Alert
Prepare for Sales Tax Changes to Data Processing Rule in Texas
Businesses with Texas customers that operate as an online marketplace provider may be impacted by the proposed changes to Rule 3.330 related to data processing.
Stay ahead of potential tax liabilities by understanding the proposed changes to Rule 3.330 for online marketplace providers in Texas and review your services against the new definition of data processing to support compliance and mitigate risks as the landscape evolves.
Increased Responsibility and Tax Liability for Marketplace Providers
The comptroller issued a private letter ruling, noting that a taxpayer’s sale of membership-based consulting services that included both nontaxable services and data processing services were taxable at the full membership amount, but for the 20% exemption.
The comptroller has taken a similar position in audits, which has led to a proposal of amending Rule 3.330 related to data processing.
Reason for Change
The proposed changes are intended to help online marketplaces navigate their responsibilities of the tax statutes, as well as the taxability of fees charged by online marketplaces to marketplace sellers.
The comptroller aims to accomplish this through redefining data processing in general, including or excluding specific services, and addressing ancillary services. The amended rule seeks to address both transactions between a marketplace seller and an end user as well as a marketplace seller and a marketplace provider.
Proposed Changes
Under the preexisting rule, data processing is defined as, “the processing of information for the purpose of compiling and producing records of transactions, maintaining information, and entering and retrieving information”. The changes to the rule would include modifications to the general definition to define data processing as “the computerized entry, retrieval, search, compilation, manipulation, or storage of data or information.”
The proposed rule then elaborates on specific inclusions and exclusions and provides examples. These include when services such as search engine optimization, lead generation, and social media marketing are taxable.
Essence of Transaction
The proposed changes alter the long-standing essence of the transaction position that the comptroller has utilized in determining what was a taxable data processing service. Modifications to the rule include allowing the comptroller to exercise judgment on the service provided rather than the true object of what the customer is seeking. The proposed rule also added the term “nontaxable related services” and emphasizes that a single charge for both taxable and nontaxable related services is taxable if the taxable portion represents more than 5% of the total charge.
The proposed changes would also clarify the sourcing of data processing services with respect to in-state and out-of-state use as well as clarify the local level sourcing for in-state use.
Impact of Rule Change
The changes seem to go beyond clarifying the intention of the statute, but redefining the definition of what is included in data processing.
There appears to be discrimination between commissions earned online and those provided offline, thus a potential violation of the Internet Tax Freedom Act.
Additionally, because there are two transactions involved, the way the proposed rule reads, there’s a potential for double taxation with respect to a commission or fee charged by a marketplace provider.
The changes to the rule could have an unintended impact on the franchise tax, as the franchise tax law references sales tax definitions. The revisions in the rule could result in additional confusion in the sourcing of receipts for franchise tax computations.
Next Steps
The proposed rule has no effective date. As such, if the proposed rule is adopted, the changes wouldn’t be prospective, but rather apply to historic transactions.
Data Processing
Companies should consider further assessing their products and services that might fall into the proposed definition of data processing and the impact on their tax collection responsibilities.
Additionally, companies should evaluate the sourcing of their receipts for both sales and use tax as well as franchise tax purposes. The period for public comment closed October 13, 2024, and the expected changes will occur shortly after depending on public comment received by the comptroller.
We’re Here to Help
For more information about how changes to Rule 3.330 could affect your business, contact your Moss Adams professional.