Idaho’s new software sales tax exemption: big hits are coming to the revenue stream

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IDAHO’S NEW SOFTWARE SALES TAX EXEMPTION – BIG HITS ARE COMING TO THE REVENUE STREAM FROM HOUSE BILL 598
 
At first glance the 2014 legislative session looks like there was very little in the way of tax cuts. The Governor earmarked $30 million for unspecified tax cuts in his Executive Budget. Only four pieces of tax legislation were enacted, and combined they had a relatively small “official” impact of minus $9.4 million in FY 2015 according to the Legislative Services Office Sine Die Report.
 
One bill, HB 546, actually had its Fiscal Note changed mid-stream from a revenue reduction of $3 million to a revenue increase of $7 million (and that Fiscal Note change was NOT related to the Senate amendment). Looking strictly at Fiscal Notes, that change flips the combined revenue impact of these three bills from a loss of $9.4 million in FY 2015 to a gain of $0.6 million in FY 2015. (The LSO Sine Die Report, published in April 2014, had not adopted the revised HB 546 Fiscal Note.)
 
Unfortunately, the real fiscal impact of enacted 2014 revenue legislation is grossly understated. Sloppy Fiscal Note practices, a lack of rigorous fiscal analysis that addresses (among other things) timing issues, and misleading (bordering on deceptive) statements by proponents combine to put the public in the dark when it comes to the real fiscal impacts of legislation enacted in the 2014 session.
 
House Bill 598, pushed by the Idaho Technology Council, will exempt all sales of application software in cases where it is delivered electronically (from the so-called “cloud”), or where it is loaded on the user’s computer by the vendor and the distribution media are not left behind (the so-called “load and leave” method). Since electronic delivery is a rapidly growing method of software delivery, this new exemption will have a rapidly growing fiscal impact, i.e., revenue loss.
 
An analysis of sales tax returns and audits that was done by the Idaho Tax Commission and presented to the House Revenue and Taxation Committee found the immediate revenue loss from just the 28 firms they examined is $5 million. The Commission believes the initial FY 2015 impact will be at least $8 million of lost revenue (compared to $2 million reported by LSO per the Fiscal Note), and reach $40 million in a very short period of time (the LSO General Fund Budget Update as of Sine Die, only reports impacts through FY 2016, with a $5 million estimated revenue loss in the second year).
 
HB 598 was sold in part on the erroneous statement that it is “consistent with Idaho tax policy excluding services from state sales taxation.” First, Idaho does not exclude services from sales taxation – quite a few services are in fact subject to the sales tax in Idaho. Second, the point is irrelevant – since 1986 Idaho’s sales tax statute has said: “the term ‘tangible personal property’ includes any computer software which is not a custom computer program” (see I.C. 63-3616(b)(i)).
 
That was changed in the 2013 Legislative session by House Bill 243 that added the following words (shown here in bold): “is not a custom computer program and is not application software accessed over the Internet or through wireless media.” This meant software that was run at the seller’s location and was not loaded and left at the user’s location was exempted from the sales tax, so long as “that same computer software or comparable computer software that performs the same functions” is not available “in a storage media or by electronic download.”
 
The somewhat convoluted language of HB 243 meant that software exclusively available to run remotely was made newly exempt from the sales tax. That was a new exemption, but it was fairly limited and the fiscal impact estimate of a $700,000 revenue loss was probably reasonable.
 
HB 598 changes everything when it comes to sales taxation of computer software. Its Statement of Purpose says (referring to HB 243): “this section was amended in 2013…but problems were encountered in the rulemaking process that made further legislation necessary.” That sounds a lot like a technical correction, but the reality is HB 598 goes far, far beyond the new exemption created last year in HB 243.
 
HB 598 strikes the following language that has been the policy in Idaho Code (see I.C. 63-3616) for almost three decades: “Computer software is deemed to be tangible personal property for purposes of this chapter regardless of the method by which the title, possession or right to use the software is transferred to the user.”
 
Now, under HB 598, all application software that is delivered electronically (i.e., downloaded) will be exempt, even if it is also available on storage media (i.e., CDs or DVDs). Also, application programs that are loaded by the vendor at the user’s location, but where the storage media is not transferred to the user, will also be exempt.
 
To understand how significant this change is, consider that most software developers, both large and small, are now offering download versions of their products directly over the Internet. With this new sales tax exemption, Idaho consumers and businesses will have a potent reason (6%) to go the download route when they purchase their various application software programs. And in the case of “apps” that run on smartphones and tablets, download is the only way they are made available. Apps were clearly taxable before HB 598, now they are exempt.
 
Also, most large enterprise software is delivered under the “load and leave” method, something that has traditionally been taxable (including under HB 243) but under HB 598 becomes exempt. These are large packages that do everything from inventory management, sales and distribution, production planning, accounting, finance, etc., etc., etc. They can easily cost in the millions of dollars. Every large corporation uses them. And up to now, they have been taxable.
 
It is hard to understand why Idaho, having already given up a substantial part of its revenue stream over the past decade and a half, and having fallen significantly behind on such fundamental obligations as its employee pay and its Constitutional duty to provide “general, uniform and thorough…public free common schools,” would choose instead to provide a massive new sales tax exemption without so much as a thorough examination of that new exemption’s true costs.
 
Michael Ferguson, Director
Idaho Center for Fiscal Policy
May 19, 2014
 
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