Uncertainly in Alabama on the Taxation of Electronically Delivered Information

September 16, 2015

Alabama has revoked a twenty-year-old sales tax ruling, and in doing so has ruled that electronically transmitted information is taxable tangible personal property for sales tax purposes.  The notice issued by the Alabama Department of Revenue on September 3, 2015 cites advances in technology and analogous expansions of the definition of “tangible personal property” to canned (i.e., prewritten) software and electricity as support for it decision.  Alabama’s decision seems troubling when considering the otherwise limited application of it sales tax and the means by which it has expanded its sales tax in the past.

The application of a state’s sales tax to what most states consider a service (i.e., an information service) is typically accomplished by the enactment of a statute that specifically enumerates the service as being subject to sales tax.  Alabama’s informal memorandum (which seems to be the best characterization of the document issued by the Department) is a prime example of a significant change in tax policy being established by an administrative agency.  Other states have issued similar informal guidance, for example, by ruling that sales tax applies to software-as-a-service (SaaS).  However, states that have administratively concluded that SaaS is taxable have largely already had an enacted statute stating that canned software is taxable regardless of the method of delivery.  In such case, the taxing authority is arguably making a reasonable interpretation of existing law.  Here, Alabama does not otherwise tax information services.

The expansion of Alabama’s tax base to canned software was accomplished through an Alabama Supreme Court case in 1996, which held that canned software is “tangible personal property.”  The Department of Revenue subsequently promulgated a regulation addressing the taxation of computer software in more detail.  Thus, in the case of software, the Department had a decision of the state’s highest court that it was interpreting.  The Department’s reliance on that very case, which addressed the narrow issue of whether canned software is subject to sales tax, to support its conclusion that electronically transmitted information is also tangible personal property is quite a stretch.

This is especially the case given the fact that Alabama does not otherwise tax information services.  How expansive are taxpayers to interpret this pronouncement?  Is all electronically transmitted information now taxable?  Can sales tax be avoided if the information is delivered in hard copy because the application of the “true object” test, which Alabama applies, results in the principal purpose of the sale being a nontaxable transfer intangible property?

Essentially, Alabama’s notice leaves taxpayers, both those providing information services online and in a tangible form, with a significant amount of uncertainty.  Still, this is not terribly surprising, given the slow nature of state legislatures to react to new methods by which products and services are delivered.  Tax administrators across the country are routinely faced with similar questions requiring them to fit a square peg into a round hole.  Unfortunately, the conclusions are anything but uniform; leaving taxpayers, especially those offering products and services online to customers in multiple states, with a certain level of risk.