By Open Weaver Banks and Liz Cha

The Arizona Department of Revenue (Department) issued a taxpayer information ruling stating that a taxpayer’s gross income from transactions provided through the use of computer software is not subject to tax under the personal property rental classification for Arizona Transaction Privilege Tax purposes.

The taxpayer’s software provides its customers with subscription billing and reoccurring payment provider services through a web-based portal. The taxpayer charges its client a percentage of successful billing transactions made during a particular time period. If a client violates the payment agreement with the taxpayer, the taxpayer will discontinue provision of its payment processing services and disable access to its software and web-based portal.

Under Arizona case law, software is treated as tangible personal property. The Arizona Transaction Privilege Tax generally subjects tangible personal property to tax when a taxpayer grants its customer the right to the tangible personal property for a perpetual duration (i.e., a sale) or for a fixed period of time at a fixed amount (i.e, a rental). The Department determined that the taxpayer’s activities would not be considered retail sales because the taxpayer’s billing practices were based on (1) a periodic fee and (2) the taxpayer could discontinue service if the customer failed to pay. With regard to whether the taxpayer’s services constituted a rental, the Department relied on Arizona precedent that taxpayer’s customers must gain sufficient control and use of software to constitute the rental of tangible personal property. In this case, the taxpayer’s customers lacked sufficient control of the software because both the taxpayer and customer used the software and the taxpayer updated information on the portal either manually or automatically so that the clients could view the status of payments processed and other analytical information. Accordingly, the Department determined that gross income from taxpayer’s software services was not a taxable activity under the Arizona Transaction Privilege Tax.

Arizona Taxpayer Information Ruling LR 16-011, Arizona Department of Revenue (September 23, 2016).