By Mark A. Balistrieri, CPA

Applying sales and use tax to software purchases in a multijurisdictional setting has long been perplexing to businesses and tax professionals alike. The complexity has only grown with the evolution of software as a service (SaaS), the ability to access software that does not reside on networks at a company’s physical location, and pricing models that have evolved beyond the traditional one license to one user.

In Pennsylvania, the Department of Revenue (DOR) has historically treated the purchase of software as the purchase of tangible personal property, but the sourcing has changed multiple times over the years. In 2012, the DOR issued a bulletin addressing cloud computing, stating that the purchase of software was taxable in Pennsylvania to the extent that the users of the software were in Pennsylvania. The guidance allowed for a purchaser to calculate a percentage based on a reasonable methodology that the DOR would examine upon review.  

In 2016, DOR’s position of treating software as tangible personal property was codified, including software and other digital products in the definition of tangible personal property. At this time the DOR still applied the sourcing guidance from 2012, thus software is still considered taxable in Pennsylvania to the extent the users are in Pennsylvania.

More recently, the DOR has begun to apply more uniformed, and restrictive, methodologies to determine the number/percentage of software users located in Pennsylvania. The DOR’s approach is based on the premise that software purchases are still based on the model of one user equals one purchased license. The DOR has begun requiring taxpayers to reconcile the total number of users to the stated number of pricing units on an invoice, whether that unit be one user license or some other unit of measure, including enterprisewide licenses. The DOR also does not distinguish between software that is downloaded on the purchaser side of a firewall, accessed via cloud or virtual means, or via SaaS. When the total number of users is not equal to the units stated on the invoice the DOR has either adjusted the number of Pennsylvania users or denied any allocation of users outside of Pennsylvania.  

In March 2022, the DOR amended the Sales Tax Exemption Certificate (Form REV-1220). The certificate can be presented to a software vendor, which allows the vendor to charge Pennsylvania tax only on the portion of the software accessed by Pennsylvania users. However, the form does not ask the purchaser to state a percentage or even the number of Pennsylvania users; instead, the form requires the purchaser to state the total number of licenses purchased and the number of users located outside of Pennsylvania. Seemingly, the amended form does not account for pricing models such as enterprisewide licenses, those based on data used by the purchaser, or any other measurement a purchaser can negotiate with a software provider.  

Additionally, the DOR has stated a presumption that if the vendor issues an invoice to a Pennsylvania billing address, that constitutes the purchaser receiving the software in Pennsylvania, whether or not the software remains on a remote server located outside Pennsylvania or is accessed via the cloud or any other means, thus constituting the right to use the software in total in Pennsylvania. Since the 2016 law change defined software as tangible personal property, and Pennsylvania taxes all tangible personal property when received in Pennsylvania, the default is that all users are located in Pennsylvania until documented otherwise.  

During audit and refund reviews, the DOR has implemented a policy that when the number of units stated on the invoice does not equal the number of total users in all jurisdictions the DOR will adjust the applied user percentage. For example, when the number of units on the invoices exceeds the number of total software users, the difference is treated as a specific license for an unassigned user. Since the invoices were billed to Pennsylvania, those unassigned licenses equate to Pennsylvania users, thus increasing the taxable base in Pennsylvania. In an instance where the number of units is not based on one license per user (i.e., an enterprisewide license), and therefore the number of invoiced units may exceed the number of total users, the DOR may reject any allocation of non-Pennsylvania users and source 100% of the purchase to Pennsylvania. This can be problematic because other jurisdictions where users are located may still require sales and use tax to be remitted to their jurisdictions based on the number of users working in their jurisdiction. The DOR does not consider how other jurisdictions may apply a multiple-points-of-use percentage to the same software purchase, so a taxpayer could potentially pay tax on more than 100% of the total purchase.

When purchasing software that will be accessed by users in multiple jurisdictions, Pennsylvania taxpayers should perform diligence on the available support for the multiple-points-of-use percentage and how to properly apply that percentage to the purchase to determine the proper amount of sales and use tax due in the applicable jurisdictions. Data points to consider include the following:  

• What is the unit of measure the vendor is using for billing (a per user license; enterprisewide licenses; other pricing unit – units can be based on data used, number of employees, purchaser revenues, etc.).
• What information does the purchaser have to document total users of the software and where those users perform their job duties.  
• Is the software downloaded to a specific server, and where is that server located, or is the software accessed via the cloud.
• What software upgrades and maintenance fees are included in the purchase contract, and are those separately billed.  
• In what other jurisdictions are the software users located, and do those jurisdictions allow/require for the multiple-points-of-use sourcing.  

The multiple-points-of-use methodology allows taxpayers to properly apply sales and use taxes to various jurisdictions. However, for Pennsylvania taxpayers, it begins with supporting the proper portion to Pennsylvania based on the facts and circumstances for each taxpayer.

Mark A. Balistrieri, CPA, is director, state and local tax, with Schneider Downs & Co. Inc. in Pittsburgh. He can be reached at mbalistrieri@schneiderdowns.com.

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Statements of fact and opinion are the authors’ responsibility alone and do not imply an opinion on the part of the PICPA's officers or members. The information contained herein does not constitute accounting, legal, or professional advice. For actionable advice, you must engage or consult with a qualified professional.