August 1999

STATE AND LOCAL TAXATION

THE COMPUTER SERVICES SALES TAX QUANDARY

By Mark Stone, CFP, CPA,
Margolin, Winer & Evens LLP

As the impact of computers on society expands, it is essential that businesses and consumers understand the implications of sales tax on computer services. Although the application of sales tax for computer services may seem well defined on the surface, the statutory language is more ambiguous. Advisory opinions issued by the New York State Commissioner of Taxation and Finance are necessary to adequately interpret the statutory law.

To determine the taxability of computer services, the purchaser must make a distinction between hardware and software services. Under section 1105(c) of the New York Tax Law, the state imposes a tax on the receipt from every sale (except resale) of certain services, including the maintenance, service, or repair of tangible personal property. As such, New York State taxes services directly related to computer hardware. While hardware services are subject to sales tax, software services are generally exempt under Technical Service Bulletin M-93(3)S and New York State Law section 1115(o). If services related to software are provided to a customer in conjunction with taxable property or services, the exempt charges must be reasonable and separately stated on the invoice. If these services are not separately stated, the entire invoice will be subject to sales tax.

Practitioners may find it difficult to distinguish between tax-exempt software services and taxable hardware services. For example, will New York State classify services provided in the installation of a computer as tax-exempt? To answer this question, the meaning of "hardware services" must be interpreted.

New York's position on distinguishing between hardware and software services comes primarily from TSB advisory opinions. Although these opinions provide the Department of Finance's interpretation, they relate only to the taxpayer requesting the opinion. The Department of Finance has issued two key advisory opinions relating to this area: David Zucker in TSB-A-96(53)S and Xecu-Track Accounting Services, Inc., in TSB-A-98(27)S. Under Xecu-Track, the department gave its interpretation of hardware sales based on different scenarios. Let's analyze two of these scenarios.

Scenario 1. A computer consultant is called to service a computer. The consultant determines that the computer has a defective network card. To service this internal component, the consultant opens the computer and installs a new card. As a result, approximately half the consultant's time is spent assessing the problem, while the other half is spent on actual repairs. In this scenario, the repairs involve a physical component (such as electronic and electrical devices) of the computer, and New York State will subject the time spent to sales tax.

Scenario 2. A computer consultant sells both sales-taxable prewritten software and hardware to a company. The consultant is also hired to configure the operating software of a computer network. Accordingly, the consultant sets up all network computers to enable the software on these computers to work together. In this scenario, the computer is not opened; the work is done using the keyboard only. Will the state subject such a service to sales tax? The answer is "no," since the consultant provided only software services. When sending an invoice to the customer, the service provider should separately state time spent on tax-exempt services. If services are not separately stated, then the state will subject the entire invoice to tax.

The distinguishing difference in these scenarios was whether the computer was opened for hardware repairs. If the computer was opened, then the state will generally subject the services to sales tax. In issuing these opinions, the Department of Finance had to define the term "hardware." The advisory opinion in Xecu-Track based its definition on Webster's Ninth New Collegiate Dictionary (1985 ed.), defining "hardware" as the physical components (such as electronic and electrical devices) of a computer. Both opinions stress the importance of separately invoicing clients to preserve the portions of the sale that are tax-exempt. *

State and Local Editor:
Barry H. Horowitz, CPA
Eisner & Lubin LLP

Interstate Editor:
Nicholas Nessi, CPA
BDO Seidman LLP

Contributing Editors:
Henry Goldwasser, CPA
M.R. Weiser & Co. LLP

Steven M. Kaplan, CPA
Kahn, Hoffman, Nonenmacher & Hochman, LLP

John J. Fielding, CPA
PricewaterhouseCoopers LLP

Warren Weinstock, CPA
Paneth, Haber & Zimmerman LLP

The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.