No matter which industry your company is in, chances are you’re purchasing multiple types of software to run the business, and you may owe sales tax depending on the type of transaction. The sale of canned software in Illinois is subject to sales tax since the transaction is considered to be a transfer of tangible property while custom software is not subject to Illinois sales tax. However, many companies are now purchasing software “in the cloud”, which leaves a gray area in determining the correct tax.
Determining IL Sales Tax for Cloud Software
To determine the proper treatment, it is necessary to decide whether the cloud software is a sale of a service (nontaxable under Illinois law) or a transfer of tangible property (taxable under Illinois law). In recent years, the Illinois Department of Revenue (IDOR) has not provided guidance to taxpayers regarding their interpretation for the taxation of cloud-based services, leaving taxpayers in a difficult position. For an extended period of time, the IDOR has indicated that they were studying this area and would provide guidance in the future.
New Guidance for Software Purchases and IL Sales Tax
The IDOR has recently issued a “General Information Letter” that clarifies the Department’s current view on the application of Illinois sales tax to cloud-based software services. The letter indicates that the Department does not consider the viewing, downloading, or electronically transmitting of video, text and other data over the internet to be a transfer of tangible property. Therefore they indicate that computer software provided through a cloud based delivery system (a system in which software is never downloaded onto a client’s computer and is only accessed remotely) is not subject to sales tax.
However, they also indicate that if the company provides the customer an application program interface (API), applet, desktop agent, or a remote access agent to enable the customer to access the provider’s network and services, it then appears that the customer is receiving a transfer of software that is subject to tax. Therefore, under these circumstances, the transaction would be subject to sales tax. In order to determine the correct tax treatment, taxpayers will need to know whether their particular cloud-based software uses an API. It may be necessary to review the license and service agreement to determine whether this applies in a particular case.
The IDOR letter also states that they will continue to review the application of sales tax to cloud-based software arrangements. If, in the future, they determine that cloud based services should be considered taxable, they will apply such a rule only prospectively.
How DHJJ Can Help
The proper application of the Illinois sales tax rules can be complex. If you have any questions on how this may impact your business, please contact the DHJJ SALT team at 630.420.1360 or email Lee at email@example.com.