What changes did Michigan make to sales tax on software and digital goods?
What is Michigan's new guidance for sales tax on software and digital goods?
The Michigan tax agency has updated its guidance on how sales and use tax applies to software and digital goods. The new guidance, Revenue Administrative Bulletin 2023-10, replaces an older document from 1999 (called RAB 1999-5).
- The definition and taxability of computer software, including prewritten and custom software, software delivered by any means, and software maintenance contracts.
- The analysis of whether software is delivered in Michigan and subject to tax, depending on the method and degree of delivery.
- The “incidental to service” test used to determine if a transaction involving software and services is taxable or not.
- The examples of digital goods that are considered prewritten computer software and subject to tax, such as applications and video games.
When does Michigan’s new software and digital good guidance take effect and apply?
The new guidance takes effect as of July 31, 2023, and applies retroactively to all open tax periods.
Why was the new guidance issued?
It is intended to clarify the tax treatment of software and digital goods in light of recent legislation and court decisions.
Now that you have a general overview of the new guidance, in the following sections, we will explain the main topics covered by Revenue Administrative Bulletin 2023-10, including the taxability of computer software and digital goods, the analysis of software delivery in Michigan, and the incidental to service test. By the end of this article, you should have a better understanding of how sales and use tax applies to software and digital goods in Michigan.
A. General Overview of Sales and Use Tax Impositions
This section covers how sales and use tax works in Michigan. Sales tax and use tax are added to the price of goods and services when you buy or use them in Michigan. The current sales and use tax rate imposed is 6%.
B. Taxability of Computer Software and the Implications of Auto-Owners
The key takeaway from this section is how the “Auto-Owners” court case (Auto-Owners Ins Co v Dep’t of Treasury, 313 Mich App 56 [2015]) created a process by which we can analyze (first) whether it's considered “prewritten computer software” and therefore taxable based on the delivery component, and (second) whether a single-mixed transaction involving prewritten software and services is taxable or not using the "incidental to services" test. More information on the “incidental to services” test can be found here.
Also, here are a couple of example scenarios from the bulletin of what delivery of software may look like. You can also find additional examples on the bulletin here:
Example 1. ABC LLC is an out-of-state vendor that sells a subscription service to XYZ, Inc, a Michigan corporation, through which XYZ can access ABC’s online database service through ABC’s software. All computer code involved with the software is controlled, maintained, and updated by ABC and resides solely on ABC’s servers. XYZ accesses ABC’s database through a web browser and no code, application, or desktop agent is delivered to XYZ. This transaction does not involve the sale of prewritten computer software in Michigan, so it is not taxable. See Auto-Owners at 72-73.
Example 2. Data, LLC provides construction and engineering information to its Michigan-based customers. Contractor, Inc entered into a contract with Data, LLC under which Contractor, Inc submits various variables to Data, LLC over the Internet and, after analyzing those variables, Data, LLC provides parameters and values to aid Contractor in its construction projects. Contractor, Inc does not use Data, LLC’s software and does not download any of Data LLC’s code to its computers. This transaction does not involve the sale of prewritten computer software in Michigan, so it is not taxable. See Auto-Owners at 73-75.
C. Service Maintenance Contracts for Prewritten Computer Software
Section C covers how sales tax and use tax apply to service maintenance contracts for computer software in Michigan. Service maintenance contracts are contracts that obligate a vendor of computer software to provide a customer with future updates or upgrades to computer software, support services with respect to computer software, or both.
There are two types of service maintenance contracts: optional and mandatory. Optional service maintenance contracts are contracts that you don’t have to buy if you don’t want to. Mandatory service maintenance contracts are contracts that you have to buy if you want to buy computer software.
A more in-depth explanation of optional and mandatory contracts can be found on the bulletin here.
D. Digital Goods and Micro-transactions
Section D addresses how sales tax and use tax apply to digital goods and micro-transactions in Michigan. Digital goods are products that exist only in a digital or electronic form and are transferred electronically. Micro-transactions are small payments for digital goods or services, such as in-app purchases or online gaming.
According to this bulletin, digital goods and micro-transactions are generally exempt in Michigan, unless they are considered prewritten computer software. The bulletin provides quite a few examples of different types of digital goods and micro-transactions and how they are taxed based on these rules. We’ll list a couple below and for more examples from the bulletin, click here.
Example 1. Customer purchases recorded music that is transferred electronically in the form of a MP3. This purchase involves a digital good and is not taxable.
Example 2. Customer purchases a game that is downloaded or installed on its electronic device. While playing the game, customer purchases “gold coins” and “gems” for $10.00 that are used in the game. The purchased coins and gems become available to the customer within the game and do not require or involve the download of any additional software onto the device because the downloaded game contained the necessary code to make the coins and gems available. Instead, the coins and gems appear virtually within the game. The $10.00 purchase of the coins and gems is taxable as a purchase of “prewritten computer software.”
E. Sourcing of Prewritten Computer Software
Section E explores how to determine the taxing jurisdiction for the sale of prewritten computer software and digital products in Michigan.
The bulletin outlines different rules for sourcing prewritten computer software and digital products depending on whether they are delivered by tangible storage media, electronic delivery, or load and leave. Tangible storage media is something that you can touch and hold, like a CD or a flash drive. Electronic delivery is when the software or digital product is transferred to you by email, download, or remote access. Load and leave is when the software or digital product is delivered to you by using a tangible storage media that is not physically transferred to you.
The bulletin provides some examples of how to apply these rules for different types of transactions involving prewritten computer software and digital products (added below). If you’d like to view more examples, they can be found on the bulletin here.
Example 1. Transaction includes not only a license agreement but also a copy of the prewritten computer software and the software is received by the purchaser at a business location of the seller. The sale is sourced to the business location of the seller. MCL 205.69(1)(a); MCL 205.110(1)(a).
Example 2. Prewritten computer software is not received by the purchaser at the business location of the seller. The sale is sourced to the location where the software is received by the purchaser or the purchaser’s designee, as indicated by instructions for delivery. MCL 205.69(1)(b); MCL 205.110(1)(b).