When a manufacturer outsources its entire computer division, are the outsourced services and the equipment the provider buys exempt -- and what about equipment the provider buys as the manufacturer's agent?

Plain-English summary

Connecticut's "outsourcing exemption" (Conn. Gen. Stat. § 12-412(74), as amended by 1995 Conn. Pub. Acts 160, § 45) exempts computer and data processing services a provider renders after taking over data processing operations that the customer used to run for itself — and it also exempts the computers and data processing equipment the provider buys to deliver those services. It doesn't apply between related persons. This ruling works through a full outsourcing deal by a manufacturer.

The manufacturer (the "Company") ran its own Computer Division — hardware, software, printers, scanners, programmers, and support staff. It planned to hand the whole division (and most of its people) to an unrelated Service Provider, which would then provide the services back to the Company. At the start, the Company would sell certain assets (hardware, prewritten software, related equipment) to the Provider; the Provider would also use Company-owned/leased assets, would replace and upgrade equipment, and would buy some new equipment as agent for the Company (title vesting in the Company) and other materials/supplies for itself.

DRS's answers:

• The outsourced services are exempt. The 1995 amendment added subparagraph (B), which — for outsourcing begun on or after July 1, 1995 — removed the older subparagraph (A)(i) requirement (from Ruling No. 95-9) that the provider take over all of the customer's functions at a specific location. Now all or any portion of the data processing operations taken over is exempt. So the services are exempt (they'd likely qualify under (A)(i) too, but "unquestionably" under (B)).
• The Provider's equipment purchases are exempt. Computers and data processing equipment the Provider buys to perform the exempt services are exempt under (B) — whether bought from the Company or from anyone else, and the statute doesn't require the items to be used exclusively for the exempt services. The Company's initial bulk sale of its used assets to the Provider is separately exempt as a casual sale (used items sold by a non-dealer; Regs. § 12-426-17(c)(5); Ruling No. 94-11).
• Agent purchases are TAXABLE. Equipment the Provider buys as the Company's agent — with title vesting in the Company — is taxable. The equipment exemption applies only when items are sold "to the retailer" (the Provider), not to the customer. An agent takes on the tax status of its principal (Rich-Taubman Associates v. Commissioner): a tax-exempt principal's agent buys exempt, but a non-exempt principal's agent buys taxably — even though that same agent, buying for itself, could have bought exempt.

DRS said this Ruling amplifies and distinguishes Ruling No. 95-9 (named in prose, not linked).

What this means for you

Businesses outsourcing their data processing (post-July 1, 1995)

After the 1995 amendment (subparagraph (B)), you don't have to move your entire data-processing operation or an entire location to get the exemption — any portion the provider takes over qualifies. That's a meaningful loosening from the earlier "all functions at a specific location" reading in Ruling No. 95-9.

Outsourcing providers buying equipment

Computers and data processing equipment you buy to provide the exempt services are exempt — from the customer or any other seller — and you don't have to use them exclusively for the exempt work. Buying the customer's used IT assets in bulk at the start is also exempt as a casual sale. Keep the purchases in your own name to preserve the exemption.

The agent-purchase trap

If you buy equipment as the customer's agent, with title going to the customer, you're buying as the customer — and if the customer couldn't buy it exempt, neither can you in that capacity. The exemption for equipment runs to items sold to the provider, not to the customer. Structure purchases you want exempt as your own purchases, not agency purchases for the customer.

Accountants and tax professionals

Three separate exemptions/analyses are in play: (1) exempt services under § 12-412(74)(B); (2) exempt equipment sold to the retailer under (B); and (3) the casual sale exemption for the initial asset transfer (Regs. § 12-426-17(c)(5)). Overlay agency law: per Rich-Taubman, an agent acquires the principal's tax status, so agent-for-the-customer purchases follow the customer's (non-exempt) status. And the whole exemption is off if the parties are related persons (§ 12-217m).

Common questions

Q: Are the outsourced computer services exempt?
A: Yes. Under § 12-412(74) as amended in 1995, services a provider renders after taking over the customer's data processing operations (for operations acquired on/after July 1, 1995) are exempt — and now any portion taken over qualifies, not just an entire location's functions.

Q: Is the equipment the provider buys exempt?
A: Yes, when bought by the provider to deliver the exempt services — from the customer or anyone else, and without an exclusive-use requirement. The customer's initial bulk sale of used IT assets to the provider is also exempt as a casual sale.

Q: Why is agent-purchased equipment taxable?
A: Because it's effectively sold to the customer (title vests in the customer), not to the provider, and the equipment exemption applies only to items sold to the provider. An agent takes on the principal's tax status, so buying as the non-exempt customer's agent is taxable (Rich-Taubman Associates v. Commissioner).

Q: What changed from Ruling No. 95-9?
A: Ruling No. 95-9 required the provider to take over all functions at a specific location (under subparagraph (A)(i)). The 1995 amendment's subparagraph (B) dropped that, exempting any portion of the operations taken over on/after July 1, 1995. This ruling amplifies and distinguishes 95-9.

Citations and references

Statutes and regulations:

• Conn. Gen. Stat. § 12-412(74), as amended by 1995 Conn. Pub. Acts 160, § 45 (exemption for outsourced computer and data processing services under subpara. (A)(i)/(A)(ii)/(B), and for computers/data processing equipment sold to the outsourcing retailer; inapplicable between related persons)
• Conn. Gen. Stat. § 12-217m (definition of "related person")
• Conn. Agencies Regs. § 12-426-17(c)(5) (casual sale of used items by a person not in the business of selling them)

Case law and related rulings:

• Rich-Taubman Associates v. Commissioner of Revenue Services, 236 Conn. 613 (1996) (an agent acquires the tax status of its principal)
• Ruling No. 95-9 (earlier reading of subparagraph (A)(i) requiring takeover of all functions at a specific location) — amplified and distinguished here
• Ruling No. 94-11 (casual sale treatment)

Source

• Landing page: Connecticut DRS Rulings
• Ruling: Ruling 96-8

Original ruling text

Ruling 96-8, Sales and Use Taxes / Computer and Data Processing Services / "Outsourcing Exemption"

FACTS:

A company engaged in manufacturing (the "Company") has an information technology division ("the Computer Division") to support its computer-related needs. The Computer Division uses an array of computer hardware and software and other equipment such as printers and scanners, and employs a staff of computer programmers, technicians and end-user support personnel.

The Company intends to transfer all of the functions of the Computer Division, together with most of the Computer Division's personnel, to an outside computer and data processing service provider (the "Service Provider"), which will then provide the Company with the computer and data processing services previously provided internally by the Computer Division. Neither the Company nor the Service Provider is a "related person," as that term is defined in Conn. Gen. Stat. §12-217m(7), with respect to the other.

At the commencement of the agreement between the Company and the Service Provider, the Company will sell certain assets to the Service Provider, which the Service Provider will use to perform its services for the Company. These assets will consist of computer hardware and prewritten software and related data processing equipment, such as printers and scanners. The Service Provider will also use other assets of the Company that the Company will continue to own or lease (as lessee). These assets will consist of computer hardware and prewritten software.

The Service Provider will replace, upgrade and provide additional equipment as may be necessary for the performance of its services. The Service Provider will purchase this additional equipment as agent for the Company, and title to the equipment will vest in the Company. The Service Provider will also purchase materials and supplies other than computers and data processing equipment for its own use in fulfilling its contract with the Company, title to which will vest in the Service Provider.

ISSUES:

Whether the computer and data processing services provided by the Service Provider to the Company will be exempt from sales and use taxes under Conn. Gen. Stat. §12-412(74), as amended by 1995 Conn. Pub. Acts 160, §45;

Whether the computers and data processing equipment purchased by the Service Provider, either from the Company or elsewhere, will be exempt from sales and use taxes under Conn. Gen. Stat. §12-412(74), as amended by 1995 Conn. Pub. Acts 160, §45; and

Whether the equipment purchased by the Service Provider as agent for the Company will be subject to sales and use taxes.

DISCUSSION:

Conn. Gen. Stat. §12-412(74), as amended by 1995 Conn. Pub. Acts 160, §45, exempts the following:

(A) Sales of computer and data processing services rendered to a customer (i) by a retailer which, on or after July 1, 1991, acquired the operations of a data processing facility from the customer, provided such customer operated the facility for its own use or (ii) by a retailer which, on or after July 1, 1993, acquired the operations of the data processing facility from the retailer described in subparagraph (A)(i) of this subsection, provided such customer formerly operated the facility for its own use. (B) Sales of computer and data processing services rendered to a customer by a retailer which, on or after July 1, 1995, acquired the data processing operations from the customer, provided such customer formerly conducted such data processing operations for its own use. Sales of and the storage, use or other consumption of computers or data processing equipment, when sold to the retailer described in this subparagraph and used by such retailer to provide the services described in this subparagraph. The provisions in this subparagraph shall not apply if the retailer is a related person, as defined in section 12-217m, with respect to the customer or the customer is a related person, as defined therein, with respect to the retailer.

In Ruling No. 95-9 the Department applied the provisions of subparagraph (A)(i) of this exemption to the outsourcing of computer and data processing operations previously performed internally by banks. On page 3, the Ruling concluded that "to 'acquire the operations of a data processing facility' means to take over all of the data processing functions formerly conducted by a service recipient at a specific location of the service recipient's business premises where such computer and data processing functions were performed." However, at approximately the same time as the Department issued Ruling No. 95-9 , the General Assembly amended Conn. Gen. Stat. §12-412(74) by adding subparagraph (B), which extended the scope of the exemption to computer and data processing services where the retailer "acquired the data processing operations from the customer " on or after July 1, 1995. The effect of this amendment, for data processing outsourcing begun on or after that date, is to eliminate the requirement that the service provider must take over all of the functions previously conducted by the service recipient at a specific location. Instead, all or any portion of the data processing operations formerly conducted by the service recipient that are taken over by the new service provider are exempt. Although the services to be provided by the Service Provider to the Company may be exempt under the requirements of subparagraph (A)(i) of the statute, they will unquestionably be so under the requirements of subparagraph (B).

The exemption in Conn. Gen. Stat. §12-412(74), as amended by 1995 Conn. Pub. Acts 160, §45, also applies to sales of "computers or data processing equipment," when sold to a retailer, such as the Service Provider, that is providing the type of exempt outsourced computer and data processing services described in subparagraph (B) of the statute, when the data processing operations were acquired on or after July 1, 1995 and when the items are "used by such retailer to provide the services described in this subparagraph . . . ." To the extent that the Service Provider purchases any computer hardware, prewritten software, printers, scanners or similar data processing equipment for use in providing its services to the Company, whether it purchases the items from the Company or from anyone else, those purchases will be exempt from sales and use taxes under this provision. The statute does not require that the computers and data processing equipment be purchased from the customer (the service recipient), nor does it require that they be used exclusively to perform the exempt outsourced computer and data processing services described in §12-412(74)(B). (The purchase of the Company's assets by the Service Provider at the commencement of the agreement will also be exempt from sales and use taxes as a casual sale, since it will be a sale of used items by an owner that is not engaged in the selling of such items as a business. See Conn. Agencies Regs. §12-426-17(c)(5); see also Ruling No. 94-11 .)

The equipment the Service Provider purchases as the agent of the Company will not be exempt from sales and use taxes. The exemption for purchases of computers and data processing equipment in Conn. Gen. Stat. §12-412(74)(B) applies only when those items are sold "to the retailer" of the exempt services-- here the Service Provider--and not when they are sold to anyone else, including the Company. When a person makes purchases as the agent of another, it makes those purchases not in its own capacity, but in that of its principal. In Rich-Taubman Associates v. Commissioner of Revenue Services, 236 Conn. 613, ----A.2d ---- (1996), the Connecticut Supreme Court held that the plaintiff, acting as agent for a municipality exempt from sales and use taxes on its purchases, acquired the tax-exempt status of its principal:

Section 12-412(1) should not be read to impose use tax liability on purchases that would otherwise be exempt from taxation merely because the city, in the interest of economy and efficiency, has appointed an agent to procure the materials and services necessary to ensure the successful and efficient operation of its parking garage.

Id. , at 620.

Conversely, if purchases made directly by a principal would not be exempt from sales and use taxes, then purchases made by a person acting as the principal's agent would also not be exempt, even though the agent, were it acting on its own behalf, would be able to make the purchases exempt.

RULING:

The computer and data processing services provided by the Service Provider to the Company will be exempt from sales and use taxes under Conn. Gen. Stat. §12-412(74), as amended by 1995 Conn. Pub. Acts 160, §45.

The computers and data processing equipment purchased by the Service Provider, either from the Company or elsewhere, will be exempt from sales and use taxes under Conn. Gen. Stat. 12-412(74), as amended by 1995 Conn. Pub. Acts 160, 45.

The equipment purchased by the Service Provider as agent for the Company will be subject to sales and use taxes.

This Ruling amplifies and distinguishes Ruling No. 95-9.

LEGAL DIVISION

JULY 16, 1996