Michigan: Decision regarding pre-written computer software applied to all open tax years

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In November 2015, the Michigan Court of Appeals reached a decision in the case Auto-Owners Insurance v. Department of Treasury holding that various cloud-computing transactions were not subject to use taxes despite the Treasury Department’s opposite conclusion. This was the last of several cases in which the courts reached a conclusion contradicting the Treasury Department’s position. (We discussed the details of Auto-Owners in our November 19, 2015, Multistate Tax Update.)

On Jan. 11, 2016, the Treasury Department put to the bed speculation over how it would handle these losses and issued a Notice to Taxpayers that it would not continue to fight; it is giving full retroactive effect to the judicial rulings.

The cases involve a portion of the Use Tax Act, MCL 205.92b(o), which defines pre-written computer software as “computer software, including prewritten upgrades, that is delivered by any means and that is not designed and developed by the author or other creator to the specifications of a specific purchaser.”

The Use Tax Act also specifies that such prewritten computer software includes:

(i) Any combination of 2 or more prewritten computer software programs or portions of prewritten computer software programs

(ii) Computer software designed and developed by the author or other creator to the specifications of a specific purchaser if it is sold to a person other than that specific purchaser.

(iii) The modification or enhancement of prewritten computer software or portions of prewritten computer software where the modification or enhancement is designed and developed to the specifications of a specific purchaser unless there is a reasonable, separately stated charge or an invoice or other statement of the price is given to the purchaser for the modification or enhancement. If a person other than the original author or creator modifies or enhances prewritten computer software, that person is considered to be the author or creator of only that person’s modifications or enhancements.

The crux of the issue before the courts was what cloud-based products are subject to the use tax on pre-written software. In Auto-Owners, the court held that the majority of transactions at issue, categorized as code that enabled the vendor’s system to operate, were not taxable because they did not satisfy the requirement that prewritten computer software must be delivered, in any manner. The court justified this on the grounds that that there was no proof that code was electronically delivered to Auto-Owners, or that Auto-Owners exercised any ownership over the vendor’s code.

In the other major category, products for which pre-written software was electronically delivered to Auto-Owners, the court nevertheless concluded that these were merely incidental to the vendor’s rendering of professional services. As such, they were not subject to the use tax either.

The January notice directs taxpayers seeking a refund for products that fall within the Auto-Owners decision to file a written refund request, including the necessary documentation to support the refund, with the department within the statute of limitations. This is generally four years after the date set for the filing of the original return, but there are exceptions.

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