A company hosts proprietary software and offers it two ways: a subscription where the client logs in and uses the software, and an outsourcing package where the company does the work and the client rarely touches the software. Which charges are subject to Tennessee sales and use tax?

Plain-English summary

The company (its identity is redacted) helps Tennessee clients manage documents using its own proprietary software, which it hosts on its own servers; clients reach it over the Internet from within Tennessee. It sells two packages, and the question was which one is taxable.

• Subscription Package: the company licenses the software to the client, who logs in with a username and password and uses the software itself — uploading documents, viewing them, running the built-in tools, and generating reports.
• Business Process Outsourcing (BPO) Package: the client gets the same software, but the company does the work that the client would otherwise do under the subscription. The client keeps a login but "rarely, if ever" uses the software for more than pulling a report.

The Department split the two. The Subscription Package is taxable as remotely accessed software. Since the 2015 remote-software law, when a customer accesses and uses a dealer's hosted software from a Tennessee location, that access is treated as a taxable sale of the software (Tenn. Code Ann. § 67-6-231(a)(2)). The clients use the company's hosted software from Tennessee, and the sole value of the subscription is that software access — so no "true object" weighing was needed; it's simply taxable software.

The BPO Package is not taxable. It bundles the same software access with the company's document-management services, but the Department applied the "true object" test and found the software access is "merely incidental" to the real purpose. Clients buy the BPO package precisely to avoid having to use the software — they're paying the company to do the work — so the company itself is the real user of the software, and the true object is a nontaxable service. When the taxable element (software access) is only incidental to a nontaxable true object, the entire charge is nontaxable. The fact that a service is performed with otherwise-taxable software does not, by itself, make the service taxable.

What this means for you

Software vendors with self-serve vs. done-for-you tiers

The same software can produce opposite sales-tax results depending on who uses it. A self-serve subscription where the customer logs in and operates the software from Tennessee is taxable remotely accessed software. A done-for-you / outsourcing tier where you operate the software and merely deliver a service or result is generally a nontaxable service — provided the customer's own software access is genuinely incidental (here, "rarely, if ever" more than pulling a report).

How the "true object" test works

When a charge bundles a taxable item with a nontaxable service, Tennessee asks what the customer is really buying. If the true object is the nontaxable service and the taxable piece is "merely incidental," the whole charge is nontaxable. If the taxable piece is "crucial," "essential," "necessary," or "integral" — or if its access is the sole value — the whole charge is taxable. Pricing structure and how customers actually use the product both matter.

Accountants and tax professionals

Contrast the two holdings: the Subscription Package is taxable software under § 67-6-231(a)(2) (sole value = access; true-object test unnecessary), while the BPO Package is a nontaxable service because the software is incidental and the vendor is the user — Nashville Mobilphone Co. v. Woods and Equifax Check Services v. Johnson confirm that merely using otherwise-taxable items to furnish a service doesn't make the service taxable. This is the same software-vs.-service axis seen across the Tennessee remote-software rulings (e.g., LR 16-01, LR 16-02, LR 16-07).

Common questions

Q: Is a SaaS subscription taxable in Tennessee?
A: Yes, generally. When a customer accesses and uses a vendor's hosted software from a Tennessee location, that access is taxed as remotely accessed software (§ 67-6-231(a)(2)). Here the subscription was taxable because its sole value was access to the software.

Q: Why wasn't the outsourcing package taxable when it included the same software?
A: Because the true object of the outsourcing package was the company's document-management service, not the software. Clients bought it to avoid using the software themselves, so the software access was "merely incidental," and the company — not the client — was the real user.

Q: Where's the line between taxable software and a nontaxable service?
A: Ask who uses the software and what the customer is really paying for. If the customer logs in and uses the software (and that access is the value), it's taxable. If the vendor uses the software to perform a service and the customer's access is incidental, it's a nontaxable service.

Q: Can I rely on this letter ruling?
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. Confirm your own facts with a tax professional.

Citations and references

Tennessee statutes (Tenn. Code Ann.):

• § 67-6-231(a), (a)(2) (use of computer software; software a customer remotely accesses from Tennessee is a taxable sale)
• § 67-6-205 (sales tax applies only to specifically enumerated services); § 67-6-102(76) ("retail sale"); § 67-6-102(78)(A), (C), (K) ("sale")
• § 67-6-102(18) ("computer software"); § 67-6-102(68) ("prewritten computer software"); § 67-6-102(24) ("delivered electronically"); § 67-6-102(89)(A) ("tangible personal property")
• 2015 Tenn. Pub. Acts Ch. 514, § 22 (2015 remote-software law, effective July 1, 2015)

Cases (true-object / incidental-use):

• Nashville Mobilphone Co., Inc. v. Woods, 655 S.W.2d 934 (Tenn. 1983); Equifax Check Services, Inc. v. Johnson, 2000 WL 827963 (Tenn. Ct. App. 2000) (using otherwise-taxable items to furnish a service does not, alone, make the service taxable)
• 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); and Letter Ruling 14-10 (true-object / bundling)
• Covington Pike Toyota, Inc. v. Cardwell, 829 S.W.2d 132 (Tenn. 1992); Ryder Truck Rental, Inc. v. Huddleston, 1994 WL 420911 (Tenn. Ct. App. 1994) (only enumerated services are taxed); software-as-property Creasy Sys. Consultants, Inc. v. Olsen, 716 S.W.2d 35 (Tenn. 1986) and Univ. Computing Co. v. Olsen, 677 S.W.2d 445 (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/15-07.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
LETTER RULING # 15-07
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 and use tax to remotely accessed software.
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
[REDACTED – TAXPAYER’S NAME] (the “Taxpayer”) is a company located in [REDACTED], Tennessee,
that assists in the management of its clients’ (the “Client” or “Clients”) [SPECIFIED DOCUMENTS]
through an offering of [REDACTED -DESCRIPTION OF BUSINESS SOLUTIONS].

Page: 1

The Taxpayer offers [REDACTED] packages, a Subscription Package and a [BUSINESS PROCESS
OUTSOURCING] Package (“[BUSINESS PROCESS OUTSOURCING] Package”). Through both packages,
the Taxpayer grants a non-exclusive, non-transferable right to access and use its proprietary
software. The Taxpayer hosts the software on its own servers, which the Clients access over the
Internet from locations within Tennessee. The Taxpayer bills its Clients for either package monthly,
quarterly, or annually, depending on the terms of the contract with the particular Client.
Subscription Package
Under its Subscription Package, the Taxpayer licenses its proprietary software to the Client. The
Client accesses the software via a web portal with a username and password. The software provides
the Client with a central depository to view [SPECIFIED DOCUMENTS] and permits the Client to
[REDACTED - DESCRIPTION OF VARIOUS ACTIONS]. To achieve this result, the Client’s [REDACTED]
information is uploaded into the software, along with the [SPECIFIED DOCUMENTS] on a monthly
basis. Typically, these [SPECIFIED DOCUMENTS] are received in an electronic format and
automatically uploaded to the software. However, if the Taxpayer receives a paper [SPECIFIED
DOCUMENT], the Taxpayer scans the [SPECIFIED DOCUMENT] into an electronic format and uploads
it to the software.
Upon the upload of [SPECIFIED DOCUMENTS], the software automatically populates key data fields,
such as [REDACTED]. Clients typically use the software to [REDACTED – DESCRIPTION OF VARIOUS
ACTIONS].
[REDACTED].
[BUSINESS PROCESS OUTSOURCING] Package
Under the [BUSINESS PROCESS OUTSOURCING] Package, the Taxpayer provides the Clients with the
identical proprietary software that it provides under the Subscription Package; however, the
Taxpayer provides services under the [BUSINESS PROCESS OUTSOURCING] Package that the Client
would perform itself under the Subscription Package, including [REDACTED - DESCRIPTION OF
VARIOUS ACTIONS]. Although the Client maintains access to the software under the [BUSINESS
PROCESS OUTSOURCING] Package, it rarely, if ever, uses the software for more than generating a
report.

RULING

1. Are the Taxpayer’s charges for the Subscription Package subject to Tennessee sales and use
   tax?
   Ruling: Yes, the Taxpayer’s Subscription Package is subject to the Tennessee sales and use
   tax as remotely accessed software.
2. Are the Taxpayer’s charges for the [BUSINESS PROCESS OUTSOURCING] Package subject to
   the Tennessee sales and use tax?

Page: 2

Ruling: No, the Taxpayer’s [BUSINESS PROCESS OUTSOURCING] Package is not subject to the
Tennessee sales and use tax. Although the [BUSINESS PROCESS OUTSOURCING] Package
includes both remotely accessed software and services, the true object of the [BUSINESS
PROCESS OUTSOURCING] Package is the provision of nontaxable [BUSINESS PROCESS]
management services.
ANALYSIS
LEGAL BACKGROUND
Under the Retailers’ Sales Tax Act,1 the retail sale in Tennessee of tangible personal property and
specifically enumerated services are subject to the sales and use 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.”2
TENN. CODE ANN. § 67-6-102(78)(A) (Supp. 2015) 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.”3 Tangible personal property also includes
“prewritten computer software,” which is defined in TENN. CODE ANN. § 67-6-102(68) in pertinent part
as “computer software, including prewritten upgrades, that is not designed and developed by the
author or other creator to the specifications of a specific purchaser.”4
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.5 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

1

Tennessee Retailers’ Sales Tax Act, Ch. 3, §§ 1-18, 1947 Tenn. Pub. Acts Ch. 22, §§ 22-54 (codified as amended
at TENN. CODE ANN. §§ 67-6-101 to -907 (2013 & Supp. 2015)).
2

TENN. CODE ANN. § 67-6-102(76) (Supp. 2015).

3

TENN. CODE ANN. § 67-6-102(89)(A).

4

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.

5

TENN. CODE ANN. § 67-6-102(78)(C).

Page: 3

programmed into a computer, created on the premises of the consumer or
otherwise provided.6
“Computer software” is “a set of coded instructions designed to cause a computer . . . to perform a
task.”7 Computer software is “delivered electronically” if delivered “by means other than tangible
storage media.”8 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.9
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.10
In response to advances in technology that allow the remote access and use of software over the
Internet, the Tennessee General Assembly adopted into law 2015 Tenn. Pub. Acts Ch. 514, § 22. This
new law effectively treats all uses of computer software in this state equally, regardless of how a
person accesses the software. It amends TENN. CODE ANN. § 67-6-231(a) to include a new subdivision
(2), which states in pertinent part that
[f]or purposes of subdivision (a)(1), “use of computer software” includes the access
and use of software that remains in the possession of the dealer who provides the
software or in the possession of a third party on behalf of such dealer. If the
customer accesses the software from a location in this state as indicated by the
residential street address or the primary business address of the customer, such
access shall be deemed equivalent to the sale of licensing of the software and
11

electronic delivery of the software for use in the state.

As a result, effective for all billing periods beginning on or after July 1, 2015, the access and use of
12

computer software in this state, which has generally been subject to tax since 1977,
subject to sales and use tax regardless of a customer’s chosen method of use.

remains

6

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).

7

TENN. CODE ANN. § 67-6-102(18).

8

TENN. CODE ANN. § 67-6-102(24).

9

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

10

TENN. CODE ANN. § 67-6-102(78)(K).

11

2015 Tenn. Pub. Acts Ch. 514, § 22 (codified at TENN. CODE ANN. § 67-6-231(a)(2) (Supp. 2015)).

12

The General Assembly amended the definition of “tangible personal property” in 1977 to specifically include
computer software in response to the Tennessee Supreme Court’s holding to the contrary in Commerce Union
Bank, 538 S.W.2d at 408. 1977 Tenn. Pub. Acts Ch. 42 (defining “tangible personal property” to include computer
software); see also Univ. Computing Co. v. Olsen, 677 S.W.2d 445, 447 (Tenn. 1984) (detailing the General
Assembly’s actions taken to subject computer software to sales and use tax).
Page: 4

The sales and use tax also applies to retail sales of services specifically enumerated in the Retailers’
Sales Tax Act.13 Notably, the application of the sales tax to retail sales of services in Tennessee
remains unaffected by the enactment of 2015 Tenn. Pub. Acts Ch. 514, § 22. The sales tax remains
applicable only to those services specifically enumerated in the Retailers’ Sales Tax Act.14 As
reassurance of this fact, the General Assembly included language in Section 22 stating that nothing
in the new subdivision (a)(2) of TENN. CODE ANN. § 67-6-231
shall be construed to impose a tax on any services that are not currently subject to
tax under this chapter, such as, but not limited to, information or data processing
services, including the capability of the customer to analyze such information or data
provided by the dealer; payment or transaction processing services; payroll
processing services; billing and collection services; Internet access; the storage of
data, digital codes, or computer software; or the service of converting, managing,
15

and distributing digital products.

Therefore, while the new TENN. CODE ANN. § 67-6-231(a)(2) modernizes taxation on the use of
computer software in this state, it has no effect on the taxation of services.
Additionally, 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 as a bundled
transaction.16 Finally, when a transaction involves taxable and nontaxable components and the
transaction’s true object or a “crucial,”17 “essential,”18 “necessary,”19 “consequential,”20 or “integral”21

13

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-III, 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).

14

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-III, 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).

15

2015 Tenn. Pub. Acts Ch. 514, § 22 (codified at TENN. CODE ANN. § 67-6-231(a)(2) (Supp. 2015)).

16

See generally Tenn. Dept. of Rev. Ltr. Rul. 14-10 (Oct. 14, 2014) [hereinafter “Ltr. Rul. 14-10”] (discussing
Tennessee
law
regarding
bundling
and
the
“true
object”
test),
available
at
http://www.tennessee.gov/assets/entities/revenue/attachments/14-10.pdf.

17

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).

18

Id.; 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
Page: 5

element of the transaction is subject tax, the entire transaction is subject to sales tax.22 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.23
APPLICATION
1.

SUBSCRIPTION PACKAGE

The Taxpayer’s Subscription Package is subject to the Tennessee sales and use tax.
Prior to the enactment of 2015 Tenn. Pub. Acts Ch. 514, § 22, effective July 1, 2015, no sale, transfer,
or electronic delivery of tangible personal property or computer software occurred in Tennessee
when the Taxpayer charged its Clients for the Subscription Package. However, the Taxpayer’s
Subscription Package now constitutes a taxable sale as remotely accessed software.
With respect to the taxable use in this state of computer software that remains in possession of the
dealer, TENN. CODE ANN. § 67-6-231(a)(2) requires the access and use of the computer software by a
customer within this state. The Taxpayer’s software is a set of coded instructions that enables a
computer to perform a task and, thus, constitutes computer software for Tennessee sales and use
tax purposes.24 The Taxpayer’s software is housed on its own server, but the Clients use this
software to manage their [REDACTED - BUSINESS PROCESS] from within Tennessee.
Analysis under the principles set forth in the “true object” test is unnecessary because the sole value
of the Subscription Package is the access to the software.
Accordingly, the Subscription Package is subject to the Tennessee sales and use tax as remotely
accessed software.
“equipment, engineering, and installation combine in this instance to produce BellSouth's desired result: a
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).
19

See supra note 18.

20

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”).
21

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

22

See generally Ltr. Rul. No. 14-10, supra note 16.

23

See generally id.

24

The Taxpayer does not provide nontaxable data processing services through its Subscription Package.
Instead, the Clients use the Taxpayer’s data processing software to process information contained in their
[SPECIFIED DOCUMENTS].

Page: 6

2. [BUSINESS PROCESS OUTSOURCING] PACKAGE
The Taxpayer’s [BUSINESS PROCESS OUTSOURCING] Package is not subject to the Tennessee sales
and use tax.
The [BUSINESS PROCESS OUTSOURCING] Package includes both the provision of [REDACTED BUSINESS PROCESS] management services and access over the Internet to the Taxpayer’s
proprietary software. However, the Clients’ access of the software is merely incidental or secondary
to the primary purpose of outsourcing the Clients’ [REDACTED - BUSINESS PROCESS] management
operations whereby the Taxpayer [REDACTED = DESCRIPTION OF VARIOUS ACTIONS]. The value of
the [BUSINESS PROCESS OUTSOURCING] Package is in avoiding the need to use the Taxpayer’s
software, and to this end, the Taxpayer is the ultimate user of the software. Thus, the true object of
the transaction is the provision of nontaxable services.25
Accordingly, the [BUSINESS PROCESS OUTSOURCING] Package is not subject to the Tennessee sales
and use tax.

Grant Marshall
Assistant General Counsel

25

APPROVED:

Richard H. Roberts
Commissioner of Revenue

DATE:

November 23, 2015

See, e.g., Nashville Mobilphone Co., Inc. v. Woods, 655 S.W.2d 934, 937 (Tenn. 1983) (providing that merely using
otherwise taxable items in order to furnish a service does not alone subject the transaction to sales and use tax
if the primary purpose of the sale is nontaxable); Equifax Check Services, Inc. v. Johnson, No. M1999-00782-COAR3-CV, 2000 WL 827963 at *3 (Tenn. Ct. App. June 27, 2000) (same).

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