June 01--BOISE -- Multimillion-dollar software installations by corporations will be tax-free in Idaho on July 1, while downloads of e-books or entertainment software will still be taxed under a new law that goes into effect that day.
The state stands to lose as much as $40 million a year in sales taxes in the future, much of that from large software system upgrades at big businesses.
It all stemmed from efforts by the Idaho Technology Council and businesses to get Idaho lawmakers to remove sales taxes from "cloud" services, where the software is accessed remotely and isn't installed on a business's own computers. Legislation in 2013 granted a sales tax exemption for the use of cloud-based software, after tech businesses told lawmakers that some likely would leave Idaho without such an exemption.
That new law didn't exempt the three other ways of delivering software: buying a physical disk; downloading software online; or installations of major enterprise software systems at businesses done through the "load and leave" method, where the vendor comes to the business and installs the software, then leaves it.
This year, the Technology Council came back to the Legislature and said the first "cloud" exemption wasn't working, that the state Tax Commission's interpretation of it was too narrow. The council, joined by some of the state's largest businesses, pushed legislation to exempt both downloaded and load-and-leave software sales, too.
Backers of the bill touted it as treating cloud-based services like other tax-exempt services, from health care to haircuts.
But the biggest beneficiaries may be banks, hospitals and other large businesses when they upgrade their internal software systems, regardless of whether remote access is involved.
The Tax Commission itself is in the midst of an upgrade to the new GenTax system, which is costing the state $5.2 million. That's an example of a transaction that, if it were at a private business, would currently be subject to sales tax, but would become tax-exempt as of July 1. Much of the new software for the big upgrade was transferred to the commission electronically as part of the purchase.
Rich Jackson, chairman of the Idaho Tax Commission, said the 2013 bill seemed clear, but questions arose during rule-making sessions about everything from the tax status of downloaded e-books and video games to what "load and leave" really meant.
In response, said Jay Larsen, Technology Council president, "We took the ambiguity out. We had to make it a broader bill."
When the bill was in the Legislature, its fiscal note estimated it would cost the state general fund between $2 million and $5 million a year. The Tax Commission estimated the first-year cost at $8 million, rising quickly to $40 million a year.
Former state chief economist Mike Ferguson, now head of the Idaho Center on Fiscal Policy, analyzed the bill and found its fiscal impact "grossly understated." He agreed with the Tax Commission's estimates that the fiscal hit to the state would quickly rise to $40 million a year.
"What I'm baffled by is how that's supposed to help the technology industry," Ferguson said. "What it'll do is create a huge hole in the revenue stream. ... It'll make it a lot harder to provide public and higher education, which seems to me to be a pretty big factor in making a place attractive to companies that require highly skilled, highly educated workforces."
The new bill, House Bill 598, excludes entertainment items like e-books but adds the two other delivery categories to the exemption, giving Idaho one of the nation's broadest tax exemptions for software sales. As of July 1, when the law takes effect, the only software sales that will be taxable in Idaho will be those where the purchaser buys the software on a physical storage item, like a TurboTax disk. The same TurboTax program downloaded online will be tax-free.
Ron Alt, senior research manager at the Federation of Tax Administrators, said that's a situation most tax laws try to avoid. "You don't want to be changing how you tax something based upon how it's delivered; you want to treat the taxpayers the same," he said. "That way, you don't distort the economy, you don't create distortions in decision-making."
Larsen, of the Technology Council, said if necessary, his group could seek amendments to the bill next year. "We're going to have to continue to come back to the Legislature on this, because actually how we deliver software five years from now will probably be significantly different than it is today," he said.
Jackson said that after this summer's rule-making sessions, some changes to the law could be proposed. "The policymakers have spoken -- we have to administer the law," he said. "If we find flaws in that, we will draw it to the policymakers' attention."
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