Did You Pay Too Much New York Sales Tax on That Computer Hardware?
May 2002
By David Bunning, Greenberg
Traurig, New York Office
View or download the PDF version of this Alert
here.
Dot.coms and other cash-strapped businesses swimming against the current
economic tide may be surprised to learn that they paid New York sales tax
on the purchase, lease, or rental1
of tax-exempt computer hardware and related items and may be entitled to
a refund. New York, in an effort to encourage the growth of high-tech businesses,
passed a number of sales tax exemptions which render the purchase or lease
of computer hardware and other equipment exempt from New York State and
local sales and use tax when used for certain specified purposes.
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| "Businesses involved in any of
the activities for which these exemptions apply should review invoices
to determine whether New York sales tax was paid on tax-exempt items." |
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Recently, in the course of processing a sales tax refund of nearly $200,000,
a representative of the New York State Department of Taxation and Finance
("Department") remarked that he was unfamiliar with the parameters of one
of these exemptions and needed to research it and discuss it with his supervisor.
This dearth of refund claims suggests either that taxpayers and their professionals
have perfectly assimilated these exemptions and routinely report and pay
the correct amount of sales tax, or (more likely) that sales tax has been
paid on exempt items and that refunds are waiting to be claimed.
It is easy to understand how this can happen. In the typical example,
the purchaser is presented with an invoice for hardware, software, shipping,
maintenance agreements, and related items, on which an amount for sales
tax appears as a line item, and the purchaser pays the invoice without further
thought to the sales tax. There is no reason that the purchaser would ever
review the propriety of the tax after it was paid.
In cases where an exemption from sales tax is known to exist at the time
of purchase, the purchaser claims the exemption by presenting to the vendor
a Form ST-121.3 ("Exempt Use Certificate for Computer System Hardware")
or a Form ST-121.5 ("Exempt Use Certificate for Operators of Internet Data
Centers (Web Hosting)"). When the tax is paid on items later found to be
exempt from tax, in order to claim the refund, the purchaser must file with
the Department a Form AU-11 ("Application for Credit or Refund") with the
required supporting information and documentation. The claim for refund
must be filed within three years of the date that the tax was payable to
the Department by the vendor.
Now — before one more day of the three-year statute runs — is an appropriate
time to review these exemptions and compare them with your invoices to see
if tax was paid on tax-exempt items. This alert considers the three most
recently enacted exemptions from New York sales and use tax that apply to
the purchase of computer system hardware and related equipment.
The first is for the purchase of "computer system hardware used or consumed
directly and predominantly in designing and developing computer software
for sale." The second exemption is for the purchase of "computer system
hardware used or consumed directly and predominantly in…providing the service,
for sale, of designing and developing internet websites."
The third is for the purchase of "machinery, equipment, and other tangible
personal property specified herein, sold to a person operating an internet
data center located in this state for use in such center" which property
will be located or installed in an internet data center and "is required
for and directly related to the provision of internet website services for
sale by the operator of the center." Each of these exemptions is more fully
explained below:
1. Computer System Hardware Used or Consumed Directly and Predominantly
in Designing and Developing Software for Sale.
This exemption is set forth in Tax Law 1115(a)(35), effective June 1,
1998. The Department explained the scope of this exemption in Technical
Services Bureau Memorandum TSB-M-98(5)S (June 8, 1998)2
concerning the purchase or lease of "computer system hardware," which includes
"associated parts" and "embedded software."
"Computer system hardware" includes computers (micro-, mini-, mainframe
and personal), disk drives, CD-ROM drives, external modems, printers, scanners,
monitors, keyboards, mouses, network interfaces, network hubs, and network
routers. "Associated parts" are defined as "any component of, or attachment
to, computer system hardware that is used in connection with, and is necessary
to, the performance of the hardware’s operation." This includes motherboards,
daughterboards, CPUs, controller cards, hard drives, internal modems, network
interface cards, video cards, and network wiring and cables.
The TSB Memorandum also defines the statutory terms "directly" and "predominantly."
"Directly" means that the hardware is actually used in designing and developing
computer software for sale or that it has an active, causal relationship
in the design and development of the software for sale. The exemption does
not apply to computer system hardware used in activities that are collateral
to the actual design and development process, such as in "administration,
production, or distribution activities."
"Predominantly" means that the hardware must be used more than 50% of
the time in the design and development of computer software for sale.
"Designing and developing," includes "systems analysis, program design,
coding, testing, debugging and documentation that are part of the design
and development of computer software for sale" and "includes activities
carried on from the conceptual stage, through the planning, evaluation and
testing stages of development."
The exemption does not include the purchase of software, except "embedded
software" such as is found in a memory chip, which is considered part of
the hardware. If the purchase of hardware includes the purchase of software,
the price must be allocated between them and only the hardware portion is
exempt from tax. Although the purchase of software used to design or develop
software is not subject to this exemption, prewritten computer software
used or consumed directly and predominantly in the production of tangible
personal property for sale, or directly and predominantly in research and
development, is exempt from sales tax. (Prewritten software is defined by
statute to be tangible personal property and its retail sale is subject
to sales tax, in contrast to custom-designed software, the retail sale of
which is not subject to sales tax.)
The exemption also does not apply to installation charges, maintenance
charges, tools, or supplies.
2. Computer System Hardware Used or Consumed Directly and Predominantly
in Providing the Service, for Sale, of Designing and Developing Internet
Websites.
This exemption is set forth in Tax Law Section 1115(a)(35), effective
March 1, 2001. The hardware and related equipment which are the subject
of this exemption are the same as that explained above. The same requirements
of "directly" and "predominantly" apply. The difference is that the hardware
must be used "in providing the service, for sale, of designing and developing
internet websites." These terms are not defined by statute or in a TSB memorandum.
3. Machinery, Equipment, and Tangible Personal Property Sold to a Person
Operating an Internet Data Center in New York.
The third exemption is set forth in Tax Law Section 1115(a)(37), effective
September 1, 2000. It covers a much wider range of property than do the
first two exemptions. The property must be "located or installed in a facility
or structure which is an internet data center." The property must be "required
for and directly related to the provision of internet website services for
sale by the operator of the center."
The property subject to this exemption includes: "computer system hardware,
including servers and routers, computer software, storage racks and cages
for computer equipment, interior fiber optic and copper cables, property
required to maintain the appropriate climate controlled environment for
the property in the internet data center such as air filtration and air
conditioning equipment and vapor barriers, property related to fire control
such as fire suppression equipment and alarms, power generators, power conditioners,
property related to providing a secure environment such as protective barriers,
property which when installed in such facility or structure will constitute
raised flooring and other similar property." This list is non-exclusive.
An "operator of an internet data center" is defined as "a person (a)
operating a facility which consists of a data center specifically designed
and constructed to provide a high security environment for the location
of servers and similar equipment on which reside internet websites; and
(b) providing at such facility the internet web services of: (i) uninterrupted
internet access of its customers’ web pages in a secure environment and
(ii) continuous internet traffic management for its customers’ web pages."
However, it also states that a person primarily engaged in the sale from
the center of internet access services is not providing internet website
services for sale. For this purpose, the statute defines "primarily engaged"
to mean that more than 50% of the use of all the machinery equipment and
other specified property in any internet data center is for the rendition
of an internet access service.
Technical Services Bureau Memorandum TSB-M-00(7)S (August 15, 2000) explains
that "uninterrupted internet access means twenty-four hours a day, seven
days a week, three hundred sixty-five days a year." It also states that
the property must be required for and directly related to the provision
of internet website services for sale by the operator of the center. The
memorandum clarifies that the exemption includes the purchase of the otherwise
taxable services of providing (i) installing, maintaining, servicing and
repairing tangible personal property and (ii) protective and detective services.
Conclusion
A review of these provisions confirms their complexity. It is entirely
possible that purchasers of computer hardware systems and related products
used to design and develop software, design and develop internet sites,
and for use in operating internet data centers, may have improperly paid
New York Sales tax on the purchase or lease of tax-exempt items. Businesses
involved in any of the activities for which these exemptions apply should
review invoices to determine whether New York sales tax was paid on tax-exempt
items. If so, the necessary supporting documentation should be assembled
and a claim for refund should be promptly filed.
Greenberg Traurig has experience in assisting taxpayers throughout the
refund process, including preparing and submitting the refund claim, and
working with the Department to expedite its consideration and allowance.
We would welcome the opportunity to be of assistance.
Footnotes
1 New York sales tax is imposed on the purchase,
lease or rental of tangible personal property. Tax Law section 1101(b)(5).
The exemptions described here apply to the purchase, lease or rental of
the described property. As used in this alert, the term "purchase" includes
lease or rental, and the term "purchaser" includes one who leases or rents
such equipment.
2 Technical Services Bureau ("TSB") Memoranda
"generally address distinct statutory or regulatory provisions or distinct
issues." Tax Regulation (20 NYCRR) section 2375.6(a)(1)(ii). They are "advisory
in nature . . . do not have legal force or effect, do not set precedent,
and are not binding." Tax Regulation (20 NYCRR) section 2375.6(c).
© 2002 Greenberg Traurig
Additional Information:
For more information, please review our Tax Practice description, or
feel free to contact one of our attorneys.
This GT ALERT is issued for general purposes only and is not intended
to be construed or used as legal advice. Greenberg Traurig attorneys provide
practical, result-oriented strategies and solutions tailored to meet our
clients’ individual legal needs. The Firm’s responsive approach to client
service often cuts across legal subject matter, applying the right experience
and resources to provide cost-effective solutions.
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