Changes to Massachusetts tax policy became law became last week on July 24, 2013. One change included a new tax on “Software Services” involving “prewritten” software. This new tax became effective one week later – July 31, 2013.

I wrote an analysis of that law which generate some really great dialog (see the comments). In my analysis, I was alarmed because I though the intent of the new tax law did not match the wording. I sent my feedback to the Department of Revenue (DOR) asking for clarification. The DOR has responded.

The DOR response has a short overview page that includes a link to an FAQ on the new software services tax that contains the key clarifications. This FAQ is well done and provides a good deal of new, clarifying information in the form of 29 Questions with Answers. (I don’t necessarily like the answers it provides, as I wish the policies were different, but there’s no questioning that they do clear up certain areas of confusion substantially.)

Here is my take on a couple of the FAQ responses that, while very clear, are not the answers I was hoping to hear. The FAQ items cited are included verbatim in blue text.

FAQ Item 5 – Blindsided

FAQ 5. Why were businesses given such short notice of the new tax?

A. The effective date was set by legislation, not by the Department of Revenue. The Department’s TIR 13-10, “Sales and use Tax on Computer and Software Services” was issued one day after the legislation became law.

ANALYSIS

First, it is important to realize that the DOR was not responsible for writing the law, but they are trying to stay on top of it and issue timely guidance. One day after for the original TIR 13-10 and one week after that for this updated FAQ does not seem unreasonable since drafting answers these questions (many unanticipated by lawmakers) is not a casual endeavor. The authors of the FAQ appear to have taken into consideration lots of input, judging from the breadth of the questions it answers (including a couple of fairly esoteric ones).

This item is not speaking for lawmakers who should still explain how they thought they were acting responsibly by adding “sales tax” to software services where there never was such a thing before and have it become effective within a mere 7 days of becoming law. I did not say “why did they only give 7 days notice” because I don’t see this as giving the community “notice” – most effected consultants and services companies probably don’t even know about it yet – and it really did come out of the blue.

Lawmakers also still need to explain why they did not ask for feedback from the software services community in advance. Then the DOR FAQ could have been ready in advance. And maybe the law could have even been written more clearly. Did they ask for feedback in advance? If the publication of Working Draft Directive 13-XX: Criteria for Determining Whether a Transaction is a Taxable Sale of Pre-written Software or a Non-taxable Service is used as evidence that sufficient notice was given to the software services community, I strongly disagree. That draft was not a sufficient indicator of what was to come.

How the Software Services Community was Blindsided

1. The publication of Working Draft Directive 13-XX: Criteria for Determining Whether a Transaction is a Taxable Sale of Pre-written Software or a Non-taxable Service is VERY DIFFERENT from the final law.
2. The draft targeted software services tied to a larger software sale. Consider this key bullet from Directive 1 in the draft: “Pre-written software is bundled with a non-taxable service and sold for a single price, but only where the software constitutes the predominant value of the sale.” I can see this as taxing the services sold to make the software sale possible (think Enterprise Software which often require major integration) and to make it harder for vendors to shift licensing costs to services costs to avoid taxes.
3. The draft exempted custom software and projects where the services were dominant part of the transaction. Consider these two key bullets from Directive 2 in the draft:  “The seller is providing custom software.” and “Substantial personal or professional services are performed by seller’s employees and are bundled with the use of software and sold for a single price, and such services constitute the predominant value of the sale.”
4. These seemed to be reasonable & logical criteria for taxation (Directive 1) and non-taxation (Directive 2).  So why worry?
5. The actual legislation took a major turn and is SO DIFFERENT in its scope and intent that it is not a logical successor to the draft. There is NO WAY our lawmakers can expect a reasonable reading of the draft suggests we might arrive at this final legislation.
6. And, as mentioned, most impacted software services professionals don’t even know about the draft, the law, or the tax. HOW WERE WE SUPPOSED TO KNOW THIS WAS HAPPENING? How many lawmakers made an effort to socialize this with those of us in the profession? Anyone have any evidence that any outreach happened? Anyone reach out to your professional organization, company, or community group?

FAQ Items 9 and 10 – Taxing Open Source

FAQ 9. How does the new tax apply to use of Open Source software?

FAQ 10. Is Website Design a taxable service?

A9. Open Source software is available free on the Internet. Thus, no tax applies to the transfer of Open Source software where there is no consideration for the transfer. If a seller customizes Open Source software and sells it to one or more customers to be used on any electronic device, that customized software is subject to tax.

A10. The Department understands that website design may be accomplished in various ways. If the website designer is configuring or modifying Open Source (free) code or other prewritten software for the needs of a customer, the designer’s charges to that customer are subject to tax. If the website designer is creating custom software for its customer (that is, not based on other prewritten software), then the charges are not taxable.

ANALYSIS

I will tackle FAQ items 9 and 10 together here since my reaction spans both, and is one of astonishment. I had expected that the clarification on the tax law would be “oh my goodness, we never intended that, please let me amend that immediately!!” – but that’s plainly not the case.

This new tax law explicitly taxes software services and software consulting whenever “customizing” or “configuring” open source software is involved. This is pretty much every software application that uses open source – which is most software applications.

The tax law does exempt building completely from scratch, but I don’t know of too many projects outside academia or hobbies that would apply to since it is usually a terrible waste of time. The law also exempts just handing over open source software “as is” (if your customer doesn’t want to download it themselves?) – but if you install it for the customer, that service will be taxed (see FAQ item 21 which clarifies that software installation services are taxable).

More generally, the tax on software services is triggered by customizing or configuring any prewritten software – including software that is freely available like open source.

Response – Activism

While my first essay attempted to show how the new tax law was written to be so sweeping, my hope was this would open eyes since I thought the vagueness of the law was unintended. Appears I was wrong.

I encourage everyone to read up on this and stay fact-based. I recommend starting with the most recent DOR short overview page and especially the linked FAQ.

The time has come to get organized and respond. My plans will include:

• Continue to increase awareness
• Continue to work with colleagues to plan a course of action
• Broaden the number of people I am aligning with (I’ll be making some phone calls)
• I will be contacting (again) my state rep and senator letting them know I believe this is just wrong

What else should I do? What do you plan to do?