Is a monthly application-service-provider (ASP/SaaS) hosting fee, and its bundled add-on services like database setup, installation, bank reconciliation, and training, subject to Tennessee sales tax — and does the taxpayer owe use tax on the software licenses and hosting services it buys to run the ASP business?

Subject

Sales and use tax treatment of application service provider (ASP) hosting fees, bundled add-on services, and the provider's own software/hosting purchases.

Plain-English summary

The Tennessee Department of Revenue answered 14 questions from an application-service-provider (ASP) — essentially an early-2000s version of SaaS — about its monthly hosting fee, several add-on services, and the software/hosting inputs it buys to run its business.

The core ASP fee is not taxed, on its own. The customer never gets a copy of the software (it stays on the taxpayer's server); the customer's computer only gets a small connection icon, which the Department found isn't itself "computer software" for tax purposes. Since software (defined as tangible personal property) never transfers to the customer, and none of the seven bundled ASP components (application use, the connection icon, data hosting, Internet/email, web hosting, domain registration, virus protection) are on Tennessee's list of specifically taxable services, the whole package is exempt — as long as it isn't bundled with a taxable product or service that isn't separately, optionally priced. The same untaxed result applies whether the customer is in Tennessee or out of state.

Most add-on services are also untaxed if billed separately: database setup, bank reconciliation, and software training are not on Tennessee's taxable-services list, so charging for them as separate line items keeps them exempt. The one exception is on-site installation/configuration — but only when actual hardware or software installation happens; here, since the "installation" is really just setting up an access connection (not installing tangible property), even that charge stays untaxed.

The provider itself owes tax on its own inputs. Because the ASP company — not its customers — is the true end user of the software running on its servers, it must pay sales/use tax on the monthly software subscription fees and individual software licenses it buys from its suppliers (self-assessing use tax if the supplier didn't collect it). Likewise, cabinet rental for server storage from its outside hosting company is a taxable rental of tangible personal property, and installing tangible property (like backup servers) at the host facility is taxable — but pass-through services like Internet access, line usage, firewall management, tape backup, and domain-name setup remain untaxed if billed separately. None of this changes if the hosting company were located outside Tennessee instead.

What this means for you

SaaS, ASP, and cloud-hosting providers

If your software never physically transfers to the customer — it just runs on your servers while the customer connects via a thin client, icon, or browser — your core subscription fee likely isn't taxed as a software sale in Tennessee, and neither are companion services like setup, training, or reconciliation, provided each is billed as its own separately stated, optional line item rather than bundled into one inseparable package. But don't assume your own supply chain is tax-free: you're the "end user" of the software licenses and server infrastructure you buy to deliver the service, so expect to self-assess use tax on inputs your suppliers don't already tax, and expect equipment/cabinet rentals from your hosting provider to be taxable to you.

Accountants and tax professionals

This ruling is a clear early SaaS-era illustration of two rules working together: the "software never transfers" analysis that keeps hosted-service fees out of the tangible-personal-property tax base, and the Nashville Mobilphone Co. v. Woods "provider is the ultimate consumer" doctrine that flips the tax burden back onto the provider for its own inputs. Watch the separate-and-optional-billing requirement closely — bundling any of these normally exempt services into a single non-itemized charge with a taxable item pulls the whole charge into the tax base.

Common questions

Q: Does a monthly SaaS/ASP subscription fee count as a taxable software sale in Tennessee?
A: Not on its own, if the software stays on the provider's servers and the customer only gets a connection mechanism (not a copy of the software) — but bundling the fee with a taxable product or service that isn't separately and optionally priced pulls the whole charge into tax.

Q: Are setup, training, or reconciliation services taxable if billed as separate line items?
A: No. None of these are on Tennessee's specifically-taxable-services list, so billing them separately from any taxable charge keeps them exempt.

Q: Does a SaaS/hosting provider owe tax on the software licenses and equipment it buys to run its service?
A: Yes. The provider, not its customers, is the end user/consumer of the software and hosting equipment, so it owes sales or use tax on those purchases (self-assessing use tax if its supplier didn't collect it).

Q: Does the customer's location (Tennessee vs. out-of-state) change whether the ASP fee is taxable?
A: No. The core ASP fee stays untaxed either way under the facts presented, since no taxable transaction occurs in Tennessee.

Q: Does this ruling bind the Department for other SaaS/ASP businesses?
A: No. This is a Revenue Ruling — advisory only and not binding on the Department, even for the taxpayer who requested it.

Citations and references

Statutes and cases:

• Tenn. Code Ann. § 67-6-102(a)(34)(B) (software as tangible personal property; connection icon not treated as software)
• Tenn. Code Ann. § 67-6-201, § 67-6-205, § 67-6-102(a)(32)(F) (services taxable only if specifically enumerated)
• Tenn. Code Ann. § 67-6-102(a)(35) (definition of "sales price," incl. bundled taxable/nontaxable charges)
• Tenn. Code Ann. § 67-6-203 (use tax on tangible personal property used/consumed in Tennessee)
• Tenn. Code Ann. § 67-6-204, § 67-6-102(a)(24) (tax on lease/rental of tangible personal property, incl. software licenses)
• Nashville Mobilphone Co., Inc. v. Woods, 655 S.W.2d 934 (Tenn. 1983) (service provider is the end user/consumer of property used to render the service)

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/07-05.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
REVENUE RULING # 07-05

WARNING
Revenue rulings are not binding on the Department. This presentation of the ruling
in a redacted form is information only. Rulings are made in response to particular
facts presented and are not intended necessarily as statements of Departmental
policy.

SUBJECT
Application of sales and use tax to various transactions involving computer connections,
telecommunications, and related services.

SCOPE
Revenue rulings are statements regarding the substantive application of law and
statements of procedure that affect the rights and duties of taxpayers and other members
of the public. Revenue rulings are advisory in nature and are not binding on the
Department.
FACTS
The Taxpayer is a Tennessee domestic corporation that provides computer services from
[LOCATION]. The Taxpayer also sells various computer hardware and software support
services which may be provided via the Internet, telephone, onsite from its [LOCATION]
office, or offsite at the customer’s location.
The Taxpayer has nexus in various other jurisdictions due to installation and training
provided at customer locations in states outside of Tennessee. The Taxpayer collects and
remits sales tax in various jurisdictions throughout the United States.
The Taxpayer is providing a computer service known as ASP (application software
provider). This service involves providing a customer with the use of software located on
the Taxpayer’s computer server rather than on the customer’s computer. The customer
accesses the application software (on the Taxpayer’s server) by using an icon (installed
on the customer’s computer) and access code provided by the Taxpayer. As an ASP, the
Taxpayer contracts to provide its customers with the following services:

1. Use of application software located on the Taxpayer’s server to process data for
   such purposes as accounting, spreadsheet preparation, and word processing.

2. Use of an operating connection (icon) located on the customer’s computer
required to access the application software.

3. Data hosting—the customer’s data will be located on the Taxpayer’s server.
4. Internet access with e-mail service.
5. Basic web site hosting.
6. Domain name registration.
7. Virus protection management.
   The operating connection (#2 above) is downloaded onto the customer’s computer. No
   software is downloaded to the customer. The application software remains on the
   Taxpayer’s server while being used by the customer. The customer’s data is stored on
   the Taxpayer’s server. The customer does have the ability to print reports at its own
   location. The software located on the server consists of licenses that are either purchased
   or subscribed to by the Taxpayer. The Taxpayer must obtain a license from its software
   supplier for each ASP customer.
   The customer will connect with the Taxpayer’s server via the customer’s Internet service
   or telephone lines. The connection is made using an icon that enables a remote customer
   to access an offsite server. This connection belongs to the Taxpayer but is installed on
   the customer’s computer by either the Taxpayer or the customer. The operational
   connection allows the customer to access the applications software which is loaded on the
   Taxpayer’s servers. The customer cannot download the applications software onto its
   computers. The ASP service also includes telephone technical support provided by the
   Taxpayer’s employees located in Tennessee.
   A single monthly fee is charged for the services listed above. The fee is either a flat
   monthly charge or a varying monthly usage fee based upon the number of times the
   software is utilized during the month. The usage fee requires a minimum payment.
   Other services billed as a separate line item on the contract and on the invoice are as
   follows:
8. Database set-up: The fee covers set-up of the customer’s database on the
   Taxpayer’s Tennessee computer server by the Taxpayer’s employees located in
   Tennessee.
9. Icon installation and configuration: The Taxpayer’s employees will go to the
   customer’s location and install or configure the necessary connection for
   accessing the server. Phone installation assistance is available as an alternative.
10. Bank reconciliation services: The reconciliation is to be performed by the
    Taxpayer’s employees located in Tennessee. The employees will access the
    customer’s data via the computer server, perform the reconciliation, and place the
    information on the server for the customer to access.
11. Software training: The Taxpayer trains the customer how to use the ASP
    services. The training can be provided onsite at the customer’s location or offsite
    at the Taxpayer’s Tennessee office.

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The Taxpayer has contracted with an outside computer hosting service to provide the
services to the customer. The hosting service is located in Tennessee. The Taxpayer’s
computer servers will be installed at the hosting service location. The hosting service
will monitor and arrange the use of the servers. The following specific services will be
provided by the hosting service and will be billed to the Taxpayer separately by line item
on a monthly basis:
1.
2.
3.
4.
5.
6.
7.

Cabinet rental for storage of the client’s servers
Internet access
Line usage, i.e. the use of telecommunication lines to provide internet access.
Firewall management service
Tape backup service
Monitoring the use of the client’s servers
Installation charges for:
a. Installing the Taxpayer’s computers at the host facility
b. Establishing domain names for each of the Taxpayer’s customers
c. Installing a line to the Taxpayer’s office
d. Installing firewall management
e. Installing tape backup systems
f. Installing backup servers and software

QUESTIONS
1.
2.
3.
4.
5.
6.

7.
8.
9.
10.
11.

Is the monthly ASP fee subject to Tennessee sales tax when the ASP services are
sold to and used by a customer located in Tennessee?
If yes, which of the seven ASP services would be exempt if billed separately?
Does Tennessee sales tax apply to the monthly ASP services purchased and used
by out-of-state customers?
Is the one-time database set-up fee subject to Tennessee sales tax if sold to
Tennessee customers and billed separately?
Is the one-time database set-up fee subject to Tennessee sales tax if sold to out-ofstate customers and billed separately?
Are the hardware/software installation and configuration fees subject to
Tennessee sales tax if performed at a customer’s Tennessee location and billed
separately?
Are bank reconciliation service fees subject to Tennessee sales tax if provided to
Tennessee customers and billed separately?
Are bank reconciliation service fees subject to Tennessee sales tax if provided to
out-of-state customers and billed separately?
Are ASP training charges subject to Tennessee sales tax if the training is
performed in Tennessee and billed separately?
Are ASP training charges subject to Tennessee sales tax if the training is
performed outside Tennessee and billed separately?
Should the Taxpayer pay Tennessee sales or use tax on the monthly software
subscription fees that the Taxpayer pays to its suppliers?

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12.
13.
14.

Should the Taxpayer pay Tennessee sales or use tax on its acquisition of
individual software licenses?
Should the Taxpayer pay Tennessee sales tax on all of the services for which the
outside computer hosting service charges the Taxpayer?
Would the sales tax consequences of the ASP services and the services purchased
to provide such services change if the hosting service was located outside
Tennessee?

RULINGS
1.

2.
3.
4.
5.
6.
7.
8.
9.
10.
11.

12.

13.

14.

The monthly ASP fee charged to Tennessee customers is not subject to Tennessee
sales tax unless the fee is bundled (combined) with the sale of a taxable product or
taxable service.
None of the seven ASP services the Taxpayer included in the facts are subject to
Tennessee sales and use tax.
The monthly ASP fee charged to out-of-state customers is not subject to
Tennessee sales tax.
The database set-up fee is not subject to Tennessee sales tax.
Please see the response to question 4.
Charges for the installation of computer hardware and software in Tennessee are
subject to sales tax.
Bank reconciliation service fees are not subject to Tennessee sales tax.
Please see the response to question 7.
ASP training charges are not subject to Tennessee sales tax.
Please see the response to question 9.
The supplier should collect sales tax on the sale of the monthly software
subscription fees to the Taxpayer. If the supplier did not collect sales tax, the
Taxpayer should remit use tax to the Department of Revenue.
The supplier should collect sales tax when it grants the individual software license
to the Taxpayer. If the supplier did not collect sales tax, the Taxpayer should
remit use tax to the Department of Revenue
The services which include the lease or rental of tangible personal property are
subject to sales and use tax. The installation of tangible personal property will be
taxable if the property remains tangible personal property after installation. The
remaining services are not taxable.
No.

ANALYSIS
1.
Standing alone, the ASP fee is not taxable. However, if the ASP fee is combined
(bundled) with the sale of tangible personal property or a taxable service, and the charges
for the non-taxable services are not separate and optional from the taxable charges, then
the sales tax applies to the total package.

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Tenn. Code Ann. § 67-6-102(a)(34)(B) defines software as tangible personal property for
the purposes of the sales and use tax. Specifically, it provides:
“Sale” also means such transfer of customized or packaged computer
software, which is defined to mean information and directions loaded into
a computer which dictate different functions to be performed by the
computer, whether contained on tapes, discs, cards, or other device or
material. For such purpose, computer software shall be considered
tangible personal property…
The software remains on the Taxpayer’s servers. Thus, the Taxpayer, rather than the
Taxpayer’s customer, is the end user and consumer. The customers are provided an icon
and access code to access the software from their computers. Based on the facts as
presented, the access connection is not considered “computer software” and therefore, is
not a taxable sale as defined above.
2.
As provided in Tenn. Code Ann. § 67-6-201, the sale or use of tangible
personal property is taxable unless specifically exempt. Conversely, services are
exempt from sales tax unless they are either identified as taxable under Tenn.
Code Ann. §§67-6-205 and 67-6-102(a)(32)(F), or provided as part of the sale of
tangible personal property. Tenn. Code Ann. § 67-6-102(a)(35). None of the
seven services listed in the facts are taxable; neither firewall management nor tape
back-up constitutes installation of software. Similarly, none of the seven services
listed in the facts are provided as part of the sale or tangible personal property.
These services are, therefore, not taxable if billed separately from a taxable
transaction.
3.
As provided in the response to question 2, the services are not subject to
Tennessee sales and use tax. Because no taxable transaction occurred in
Tennessee, the fees charged to the out-of-state customers would not be subject to
Tennessee sales tax.
4.
Services are not subject to the sales and use tax unless specifically included in
Tenn. Code Ann. §§67-6-205 and 67-6-102(a)(32)(F). Setting up a database on the
Taxpayer’s server is not a taxable service when sold independently from otherwise
taxable property or services.
5.

Please see the response to question 4.

6.
Tenn. Code Ann. § 67-6-102(a)(32)(F)(iv) and (vi) provide that the installation of
tangible personal property (which remains tangible personal property after installation)
and repair services are taxable services. However, since no software or hardware is
installed, the installation and configuration fees charged to a Tennessee customer are not
subject to sales and use tax.

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7.
Services are not subject to sales and use tax unless specifically included by Tenn.
Code Ann. §§67-6-205 and 67-6-102(a)(32)(F). Bank reconciliation fees are not a
taxable service when sold independently from otherwise taxable property or services.
8.

Please see the response to question 7.

9.
Services are not subject to sales and use tax unless specifically included by Tenn.
Code Ann. §§67-6-205 and 67-6-102(a)(32)(F). Training charges are not a taxable
service when sold independently from otherwise taxable property or services.
10.

Please see the response to question 9.

11.
Tenn. Code Ann. § 67-6-203 imposes sales and use tax on the user and consumer
of tangible personal property and taxable services. The statute provides that:
A tax is levied at the rate of the tax levied on the sale of tangible personal
property at retail by the provisions of § 67-6-202 of the cost price of each
item or article of tangible personal property when the same is not sold but
is used, consumed, distributed, or stored for use or consumption in this
state…
The Taxpayer is the ultimate user and consumer of the software used to provide the ASP
service. As noted above, software is defined as tangible personal property, thus the
subscription fees paid by the Taxpayer to its software supplier would be subject to sales
and use tax. The Taxpayer is also the user and consumer of any telecommunications
service purchased to provide its service and it must pay sales and use tax for those
services.
12.
Tenn. Code Ann. § 67-6-204 provides that sales and use tax applies to “the gross
proceeds of all leases and rentals of tangible personal property in this state…” if such a
lease is part of a regular business practice. Tenn. Code Ann. § 67-6-102(a)(24) defines
“lease or rental” to mean the leasing or renting of tangible personal property and the
possession or use thereof by the lessee or renter for a consideration, without transfer of
the title of such property.” Tenn. Code Ann. § 67-6-102(a)(34)(B) provides that
computer software is tangible personal property. A license to use software is a lease of
tangible personal property, and therefore, is subject to sales tax.
13.
As noted in the previous question, the lease or rental of tangible personal property
is subject to sales and use tax. Although the Taxpayer may pass along some of the
supplier costs to its customers, the Taxpayer is the end user and consumer. As the end
user and consumer, Taxpayer is liable for sales tax on the lease or rental of tangible
personal property and any related taxable services. Nashville Mobilphone Co., v. Woods,
655 S.W.2d 934 (Tenn. 1983). The cabinet rental for storage on the Taxpayer’s servers is
a rental of tangible personal property, and therefore, is subject to sales tax. As noted in
the response to question 7, charges for the installation of tangible personal property
which remains tangible personal property after installation is subject to sales tax. The

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following services provided by the host and billed to the Taxpayer, if sold separately
from the taxable items, would not be subject to sales tax: Internet access, line use,
firewall management service, tape backup service, the monitoring of the client’s servers,
and, the establishment of domain names for each of the Taxpayer’s customers.
14.
The Taxpayer’s charges to its Tennessee customers for the sale or rental of
tangible personal property, and charges for the installation of tangible personal property
which remains tangible personal property after installation, would be subject to
Tennessee sales tax.

Deborah A. Toon
Tax Counsel

APPROVED: Reagan Farr
Commissioner of Revenue

DATE: 02-13-07

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