Tax Law Insights

South Carolina imposes sales tax on retail sales of tangible personal property.  South Carolina generally does not impose a sales tax on intangible property, however, certain intangible property is deemed to be tangible personal property that is subject to sales tax.  Deemed tangible personal property includes charges for communications.  South Carolina defines charges for communications to include the proceeds accruing from the charges for the ways or means for the transmission of the voice or messages.  The South Carolina Department of Revenue (DOR) takes the position charges for the ways or means of communication include charges for access to, or use of, a communication system.  Examples of communication services that have been found to be taxable include telephone services, paging services, answering services, cable television services, streaming services, satellite television, satellite radio, e-mail services, and database access transmission services (e.g. legal research services, credit reporting services, and charges to access a website).

In the context of cloud based services, DOR has issued guidance finding charges by an Application Service Provider are subject to sales tax as charges for the ways or means of for access to a communication system.  An Application Service Provider is a company that provides customers access or use of software on the company’s website.  An Application Service Provider is essentially equivalent to the more commonly used term Software as a Service (SaaS).  The SaaS model allows a customer to access a company’s applications on the company’s infrastructure.

DOR recently issued a private letter ruling, SC Private Letter Ruling #20-1, which determined that charges for cloud-based software that collects and stores customers’ billing and revenue data and provides inventory management and reporting analytics were subject to sales tax.  The software was billed on a monthly subscription basis.  While the software manipulated data, the company itself did not manipulate any of the data (there is a South Carolina sales tax exemption for data processing).  This guidance is a relatively straight-forward extension of DOR’s position regarding Application Service Providers (i.e. SaaS).

DOR has not issued specific guidance addressing Platform as a Service (PaaS) or Infrastructure as a Service (IaaS).  The PaaS model allows a customer to utilize its software on a company’s cloud infrastructure in an environment provided by the company.  The IaaS model allows a customer to utilize a company’s cloud infrastructure to run the customer’s software in a configuration determined by the customer.

The taxability of charges for PaaS and IaaS services is unclear.  If DOR were to assert the charges are for the ways or means of communication then South Carolina sales tax would apply to charges for the services.  If the services were instead characterized as charges for software (which is generally not subject to sales tax if electronically delivered) then South Carolina sales tax should not apply.  If the charges were considered to be the equivalent of charges for the use of tangible personal property (i.e. the underlying cloud hardware) then South Carolina sales tax would not apply unless the use of the hardware is sourced to South Carolina instead of the location of the hardware.

Out-of-state cloud providers may not have been concerned with South Carolina sales tax in the past if they did not have a physical presence in South Carolina.  Out-of-state cloud providers which are now obligated to collect South Carolina sales tax because they have economic nexus (generally sales of $100,000 or more in a year) must now grapple with the uncertain applicability of South Carolina sales tax to certain cloud based services.  Depending on the circumstances, cloud providers and their customers may need to review their contractual relationships and so as not to trigger an unintended South Carolina sales tax obligation.