In a decision involving the true object, or “essence of the transaction” test, the Texas court of appeals upheld the trial court’s decision in favor of the taxpayer refund claim for sales tax assessed on the provision of bill pay services. In Hegar v. CheckFree Services Corporation, NO. 14-15-00027-CV (Tex. Ct. App., April 19, 2016), the Court of Appeals affirmed the trial court’s judgment in favor of CheckFree, awarding it a refund of sales tax paid on bill pay services provided to banks. CheckFree contracted with several banks to provide bill pay services through the banks’ on-line banking services to the banks’ customers. On audit, the Comptroller determined that CheckFree provided taxable data processing services to the banks, under Texas Code Section 151.0035 and 34 Tex. Admin. Code §3.330(a)(1).
Texas Court says the “Essence of Transaction” involving a Provider’s technology platform is not “Data Processing”
Under Texas sales tax law, the term “data processing service” includes: word processing, data entry, data retrieval, data search, information compilation, payroll and business accounting data production, … and other computerized data and information storage or manipulation. “Data processing service” also includes the use of a computer or computer time for data processing whether the processing is performed by the provider of the computer or computer time or by the purchaser or other beneficiary of the service…. [Texas Code Section 151.0035]
the court of appeals affirmed the trial court’s judgment that CheckFree is entitled to a refund of the sales tax it paid on the services it provided to the banks because those services were not subject to a tax.
The Comptroller’s regulations define “data processing” to include
the processing of information for the purpose of compiling and producing records of transactions, maintaining information, and entering and retrieving information. It specifically includes word processing, payroll and business accounting, and computerized data and information storage or manipulation. The charge for data processing services is taxable regardless of the ownership of the computer. Examples of data processing services include entering inventory control data for a company, maintaining records of employee work time, filing payroll tax returns, preparing W-2 forms, and computing and preparing payroll checks.
[34 Tex. Admin. Code §3.330(a)(1)] The Comptroller has also defined that “data processing services” do not include “the use of a computer by a provider of other services when the computer is used to facilitate the performance of the service or the application of the knowledge of the physical sciences, accounting principles, and tax laws.” [Id.] Examples of this include “the use of a computer to provide interpretive or enhancement geophysical services or the use of a computer by a CPA firm, enrolled agent, or bookkeeping firm to produce a financial report, prepare federal income tax, state franchise or sales tax returns, or charges for temporary secretarial personnel who as part of their function use word processing equipment.” [Id.]
After paying the sales tax assessed and filing a refund claim, the court of appeals affirmed the trial court’s judgment that CheckFree is entitled to a refund of the sales tax it paid on the services it provided to the banks because those services were not subject to a tax. Taxpayer’s representatives described CheckFree's services, largely focusing on three types of activities that CheckFree provides to the banks: (1) the electronic delivery platform that CheckFree used to facilitate the performance of the bill pay service provided to the bank's customers, (2) the actual bill pay service, and (3) other aspects of the transactions, such as invoices, reports, and customer service that were provided to the banks and the bank's customers. They explained that the technology platform through which the bill pay services operated was neither sold nor licensed to the banks. In providing these services, CheckFree employed thousands of professionals who monitored transactions to prevent fraud and to ensure compliance with banking regulations, and provided professional support services to the banks.
Based upon this evidence, the trial court's findings and conclusions properly focused on the “essence of the transaction” at issue, rather than simply the involvement of a computer, to determine the nature of the services CheckFree provided. [citing Combs v. Roark Amusement & Vending, 422 S.W.3d 632, 637 & n.14 (2013)(explaining that the “economic realities underlying the transactions in issue” should not be disregarded in determining the plain meaning of taxing statutes and noting the long-standing tradition of focusing on the “essence” or “object” of a transaction to determine whether a tax is due)] In accord with the Comptroller's rule, the trial court was required to determine whether CheckFree does something more than “compiling and producing records of transactions, maintaining information, and entering and retrieving information,” such as providing physical science, legal, or accounting services based on the information—i.e., providing professional services that are facilitated by the use of a computer. [Id.]
even though CheckFree utilized a cloud-based technology platform and technology to deliver its bill pay services, none of the transactions at issue consist of “data processing” .... To the contrary, the court noted, to the extent that CheckFree provided any of these services, they were ancillary to the professional bill pay services provided by CheckFree for the bank's customers.
Supported by the testimony of CheckFree’s representatives regarding the role of the professionals employed by CheckFree, the trial court determined the following:
- Bill pay service is a professional service requiring accredited or certified professionals across several areas including ACH processing, financial crime investigation, treasury, anti-money laundering, and accounting.
- CheckFree employs over 3,000 associates and professionals necessary to facilitate the bill pay service.
- These professionals manage the actual bill pay process and make decisions at multiple stages of the bill pay process.
- These professionals are responsible for critical monitoring and detection of fraud, money laundering, and other financial risks.
- These professionals are also responsible for compliance with complex government regulations.
- A team deals with errors and other customer service issues that arise after bill payment occurs.
- These professionals are not a minor part of the bill pay service delivery; instead, they are the “secret sauce” of the service.
As such, the court closely scrutinized the importance of the professionals and their services to the overall transaction. In response to this scrutiny, the court refuted the Comptroller’s assertion that because the users of the bill pay service input data into CheckFree's system, which CheckFree relied on to ultimately pay their bills, CheckFree was selling taxable data processing services to the banks. The court noted that the facts establish that CheckFree provides a professional service—facilitated by the use of computers and an electronic commerce system—that requires the oversight and management of thousands of certified specialists to achieve the goal of paying the bills of the banks' customers.
this decision does cast favorable light on the analysis of the sales tax treatment under Texas Administrative Code §3.330(a)(1) of technology-based services provided in mixed transactions with other services and solutions.
Though this decision should not be interpreted to open the doors for cloud-based solution providers to treat the sale of their solutions to Texas customers as nontaxable, it does cast favorable light on the analysis of the sales tax treatment under Texas Administrative Code §3.330(a)(1) of technology-based services provided in mixed transactions with other services and solutions. Texas interprets all software, delivered in a tangible medium, electronically delivered or remotely accessed to be tangible personal property. [see Texas Code Sec. 151; Texas Admin. Code Secs. 3.308(b)(2), 3.330(a)] Texas has also ruled that cloud computing that includes data storage, retrieval, manipulation, data transfer taxable is data processing; that cloud services that include bulk and transactional email-sending services are taxable telecommunications, and; that cloud services that include gathering information from around the web and making it available to customers is a taxable information service. [Letter No. 201207533L, Texas Comptroller (7/31/12)] As such, Taxpayers should proceed with caution when providing cloud- or technology-based solutions to customers in Texas. However, Taxpayers should also evaluate such transactions involving a mixture of services, to determine the “essence of the transaction”.
Texas Administrative Code §3.330(a)(1) provides that data processing services do not include the use of a computer system or technology platform – cloud-based or otherwise – to provide other services, when the “essence of the transaction” involving the use of such processes or technology is the provision of nontaxable services. While it is evident that the courts, and therefore the Comptroller, will scrutinize the significance of the nontaxable services to the transaction, as the court of appeals noted in deciding this case, “the economic realities underlying the transactions in issue” should not be disregarded in determining the plain meaning of taxing statutes and noting the long standing tradition of focusing on the “essence” or “object” of a transaction to determine whether a tax is due”. [Hegar v. CheckFree Services Corporation, NO. 14-15-00027-CV (Tex. Ct. App., April 19, 2016)(citing Combs v. Roark Amusement & Vending, 422 S.W.3d 632, 637 & n.14 (2013))]