A Tennessee firm resells ERP software and separately offers optional consulting services — training, configuration, project management, data conversion, documentation, testing, and report writing. Which of those services must it charge Tennessee sales tax on?

Plain-English summary

A Tennessee consulting firm (its name is redacted) resells mid-market ERP software and also offers clients a menu of optional, hourly-billed services. It already charges sales tax on the clearly taxable work — installing software, building upgrades and updates, custom development, and customizing software. It asked the Department about its other offerings, which it calls "Additional Services": Training, Configuration, Project Management and Client Correspondence, Data Conversion, Documentation, Testing, and Report Writing.

The Department's bottom line: almost all of these are not taxable when sold on their own. Tennessee taxes retail sales of tangible personal property (which includes prewritten computer software) and a short list of specifically enumerated services — it does not tax services generally. None of the Additional Services, taken alone, is an enumerated taxable service, and none of them creates, fabricates, modifies, or enhances software code. Training, Configuration, Project Management/Client Correspondence, Data Conversion, Documentation, and Testing are therefore not taxable stand-alone.

The one exception is Report Writing. When the firm builds reports just by clicking boxes, dragging fields, and using the report-writer tools already inside the software, that is still nontaxable. But if a Report Writing job involves software coding or programming that is more than "merely incidental," it becomes a taxable sale of computer software.

The bigger lesson is about combinations. A service that is nontaxable by itself can still be taxed when it is sold as part of a larger taxable deal. Tennessee uses the "true object" test and a bundling rule: if an otherwise-nontaxable service is a "crucial," "essential," "necessary," "consequential," or "integral" part of delivering a taxable item or service — for example, project management or testing that is required to install or customize software — then that service rides along and is taxed too. And when taxable and nontaxable items are sold for a single price, the whole price is taxable. Crucially, separately itemizing the charge does not make it nontaxable ("[a] taxpayer cannot transform a properly taxable amount into a nontaxable amount through the simple expedient of a separately stated invoice charge"). So the firm has to look at the real object of each individual client contract.

What this means for you

Software resellers, ERP consultants, and IT service providers

Selling your expertise — training users, configuring settings, managing the project, moving a client's own data, writing documentation, testing — is generally not a taxable service in Tennessee, even though the software itself is taxable. The line you cannot cross is touching the code: writing, fabricating, modifying, or enhancing software (including report writing that involves real programming) is a taxable sale of computer software. "Clicking boxes," selecting built-in options, and using the publisher's drag-and-drop tools stay on the nontaxable side.

Anyone who sells services alongside a taxable product or service

Watch the bundling and "true object" traps. If you always pair a "free-standing" nontaxable service with a taxable sale — e.g., you never sell the software without your training, or never sell configuration apart from taxable installation — the Department can treat the bundled service as a necessary part of the taxable deal and tax it. Selling everything for one price has the same effect. Listing the nontaxable piece on its own invoice line is not a fix; the question is whether the items are genuinely separate and severable.

Accountants and tax professionals

The analysis runs through the enumerated-services principle (§ 67-6-205; Covington Pike Toyota, Ryder Truck Rental), the software-as-tangible-personal-property rules (§ 67-6-231(a); § 67-6-102(68), (18), (24); Creasy, Crescent Amusement, Commerce Union Bank), the statutory bundling rule (§ 67-6-102(79)(A)(iv)), and the court-made "true object" / "primary purpose" test (Thomas Nelson, AT&T, Rivergate, Qualcomm, AOL). This ruling is the Department's clearest roadmap of that framework and is cited by later TN software rulings (e.g., LR 15-07, 15-08, 15-09) as "Letter Ruling 14-10."

Common questions

Q: Is software training or configuration taxable in Tennessee?
A: Not on its own. Training users and configuring software by selecting built-in options (without writing or modifying code) are not enumerated taxable services, so stand-alone they are nontaxable. They can become taxable if they are a required, integral part of a taxable sale or are bundled into a single price with something taxable.

Q: When is report writing taxable?
A: Only when it crosses into software coding or programming that is not "merely incidental." Building reports with the software's own report-writer tools, "click-and-drag" interfaces, and built-in options is nontaxable; writing or modifying code to produce the reports is a taxable sale of computer software.

Q: If I list a nontaxable service on a separate invoice line, is it safe from tax?
A: No. Separate itemization is only a starting point. If the service is really a crucial, essential, necessary, consequential, or integral part of a taxable item or service, or is bundled with taxable items for a single price, it is taxable regardless of how the invoice is broken out.

Q: Can I rely on this letter ruling for my business?
A: No. A Tennessee letter ruling binds the Department only as to the specific taxpayer and facts it was issued to, and it can be revoked or modified. It shows how the Department reasons, but your contracts and facts may differ. Confirm your own situation with a tax professional.

Citations and references

Tennessee statutes (Tenn. Code Ann.):

• § 67-6-205 (sales tax reaches only specifically enumerated services); § 67-6-205(c)(6) (installing computer software); § 67-6-205(c)(4) (repair services for tangible personal property or computer software)
• § 67-6-231(a) (retail sale, lease, licensing, or use of computer software — prewritten or custom — is taxable however delivered)
• § 67-6-102(68) ("prewritten computer software"); § 67-6-102(18) ("computer software"); § 67-6-102(24) ("delivered electronically"); § 67-6-102(89)(A) ("tangible personal property")
• § 67-6-102(78)(A) ("sale"); § 67-6-102(78)(C) (sale includes furnishing taxable things/services); § 67-6-102(78)(K) (creating, programming, or loading software is a sale); § 67-6-102(76) ("retail sale")
• § 67-6-102(79)(A)(iv) (bundling rule — single non-itemized price); § 67-6-102(79)(A) ("sales price"); § 67-6-102(8)(A) ("bundled transaction," effective July 1, 2015); § 67-6-539 (telecommunications bundling)
• § 67-6-101 to -907 (Retailers' Sales Tax Act)

Tennessee cases cited by the ruling:

• Creasy Sys. Consultants, Inc. v. Olsen, 716 S.W.2d 35 (Tenn. 1986) (fabricating/modifying software is a taxable sale of software)
• Crescent Amusement Co. v. Carson, 213 S.W.2d 27 (Tenn. 1948) and Commerce Union Bank v. Tidwell, 538 S.W.2d 405 (Tenn. 1976) (tangible medium taxable vs. "merely incidental" to intangible content)
• Thomas Nelson, Inc. v. Olsen, 723 S.W.2d 621 (Tenn. 1987); AT&T Corp. v. Johnson, 2002 WL 31247083 (Tenn. Ct. App. 2002); Rivergate Toyota, Inc. v. Huddleston, 1998 WL 83720 (Tenn. Ct. App. 1998) (true object; crucial/essential elements; cannot escape tax via separate itemization)
• Covington Pike Toyota, Inc. v. Cardwell, 829 S.W.2d 132 (Tenn. 1992) and Ryder Truck Rental, Inc. v. Huddleston, 1994 WL 420911 (Tenn. Ct. App. 1994) (only enumerated services are taxed)
• Qualcomm, Inc. v. Chumley, 2007 WL 2827513 and AOL, Inc. v. Roberts, 2013 WL 4067977 (true-object/primary-purpose, totality of the circumstances); also Barnes & Noble Superstores v. Huddleston, 1996 WL 596955; Penske Truck Leasing Co. v. Huddleston, 795 S.W.2d 669 (Tenn. 1990); Tomkats Catering, Inc. v. Johnson, 2001 WL 1090516; Audio Visual Artistry v. Tanzer, 403 S.W.3d 789 (Tenn. Ct. App. 2012); Hudson v. Town & Country True Value Hardware, Inc., 666 S.W.2d 51 (Tenn. 1984)

Source

• Landing page: https://www.tn.gov/revenue/tax-resources/legal-resources/tax-rulings.html
• Original PDF: https://www.tn.gov/content/dam/tn/revenue/documents/rulings/sales/14-10.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
LETTER RULING # 14-10

Letter rulings are binding on the Department only with respect to the individual taxpayer
being addressed in the ruling. This ruling is based on the particular facts and
circumstances presented, and is an interpretation of the law at a specific point in time. The
law may have changed since this ruling was issued, possibly rendering it obsolete. The
presentation of this ruling in a redacted form is provided solely for informational purposes,
and is not intended as a statement of Departmental policy. Taxpayers should consult with a
tax professional before relying on any aspect of this ruling.

SUBJECT
The application of the Tennessee sales tax to software consulting services.
SCOPE

This letter ruling is an interpretation and application of the tax law as it relates to a specific set of
existing facts furnished to the Department by the taxpayer. The rulings herein are binding upon the
Department, and are applicable only to the individual taxpayer being addressed.

This letter ruling may be revoked or modified by the Commissioner at any time. Such revocation or
modification shall be effective retroactively unless the following conditions are met, in which case
the revocation shall be prospective only:

(A) The taxpayer must not have misstated or omitted material facts involved in the
transaction;

(B) Facts that develop later must not be materially different from the facts upon
which the ruling was based;

(C) The applicable law must not have been changed or amended;

(D) The ruling must have been issued originally with respect to a prospective or
proposed transaction; and

(E) The taxpayer directly involved must have acted in good faith in relying upon the
ruling; and a retroactive revocation of the ruling must inure to the taxpayer’s
detriment.

FACTS

[TAXPAYER] (the “Taxpayer”) is a consulting firm based in [CITY], Tennessee. The Taxpayer is a
reseller and certified service provider of several mid-market enterprise resource planning (“ERP”)
software systems that integrate internal management information across an entire organization and
include finance/accounting, manufacturing, sales and service, customer relationship management,
and other components. The software publishers develop, write, and distribute the software, as well

any software upgrades and patches. Any software maintenance contracts/end user license agreements
are between the Taxpayer’s clients and the software publisher.

In addition to reselling ERP software systems, the Taxpayer offers a variety of services to its clients.
If the Taxpayer sells a software system to a client, a client is under no obligation to contract with the
Taxpayer for the provision of any service. If a client chooses to utilize the Taxpayer’s services, it can
select from the Taxpayer’s service offerings those services that fit its needs.

If a client contemplates purchasing software from the Taxpayer as well as utilizing the Taxpayer’s
services, the Taxpayer will provide that client with a separate software sales proposal and a
consulting proposal, both of which include cost estimates. The Taxpayer tailors each consulting
proposal according to the specific needs of a client. The Taxpayer prepares separate invoices for the
sale of software and the provision of services. For services performed, the Taxpayer bills a client for
each service that it performs as costs are incurred at an hourly rate. A client can terminate the
Taxpayer’s services at any time.

In instances where the Taxpayer performs installation of software, upgrades/updates to software,
custom development services, and customizations to software, it collects sales tax on the fees it
charges for those services. The Taxpayer may perform any combination of the following other
services (“Additional Services”) upon the request of a client:

Training: The Taxpayer trains its clients on functionality within a software package.

Configuration: The Taxpayer works to configure an ERP software program for a client’s best and
most efficient use. This activity typically involves the Taxpayer’s review of all the front-end
configuration options within the software and assisting the client in making these decisions. Once the
Taxpayer completes its design plans, it uses screens and tools provided by the software publisher to
configure the software. Most of the Taxpayer’s work involves clicking boxes and selecting options
for the front-end screens of the software. In some cases, the Taxpayer uses tools provided by a
software publisher to load lists, such as terms and vendor lists, into the software. In configuring
software for a client, the Taxpayer never programs software or otherwise creates computer code.

Project Management and Client Correspondence: The Taxpayer offers optional project management
and client correspondence services whereby it coordinates projects, schedules resources,
communicates with clients, and reports on the status of projects.

Data Conversion: The Taxpayer assists its clients with loading data into a new module or system. For
example, if a client wants invoice information from its old system copied to the new system, the

Taxpayer can key this information into the front-end of the system or The Taxpayer can load the data
into the system using standard templates completed by the client.

Documentation: The Taxpayer prepares documentation associated with its projects. This
documentation includes system design documentation, client-specific training guides, cheat sheets,
and other general project documentation. The Taxpayer delivers this documentation to clients
electronically.

Testing: The Taxpayer assists with the creation of end user test plans for a client’s use in testing that
the software was configured according to its wishes and functions properly. In addition, a client may

ask the Taxpayer to be on-site while the client performs a test to provide guidance as needed. On
occasion, the Taxpayer may perform services to test for proper software configuration.

Report Writing: At a client’s request, the Taxpayer will provide report writing services associated
with ERP software systems. The Taxpayer utilizes built-in report writer modules that allow end users
to create queries, reports, and screen modifications using functions and screens available within the
front-end of the software system. The Taxpayer uses “click and drag” type interfaces to pull data
from the system in the format needed for reporting purposes. The Taxpayer also may use tool kits
provided by a software publisher to change the appearance of standard reports within a software
application. An example of this type of service would be moving fields around on a report based
upon a client’s request.

The Taxpayer performs a different combination of services for each of its clients, and no two client
proposals or invoices are alike.

RULING
Are the Taxpayer’s Additional Services subject to the Tennessee sales tax?

Ruling: The only Additional Service that, provided on a stand-alone basis, would be subject
to the Tennessee sales tax is the Taxpayer’s provision of its Report Writing service in
instances where that service includes coding or programming that is not merely incidental to
Report Writing. None of the other Additional Services, provided on a stand-alone basis,
would be subject to the Tennessee sales tax. Every other Additional Service is of a type that
generally is not subject to the Tennessee sales tax when sold on a stand-alone basis.
However, charges for Additional Services may be subject to the sales tax if they are required
to be included in the sales price of a taxable item or service.

ANALYSIS
LEGAL BACKGROUND

Under the Retailers’ Sales Tax Act,’ the retail sale in Tennessee of tangible personal property and
specifically enumerated services is subject to the sales tax, unless an exemption applies. “Retail sale”
is defined as “any sale, lease, or rental for any purpose other than for resale, sublease, or subrent.””

TENN. CODE ANN. § 67-6-102(78)(A) (2014) defines “sale” in pertinent part to mean “any transfer of
title or possession, or both, exchange, barter, lease or rental, conditional or otherwise, in any manner
or by any means whatsoever of tangible personal property for a consideration.” “Tangible personal
property” includes “property that can be seen, weighed, measured, felt, or touched, or that is in any
other manner perceptible to the senses.”* Tangible personal property also includes “prewritten
computer software,” which is defined in TENN. CODE ANN. § 67-6-102(68) in pertinent part as

‘ Tennessee Retailers’ Sales Tax Act, ch. 3, §§ 1-18, 1947 Tenn. Pub. Acts 22, 22-54 (codified as amended at TENN.
CODE ANN. 88 67-6-101 to -907 (2013)).

° TENN. CODE ANN. § 67-6-102(76) (Supp. 2014).

3 TENN. CODE ANN. § 67-6-102(89)(A).

“computer software, including prewritten upgrades, that is not designed and developed by the author
or other creator to the specifications of a specific purchaser.”* Conversely, the sale or use of
intangible intellectual property generally is not subject to the Tennessee sales and use tax unless
stored on a tangible storage media.”

In addition to the transfer of tangible personal property, the term “sale” also includes “the furnishing
of any of the things or services” taxable under the Retailers’ Sales Tax Act.° One of the “things”
specifically taxable is:

[t]he retail sale, lease, licensing or use of computer software in this state, including prewritten
and custom computer software . . . regardless of whether the software is delivered
electronically, delivered by use of tangible storage media, loaded or programmed into a
computer, created on the premises of the consumer or otherwise provided.’

“Computer software” is “a set of coded instructions designed to cause a computer . . . to perform a
task.”® Computer software is “delivered electronically” if delivered “by means other than tangible
storage media.”? The Tennessee Supreme Court has stated that the fabrication of, or customized
modification or enhancement to, computer software is considered a taxable sale of computer
software.'°

Additionally, the term “sale” specifically includes the transfer of computer software, including the
creation of computer software on the premises of the consumer and any programming, transferring,
or loading of computer software onto a computer."

The sales tax also applies to retail sales of services specifically enumerated in the Retailers’ Sales
Tax Act.'? One such enumerated service is “the installing of computer software, where a charge is

“ TENN. CODE ANN. § 67-6-102(68) further provides that “‘[p]rewritten computer software’ or a prewritten portion
of the computer software that is modified or enhanced to any degree, where the modification or enhancement is
designed and developed to the specifications of a specific purchaser, remains prewritten computer software.” Note,
however, that “where there is a reasonable, separately stated charge or an invoice or other statement of the price
given to the purchaser for the modification or enhancement, the modification or enhancement shall not constitute
prewritten computer software.” Id.

° Compare Crescent Amusement Co. v. Carson, 213 S.W.2d 27, 29 (Tenn. 1948) (rental films are taxable tangible
personal property), with Commerce Union Bank v. Tidwell, 538 S.W.2d 405, 407 (Tenn. 1976) (finding a tangible
method of data transfer “merely incidental” to the underlying transaction, and thus not subject to sales and use tax).

° TENN. CODE ANN. § 67-6-102(78)(C).

’ TENN. CODE ANN. § 67-6-231(a) (2013). The term “sale” specifically includes the transfer of computer software,
including the creation of computer software on the premises of the consumer and any programming, transferring, or
loading of computer software onto a computer. TENN. CODE ANN. § 67-6-102(78)(K).

° TENN. CODE ANN. § 67-6-102(18).

° TENN. CODE ANN. § 67-6-102(24).

"© See Creasy Sys. Consultants, Inc. v. Olsen, 716 S.W.2d 35, 36 (Tenn. 1986).

" TENN. CODE ANN. § 67-6-102(78)(K).

made for the installation, whether or not the installation is made as an incident to the sale of...
computer software, and whether or not any . . . computer software is transferred in conjunction with
the installation service.”’’ Another enumerated service is “the performing, for a consideration, of any
repair services with respect to any kind of tangible personal property or computer software.”

Many transactions involve more than the sale of a single item or service. When a transaction involves
items or services that are all independently subject to sales tax, the entire transaction is subject to
sales tax, regardless of how the invoice is itemized. Similarly, if all of the items or services are
independently either not subject to sales tax or are exempt, the entire transaction is not subject to
sales tax, regardless of how the invoice is itemized.

However, if a transaction involves a mixture of items that are subject to sales tax and those that are
not, itemization becomes important.'’ In Tennessee, whenever two or more items are sold for a single
sales price and at least one of the items is subject to sales tax, the entire sales price is subject to the
sales tax.'® This treatment derives from TENN. CODE ANN. § 67-6-102(79)(A)(iv), which provides that
the sales price includes “[t]he value of exempt personal property given to the purchaser where
taxable and exempt personal property have been bundled together and sold by the seller as a single
product or piece of merchandise.”'’ Moreover, there is no conceptual reason why bundling principles

' The Retailers’ Sales Tax Act imposes the sales tax only on services specifically enumerated in the Act. See, e.g.,
TENN. CODE ANN. § 67-6-205 (2013); Covington Pike Toyota, Inc. v. Cardwell, 829 S.W.2d 132, 135 (Tenn. 1992);
Ryder Truck Rental, Inc. v. Huddleston, No. 91-3382-II, 1994 WL 420911, at *3 (Tenn. Ct. App. Aug. 12, 1994)
(sales tax does not apply to all services; rather, it only applies to retail sales of services specifically enumerated by
the statute).

'S TENN. CODE ANN. § 67-6-205(c)(6).
‘4 TENN. CODE ANN. § 67-6-205(c)(4).

'’ Separately itemizing an item that, taken in isolation, would not be subject to sales tax is merely a prerequisite to a
claim of non-taxability — it is not the dispositive factor. See AT&T Corp. v. Johnson, No. M2000-01407-COA-R3-
CV, 2002 WL 31247083, at *8 (Tenn. Ct. App. Oct. 8, 2002) (“A taxpayer cannot transform a properly taxable
amount into a nontaxable amount through the simple expedient of a separately stated invoice charge.”).

‘6 Part 1 of Appendix C to the October 30, 2013 Streamlined Sales Tax Agreement defines a “bundled transaction”
in pertinent part as “the retail sale of two or more products, except real property and services to real property, where
(1) the products are otherwise distinct and identifiable, and (2) the products are sold for one non-itemized price.” See
also 2 JEROME HELLERSTEIN ET AL., STATE TAXATION: SALES AND USE, PERSONAL INCOME, AND DEATH AND GIFT
TAXES AND INTERGOVERNMENTAL IMMUNITIES { 19A.04[2][a][iv], at 19A-14 (3d ed. 1998) (defining a “bundled
transaction” as “a transaction in which two or more items that are potentially subject to different tax treatment are
sold for one undifferentiated price”).

Tennessee has statutorily adopted the Streamlined Sales Tax Agreement’s definition, but it is not effective until July
1, 2015. See TENN. CODE ANN. § 67-6-102(8)(A) (Supp. 2014, effective July 1, 2015). Tennessee has also adopted
certain bundled transaction provisions from the Streamlined Sales Tax Agreement that are currently effective, but
they are narrowly applied to telecommunications and related services. See TENN. CODE ANN. § 67-6-539 (2013).

The Streamlined Sales Tax Agreement is notably silent on the tax consequences of a bundled transaction, deferring
instead to state law. TENN. CODE ANN. § 67-6-102(79)(A)(iv) thus controls, regardless of whether the Streamlined
Sales Tax Agreement’s definition of a “bundled transaction” is effective in Tennessee.

” Tennessee addresses the bundled transaction doctrine in the unreported case of Tomkats Catering, Inc. v. Johnson,
No. M2000-03107-COA-R3-CV, 2001 WL 1090516, at *2 (Tenn. Ct. App. Sept. 19, 2001), wherein the Tennessee

should be limited to transaction involving solely tangible personal property, and in fact, Tennessee
case law suggests that these principles apply to bundles of services as well.'®

Finally, not all transactions readily lend themselves to classification for sales tax purposes. In order
to resolve the tension in these difficult transactions, Tennessee courts have developed a line of
inquiry that focuses on what is the “true object”’® of the transaction.”’ In applying this test, the courts
essentially look at the totality of the facts and circumstances”! to determine what objective is really
being accomplished by the transaction.”

If the true object of a transaction would independently be taxable, then the true object and any

“crucial,””’ “essential,” “necessary,” “consequential,””° or “integral””” elements of the transaction

Court of Appeals looked to whether a caterer’s provision of optional wait staff was separate or severable from the
provision of wait staff that was already included in the customer’s purchase of food. The court found that the
provision of optional wait staff was in fact separate, and the inquiry into whether two services are separate and
severable is similar to the Streamlined Sales Tax Agreement’s requirement that bundled products be “distinct and
identifiable.”

The bundled transaction doctrine was statutorily incorporated when the “sales price” definition was amended to
include the language currently codified at TENN. CODE ANN. § 67-6-102(79)(A)(iv). See Act of May 26, 2005, ch.
499, § 68, 2005 Tenn. Pub. Acts 1214, 1234 (codified as amended at TENN. CODE ANN. § 67-6-102(79)(A)(iv)
(Supp. 2014)); cf. TENN. CODE ANN. § 67-6-102(79)(A) (Supp. 2014) (providing that the sales price of a good or
service equals the “total amount of consideration . . . for which personal property or services are sold”).

'8 See generally Tomkats Catering, Inc., 2001 WL 1090516, at *2; see also TENN. CODE ANN. § 67-6-102(8)(A)
(Supp. 2014, effective July 1, 2015).

'. This inquiry is sometimes stated as the “primary purpose” test. See generally Qualcomm, Inc. v. Chumley, No.
M2006-01398-COA-R3-CV, 2007 WL 2827513, at *4-5 (Tenn. Ct. App. Sept. 26, 2007) (giving a synopsis of the
“true object” or “primary purpose” test in Tennessee).

°° This analysis is not entirely unique to Tennessee, but the application of the test does vary in other states. See
generally 2 JEROME HELLERSTEIN ET AL., STATE TAXATION: SALES AND USE, PERSONAL INCOME, AND DEATH AND
GIFT TAXES AND INTERGOVERNMENTAL IMMUNITIES § 12.08[1], at 12-108 (3d ed. 1998 & Supp. 2014) (discussing
the “true object” test).

! See, e.g., AOL, Inc. v. Roberts, No. M2012-01937-COA-R3-CV, 2013 WL 4067977, at 6 (Tenn. Ct. App. Aug.
12, 2013) (basing the holding on the “totality of the circumstances”).

°° Note that it could be possible that there is not a single true object of the transaction, but rather multiple objects of
the transaction. In that case, each object of the transaction should be analyzed separately for tax purposes. Cf.
Penske Truck Leasing Co. v. Huddleston, 795 S.W.2d 669, 670-71 (Tenn. 1990) (holding that a long-term truck
lease agreement and a fuel agreement were truly separate agreements and should be treated as separate transactions
for sales tax purposes, despite being embodied in a single contract document).

3 See, e.g., Thomas Nelson, Inc. v. Olsen, 723 S.W.2d 621, 624 (Tenn. 1987) (holding that a transaction involving
the sale of non-taxable intangible advertising concepts was nevertheless subject to sales tax on the entire amount of
the transaction because advertising models, which were tangible personal property, were an “essential,” “crucial,”
and “necessary” element of the transaction).

4 Td.; see also AT&T Corp. v. Johnson, No. M2000-01407-COA-R3-CV, 2002 WL 31247083, at 8 (Tenn. Ct. App.
Oct. 8, 2002) (holding that a transaction involving the sale of engineering services along with separately itemized
tangible telecommunications systems was subject to sales tax on the entire amount of the contract because
“equipment, engineering, and installation combine in this instance to produce BellSouth's desired result: a

will be subject to sales tax.” In addition, if a taxable component of a transaction is “crucial,”
“essential,” “necessary,” “consequential,” or “integral,” the transaction will be subject to sales tax
even if the true object of the transaction is not independently subject to sales tax.

Only if the true object of the transaction is not independently subject to sales tax and the items that
would be subject to sales tax are “merely incidental” to the true object of the transaction will the
transaction not be subject to sales tax.”°

In practice, the true object test is applied in three specific types of transactions, all of which are
usually capable of being characterized in different manners. These include 1) so called “mixed
transactions,” 2) transfers of tangible personal property in association with a sale of intangible
property, and 3) certain service transactions.”

A “mixed transaction” is generally understood to be a transaction involving the inseparable”! transfer
of tangible personal property along with a service, where at least one aspect of the transaction is

functioning item of tangible personal property assembled on the customer's premises,” and further describing the
engineering services as “‘essential’” and “‘integral’” to the sale of tangible personal property).

°° See supra note 26.

° See Rivergate Toyota, Inc. v. Huddleston, No. 01A01-9602-CH-00053, 1998 WL 83720, at 4 (Tenn. Ct. App.
Feb. 27, 1998) (holding that a transaction involving the commission and distribution of advertising brochures was
subject to sales tax on the “‘entire cost of the transaction’” because, although the transaction involved a number of
services, the brochures themselves “were not inconsequential elements of the transaction but, in fact, were the sole
purpose of the contract”).

“cc

7 See AT&T Corp. v. Johnson, 2002 WL 31247083, at 8.

°° Cf. Crescent Amusement Co. v. Carson, 213 S.W.2d 27, 29 (Tenn. 1948) (holding that a transaction involving the
sale of a license to display motion pictures accompanied by a film reel on which the movies were recorded was a
taxable sale of tangible personal property).

°° In Commerce Union Bank v. Tidwell, 538 S.W.2d 405 (Tenn. 1976), the Tennessee Supreme Court addressed a
situation involving the sale of computer software encoded on a magnetic tape. At the time, computer software was
not subject to sales tax, but magnetic tapes would have been subject to sales tax as the sale of tangible personal
property. See generally id. at 408. The taxpayer argued that the sale was of intangible property, while the Tennessee
Department of Revenue argued that the sales of tangible personal property and should be subject to tax. Id. at 407.
The Court held in favor of the taxpayer, finding that what was actually purchased was intangible information, and
stated that a “[t]ransfer of tangible personal property under these circumstances is merely incidental to the purchase
of the intangible knowledge and information stored on the tapes.” Id. at 408. Although the Court did not, at that
time, present the analysis as a “true object” test, it nevertheless employed the same logic.

3° See KIMBERLY M. REEDER ET AL., TRUE OBJECT OF TRANSACTION AND TAXATION OF SERVICES 2-3 (ABA/IPT
Advanced Sales & Use Tax Seminar Mar. 29, 2006), available at
http://meetings.abanet.org/meeting/tax/IPT06/media/wilson.pdf (last visited July 8, 2014) (offering examples of the
types of transactions that typically give rise to the use of the true object test).

3! Whether business activities are separable does not turn solely on how the activities are itemized and presented to
the customer. As previously stated, separately itemizing an item that would, standing alone, not be subject to tax is
merely a prerequisite to a claim of non-taxability. See AT&T Corp. v. Johnson, 2002 WL 31247083, at *8 (“A
taxpayer cannot transform a properly taxable amount into a nontaxable amount through the simple expedient of a

independently taxable.” For example, a transaction involving the commission of an artist to paint a
portrait could be characterized as either the provision of services or the sale of tangible personal
property.*’ Tennessee generally does not impose a tax on the service of painting portraits, but it does
impose tax on a portrait because it is tangible personal property. Since the sales tax treatment turns
on the characterization of the transaction, courts look to the true object of the transaction to
determine its real character.

Similarly, transfers of tangible personal property in association with a sale of intangible property
raise characterization issues because intangible property rights are generally not subject to sales tax
in Tennessee. For example, in the unreported case of Barnes & Noble Superstores, Inc. v.
Huddleston,™ the Tennessee Court of Appeals held that the sale of a discount card that entitled its
bearer to future discounts on merchandise was not subject to sales tax because, even though tangible
personal property in the form of the discount card was transferred to the customer, the true object of
the transaction was really the purchase of an “intangible right”®’ that was not subject to sales tax.

Finally, some services are themselves inherently difficult to classify because many states, like
Tennessee, only impose the sales tax on enumerated services. In a time when organizations are
outsourcing operations to service providers that were traditionally performed by internal employees,
the question often arises as to whether characterization of the service should be limited to what the
service provider claims to provide, or should be properly characterized according to the true object of
the customer’s broader operation for which service is rendered.” An example of this type of
transaction would be a staffing company providing temporary workers for its client to assist with
repairing tangible personal property.’ Under Tennessee law, the provision of temporary workers is
not a taxable service, but repairing tangible personal property is a taxable service, *” so a court would

separately stated invoice charge.”). If two items are separable, then they should be analyzed as either separate
transactions or, if sold for a single price, as a bundled transaction.

°° The concept of a “mixed transaction” developed from case law analyzing transactions under the Uniform
Commercial Code. The Tennessee Court of Appeals has recognized that “many transactions are neither pure sale of
goods nor pure service transactions, but a combination of the two, i.e. a hybrid contract,” Audio Visual Artistry v.
Tanzer, 403 S.W.3d 789, 797 (Tenn. Ct. App. 2012), and the Tennessee Supreme Court has adopted the
“predominant purpose” test to determine whether a contract involves predominantly the sale of goods or the sale of a
service. See Hudson v. Town & Country True Value Hardware, Inc., 666 S.W.2d 51, 54 (Tenn.1984). This inquiry is
quite relevant under the Uniform Commercial Code since its provisions only apply to sales of goods, see id. at 53,
and the inquiry is remarkably similar to the “true object” test employed in the tax context.

3 See generally 2 JEROME HELLERSTEIN ET AL., STATE TAXATION: SALES AND USE, PERSONAL INCOME, AND DEATH
AND GIFT TAXES AND INTERGOVERNMENTAL IMMUNITIES { 12.08[1], at 12-108 (3d ed. 1998 & Supp. 2014).

** No. 01A01-9604-CH-00149, 1996 WL 596955, at *2 (Tenn. Ct. App. Oct. 18, 1996).

• Td.

°6 See, e.g., TENN. CODE ANN. § 67-6-205.

°” See generally REEDER, supra note 33, at 7-8.

°° Cf. id. at 8-9 (giving the examples of managerial services and hourly labor).

°° See TENN. CODE ANN. § 67-6-205(c)(4).

have to determine the true object of the transaction to determine the sales tax consequences of the
transaction.

In conclusion, in order for a transaction to be subject to sales tax in Tennessee, it generally must
involve: 1) the sale of tangible personal property or computer software in Tennessee; 2) the
furnishing of taxable things or services in Tennessee; 3) a bundled transaction containing at least one
item subject to sales tax; or 4) a transaction where the true object or one of the “crucial,” “essential,”
“necessary,” “consequential,” or “integral” elements thereof are subject to sales tax.

APPLICATION

The Taxpayer sells ERP software, software installation services, and performs software programming
for its clients.“ The Taxpayer also offers Additional Services at an hourly rate, and its customers
may contract for various combinations of these items and services.

To determine the taxability of a transaction,*' it is necessary to determine first whether each type of
Additional Service would be subject to tax on a stand-alone basis since a customer might contract for
only that one type of Additional Service. Then, one must consider how the result might change if the
Taxpayer were to provide a combination of different types of Additional Services and, possibly,
taxable ERP software, software installation, and/or software programming to the same customer.

I. SALES TAX TREATMENT OF EACH TYPE OF ADDITIONAL SERVICE

Each type of Additional Service must be analyzed to determine if the transaction involves the
provision of an enumerated service. If any of the following Additional Services is properly
characterized as an enumerated service, the Taxpayer’s provision of that Additional Service on a
stand-alone basis will be subject to sales tax.

Training

The Taxpayer’s Training services themselves are not the sale of tangible personal property or
computer software. Moreover, through its Training services, the Taxpayer does not fabricate, modify,
or enhance computer software, nor does it perform a specifically enumerated taxable service.
Accordingly, Training services are not taxable on a stand-alone basis.

Configuration

After consulting with a client as to how that client wants to utilize ERP software, the Taxpayer clicks
boxes and selects options already built into that software that give direction within the software. This
service does not constitute the sale of prewritten or custom computer software. Significantly, this
activity does not involve the modification or enhancement of software code; the Taxpayer simply

“° The installation of computer software and the creation of software on its customer’s premises are each subject to
the Tennessee sales tax. See TENN. CODE ANN. §8 67-6-102(78)(K); 67-6-205(c)(6) (2013).

“ Because the Taxpayer’s customers may contract for only a single type of service or multiple combinations thereof,
this ruling cannot specifically address the applicability of the sales tax to all possible scenarios involving sales of the
Taxpayer’s Additional Services.

activates features already coded within the existing software to optimize the software’s functionality.
As such, the Configuration services are not taxable on a stand-alone basis.

Note that because Configuration is often an integral part of the sale of software or a taxable service,
such as software installation, a separately itemized charge for Configuration could nevertheless be
taxable when provided in conjunction with such software or taxable service. See below for further
discussion.

Project Management and Client Correspondence

The Taxpayer states that the Project Management and Client Correspondence service involves its
coordination of projects, scheduling of resources, communication with clients, and reporting on the
status of projects. This type of service does not itself involve the sale of tangible personal property or
computer software. Additionally, this service does not involve the creation, fabrication, modification,
or enhancement of computer software, nor does it constitute a specifically enumerated taxable
service. Thus, Project Management and Client Correspondence services are not taxable on a stand-
alone basis.

Data Conversion

The Taxpayer describes its Data Conversion service as assisting a client in loading that client’s
existing data into a new module or system. This type of service does not involve the sale of tangible
personal property or computer software. Through this service, the Taxpayer is relocating preexisting
data that belongs to its customer and never gains control of such data. Additionally, through this
service, the Taxpayer does not fabricate, modify, or enhance computer software. The Taxpayer also
does not perform a specifically enumerated taxable service. Accordingly, Data Conversion services
are not taxable on a stand-alone basis.

Documentation

The Taxpayer states that through this service it prepares documentation associated with its projects
and transmits this information to clients electronically. Since the documentation is transmitted
electronically, it does not involve a sale of tangible personal property, and electronic records are not
computer software. Documentation services also are not a specifically enumerated taxable service.
Consequently, Documentation services are not taxable on a stand-alone basis.

Testing

When providing testing services, the Taxpayer assists a client with the creation of test plans to
determine if software was configured properly or provides on-site guidance while the client performs
its own test. Testing may further entail the Taxpayer performing services to test for proper
configuration. Testing of computer software, in contrast to the repair or installation of computer
software, is not a specifically enumerated service. Therefore, Testing services are not taxable on a
stand-alone basis.

Report Writing

With regard to its Report Writing service, the Taxpayer states that it utilizes built-in report writer
modules, “click and drag” type interfaces that are part of a software package, and tool kits provided
by a software publisher to generate reports for its clients.

If the Report Writing service involves only the clicking of boxes and selecting of options within an
already existing software program or using “click and drag” interfaces within an existing software
program to run reports, the Taxpayer does not perform customized modifications or enhancements to
software code but rather uses tools provided by a software publisher to optimize software
functionality. Under such particular facts, the Taxpayer’s Report Writing services would not
constitute a specifically enumerated service and, as such, would not be a taxable service on a stand-
alone basis.

Note that if the Taxpayer’s Report Writing service involves an amount of software coding or
programming that is not merely incidental to Report Writing, the Report Writing would be subject to
the sales and use tax as the sale of computer software.”

II. TRANSACTIONS INVOLVING MULTIPLE TYPES OF SERVICES

Transactions involving multiple types of services and items raise additional issues not present when
the Taxpayer provides a single service on a stand-alone basis. Some combinations are relatively
straightforward. For example, if the Taxpayer provides its customer a combination of Additional
Services, all of which are independently not subject to tax, then the entire transaction is not subject to
tax.

However, the Taxpayer may provide its customer a combination of services including some of which
are independently subject to sales tax, particularly if the transaction involves the provision of both
nontaxable Additional Services and taxable items or services. In this case, the result necessarily will
depend upon the totality of the circumstances.

For example, suppose one of the Taxpayer’s contracts requires that it provide Project Management
and Client Correspondence services or Documentation services in conjunction with installing,
creating, or customizing software. Project Management, Client Correspondence, and Documentation
services are not independently taxable services, but if the Taxpayer performs these services in
conjunction with the primary taxable item or service, the circumstances would suggest that such
activity is a “crucial,” “essential,” “necessary,” “consequential,” or “integral” element of providing
the taxable service. The Taxpayer would not be able to effectively perform the taxable service
without the related Project Management, Client Correspondence, or Documentation service.
Separately stating a fee for these elements of a service does not render that fee non-taxable. If the
item or service to which a Project Management, Client Correspondence, or Documentation service
fee relates is a service subject to tax, the Project Management, Client Correspondence, or
Documentation service fee also will be subject to tax as a necessary component of a taxable item or
service.

“ It should be noted that if the Taxpayer charges one sales price for its Report Writing services that covers both
services where the Taxpayer codes and programs software as well as services where the Taxpayer clicks boxes and
selects options within an already existing software program or uses “click and drag” interfaces within an existing
software program to run reports, the entire sales price for Report Writing services would be subject to tax as a
bundled transaction.

Likewise, suppose one of the Taxpayer’s contracts requires the Taxpayer to provide Testing services
in conjunction with creating or customizing software. Testing of computer software is not an
independently taxable service, but if the Taxpayer performs Testing services on the created or
customized software, the circumstances would suggest that the Testing was a “crucial,” “essential,”
“necessary,” “consequential,” or “integral” element of providing the taxable service of creating or
customizing software to ensure that the software meets the customer’s specifications. As such, under
those circumstances, the required Testing services would be subject to sales tax in addition to the
software programming.”

The Taxpayer has described its Additional Services as optional and separate from its sale of ERP
software. If, however, there is an otherwise non-taxable Additional Service that the Taxpayer always
requires be purchased with its sale of either ERP software or a taxable item or service, the totality of
circumstances would indicate that such Additional Service was a “crucial,” “essential,” “necessary,”
“consequential,” or “integral” element of the transaction, and would therefore be subject to sales tax.
For example, if the Taxpayer never sells the ERP software without its Training services, the Training
services would be necessary to complete the sale of the software and, thus, subject to the sales tax.

Along the same lines, if the Taxpayer never sells its otherwise non-taxable Configuration services
separately from its taxable installation of software, the totality of the circumstances might indicate
that the Configuration services would be necessary to complete the sale of the taxable installation
service, and thus subject to the sales tax.

CONCLUSION

To determine the sales tax consequences of its service offerings, the Taxpayer must examine the
totality of the circumstances for each individual client contract. When the Taxpayer sells a
combination of items and services, it should consider whether the circumstances suggest that the true
object of the transaction or any of the crucial elements thereof would be subject to sales tax. If so, the
entire transaction is subject to sales tax.

Jennifer Wilson
Assistant General Counsel

APPROVED: Richard H. Roberts
Commissioner of Revenue

DATE: October 13, 2014

‘8 Alternatively, if the Taxpayer were to provide Testing services in addition to creating or customizing software, but
the Testing services were performed on a different and unrelated piece of software from what the Taxpayer created
or customized, then the transaction would properly be viewed as having two separate objects that should be treated
separately for sales tax purposes. The Testing service in that case would most likely not be subject to sales tax. This
assumes that the Taxpayer separately itemizes the services, thus avoiding any potential bundling issues. However, if
the charges for the nontaxable services are included in the sales price of a taxable good or service, such charges will
be subject to taxation as a bundled transaction.