New York Sales Tax Rulings Continue Hard Line on Bundled Sales that Include Software

At a glance

• The main takeaway: Recent New York administrative decisions illustrate the state’s reluctance to apply the primary function test to the bundled sale of software or software-as-a-service (SaaS) with nontaxable services.
• Assess the impact: Businesses need to be aware that how they market their software/SaaS and other services may have significant sales tax ramifications.  
• Take the next step: Aprio’s State and Local Tax (SALT) team can help your business address taxability issues on software and SaaS services.

Schedule a free consultation today to learn more!

The full story

Two recently issued sales tax rulings in New York further solidify the state’s reluctance to apply the primary function test when taxable tangible personal property (e.g., software or SaaS) is sold for a bundled price with nontaxable services. For these types of transactions, the New York will generally treat the entire sale price as being subject to sales tax if a nonincidental part of the transaction is the license to use software.   

On May 2, 2024, In the Matter of the Petition of Beeline.com, Inc., the New York Tax Appeals Tribunal (Tribunal) upheld a 2023 ruling of the state’s Division of Tax Appeals (DTA) where it was held that a taxpayer’s fees charged for its vendor management system that match customers needing temporary workers with the suppliers of temporary labor was subject to sales tax. The Tribunal agreed with the administrative law judge’s (ALJ) conclusion that the taxpayer’s software, which was licensed to its customers pursuant to its services agreements, was not incidental or inconsequential as compared to the nontaxable services provided by the taxpayer. Thus, the taxpayer’s receipts under its service agreements were deemed to be a taxable sale of tangible personal property. Additional details and analysis regarding this case and the ALJ’s decision can be found in an article published in our March 2023 SALT Newsletter.

A week later, on May 9, 2024, the DTA reached the same conclusion In the Matter of the Petition of FacilitySource, LLC.[1] This case, similar to Beeline.com, involved a taxpayer with bundled transactions that consisted of the license of software and the provision of nontaxable services.

A closer look at the FacilitySource decision  

The issue addressed in FacilitySource was whether the taxpayer’s facilities management services should be taxable as sales of prewritten software. Pursuant to New York sales tax guidance, the receipts derived from a license to use prewritten software, including software-as-a-service (SaaS), are treated as a taxable sale of tangible personal property. The facilities management services at issue in the case consisted of 24/7 call-in transaction center access, web-based portal access, work order management, vendor management, electronic invoicing, and data analytics.  Certain elements of the facilities management services were very labor intensive. For example, for the period under audit, the taxpayer’s call center employed up to 185 individuals. Further, on average, four-to-eight employees were involved in the processing of facilities work order.

As part of the “integrated facilities management” service sold by the taxpayer, customers received licensed access to a remotely accessed software platform that enabled users to enter facility work requests, dispatch work orders, allow for general tracking of all work orders, and create facility reports. Similar to the service agreements in the Beeline.com case, all the sample customer agreements reviewed by the DTA in FacilitySource granted a license to the customer to use the taxpayer’s software. The taxpayer’s software platform was consistently touted in its marketing materials as a component of the facility management service, and the taxpayer’s CEO testified that the company could not deliver its overall service without the use of the software.  From a pricing perspective, customers could not purchase a license to the software separately from the overall facilities management service. Instead, the integrated facilities management services, including the license to access the taxpayer’s software, were sold for a bundled price. 

The FacilitySource ruling explained

In assessing whether the taxpayer’s receipts from its facilities management service were subject to sales tax, the DTA first concluded that the taxpayer “clearly” sold a “bundle of prewritten computer software and services for one charge.” This conclusion was easily supported by the sample service agreement reviewed by the ALJ. Given the bundled nature of the sales, the taxpayer argued that the “primary function” test must be applied. The “primary function” test is similar to other states use of the “true object” test whereby the transaction as a whole is examined to determine whether the true purpose of the sale was to provide something taxable versus something nontaxable. This is invariably a somewhat subjective test that often results in both sides arguing for their respective preferred “primary function.” 

However, the DTA, consistent with the Tribunal’s decision in Beeline.com and prior sales tax rulings, concluded the “primary function” test only applies when there is a sale of bundled taxable and nontaxable services. New York has consistently not applied the “primary function” test to the mixed bundle sales of taxable tangible personal property (including software) and nontaxable services. Instead, where a bundled sale includes taxable tangible personal property, the entire charge is subject to sales unless the tangible personal property is deemed to be an inconsequential element of the overall sale.

The bottom line

The Tribunal’s decision in Beeline.com and the DTA ruling in FacilitySource reflect New York’s continued reluctance to apply the “primary function” test to transactions that involve a bundled sale of software (or SaaS) and nontaxable services. Further, the cases illustrate that a business’ marketing focus on its “software platform” or services being delivered through a “SaaS model” is often detrimental to any attempt to argue that its bundled price is not subject to New York sales tax even when the remaining services would otherwise not be subject to tax if sold separately. 

Thus, service providers need to be aware of the sales tax ramifications of how they market their services, as well as the impact of software licensing provisions in their service agreements. This will enable the business to make informed decisions as to whether the collection of sales tax is required and whether it may make sense to “unbundle” (i.e., separately state) the price of the software license from the price of the services to reduce sales tax being charged to its customers. 

Aprio’s SALT team has experience addressing these types of taxability issues, and we can assist your business to ensure that it complies with its sales and use tax obligations so that it does not incur unexpected liabilities and penalties. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

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[1] The DTA case was a consolidated decision of both In the Matter of the Petition of FacilitySource, LLC, DTA No. 829500 and In the Matter of the Petition of FacilitySource Northeast Services, LLC, DTA No. 829501.