e.g., Thomas Nelson, Inc. v. Olsen, 723 S.W.2d 621, 625 (Tenn. 1987), and conversely, where a sale of tangible
personal property is accompanied by a non-enumerated service that are a “crucial,” “essential,” or “integral” element
of the transaction, the sales price will include the entire cost of the transaction, including the value of the non-
enumerated services. See, e.g., AT&T v. Johnson, No. M2000-01407-COA-R3-CV, 2002 WL 31247083, at 7-9
(Tenn. Ct. App. Oct. 8, 2002); see also Rivergate Toyota, Inc. v. Huddleston, No. 01A01-9602-CH-00053, 1998 WL
83720, at 4 (Tenn. Ct. App. Feb. 27, 1998). In contrast, where a transfer of tangible personal property or a service
is “merely incidental” to a sale of a non-enumerated service, the transaction would not be subject to the sales tax.
See Commerce Union Bank v. Tidwell, 538 S.W.2d 405, 407 (Tenn. 1976) (citing Washington Times-Herald, Inc. v.
District of Columbia, 213 F/2d 23 (1954)); cf. Nashville Mobilphone v. Woods, 655 S.W.2d 934, 935-37 (Tenn.
1983) (holding that the renting of radio equipment was merely incidental to the taxpayer’s principal business of
“furnishing services as a ‘radio common carrier system,’” and therefore the taxpayer’s purchase of the radio
equipment was subject to sales or use tax).

'4 TENN. CODE ANN. § 67-6-102(78)(A).

'S TENN. CODE ANN. § 67-6-102(78)(K).

1° TENN. CODE ANN. § 67-6-102(78)(C).

lease, licensing or use of computer software.”'’ Thus, if the Taxpayer transfers title, possession,

or control of any computer software to its customers, then such transfer will be subject to the
Tennessee sales and use tax.'®

Here, the facts indicate that the Taxpayer does not transfer title or possession of the software to
its customers. In instances where the virtual lab is set up on the Taxpayer’s hardware, there is no
question that the software always remains on the Taxpayer’s hardware and the Taxpayer
maintains control of the software at all times; neither title nor possession transfer to the customer
at any time.

In instances where the Taxpayer creates the virtual lab on the customer’s hardware, there is still
no transfer of title or possession of the software to the customer. First, the facts indicate that title
to the software does not transfer to the customer; the Taxpayer retains the license to the software.
Next, although the software used for the virtual lab demonstration has been placed on the
customer’s computer hardware, there is no transfer of possession to the customer. The virtual lab
configuration is not set up for use by the customer; rather, the software is placed onto the
computer hardware for the Taxpayer’s demonstration to the customer, and is subsequently
removed. Significantly, the Taxpayer remains the exclusive operator of the virtual lab
configuration. The customer does not have any access to or use or control of the software, and
thus does not have any requisite dominion or control over the software to constitute possession.”

Next, the virtual lab does not involve an enumerated service. As stated above, only specifically
enumerated services are subject to the Tennessee sales and use tax. Based on the facts provided,
the only taxable service that the Taxpayer potentially furnishes is “the installing of computer
software, where a charge is made for the installation, whether or not the installation is made as
an incident to the sale of . .. computer software, and whether or not any . . . computer software is
transferred in conjunction with the installation service.” ~”

In this case, no installation of computer software takes place. Neither the Tennessee Code nor the
Tennessee courts have defined the terms “install” or “installation” for purposes of Tennessee
sales and use taxation. However, the Tennessee Supreme Court has specifically stated that,
because the Retailers’ Sales Tax Act does not contain a definition of the term “installing,” the

'” TENN. CODE ANN. § 67-6-231(a).

'® Note that TENN. CODE ANN. § 67-6-231 specifically provides that the sale or use of computer software is subject
to the sales and use tax, regardless of whether the software is delivered electronically or via tangible storage media.

19 “Possession” is not defined under the Retailers’ Sales Act. When a term is not defined under that statute, the
Tennessee Supreme Court has stated that the term must be given its ordinary and common meaning. See e.g., Byrant
v. Genco Stamping & Mfg. Co., 33 S.W.3d 761, 765 (Tenn. 2000); Tenn. Farmers Assur. Co. v. Chumley, 197 S.W.3d
767, 782-83 (Tenn. Ct. App. 2006); Beare Co. v. Tenn. Dep’t of Revenue, 858 S.W.2d 906, 908 (Tenn. 1993).
Possession is generally understood to mean having or holding property in one’s power, the exercise of dominion
over property, or the right to exercise exclusive control over something. See BLACK’s LAW DICTIONARY 8™ EDITION
(2007); see also, Ford v. Oklahoma Tax Commission, 285 P.2d 436, 437 (Okl. 1955). In this case, the customer has
none of these incidents of possession.

°° TENN. CODE ANN. § 67-6-205(c)(6).

term must be given its ordinary and common meaning.*' The Tennessee Supreme Court has also
generally stated that when a statute does not define a term, it is proper to look to common usage to
determine the term’s meaning. **

In common usage, the term “install” generally means to set up something for use or service.”
Although not dispositive, courts in other jurisdictions have also adopted this or a similar
definition of the term.” This definition, however, is overly vague. As a result, it is proper to
consider what a reasonably prudent person would consider “installation” in the context of sales
and use taxation. Under the common understanding of the term, the concept of installation does
not encompass a service, the furnishing of which includes the seller’s own tangible personal
property being set up for the seller’s use and then removed in the context of a single event.

In this case, the Taxpayer provides a service in which its own tangible personal property, in the
form of prewritten computer software, is both set up for use and removed in the context of a
single event (i.e., the creation of a virtual lab for product demonstration purposes). Here, the
Taxpayer only temporarily inputs the software onto either its own computer hardware or the
customer’s hardware, to demonstrate to the customer how the program will work in conjunction
with that customer’s data. After demonstration and consultation, the Taxpayer removes the
software. The temporary placement of the Taxpayer’s own software onto computer hardware for
demonstration purposes, followed immediately by the removal of such software, is not an
activity that a reasonably prudent person would consider “installation” in the context of the sales
and use tax.

Moreover, even if the input of the Taxpayer’s software on the customer’s computer hardware
could be characterized as installation, the transaction would nevertheless not be taxable. The
primary purpose of the transaction is the consulting service, to which the temporary input of the
software onto the computer is merely incidental. Tennessee’s courts “have developed a method
whereby judicial inquiry is made into the ‘primary purpose’ or ‘true object’ of the activity or
business at issue.”~ Although there is loading of the software onto the customer’s hardware, it is
not set up with the intention of any use by the customer. Customers purchase the consulting
service so that they can determine their software needs and preferences in conjunction with their
data. The temporary input of software, while necessary to conduct the virtual lab demonstration,
is not the “true object” of the transaction.

*! Eusco, Inc. v. Huddleston, 835 S.W.2d 576, 580 (Tenn. 1992).

*° See e.g., Byrant v. Genco Stamping & Mfg. Co., 33 S.W.3d 761, 765 (Tenn. 2000); Tenn. Farmers Assur. Co. v.
Chumley, 197 S.W.3d 767, 782-83 (Tenn. Ct. App. 2006); Beare Co. v. Tenn. Dep’t of Revenue, 858 S.W.2d 906,
908 (Tenn. 1993).

°3 See MERRIAM-WEBSTER COLLEGIATE DICTIONARY 11™ EDITION (2007).

*4 F..g., Cent. Me. Power Co. v. Johnson, 263 A.2d 713 (Maine 1970) (defining the term “install” as “to set up for
use or service” for state taxation purposes).

° Qualcomm Inc. v. Chumley, No. M2006-01398-COA-R3-CV, 2007 WL 2827513, at 4 (Tenn. Ct. App. Sept. 26,
2007).

Since the Taxpayer’s service does not fall within the scope of any other section in the Retailers’
Sales Tax Act describing taxable services, the Taxpayer’s service is not subject to the Tennessee
sales and use tax as an enumerated service.

Additionally, the facts indicate that the Taxpayer does not make sales of tangible personal
property or computer software and does not furnish any services enumerated in the Retailers’
Sales Tax Act. Provided that the Taxpayer does not make sales of taxable goods or services in
conjunction with the sale of its consulting services, the sale of such consulting services cannot be
characterized as the furnishing of an otherwise nontaxable service that is sold as part of the sale
of a taxable good or service.”°

Finally, the analysis of whether the sale of a non-enumerated service is accompanied by tangible
personal property that is a “crucial,” “essential,” or “integral” element of the transaction”” is
unnecessary because the Taxpayer under these facts does not sell any item of tangible personal
property or software in conjunction with the virtual lab consulting and demonstration services.

Accordingly, when the Taxpayer creates a virtual lab and, for testing or demonstration purposes,
temporarily inputs software onto computer hardware, the charge is not subject to the Tennessee
sales and use tax. It is immaterial whether the Taxpayer creates the virtual lab utilizing the
Taxpayer’s hardware or utilizing the customer’s hardware.

3. Data Backup

The Tennessee sales and use tax does not apply to charges for the backup of the customer’s data
to the Taxpayer’s servers.

The Taxpayer’s backup service will be subject to the Tennessee sales and use tax if the charges
for the service relate to: 1) the sale of tangible personal property or computer software in
Tennessee; 2) the furnishing of a taxable service in Tennessee; 3) the furnishing of an otherwise
nontaxable good or service that is bundled with a taxable good or service; or 4) the furnishing of
a non-enumerated service that necessary to complete the sale of a taxable good or service.

First, no sale or transfer of tangible personal property, including prewritten software, occurs in
conjunction with the Taxpayer’s furnishing of the backup service. A “sale” in part is “any
transfer of title or possession, or both, exchange, barter, lease or rental, conditional or otherwise,
in any manner or by any means whatsoever of tangible personal property for a consideration.”

In the case of the backup of data, no transfer of tangible personal property or computer software
occurs between the Taxpayer and its customer. Additionally, the Taxpayer does not sell, lease,
license, or otherwise provide the use of tangible personal property or computer software to its
client in conjunction with this service. Here, the Taxpayer is taking the customer’s data, copying

°6 See TENN. CODE ANN. § 67-6-102(79)(A).
*” See supra note 15.

°8 TENN. CODE ANN. § 67-6-102(78)(A) (emphasis added).

it, and moving it to another device for storage. The Taxpayer does not transfer title or possession
of tangible personal property or software to its customers during the backup service. The only
thing transferred is the customer’s data from the customer to the Taxpayer. Accordingly, there is
no sale of tangible personal property or computer software in conjunction with the backing up of
a customer’s data to the Taxpayer’s servers.

Second, the Taxpayer’s backup service does not constitute a taxable service for Tennessee sales
and use tax purposes. As noted above, only specifically enumerated services are subject to the
Tennessee sales and use tax. Data backup is not a specifically enumerated service and cannot be
properly characterized as any of the enumerated services.

Third, because the Taxpayer does not make sales of tangible personal property in conjunction
with the backup service, and does not provide a taxable service, no part of the backup service can
be characterized as the furnishing of an otherwise nontaxable service that is sold as part of the
sale of a taxable good or service. ~”

Finally, analysis of whether sale of a non-enumerated service is accompanied by tangible
personal property that is a “crucial,” “essential,” or “integral” element of the transaction” is
unnecessary because the Taxpayer under these facts does not sell any item of tangible personal
property or software in conjunction with backing up the customer’s data.

Accordingly, charges for the Taxpayer’s backup service are not subject to the Tennessee sales
31
and use tax.

Lauren A. Fields
Assistant General Counsel — Research
and Taxation

APPROVED: Richard H. Roberts
Commissioner of Revenue

DATE: November 25, 2013

°° See TENN. CODE ANN. § 67-6-102(79)(A).
30
See supra note 15.

3! Note that the Retailer’s Sales Tax Act does not require that the Taxpayer maintain specific documentation with
respect to its sales of nontaxable services. However, there is a general requirement that each dealer keep records of
its sales and purchases. TENN. CODE ANN. § 67-6-523 (2006) generally requires all taxpayers to establish and
maintain records that are adequate for auditors to use in determining the correct amount of the taxpayer’s tax
liability. The Taxpayer should therefore keep records of its sales and purchases, including copies of invoices and
purchase orders. Records of business transactions must be retained for a minimum of three years from December 31
of the year in which the associated Tennessee sales and use tax return was filed.