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Court: Tax abatement still available for software used out of state

The normal abatement process remains available to vendors and purchasers of software used outside of Massachusetts, even if they did not follow the regulations for sales tax apportionment prescribed by the state’s commissioner of revenue, the Massachusetts Supreme Judicial Court ruled on May 21.

Tax practitioners across the country had been watching to see how the SJC would rule in Oracle, et al. v. Commissioner of Revenue, University of Connecticut Law School tax professor Richard D. Pomp told Massachusetts Lawyers Weekly in February, after oral arguments had been held.

That is because Oracle involved the tax treatment of an increasingly common modern business scenario: A company purchases multiple licenses for software, which is delivered digitally and used by employees outside of the employer’s home state.

In 2005, while doing away with an antiquated distinction between software delivered in “tangible form,” like a CD-ROM or disk, and pre-written software delivered electronically, the Massachusetts Legislature granted the commissioner of revenue the authority to establish rules for apportioning sales and use tax on computer software that is transferred for use in multiple states, which the commissioner had done by October 2006.

The commissioner’s regulations offer three separate options by which taxpayers can achieve sales tax apportionment, all of which require that steps be taken at the time the sales tax becomes due and payable.

But the subject company in Oracle, Hologic, and its vendors had not followed those regulations. Instead, the vendors remitted tax payments based on the entire value of the transactions.

Later, when Hologic notified the vendors that only a portion of the software was to be used in Massachusetts, the vendors applied for refunds through the general abatement process outlined in G.L.c. 62C, §37, for the portion of the sales tax that they had paid to the state but that was attributable to out-of-state use of the software.

The Appellate Tax Board initially upheld the commissioner’s denial of the sellers’ abatement applications on May 17, 2017, but reversed itself nearly two years later, granting the requested abatements.

The SJC has now decided that was the right move, in part due to “constitutional concerns.” In its appeal, the commissioner had argued that G.L.c. 64H, §1, does not create a right to apportionment but rather gives the commissioner the discretion to decide not only how, but also whether to apportion taxes on software transferred for use in more than one state.

Given that the Massachusetts Constitution vests authority to tax exclusively in the Legislature, the commissioner’s interpretation “raises separation of powers concerns and, thus, runs counter to the canon of constitutional avoidance,” Justice Dalila Argaez Wendlandt wrote for the court.

Moreover, deciding whether to allow apportionment of sales tax on software used outside the state was the type of fundamental policy decision that the Legislature could not properly delegate, the court found.

As for what import to give Hologic and the vendors’ failure to abide by the commissioner’s regulation, the court drew a comparison to the certification procedures outlined in G.L.c. 64H, §8, which relate to sales of property purchased for resale.

In such a circumstance, a purchaser has the option to present a vendor a certificate to get off the hook for paying sales tax. But if a seller does not obtain a certificate from the purchaser, the seller may still pursue a refund of excessive taxes paid through the general abatement process.

“We see no reason why the same would not be the case where a purchaser does not provide a vendor with a certification of multistate use of software as described in 830 Code Mass. Regs. §64H.1.3(15),” Wendlandt wrote. “As with a vendor who may seek a refund for excessive taxes paid for sales that were destined for resale, but where the purchaser did not provide the requisite certification, a software vendor is not precluded by the purchaser’s failure to provide a certification that software is to be used in multiple States from seeking an abatement.”

Richard L. Jones of Sullivan represented the taxpayers in Oracle, while Assistant Attorney General Richard S. Weitzel argued the case for the commissioner of revenue.

The 26-page ruling is Oracle USA, Inc. v. Commissioner of Revenue.