Which of my internet service company's fees -- monthly service, set-up, domain registration, custom web design, extra disk space, audio/video, and secure server -- are subject to Texas sales tax?

Subject

Internet Services — Creation Of Home Page/Web Site (Formatting, Scanning, Programming, Updating, Maintaining, Training, Creation Of Logos/Graphics)

Plain-English summary

An internet service provider asked the Comptroller which of its various fees are subject to Texas sales tax. The company's fee structure included a Monthly Service Fee (covering its out-of-state server costs, payroll, rent, etc.), a Set-Up Fee, a Domain Name Registration Fee (a pass-through reimbursement with no markup), a Custom Design Fee for building web sites, an Additional Disk Space Fee, an Audio/Video Fee, and a Secure Server Fee.

The Comptroller's answer treats the company as a data processing service provider (because it furnishes server space) and taxes most of its charges accordingly:

• Monthly Service Fee -- taxable. Under Tex. Tax Code § 151.007, "sales price" includes the total charge for a taxable service without deducting the provider's own costs, so this fee is fully taxable even though it's used to cover the provider's expenses.
• Set-Up Fee -- taxable, because it's a fee "related to providing taxable services" and is taxed the same way as the underlying service (data processing).
• Domain Name Registration Fee -- not taxable, because it's simply a reimbursement of an out-of-state registration cost with no markup.
• Custom Design Fee (building/designing the web site) -- taxable as graphic arts under Rule 3.312.
• Additional Disk Space Fee -- taxable as data processing.
• Audio/Video Fee (digitizing and hosting audio/video) and charges for scanning photographs and documents -- taxable as data processing.
• Secure Server Fee -- taxable as a service in connection with the sale of data processing, taxed the same way.

On sourcing: because the customer receives the benefit of the service in Texas, Texas tax applies even though the server itself sits out of state (the "service benefit location" is Texas). Local tax is based on the server's location if it's in Texas, or the customer's location if the server is out of state. An out-of-state provider with a presence (representation) in Texas must collect the tax; otherwise, the Texas customer must self-assess and remit use tax.

The letter also addresses a multi-state customer (e.g., a corporate office in Texas and a manufacturing office in Florida): that customer should give the provider a multistate benefit exemption certificate, and the customer itself is then responsible for reporting and paying Texas tax on just the portion of the charge that benefits the Texas location. A provider that accepts such a certificate in good faith is off the hook for collecting tax on that portion.

What this means for you

Internet service providers / web design businesses

Nearly every component of a typical ISP/web-design fee schedule is taxable in Texas -- as data processing (hosting, disk space, audio/video, secure server, set-up) or as graphic arts (custom web site design). The one clear exception here is a pure pass-through registration fee charged with no markup. If you add any markup to a pass-through cost (as the company did with its Additional Disk Space, Audio/Video, and Secure Server fees), that marked-up fee is taxable.

Multi-state business customers

If your company has offices both inside and outside Texas and buys hosting/data-processing services that benefit multiple locations, you can give your provider a multistate exemption certificate and self-report Texas tax only on the Texas-benefiting share, rather than paying Texas tax on the whole invoice.

Accountants and tax professionals

This letter is a useful checklist for classifying ISP-style charges: default to data processing services (Rule 3.330) for hosting-type charges, graphic arts (Rule 3.312) for design/logo work, and remember that reimbursement-only pass-throughs without markup escape tax under the Tax Code § 151.007 "sales price" analysis.

Common questions

Q: Is a fee that just reimburses an out-of-state vendor's cost, with no markup, taxable in Texas?
A: No -- per this letter, the Domain Name Registration Fee (a pure reimbursement with no markup) is not subject to Texas sales tax.

Q: If my company has locations in and out of Texas, do I pay Texas tax on my whole hosting bill?
A: No. You can give the provider a multistate benefit exemption certificate and self-report/pay Texas tax only on the portion of the charge that benefits your Texas location.

Q: Does it matter that the server is physically located outside Texas?
A: No. The service benefit location is considered to be in Texas if that's where the customer is, so Texas tax still applies; local tax follows the server's location if it's in Texas, or otherwise the customer's location.

Q: Is custom web site design work taxed the same as data processing?
A: No -- the Custom Design Fee is taxed separately as graphic arts under Rule 3.312, not as data processing.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.007 (definition of "Sales Price")
• 34 Tex. Admin. Code § 3.330 (data processing services)
• 34 Tex. Admin. Code § 3.312 (graphic arts)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9605L1411A03

Original ruling text

May 22, 1996

Dear ***:

Thank you for your recent letter which is restated in part with responses
below.

Fee structure:

Monthly Service Fee: this fee is used to pay for various company expenses
including the monthly fee we are charged from our out-of-state Internet
server as well as payroll, equipment, rent, etc.

Set-Up Fee: this is a customer commitment fee that the company receives
prior to initiating any business relations.

Domain Name Registration Fee: this fee is simply a reimbursement for the
registration expense charged by an out-of-state company, there is no mark-up
to our customers on this fee. This registration has to be renewed every two
years.

Custom Design Fee: this fee is based on hourly labor and typically assessed
after the customer is satisfied with the design. However, additional fees
for design charges and updates may occur periodically.

Additional Disk Space Fee: this fee is for web sites requiring more than
75 Megs. Again, this fee is assessed by the out-of-state server. There is
a mark-up to our customers on this fee.

Audio/Video Fee: service is provided by out-of-state server. There is a
mark-up to our customers on this fee.

Secure Server Fee: service is provided by out-of-state server. There is a
mark-up to our customers on this fee.

You ask:

Which fees, if any, are subject to Texas sales tax? If a marked-up fee is
subject to sales tax, is the entire fee subject to tax? If so, is the fee
subject to sales tax even if the initial fee is from an out-of-state vendor?
If an Internet customer has its corporate office in Texas and its manufacturing
office in Florida, and both offices receive and pay invoices, should this
customer be charged Texas sales tax?

Response: Tax Code Section 151.007 defines "Sales Price" to include the total
amount for which a taxable item is sold with out deduction for the cost of
materials used, labor or service employed, interest, losses, or other expenses.
Accordingly, all costs attributable to a taxable service such as the Monthly
Service Fee are subject to sales tax.

Internet services that provide server space to their clients are considered to
be performing data processing services. Out-of-state firms providing server
space to Texas residents are required to collect Texas tax if they have
representation in Texas. Otherwise, the Texas customer is required to self
assess and remit Texas use tax. The service benefit location is considered to
be in Texas even though the server may be located at a point outside Texas.
Local tax is collected based on the location of the server if it is in Texas,
or the customer's location if the server is located out of state. I am enclosing
Rule 3.330 for your reference.

A multi-state customer purchasing data processing services for the benefit of
both in-state and out-of-state locations is responsible for issuing to the
data processing service provider an exemption certificate asserting a
multi-state benefit, and for reporting and paying the tax on that portion of
the data processing charge which will benefit the Texas location. A data
processing service provider that accepts such a certificate in good faith is
relieved of responsibility for collecting and remitting tax on transactions
to which the certificate relates.

A Set-up fee related to providing taxable services is taxable in the same
manner as the service itself. Both the Set-up fee and the Monthly Service Fee
would be treated as service in connection with the provision of data
processing services.

A domain name registration fee is not subject to sales tax.

A custom design fee is subject to tax under the enclosed Rule 3.312
regarding graphic arts.

The fee for additional disk space is subject to tax as data processing.

Charges for digitizing audio and/or video and also for maintaining digital
audio and/or video on a server is subject to tax as data processing. Charges
for scanning photographs and documents are also taxed as data processing.

A secure server fee is taxable as a service in connection with a sale of
data processing and is taxed in the same manner.

This opinion is rendered based on the facts you submitted. Other facts,
though similar, may yield different results.

You may call me toll free at 1-800-531-5441, ext. 3-4680. The direct line
is 512/463-4680. You may also write to Tax Policy Division, Comptroller
of Public Accounts.

Sincerely,

Al Van Allen
Tax Policy Division

NOTE: Previous Accession Number 9605229L