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Are Internet Apps Leaving You Exposed to Sales Tax Liability?

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The Ohio Tax Department is interpreting taxable electronic information services under R.C. 5739.01(B)(3)(e) and 5739.01(Y)(1)(c) broadly, essentially declaring any transaction where computers share information taxable, regardless of why the computers are sharing information. Yet R.C. 5739.01(Y)(1)(e) explicitly excludes “personal or professional services” from the definition of electronic information services. The result is that many businesses using apps and other internet technology in lieu of human interaction are getting assessed with tax, interest, and penalties on audit. The story below provides a good example.

Sammy looked at the year-end financials and grinned widely. Flippin’ Pizza’s revenues were up by 20%. The monthly fees they’d been paying to HungryNow!, an online ordering service, had been well worth it.

HungryNow! had created a Flippin’ Pizza branded website and app with Flippin’s menu, prices, weekly specials, and promotional items, like t-shirts and mugs. Customers could order from the website or app and would receive periodic emails or texts indicating when the pizza would be ready or delivered. Not only did this technology increase Flippin’s customer base, it streamlined the ordering process--no more dropped calls, bad connections, or trying to hear soft-spoken customers over the noise of operations. Customer satisfaction was up too!

All was going great for Sammy . . . until the sales tax auditor showed up and noticed HungryNow! hadn’t been charging sales tax.

“Wait,” said Sammy to the auditor. “I checked before I signed the contract. Ordering services are a personal or professional service, and personal and professional services aren’t taxable in Ohio.”

“Well maybe,” said the auditor, “but I bet there’s more going on here.”

And with that, the auditor started asking questions. How did the website or app know Flippin’s prices or weekly specials? How did the order information get from the website or app to Flippin’s computer systems? Who was emailing or texting the customers with delivery information? If it was Flippin’, how did Flippin’s get the customer’s information? If it was HungryNow!, how did they know where the pizza was and when it was going to be delivered?

After reviewing the contract and a discussion with HungryNow!’s IT folk, the auditor had his answers. In a nutshell, HungryNow!’s and Flippin’s computer systems were talking to each other. Flippin’s computers has access to HungryNow!’s and was pulling order information, and HungryNow!’s computers had access to Flippin’s and was pulling delivery information.

“So?” said Sammy. “What’s that matter? It’s still an ordering service, which is a personal or professional service, and that’s not taxable.”

“Actually,” said the auditor, “because the computer systems have access to each other and are pulling information from each other, it’s electronic information services, and that is taxable. The auditor continued:

Under R.C. 5739.01(Y)(1)(c), electronic information services is providing access to computer systems via telecommunications equipment to:

  • Examine or acquire data stored in or accessible to the computer equipment; or
  • Place data in the equipment to be retrieved by a designed other with access.

Although the term “electronic information services” was enacted in 1993, its definition largely existed since 1983 or ‘84 as “automatic data processing and computer services.” That term was defined in part as “providing direct access to computer equipment by remote or proximate access for the purpose of . . . examining or acquiring data stored in or accessible to such computer equipment.” In 1985, the language was refined slightly, and in 1993 the current definition was enacted. Although your specific situation likely wasn’t envisioned when that language was originally enacted, the language was drafted broadly enough to encompass it.

The key here is the term “access.” If one computer can access the information in another computer, then the service is taxable, and that’s exactly what’s happening here.

“Wait,” Sammy said. “This is ridiculous. All I’m doing is having someone else take our orders for us. It’s the same as if I paid some guy to stand outside our door, take people’s orders, and bring them into us, and then walk back out and let the customer know when their pizza was going to be delivered. That’s not a taxable service. That’s a personal or professional service. The fact that the guy is using computers and the internet to perform that service doesn’t make it taxable, and the fact that it’s easier for the guy’s computer to talk to our computer rather than him talking to me or my employees doesn’t matter. The internet and computers just make his job easier. It’s still just an ordering service. I’m not paying for the computers to have an internet pow-wow. I’m paying HungryNow! to take our orders!”

“That’s an interesting argument,” said the auditor, “but the Commissioner takes a different position. My calculations indicate HungryNow! should have charged about $10,000 in tax. Here’s your assessment with interest and penalties. Thank you. Have a nice day.”

Sammy clenched his teeth, pulled out his cell phone, and called his sales tax consultant.

[Unfortunately, Sammy lost. America’s Pizza Company, LLC v. Testa, BTA No 2016-1551 (9/5/2017). The case was not appealed.]

About the Author: Steve’s Ohio tax experience began in 2006 at the Ohio General Assembly where he drafted the State’s tax legislation. Steve quickly became a expert on Ohio’s manufacturing, restaurant, oil and gas, R&D, and other sales tax exemptions and on the taxability of data processing, cloud computing, employment, and other services. In 2011, Steve joined Big 4 firm pwc and gained experience on a national level. Steve also worked for a global software development company where he was responsible for sales, use & other tax compliance.
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