![]() Software and Nexus. In August 2. 00. 9, the New Jersey Tax Court issued a consolidated ruling (PDF) on the income tax treatment of two software companies with customers in New Jersey (New Jersey). This article summarizes and makes observations about this case. Facts and Holdings. Sales and use tax rate applicable for those counties.
![]() Two software companies challenged findings of the director, division of taxation, that they were subject to the New Jersey Corporation Business Tax (CBT). The taxpayers, Accu. ZIP, Inc. 0. 05. 74. Quark, Inc. Both were incorporated and headquartered outside of New Jersey. Accu. ZIP had no employees in New Jersey while Quark had one employee there working out of his home. The director argued that the companies owed CBT because they were . Per the court, Accu. ZIP sold tangible property to New Jersey customers but did not have any property in the state and generating just two percent of its total sales in the state was de minimus. Thus, Accu. ZIP was not subject to CBT. There are two type of prewritten. Security Software Security What is Pre Written software And customized Software? The court noted though, that if Accu. ZIP were doing business in New Jersey, only the minimum tax would be owed because its activities fell within the protections of PL 8. In contrast, Quark was found to be doing business. First, the companies were selling tangible personal property, and second, they owned no property in New Jersey. The nature of what the companies transferred was relevant because the nexus protections of PL 8. The court pointed out that for New Jersey sales tax purposes, prewritten software is treated as tangible personal property even if delivered electronically. The court noted that federal income tax law would also treat the sales as transfers involving tangible property. The court referred to Income Tax Reg. Per the court, the companies . Lanco, a Delaware corporation, licensed use of its marks to a related entity in New Jersey. The New Jersey Supreme Court found that Lanco had substantial nexus in New Jersey even though it had no physical presence in the state. The court also applied the ? Ownership of property was also relevant because such ownership may cause the companies to have a substantial nexus in New Jersey. The court noted that transfer of the disks was not a transfer of the owners' copyright rights. Transferring ownership of the disks with the software, but without any ownership rights in the software . If the location of the physical disks evidenced a substantial nexus for CBT purposes then the customers would determine Quark's and Accu. ZIP's CBT fate. This test was applied in MBNA where the company had no physical presence in the state and was not subject to PL 8. The New Jersey court noted that the MBNA approach was not binding on the court. The director also argued that the companies received economic benefits from New Jersey that warranted imposition of the CBT. The court noted that was not the standard under state law. Observations. Nature of software: Federal and states laws are inconsistent, and sometimes silent, in labeling software as tangible or intangible. The New Jersey court referred to Reg. Yet, this regulation does not address the nature of software but instead provides guidance on how transactions related to software should be classified. Four possible outcomes are specified: transfer of a copyright right, transfer of a copyrighted article, services or provision of know- how. The New Jersey court did not refer to federal depreciation rules that apply differently for tangible and intangible property. Doing so would have led to the label of . It referred to Spenser Gifts, 3 New Jersey Tax 4. The court found that the real object was the intangible information rather than the tangible tapes. In the present case, the court concluded that the companies were selling software rather than information. This reasoning is questionable because what the customers wanted was the software not the disks. This analysis should have led to a conclusion that the software is either intangible or services (it enables a computer to perform particular functions), unless the court was relying on New Jersey's treatment of prewritten software as tangible for sales tax purposes (in which case it wanted to be sure it was not information, which Spenser Gifts found to be intangible). The court also referred to the federal Norwest case (1. TC 3. 58 (1. 99. 7)) for the issue of whether the parties owned property in New Jersey. In Norwest, the Tax Court held that software purchased as a copyrighted article could be treated as tangible personal property for investment tax credit (ITC) purposes. The court observed though that the ITC rules were to be interpreted broadly. Sales tax rules vary among states in their treatment of software. Several states, such as New Jersey, include prewritten software delivered on media or electronically as tangible personal property while a few states, such as California distinguish between software transferred on tangible media versus electronically (intangible). The New Jersey court found that the companies did not own property in New Jersey, but did not state where the software was located. State law specificity: State laws also differ as to their specificity in explaining when software can create income tax nexus. The Multistate Tax Commission (MTC) interpretation (PDF) of PL 8. PL 8. 6- 2. 72. While the director noted this position, the court nixed it because New Jersey, a Sovereignty Member of the MTC, is not bound by the MTC interpretation. Arguably, given the New Jersey court's labeling of the transactions as the sale of . Transfer mode: Would the New Jersey court have reached the same conclusion if the software had been transferred electronically? Unfortunately, the court did not adequately address whether software is tangible or intangible, but instead added the word . While the New Jersey court may have still reached a sale conclusion rather than license using Reg. Software versus trademarks: Lanco derived royalties from a related entity's use of its marks. Accu. ZIP and Quark received one- time payments. In both situations though, the underlying valuable asset is owned by the transferors, not the customers. No customers had rights in the trademarks of Lanco or the copyright of Accu. ZIP and Quark. However, Accu. ZIP and Quark customers owned a copy of a copyrighted article they could depreciate while Lanco's customers owned nothing. Conclusion. The New Jersey case illustrates the lack of clarity in the income tax nexus rules regarding software. When should a customer's use of software be treated as a sale versus a license and should treatment as tangible for sales tax also apply for income tax? Why should such labels matter in determining when a company is subject to state income tax? PL 8. 6- 2. 72 is outdated in only applying to sales of tangible personal property. Economic nexus is not a helpful substitute when PL 8. Modernization of PL 8. Annette Nellen, CPA/Esq., is a tax professor and director of the MST Program at San Jos. Nellen is an active member of the tax sections of the ABA and AICPA. She serves on the AICPA. She has several reports on tax reform and a blog.
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