by Teresa Farnsworth April 25, 2022

Written By Guest Blogger S.M. Oliva 

Since 1984, the State of Ohio has imposed sales and use taxes on the purchase of “automatic data processing and computer services.” In 1993, the Ohio General Assembly added a third category–“computer services.” Under current law, a transaction is taxable when “the true object of the transaction” is to receive one of these three categories of services, as opposes to “personal or professional services” where the computer-related services are “incidental or supplemental.”

Essentially, if an Ohio business pays another company to process their data for them, it must pay sales tax on that transaction. But if the business hires professional services, such as an accounting firm, which provides services that include automatic data processing, that is not a taxable transaction. Section 5739.01 of the Ohio Revised Code provides an extensive (but non-exhaustive) list of professional services that are not subject to sales tax.

State Law Lists “Separate Services,” Not Tax Exemptions

The Ohio Supreme Court recently clarified that Section 5739.01 is not a list of “tax exemptions,” but rather services that are not classified as either automatic data processing (ADP), electronic information services (EIS), or computer services subject to sales tax. This is a critical distinction, as courts must construe sales tax exemptions narrowly in favor of the state.

The case before the Court, Cincinnati Federal Savings and Loan Co. v. McClain, involved one particular item on the Section 5739.01 list, which was “custom software.” The taxpayer in this case, a bank, hired an outside company called Fiserv to provide software for its online banking system. Fiserv ran the entire backend for the bank using its own computers. Fiserv also customized its software to meet the bank’s specific needs.

The bank paid Ohio sales tax on several of its invoices from Fiserv. The bank subsequently filed a claim with the Ohio Tax Commissioner, seeking a refund of $57,412.58 in sales taxes paid. In support of this claim, the bank presented two legal theories. First, the bank argued that the services it claimed as exempt were for designing “custom software,” which was a listed item in Section 5739.01. Alternatively, the bank claimed it purchased “accounting services” from Fiserv, which was also among the listed exemptions.

The Tax Commissioner rejected both arguments. The Commissioner held that the software that the bank purchased from Fiserv was not “custom” as defined by Section 5739.01 as it was “not made specifically for the claimant,” but rather mixed-and-matched together from stock Fiserv programs. As for the accounting services argument, the Commissioner said Fiserv only provided banking software and not any work associated with provide tax advice or assessing financial data.

The Ohio Board of Tax Appeals affirmed the Commissioner’s ruling. The Supreme Court, however, partially reversed and returned the case to the Board of Tax Appeals for further consideration. The Court explained that the purpose of Section 5739.01 was not to “function as a tax exemption” but instead to identify a list of “separate services” not subject to sales tax in the first place. In other words, “When the General Assembly decided to impose sales tax on ADP and EIS, it defined and carved out those computer-related services as taxable,” while leaving a list of other services out, including custom software and accounting services.

Not an “All-or-Nothing” Proposition

While the Ohio Supreme Court agreed with the Commissioner and the Board that the bank never purchased “accounting services” from Fiserv, the question of whether it purchased “custom software” was trickier. As described above, the statute provides that a sale is taxable when the “true object” is to receive computer services rather than some other service. So the question here was whether the bank’s true object was to purchase custom software for Fiserv, or was it only buying data processing services?

The Court concluded that this was not an “all-or-nothing” proposition. The evidence in this case could support the conclusion “that some charges relate primarily to the provision of ADP and EIS while others relate primarily to the customization of software.” The bank was therefore entitled to have the Board consider that some of the Fiserv invoices it paid should not have included sales tax.

 


S.M. Oliva is a writer living in Virginia. He authors the blog Computer Chronicles Revisited.

Teresa Farnsworth
Teresa Farnsworth

Teresa Farnsworth is the VP / Account Manager at Zip2Tax. She works closely with her clients to make sure they have just what they need to collect the right amount of sales or use tax in the U.S. and Canada. Questions? Chat with Teresa on the Web site, the Subscriber User Portal, or call her direct line; 866-492-8494.


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