Indiana recently passed a new sales tax exemption for Software as a Service (“SaaS”), effective July 1, 2018. Under the new law, sales, leases, and licenses of prewritten software remains taxable, regardless of delivery mechanism, but sales, leases, and licenses of SaaS products are not subject to tax. As such, it appears that if a customer has access or control over the software code, the transaction remains taxable in Indiana. If not, the transaction will not be subject to tax going forward. This distinction is similar to the possessory versus non-possessory rules of the Chicago Personal Property Lease Transaction Tax (“Chicago Lease Tax”) which taxes the lease or license of cloud products at a lower rate, 5.25%, than leases or licenses of software delivered by other methods, which is taxed at 9%.
Per Indiana Information Bulletin No. ST8, 12/01/2016, Indiana historically taxed SaaS products used in the state. Therefore, this new exemption is a change in the way the state now taxes SaaS products. Also, the exemption is not permanent and is only in effect for six years (the exemption expires July 1, 2024).
This exemption appears to directly address a few market considerations:
- The Chicago Lease Tax reduced the rate of tax on SaaS (or any non-possessory computer lease) to 5.25% in January 1, 2016. Previously, the rate of all leased or licensed software used in the City was 9%.[1] Indiana took the exemption one step further and exempted all SaaS or cloud products that are sold, leased or licensed and used just over the border, potentially enticing consumers of SaaS and other cloud products currently located in Chicago to move to Indiana.
- Another market consideration is Amazon’s HQ2 bid. Both Chicago and Indianapolis are in the top 20 cities. This exemption, while not permanent, may attractive large online retailers because it indicates the state’s desire to work with technology companies and refrain from taxing new technology.
This exemption, however, is limited to sales tax and does not address the state’s income tax. Indiana law technically requires a “cost-based” allocation approach for income tax purposes, but the state has traditionally imposed “market-based” sourcing on out-of-state taxpayers. The Indiana Tax Court recently rejected the Department’s historical market-based approach in The University of Phoenix, Inc. v. Indiana Dep’t of State Revenue, Cause No. 49T10-1411-TA-00065 (Ind. Tax Ct. 2017). As such, it is likely that the state will strictly enforce a cost-based approach on in-state taxpayers, including in-state SaaS providers.
Therefore, while the state’s sales tax revenue may decrease due to this exemption, if new SaaS providers, such as Amazon, move into the state, it is possible that Indiana may see a corresponding increase in income tax revenue. At this time, it’s unclear whether income tax revenue would increase, but that consideration may have been part of the Legislature’s analysis when passing the sales tax exemption.
[1] The Chicago Lease Tax rate increased in January 1, 2015 from 8% to 9%.