Application Service Providers: Are They Lessors of Property or Providers of Computer Services?

Winter 2000

With the explosion of Internet-based business models comes a challenging task for the tax practitioner – keeping up with technological advances and understanding how they are driving new business models while applying tax laws that may have been written more than a decade ago. This column provides an overview of one type of Internet-based business model, the provision of application services, and two possible alternatives for the application of sales tax to this model. What is an ASP? In a typical Application Service Provider (ASP) model, a user accesses application software resident on a third party’s server via an IP network. The applications accessed range from low-end productivity programs such as word processing and spreadsheet programs to high-end enterprise resource planning (ERP) programs. Fees for access to the programs are typically based on either a subscription or pay-as-you-go basis. For those practitioners with a few years of experience, the current ASP model appears strikingly similar to what was known as a service bureau or time-sharing model. In the past, these models allowed a user to access a single shared application. Today, improved technology allows ASPs to customize their services (software) to provide an array of options based upon the requirements of their users. Not all ASPs are in fact ASPs. While pure ASPs do exist, the phrase “ASP” is more descriptive of a service offering than an industry. Companies which advertise ASP services may in fact also be providing web-hosting services, application hosting, application management, co-location, outsourcing all or some combination of these or other similar services. Is it a Lease or a Computer Service? Whether or not the service offered by a true ASP would be subject to sales or use tax depends upon whether you would classify it as either the lease or rental of tangible property or the provision of a computer service. Persuasive arguments can be made for either case. Lease or Rental of Tangible Property: Pennsylvania subjects the lease or rental of tangible personal property to sales tax.1 If an ASP were deemed to be a lessor of such property in this Common-wealth, then it would be required to charge sales tax on its monthly lease charges. The purchase of the underlying software by the ASP would not be subject to tax since it would be purchased for resale in the course of its trade or business. But there is an exception to this rule. If the software were down-loaded electronically, then it would be deemed to be intangible property.2 In this instance, neither the purchase of the underlying software nor the subsequent lease of such would be subject to tax. Provision of a Service: But would Pennsylvania consider ASP services as leases of software? Perhaps the case can be made that ASP services are computer services within the Commonwealth. Pennsylvania taxed computer services through June 30, 1997. A review of statutes that existed up to this point seems to address our ASP dilemma. Within the definition of computer processing, data preparation or processing services3 was a reference to computer timesharing. A Depart-ment of Revenue Statement of Policy expanded this definition to include “providing time-sharing or access to databases.”4 If Pennsylvania continued on a similar course, perhaps the ASP model would be considered the provision of a computer service. The ASP would pay sales or use tax on the software it purchases, unless it downloaded it from the Internet. The service itself would not be subject to tax. More Challenges to Come This brief discussion illustrates one of many tax dilemmas in the new economy. As the Internet drives new business models, it is important that practitioners fully understand the changes occurring as a result. 1 72 P.S. Section 7201(k)(1) 2 CCH Internet/Electronic Commerce Survey, Pennsylvania Department of Revenue, October 6, 1999 3 72 P.S. Sections 7201(k)(16), (ff)(1996) 4 61 Pa. Code 60.13(e)((1)(iv) James Conant, CPA, is senior manager of the technology, communications and entertainment group (TCE) at Ernst & Young LLP in Pittsburgh. Contact the author at james.conant@ey.com

Copyright Pennsylvania Institute of Certified Public Accountants Winter 2001

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