If you're a New York technology company, developer or designer and create apps, websites, web-services or any other software that you sell (either as a subscription or one time fee) it's likely that you've paid too much for any computer hardware you're using. This is the result of a little discussed provision in New York's sales tax laws, that makes the purchase of computer hardware exempt from sales tax, when its being used for the design and development of software for sale or in the service of designing and developing websites for other people.
With sales tax rates of 8.875% in New York City, this means a savings of $90 for every Apple Cinema Display or more than $220 for some higher end Macbook Pros. With so many tech companies in NYC how was it possible that almost no one we've talked to has ever heard of this?
Despite the meaningful savings such an exemption could provide to a wide array of tech companies, it was very difficult to find many references to exemption nor any clear guidelines of where it applies. This lead us to research all we could about the law, including way too much time spent investigating sales tax law and cases. We even spoke to people in the Office of the Counsel at the state's Department of Taxation and Finance for some clarity on the exemption. (The Sales Tax call center was of no help.)
At the end of our process we came across with the understanding that the exemption could apply to many tech companies and could make it an even more attractive destination for companies in the industry. To help companies that may be in the position to take advantage of the exemption, we thought it would be useful to walk through the law, and our understanding of how it applies.
The Computer Sales Tax Exemption Law
The law in our discussion is New York's Tax Law §1115(a)(35). The exemption, first enacted in 1998 and amended in 2001, makes the purchase of computer hardware exempt from sales tax when it is directly and predominantly used for:
- The design and development of computer software for sale
- Providing the service of designing and developing Internet Websites when that service is for sale
- A combination of the above two
Computer Hardware includes any of the following: Microcomputers, Minicomputers, Mainframes, Personal / Laptop Computers, Tablets, External Hard Drives, Portable Disc Drives, CD Drives, Modems, Monitors, Keyboards, Mice, Printers, Scanners, Servers, Network Interfaces, Network Hubs and Network Routers.
For the purposes of the exemption, the hardware must be used directly to perform one of the following functions: system analysis, program design, coding, testing, debugging and documentation activities. To satisfy the "predominantly", the hardware must be used at least half the time in one of these activities. This prevents people from buying a part, using it one time in such an activity and claiming an exemption.
Who Is Exempt From Paying Sales Tax?
The question for most companies is whether their business activities fall under on of the two activities that qualify for exemptions. Those that qualify as "Providing the service of designing and developing Internet Websites when that service is for sale" are rather straightforward. If you help other companies or individual design and develop websites, then the computer hardware you've purchased would be exempt. This applies to the many third party developers and designers in New York State that such work is often outsourced to.
For "the design and development of computer software for sale", things are a little more complicated. The question you probably have is "what does the state consider 'software' and when is it considered 'for sale'?"
The traditional concept of software when these laws were written was packaged items, like Microsoft Office that would be purchased and delivered in a store or as a physical product. Programs that are purchased and downloaded digitally such as apps on your phone or programs for your computer would also be included. Companies that develop such products have an obvious case for the exemption.
As technology has evolved however, the way we interact with software has also changed. Many of the software programs we use now are delivered through the cloud or as a web platform, charging a subscription for access to a service rather than a one time fee. In these cases a customer never receives a copy of the software but simply pays for access. Do such services qualify as software for sale?
In recent years, New York has become one of the few states that has broadened its interpretation and definition of what constitutes software for sale. In guidance about how such platforms are treated, the State has generally ruled that subscription web platforms like many SaaS (software as a service) products (Bulletin: ST-128 See: Remotely Accessed Software) would fall under such a classification and are subject to sales and use tax. While this has forced such platforms to collect taxes on these services, it also means that they should be eligible to take advantage of the hardware purchase exemptions.
In general as long as the computer parts are being actively used in the development of software that you will charge for it is likely to qualify for the exemption.
A Few More Complicated Eligibility Situations
As we continued to dig into the law, we learned that taxes and tax law are never simple. Exemption eligibility becomes extremely murky when it comes to free software platforms or those that mix a fee / paid business model.
Numerous apps and services these days work on a "freemium" model, where users have access to some components for free but may pay for in-app purchases or additional features. Access to the in-app functionality would obviously be considered software for sale, but the basic app may not. In such cases, would the test be whether the hardware was used "predominantly" or half the time on the paid pieces of the application? How would someone even make such a distinction? It's rare that application development is so cleanly split. Unfortunately, there isn't much in the way of a clear answer on how the state would rule or even decide in such a case.
Interestingly, even some "free" web-services might be eligible for the exemption. Under NYS law, a sale is defined as "Any transfer of title or possession or both, exchange or barter, rental, lease or license to use or consume (including, with respect to computer software, merely the right to reproduce), conditional or otherwise, in any manner or by any means whatsoever for a consideration, or any agreement therefor, including the rendering of any service, taxable under this article, for a consideration or any agreement therefor."
Under this definition, a sale does not mean a transaction needs to involve money. If you simply gave access to a website for free, it would not be a sale. If the customer however were forced to trade something in exchange, it could be. The question is what might be acceptable to the state as "consideration?" Would personal information count? How about permission to post things on Facebook? Even the people we spoke to were not sure how these things would be ruled.
Companies that are in this grey area can petition for an advisory opinion, which pushes the Department and Taxation and Finance to make a binding decision on how such situations might work. The downside is these opinions can take months to years to resolve.
Getting Your Purchases Exempt from Sales Tax or Receiving Your Refund
If you've made it this far and you or your company qualifies for the exemption there are two ways you can save on sales tax.
The first is to present the Exemption Certificate For Computer System Hardware (ST-121.3) at the time of purchase to the seller. This will permit the seller to exempt your purchases from being charged sales tax. Unfortunately, it's very likely that smaller merchants may not have heard of the exemption or have a process in place to handle it. It also requires that the merchant allocate sales tax between the cost of hardware and any pre-written software that is already loaded on to the machines you are buying. Needless to say, the complexities of the process may be hurdles in getting it accomplished.
Many online merchants do have processes in place to handle tax exemptions. In many cases however, this may come in the form of a tax refund rather than excluding the tax amount at time of purchase. Amazon and Dell are two such examples.
The other option for the exemption is to file a refund with the State of New York. If you've already paid excess sales tax on exemption eligible purchases, filing for a refund will require you to submit the information with supporting documents to the New York State Department of Taxation and Finance.