Our company runs a state agency's electronic benefits transfer (EBT) system under contract — is that a taxable data processing service, do we owe sales tax on our fee to the exempt state agency, and can we buy supplies, cards, and outside services tax-free using resale certificates?

Plain-English Summary

A company (Company A) contracted with the Texas Department of Human Services (TDHS) to build and run the Texas Electronic Benefits Transfer (EBT) System — the automated system that distributed AFDC and Food Stamp benefits to recipients through "account cards" swiped at approved retailers. Company A asked the Comptroller seven questions about how sales and use tax applied to this arrangement.

The Comptroller ruled that Company A's work — gathering, verifying, storing, and reporting benefit transaction data — is a taxable "data processing service" under Texas law, because the true object of the service is the electronic collection, manipulation, and storage of data (not specialized professional skill). Since more than 5% of the bundled monthly per-case fee related to data processing, the Comptroller treated the entire fee as taxable.

Even though the service is taxable, TDHS is a state agency and is exempt from sales and use tax, so Company A did not have to charge TDHS tax on its fee. That exemption for the buyer, however, does not make Company A's own purchases tax-free by default. The ruling draws a careful line: Company A can use a resale certificate to buy, tax-free, supplies and tangible personal property (like report paper and magnetic tape) that it hands over to TDHS, and it can pass through outside services that are truly integral to performing the data processing (telecommunications links, retailer transaction fees) tax-free as well. But Company A must pay tax on anything that ends up with someone other than TDHS — the account cards and educational materials given to benefit recipients, and the paper tapes/ink ribbons used to run its own scanners at retailer locations — because as to those items, Company A itself is the end consumer. Maintenance contracts for its equipment were also found not to be "integral" to the taxable service, so tax applies to those too.

What This Means For You

If your business provides a bundled data-processing-type service to a government agency, this ruling illustrates several practical points:

• Characterization drives everything. If the "true object" of your service is the automated collection, compiling, storing, or manipulation of data, it will likely be taxed as a "data processing service," even if it also involves training, equipment provisioning, or other activities, as long as the taxable component exceeds 5% of a bundled charge.
• A tax-exempt customer doesn't mean tax-free purchasing. Selling to an exempt government agency relieves you of charging tax on your service fee, but it does not automatically let you buy your own inputs tax-free — the resale-certificate analysis is separate and depends on where the property or service actually ends up.
• Track who receives what. Tangible personal property or services you buy that are physically transferred to your exempt customer can be purchased tax-free with a resale certificate. Property or services that go to a third party (like the agency's beneficiaries/customers) or that you keep and use yourself to perform the contract are taxable purchases — you're the consumer of those.
• "Integral" is a real test for services you resell. An outside service can be passed through tax-free only if it is essential to performing the taxable service and the taxable service could not be rendered without it (e.g., the telecom links here). General maintenance contracts on your own equipment typically won't qualify.

Q&A

Q1: Do services like verifying, storing, and reporting EBT transaction data for a state agency count as a taxable "data processing service" in Texas?
A1: Yes. The Comptroller found these services fall within the definition of "data processing services" under Comptroller Rule 3.330 and Tex. Tax Code Secs. 151.0101 and 151.0035, because the computer system and network don't merely facilitate the service — they substantially are the service.

Q2: Can the contractor buy supplies and tangible property that are ultimately transferred to the government agency tax-free?
A2: Yes. Under Tex. Tax Code Sec. 151.302, the contractor can purchase tax-free (via resale certificate) supplies and other tangible personal property, such as report paper and magnetic tape, that are ultimately transferred to the agency as part of performing the taxable service.

Q3: Can the contractor also buy tax-free the account cards and educational materials given to individual benefit recipients?
A3: No. Those items go to the benefit recipients, not to the government agency, so the contractor is considered the consumer of that tangible personal property and must pay tax on it (Tex. Tax Code Sec. 151.302).

Q4: Can the contractor purchase for resale (tax-free) related services from outside vendors, like telecommunications, maintenance contracts, and retailer transaction fees, that support the data processing service?
A4: It depends on whether the purchased service is "integral" to the taxable service. Under Tex. Tax Code Sec. 151.151, a resale certificate can be issued for a purchased service that is transferred as an integral part of the taxable service — one essential to performing it and without which it couldn't be rendered. Telecommunication services and retailer transaction fees (for taxable services) qualified as integral and could be purchased tax-free for resale. Maintenance contracts on the contractor's own equipment did not qualify, so tax was owed on those.

Q5: Can the contractor buy the supplies needed to operate its equipment at retailer locations (e.g., paper tapes and ink ribbons) tax-free?
A5: No. Only items actually transferred to the government agency may be purchased tax-free. Supplies used to run the contractor's own scanners at retailer locations are consumed by the contractor, so tax applies (Tex. Tax Code Sec. 151.302).

Q6: Does the contractor have to charge the state agency sales tax on its data-processing fee?
A6: No. The state agency is exempt from sales and use tax, so the contractor is not required to charge it tax on the service fee (Tex. Tax Code Sec. 151.309).

Q7: Since the agency is tax-exempt and the contractor doesn't have to charge it tax, does that prevent the contractor from making tax-free resale purchases of the related supplies and services?
A7: No. Data processing services remain taxable services regardless of whether the particular purchaser happens to be tax-exempt — the exempt status of the customer doesn't change the nature of the service. The contractor may still purchase tangible property transferred to the agency, and services transferred as an integral part of the taxable service, tax-free using resale certificates.

Citations

• Tex. Tax Code Sec. 151.0035 (definition of "data processing services")
• Tex. Tax Code Sec. 151.0101 (list of taxable services)
• Tex. Tax Code Sec. 151.151 (resale certificates for integral services)
• Tex. Tax Code Sec. 151.302 (sales for resale)
• Tex. Tax Code Sec. 151.309 (exemption for governmental entities)
• 34 Tex. Admin. Code Rule 3.330 (data processing services)
• 34 Tex. Admin. Code Rule 3.322 (exempt governmental entities)
• 34 Tex. Admin. Code Rule 3.285 (Resale Certificates; Sales for Resale, amended 11/01/2017 — noted in the alert banner as the current guidance on care, custody, and control of TPP)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9409L1329F09

Original ruling text

ALERT: For specific guidance relating to the care, custody and control of TPP when providing a taxable service, please see Rule 3.285, Resale Certificates; Sales for Resale (amended 11/01/2017.

September 7, 1994

Dear ***:

On August 23, 1994, you asked for seven rulings concerning services
performedby Company A for the Texas Department of Human Services (TDHS)
in connection with the implementation and administration of the Texas
Electronic Benefits Transfer System. I will not repeat the information
contained in your letter, but all answers are based on the facts set out
in that letter.

You asked the following questions:

1. Would the services performed by COMPANY A for the TDHS, as described above,
   fall within the definition of "data processing services"?

Answer: Yes. See Comptroller Rule 3.330 and Secs. 151.0101 and 151.0035, Tex.
Tax Code.

2. If the services provided by COMPANY A are taxable data using services,
   can COMPANY A purchase supplies and other tangible property that is ultimately
   transferred to TDHS tax-free?

Answer: Yes. See Sec. 151.302, Tex. Tax Code.

3. If the services provided by COMPANY A are taxable data processing services,
   can COMPANY A purchase the account cards and educational materials that are
   ultimately transferred to the benefit recipients tax-free?

Answer: No. A provider of a taxable service is considered the consumer
of tangible personal property purchased which is not transferred to the
customer. The account cards and educational materials are not transferred to
the TDHS as part of the service but to the benefit recipients. See Sec. 151.302,
Tex. Tax Code.

4. If the services provided by COMPANY A are taxable data processing services,
   can COMPANY A purchase for resale, those taxable services from outside vendors
   that are integral to the performance of the data processing services (e.g.
   telecommunication services, maintenance contracts, retailer transaction fees)?

Answer: Yes. Sec. 151.151, Tex. Tax Code, allows the service provider to give
its service providers resale certificates if the service is transferred as an
integral part of the taxable service. In your examples, telecommunication
services would be considered integral services as would retailer transaction
fees (assuming the fees are for taxable services). On the other hand,
maintenance contracts would not be considered a service that was an integral
part of the data processing services, and COMPANY A would be required to pay tax
on the service.

5. If the services provided by COMPANY A are taxable data processing services,
   can COMPANY A purchase the supplies necessary to operate equipment at
   retailer locations taxfree (e.g. paper tapes and ink ribbons)?

Answer: No, Only those items transferred to TDHS may be purchased tax
free. See Sec. 151.302, Tex. Tax Code.

6. Is COMPANY A required to charge sales tax to the TDHS, a state agency,
   for the performance of data processing services?

Answer: No. See Sec. 151.309, Tex. Tax Code.

7. If the services performed by COMPANY A for the TDHS constitute data
   processing services and if COMPANY A is not required to charge sales tax to
   the TDHS, will this preclude COMPANY A from purchasing supplies and services,
   described above, tax-free?

Answer: No. Data processing services are taxable. The fact that the purchaser
is exempt does not change the nature of the service. Therefore, COMPANY
A may purchase tangible property transferred to TDHS and services transferred
as an integral part of the service under resale certificates.

I hope this satisfactorily answers your questions. Should you require
additional information, please write me or call me toll-free at 1-800-531-5441,
extension 5-0220.

Sincerely,

Glen D. Hunt
Director, Tax Administration

Dear ****:

We hereby submit a request for ruling regarding the application of
specific provisions of the Texas Sales and Use Tax Code and applicable
administrative rules on behalf of our client, COMPANY A.

** (COMPANY A) has been engaged by the Texas Department of
Human Services (TDHS) to implement and administer the Texas Electronic Benefits
Transfer System (the Texas EBT System). The Texas EBT System is the automated
process for distributing Aid for Families with Dependent Children (AFDC) and
Food Stamp Program benefits in Texas. It is organized such that retail
merchants (retailers) provide qualifying merchandise, and sometimes cash (under
the AFDC Program), to eligible recipients. When an individual seeks to obtain
qualified merchandise or cash from a retailer, the individual's benefits are
verified by COMPANY A based on qualifying data provided by the TDHS.
COMPANY A then provides various reports to the TDHS regarding the EBT
transactions it verifies and processes. COMPANY A is responsible for making
sure federal and state funds are transferred to retailers who provide qualified
merchandise and cash to benefits recipients. COMPANY A has training seminars to
educate retailer employees on how to handle AFDC and Food Stamp transactions.
COMPANY A also provides equipment for the TDHS to use and trains TDHS employees
on how to use it. In addition, COMPANY A educates benefits recipients on the
programs by providing information packages and video tapes. COMPANY A also
trains TDHS employees on how to educate benefits recipients. Descriptions of
the EBT system and COMPANY A's functions are as follows:

COMPANY A's primary and foremost responsibilities in the administration of the Texas
EBT System are the gathering, storing, compiling, and maintenance of AFDC and
Food Stamp program transaction data. This is, in most cases, accomplished via
hardware systems and software designed, owned, and operated by COMPANY A. The process
begins when the TDHS screens each AFDC and Food Stamp applicant and determines
the amount of benefits for which the recipient is eligible. Each month, the
TDHS provides benefit information to COMPANY A by means of electronic file transfer.
COMPANY A issues an "account card", similar to a debit card, to each eligible AFDC and
Food Stamp recipient.

Ownership of the card transfers to the benefits recipient and the card is never
returned to COMPANY A. COMPANY A also provides informational packets, and sometimes
videotapes, to educate benefits recipients on how the Texas EBT System works.
The benefits recipients can then present their cards to U.S. Food and Nutrition
Service approved retailers (typically grocery and convenience stores), where
the recipients can purchase qualifying merchandise. Magnetic card readers
(scanners) are installed at each retailer location. When a qualifying purchase
is made, the account card is run through the scanner. When this occurs, a
communication link is automatically initiated between the retailer location and
COMPANY A's service center. Once COMPANY A retrieves the transaction data
from the retailers, it is verified and the benefits are approved or
disapproved. COMPANY A then stores and maintains the benefit account balances
on magnetic tape and computer hard drives. COMPANY A's computer routinely sorts
and compiles the data and generates various reports specified and requested by the
TDHS. These reports can then be transmitted to the TDHS electronically, on magnetic
tape, or on paper.

All approved retailers must have scanners installed on their premises to read
the account cards. Ownership of the scanners and processing of the data can
occur in one of three ways:

1. COMPANY A-owned equipment may be placed at the retailer location so that the
   retailer is able to service AFDC and Food Stamp program customers. In exchange,
   the retailer gathers the transactional information that COMPANY A needs to produce
   reports for the TDHS. The equipment communicates with the COMPANY A data base over
   telephone lines on a toll free basis. COMPANY A owns the equipment, repairs and
   maintains it, provides supplies needed to operate the equipment (such as paper
   tape and ink ribbons), educates the retailer's employees on how to use the
   equipment, and provides a toll-free dispatch center to take service calls and
   answer questions from the retailers. In this instance the retailers have
   minimal conversion obligations, and COMPANY A does not pay the retailer
   administrative allowances.

2. In many cases the retailer already owns a scanner which will read
   magnetic cards. The account card can be read on such equipment just like a
   debit card. When a card is scanned, the retailer's computer system communicates
   with COMPANY A's system via a communication link, again, on a toll free basis. The
   benefits are verified the same as they are when transactions originate on COMPANY A
   supplied equipment. In this situation,"COMPANY A pays the retailer an administrative
   allowance in consideration of the retailer's conversion obligations.

3. In some cases the retailer's contract with third-party processors
   (TPP's) to provide equipment, verify and process the EBT transactions. In this
   situation, the scanner communicates with the TPP network where it is then
   redirected to the COMPANY A network via a communication link supplied by
   COMPANY A. In this situation also, COMPANY A pays the retailer an administrative
   allowance in consideration of its conversion obligations.

Analysis of the Law

I. Data Processing Services Defined

"Data Processing Service" includes word processing, data entry, data
retrieval, data search, information compilation, payroll and business
accounting data production, and other computerized data and information
storage or manipulation. "Data Processing Service" also includes the use
of a computer or computer time for data processing whether the processing
is performed by the provider of the computer or computer time or by the
purchaser or other beneficiary of the service. Texas Tax Code Sec.
151.0035.

Texas Administrative Code Sec. 3.330(a) further states, "Data processing
services means the processing of information for the purpose of compiling
and producing records of transactions, maintaining information, and
entering and retrieving information. It specifically includes word
processing payroll and business accounting, and computerized data and
information storage or manipulation. The charge for data processing
services is taxable regardless of the ownership of the computer. .. Data
processing does not include the use of a computer by a provider of other
services when the computer is used to facilitate the performance of the
service or the application of the knowledge of the physical sciences,
accounting principles, and tax laws..."

As part of the EBT contract, COMPANY A provides various computerized
services including:

• retrieval of recipient qualification data
• compilation of EBT transactions
• storage of EBT transactions
• computation of recipient account balances
• production of records of transactions
• maintenance of recorded data
• data formatting
• production of reports

The essence of COMPANY A's contract with the TDHS for administration of
EBT is to provide technology, skill, and the capacity to gather, process
and record AFDC and Food Stamp benefits. The computerized network provided
by COMPANY A is necessary to accomplish these tasks. In short, the computer
system and network do not merely facilitate the service provided by COMPANY
A, they substantially are the service.

It is evident from the tax code and administrative rule pertaining to data
processing services that the intent of the legislature and the Comptroller
is to tax those services where the true object of the service being
provided is the digital collection, manipulation, and storage of
electronic data.

Further, those services that utilize computers and where the true object
of the service results from a person's specialized skill or knowledge are
recognized appropriately as professional services and not subject to tax.
The true object of the service provided by COMPANY A for the administration
of the EBT program is that of gathering, processing, manipulating, and
storing electronic media. Accordingly, we believe that what COMPANY A is
providing to the TDHS is a data processing service.

II. Taxability of Data Processing Services

According to Rule Sec. 3.330(b), data processing services are subject to
sales tax. Therefore, if the services provided by COMPANY A fall within
the definition of "data processing", then they are taxable services.

III. Taxable and Unrelated Nontaxable Services Provided for a Single Charge

Where nontaxable unrelated services and taxable services are sold or
purchased for a single charge and the portion relating to taxable services
represents more than 5.0% of the total charge, the total charge is
presumed to be taxable. Rule Sec. 3.330(d)(2).

COMPANY A's fees to the TDHS for all services provided are based on a fixed
fee per case account per month. While COMPANY A provides both taxable data
processing services and other nontaxable services, the fees are not
apportioned between the taxable and nontaxable services. This, coupled
with the fact that more than 5.0% of the services COMPANY A provides for
the State are data processing services would lead us to believe that 100% of
the services provided are taxable.

IV. Resale certificates

Providers of data processing services may issue a resale certificate in
lieu of tax to suppliers of tangible personal property only if care,
custody, and control of the property is transferred to the client. Rule
Sec. 3.330(c)(1).

A resale certificate may be issued for a service if the buyer intends to
transfer the service as an integral part of taxable services. A service
will be considered an integral part of a taxable service if the service
purchased is essential to the performance of the taxable service and
without which the taxable service could not be rendered. Rule Sec.
3.330(c)(2).

In providing data processing services, COMPANY A provides various supplies
which are ultimately transferred to the TDHS such as the paper on which the
reports are printed and the magnetic tape on which the transaction data
is stored. Additionally, COMPANY A provides paper tapes and ink ribbons to
retailers for the operation of COMPANY A's scanners. COMPANY A also purchases
the account cards and written and video taped educational materials which are
transferred to benefits recipients.

COMPANY A also purchases telecommunication services from outside vendors
which are necessary and essential to the collection of EBT data and the
bidirectional exchange of data between the in-store terminals and the
computer network. Without these telecommunication links, the on-line
capabilities of the EBT system would not be possible.

COMPANY A also contracts with third parties to provide maintenance
services for COMPANY A's computer network and scanners which are necessary
and essential to the processing of data.

V. Contracts With Governmental Agencies

According to Texas Tax Code Sec. 151.309 and to Rule Sec. 3.322, the
State of Texas, its unincorporated agencies and instrumentalities are exempt
from sales and use tax. Because of this, COMPANY A is not required to
charge sales tax on any of the services it provides to the TDHS.

Questions

Please provide a response to the following questions. To aid in our
understanding, please provide any source, cite or authority on which your
response is based.

1. Would the services performed by COMPANY A for the TDHS, as described above,
   fall within the definition of "data processing services?"

2. If the services provided by COMPANY A are taxable data processing services, can
   COMPANY A purchase supplies and other tangible property that is ultimately transferred
   to the TDHS tax-free?

3. If the services provided by COMPANY A are taxable data processing services, can
   COMPANY A purchase the account cards and educational materials that are ultimately
   transferred to the benefit recipients tax-free?

4. If the services provided by COMPANY A are taxable data processing services, can
   COMPANY A purchase for resale, those taxable services from outside vendors that are
   integral to the performance of the data processing services (i.e.
   telecommunication services, maintenance contracts, retailer transaction fees)?

5. If the services provided by COMPANY A are taxable data processing services, can
   COMPANY A purchase the supplies necessary to operate equipment at retailer locations
   tax-free? (i.e. paper tapes and ink ribbons.)

6. Is COMPANY A required to charge sales tax to the TDHS, a state agency, for the
   performance of data processing services?

7. If the services performed by COMPANY A for the TDHS constitute data processing
   services and if COMPANY A is not required to charge sales tax to the TDHS, will this
   preclude COMPANY A from purchasing the supplies and services, described above,
   tax-free?

Due to the significance of this issue to COMPANY A, we appreciate your prompt
attention to this matter. Please call me at 210/554-0319 if you have anyquestions.

Very truly yours,

NOTE: Previous Accession Number 9409807L