On Oct. 27, 2015, the Michigan Court of Appeals held in Auto-Owners Insurance Company v. Department of Treasury that a taxpayer’s use of software accessed remotely over the Web was not subject to Michigan sales and use tax. It also held that in some circumstances the installation of software on the purchaser’s computer was not subject to sales tax if the software was incidental to the provision of services. This finding was in direct contrast to the long-standing policy of the Michigan Department of Treasury, which has asserted that if a transaction involves a fee (license or subscription) for the use of prewritten computer software, the transaction is considered a taxable use of prewritten computer software in all circumstances.
Among the various contracts the taxpayer entered into, the court addressed three types of software in the Auto-Owners decision:
- Software accessed by Auto-Owners employees via the software provider’s website using a Web browser
- Software via a local desktop agent on Auto-Owners employees’ computers that allowed employees remote access to the company’s network
- Software that was necessary for an unrelated third party to provide services
The court held that all three types of software were not subject to sales and use tax.
According to the ruling, software accessed by employees of Auto-Owners via the provider’s website using a Web browser was not subject to sales and use tax because the taxpayer accessing the software did not exercise the required right or ownership over tangible personal property. Accessing the software did not involve delivery of prewritten computer software by any means.
For other types of software the analysis is not as clear-cut. Taxpayers will need to analyze the software purchased under Michigan’s incident-to-service test, which looks to see if the true object of the transaction that gave rise to the acquisition of software has its roots in a service transaction. If the transaction is deemed to be rooted in a service transaction, the software will be viewed as a component of the service transaction that is not subject to sales and use tax. Each transaction must be subjectively analyzed under the incident-to-service test, and taxpayers can expect significant scrutiny by the state if they conclude that software is exempt from sales and use tax under the test.
Michigan businesses should review their software contracts and invoices to determine if they have paid sales and use tax on items that might be exempt as a result of the court’s ruling in Auto-Owners. Michigan has consistently litigated its interpretation of use of prewritten computer software, and it is likely that the state will appeal the Auto-Owners decision to the Michigan Supreme Court.