200805095L  


To:  Nancy Prosser, Tax Policy Division

From:  Lia Edwards, Tax Policy Division

Date:  May 28, 2008

RE:  Data processing services provided by an application service provider  


A question regarding an out-of-state “software as a service [ENDNOTE: (1)]” 
provider (also known as an application service provider) has recently been 
brought to our attention by the Administrative Hearings Section.  This 
memorandum memorializes our analysis of the matter, which the taxpayer did not 
pursue to a final decision.   

Background

TAXPAYER is a California corporation with its principal office in CITY A, 
California (“Taxpayer”).  Taxpayer has sales personnel in Texas and makes sales 
to customers in Texas.
Taxpayer provides an online business application that its customers use to 
record and manage their business transactions.  The business application 
software resides on servers at the company’s data center in CITY B.  Data and 
information entered by the customers are also stored on Taxpayer’s servers in 
California.  Customers access the software through the World Wide Web. No 
special hardware or software is needed to access the software, only Internet 
access is needed.  All hardware and software required for Internet access must 
be obtained by the customers.

The web-based application supports a customer’s entire business operations, 
from customer relationship management (“CRM”) [ENDNOTE: (2)] to enterprise 
resource planning (“ERP”) [ENDNOTE: (3)].  The business information is 
generated and entered by a customer’s employees.  The information serves as the 
basic platform for business operations, allowing the customers to manage 
inventory, record sales, fulfill orders, process payroll, execute accounting 
functions, manage employees and create financial statements.  All customer data 
are held in a single database, allowing access to all performance metrics in a 
customizable, real-time dashboard.  The comprehensiveness of the application is 
illustrated by the payroll component, SERVICE, which allows a 
company to enter data once and manage all of its payroll functions, including 
paying employees and calculating earnings, deductions, taxes and company 
contributions.  This component can also prepare, print and file IRS forms such 
as the W-2 and 1099-MISC and tax returns for federal, state and local 
jurisdictions.  

Customers are given a non-exclusive, non-transferable license to use the 
service and to display content solely for the customer’s internal business 
operations during the term of the agreement.  The license agreement is not a 
concurrent user license, and the customer may not copy, modify, reverse 
engineer, disassemble, attempt to discover any source code, or otherwise modify 
the software.

Under the license agreements, customers give Taxpayer a license to copy, store, 
record, transmit, maintain, display, view, print, or otherwise use customer 
data to the extent necessary to provide the service to customers.

Taxpayer’s Position

Taxpayer does not believe that its activities are taxable.  It contends that it 
cannot be considered a data processing service provider because the actual data 
entry is done by customers’ employees, who enter the customers’ own proprietary 
data.  Taxpayer compares its role to that of a person who rents tools.  It 
argues that its role is limited to providing the software, and that any 
activities that come within the definition of data processing are performed by 
the customers. 

Relevant Authority

Data processing services are made taxable by Tax Code Section 151.0101(a)(12) 
and defined in Section 151.0035, in relevant part, as follows:

“Data processing service” includes word processing, data entry, data retrieval, 
data search, information compilation, payroll and business accounting data 
production, . . . and other computerized data and information storage or 
manipulation.  “Data processing service” also includes the use of a computer or 
computer time for data processing whether the processing is performed by the 
provider of the computer or computer time or by the purchaser or other 
beneficiary of the service.

Rather than describing the essential nature of data processing, this section 
enumerates a set of specified services that are included within data processing 
services.  A rule of statutory construction states that the words “‘includes’ 
and ‘including’ are terms of enlargement and not of limitation or exclusive 
enumeration, and use of the terms does not create a presumption that components 
not expressed are excluded.”  Tex. Gov’t Code  311.005(13).   

Under the exclusive jurisdiction given to the Comptroller by Section 
151.0101(b) to interpret the scope of the taxable services identified in 
Section 151.0101(a), the Comptroller has adopted Rule 3.330(a) to further 
define and clarify what constitutes data processing services.

Rule 3.330(a) states, in relevant part: 

(1) Data processing services - the processing of information for the purpose of 
compiling and producing records of transactions, maintaining information, and 
entering and retrieving information. It specifically includes word processing, 
payroll and business accounting, and computerized data and information storage 
or manipulation. The charge for data processing services is taxable regardless 
of the ownership of the computer. Examples of data processing services include 
entering inventory control data for a company, maintaining records of employee 
work time, filing payroll tax returns, preparing W-2 forms, and computing and 
preparing payroll checks.

Analysis

A)  Under long-standing agency policy, Taxpayer is performing taxable data 
processing services.  

In STAR Accession 9007L1031A01 (July 3, 1990), customers transferred wage and 
tax data via telephone line directly to the taxpayer’s computer in California.  
The taxpayer’s computer processed the information and made all the calculations 
necessary to prepare a tax return.  The customer then had the option of 
receiving its tax return data via telephone lines or by receiving a hard copy 
of the tax return by mail.  This service was found to be taxable data 
processing.

Taxpayer’s SERVICE is essentially the modern progeny of the 
service described in STAR Accession 9007L1031A01.  Taxpayer’s service has many 
more features, but the basic elements are still present:  the customer 
transmits the data directly to Taxpayer’s servers in California which 
manipulate and process the data to prepare a tax return.  Taxpayer’s service 
goes so far as to actually file the tax return for its customers and guarantee 
the accuracy of the information and the timeliness of the filing.  It also 
stores the data for future payroll use and so that it can be retrieved in the 
event of an audit.

Additionally, many of the other activities included as part of Taxpayer’s 
SERVICE are identical to activities identified as data 
processing services in Rule 3.330(a)(1).  For example, filing payroll tax 
returns, preparing W-2 forms, computing and preparing payroll checks and 
storing data are activities performed by Taxpayer’s payroll service which are 
specifically enumerated in the rule.

Many of the other activities performed by Taxpayer’s software also fit within 
the definition of data processing.  Customers can enter data into Taxpayer’s 
software once and the software stores and processes the data to provide the 
customer’s employees in various functional areas of the company with their own 
customizable dashboard, or customized view, of relevant data.  In order to 
provide the services promised by the software, Taxpayer’s system must perform 
activities that constitute data processing.  For example, in order to provide 
the performance metrics described by Taxpayer, the software must necessarily 
retrieve data that the customer has entered and stored on the server, compile 
it, and manipulate it into a format that is useful to the customer in 
evaluating its business.  Taxpayer’s application also maintains all CRM, 
Ecommerce and ERP information in a single database, which Taxpayer says allows 
it to “unite fragmented data,” another way of saying it performs information 
compilation.

B. Data entry by customers has no effect on Taxpayer providing taxable data 
processing services

As evidenced by several STAR documents, taxability under Section 151.0035 does 
not hinge on whether the customer does some or all of the entry of the data 
that is processed in a taxable manner by a vendor such as Taxpayer, nor does it 
restrict how much preliminary data preparation may be performed by the 
customer.  Data entry is merely one form of taxable data processing services, 
not a prerequisite to a finding of taxable data processing.  There have been 
numerous instances where a company has been found to be providing taxable data 
processing services, despite the fact that its customers input the data that is 
processed.

As noted above, the transfer by customers of wage and tax data via telephone 
line to a taxpayer’s computer in California that processed and prepared tax 
returns for customers was found to be taxable data processing.  See STAR 
Accession 9007L1031A01 (July 3, 1990).

In STAR Accession 200205106L (May 17, 2002), the taxpayer’s customers 
transmitted their data directly to the taxpayer’s server in Houston.  The 
taxpayer translated the data and transmitted it back to its customers.  The 
service was found to be taxable data processing.

STAR Accession 200002080L (February 29, 2000) describes a taxpayer who provided 
a business to business Web portal to facilitate the exchange and processing of 
information between insurance carriers and their insurance agents.  Like 
Taxpayer, the company wanted to reduce the unnecessary entry of the same data 
multiple times by its users and to relieve small firms from the burden of 
software administration.  In order to use the service, insurance agents visited 
the taxpayer’s Web site to enter their data, which was then stored in the 
appropriate carrier’s database on the taxpayer’s server.  Insurance carriers 
could then access the stored information via the Web portal.  Features of the 
service included information filtering for risk selection, online marketing 
profiles, online forms and reports.  The service was found to be taxable data 
processing with no exception made for the fact that the customer entered its 
own data into the system.

STAR Accession 200401223L (January 14, 2004) involved an application service 
provider that provided a sales and use tax rate service and a tax filing 
service.  The customer sent SKU information to the taxpayer that identified the 
nature of the item being purchased or sold and provided an address.  The 
taxpayer verified the address and provided a nine digit zip code.  It then used 
the SKU to determine taxability of the item for the particular client who sent 
the information, and returned to the customer the corrected address, taxability 
information and the proper amount of tax due.  This service was found to 
contain elements of both data processing and information services.  Again, no 
distinction was made based on the fact that the original data was input by the 
customer.  Further, the service retained a record of such transactions for its 
customers, which was then used to create an electronic tax filing or signature 
ready return for the customer.  This portion of the service was also determined 
to be taxable data processing.

STAR Accession 200112592L (December 6, 2001) contains two letters dealing with 
an online employment service.  As described in the letter dated November 6, 
2001, the employment service was accessible free of charge to job seekers via 
the Internet.  Employers paid the employment service “a fee to enter the 
employer’s data onto a server (‘implementation fee’), a fee to retrieve and 
search data (‘monthly access fee’), and a fee for entering and/or storing 
computerized data or information (‘posting jobs’).”  The taxpayer argued that 
it should be treated as a non-taxable advertising service, as the taxpayer in 
STAR Accession 200104201L (April 16, 2001) had been treated.  However, the 
Director of Tax Administration found that application of the statutory 
definition of data processing services to the activities performed by the 
employment service led to the conclusion that the taxpayer provided taxable 
data processing services.  The taxpayer asserted that the “processing of the 
data is performed exclusively by the customers or the employee candidates.”  
The Director dismissed this argument, referencing the provision in the statute 
that the use of computer time for data processing by the purchaser or other 
beneficiary of the service constitutes taxable data processing services.  The 
taxpayer pressed this issue again in its subsequent letter, to which the 
Director responded in Item 4 of his December 6, 2001 letter: 

“4. Data on my client’s website can be entered either by the customer or by my 
client.  This was considered to be data entry.  Why?

Response:  Please see response to Question No. 2.  If the true object of the 
transaction was for data processing, then Tax Code 151.0035 specifically 
provides that services are taxable whether the use of a computer is performed 
by the service provider, by the purchaser or by other beneficiary of the 
service.”

These examples support the position that it is irrelevant that Taxpayer’s 
customers input their own information into Taxpayer’s system.  The relevant 
question is:  what did the system do with that information?  Under applicable 
statutes and long-standing agency policy, Taxpayer’s system performed taxable 
data processing.


ENDNOTE(S):

(1) Wikipedia defines “software as a service” (SaaS) as “a software application 
delivery model where a software vendor develops a web-native software 
application and hosts and operates (either independently or through a 
third-party) the application for use by its customers over the Internet.  
Customers do not pay for owning the software itself but rather for using it.”  
The term SaaS has become the industry preferred term, generally replacing 
application service provider.  See 
http://en.wikipedia.org/wiki/Software_as_a_Service

(2) Customer relationship management is a broad term that covers concepts used 
by companies to manage their relationships with customers, including the 
capture, storage and analysis of customer, vendor, partner, and internal 
process information.  
http://en.wikipedia.org/wiki/Customer_relationship_management, November 16, 
2007.

(3) Enterprise Resource Planning systems integrate (or attempt to integrate) 
all data and processes of an organization into a unified system.  A typical ERP 
system will use multiple components of computer software and hardware to 
achieve the integration.  A key ingredient of most ERP systems is the use of a 
unified database to store data for the various system modules.  
http://en.wikipedia.org/wiki/Enterprise_resource_planning, November 16, 2007.]




ACCESSION NUMBER: 200805095L
SUPERSEDED: N
DOCUMENT TYPE: L
DATE: 05/28/2008
TAX TYPE: SALES