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Ruling defines tax status of modified software

By: dmc-admin//July 21, 2008//

Ruling defines tax status of modified software

By: dmc-admin//July 21, 2008//

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A recent state Supreme Court decision gave clarity to the somewhat cloudy issue of what types of computer software are exempt from Wisconsin sales tax.

In the wake of the 4-3 decision in favor of the Menasha Corp., a software installation company based in Neenah, some business attorneys say the ruling provides a sense of closure on the subject.

“There was a lot of confusion as to what sales tax should be paid if any [on customized software] and it’s nice to have a sense of finality from the Supreme Court,” said attorney Rebecca L. Bradley, chairperson-elect of the State Bar’s Business Law Section.

Bradley served as in-house counsel for software company RedPrairie Corp., before rejoining Whyte Hirschboeck Dudek, S.C., in Milwaukee.

While she does not expect the decision to generate further litigation unless the tax code is revised, Bradley and others anticipate other computer technology consumers may file for tax refunds in the wake of the decision.

“I can’t speak to specific clients of ours, but I’d imagine they will do their internal reverse audit and determine if they have a claim,” said Kevin J. Howley of Reinhart Boerner Van Deuren, S.C., in Milwaukee. “Large purchasers of custom software may have some money coming back to them.”

Costly Decision

Estimates from the Legislative Fiscal Bureau suggest the state could be responsible for more than $265 million in tax refunds and another $28 million in tax revenue will be lost this fiscal year because of the decision.

Jessica Iverson, spokesperson for the Wisconsin Department of Revenue (DOR), said that officials are still evaluating the impact of the decision. She did not know how many companies may ultimately seek refunds or interest, but so far 240 have filed claims or plan to do so in the future.

“We are still digesting the decision and its impact on the customization [of software] issue as well as deference,” said Iverson.

In the ruling, authored by Justice Annette K. Ziegler, the majority court said that a computer system purchased by Menasha in 1995 was customized and therefore exempt from state sales tax codes.

Pre-packaged, off-the-shelf software like that found at the local Best Buy is taxable under the current administrative tax code.

Maureen A. McGinnity was one of the attorneys who represented Menasha. She said the court’s ruling gives business attorneys a better sense of what types of software is taxable or custom.

“The question was how much effort does it take to make software useable for customers?” said McGinnity of Foley & Lardner, LLP, in Milwaukee. “Undoubtedly, there will be other cases that come forward which ask to apply a standard to different types of computer programs.”

In a statement, Revenue Secretary Roger M. Ervin called for revisions to the current sales tax statutes to reflect the evolution of the software industry. The current rule applied by the state Tax Appeals Commission in the case was adopted in 1987.

Dissenting Opinion

The ruling also gave power to the Tax Appeals Commission as the “final authority for hearing and determinations of all questions of law and fact,” when it comes to tax matters, Ziegler wrote in the decision.

In 2004, the Dane County Circuit Court sided with the DOR and denied Menasha its claim that it was owed more than $342,000 in tax refunds. The Court of Appeals reversed the ruling last year.

Bradley said in this case, the Supreme Court properly gave deference to the Tax Commission as the authoritative body.

“Courts at various levels don’t understand software, and think of it as something used in daily life like Excel and Word where you get a disk, plug it in and use it,” said Bradley.

“That’s not the case here, and there is very little argument to be made that the software was not customized.”

In her dissent, Chief Justice Shirley S. Abrahamson expressed concern that Wisconsin taxpayers will now have to foot the bill for the Department of Revenue’s mistake.
“Wisconsin taxpayers will pick up the tab by those who have escaped taxation as a result of the majority opinion,” wrote Abrahamson.

But McGinnity said that the decision ultimately saves the consumer time and money from having to litigate to what extent software can be customized, and whether it is taxable.

“I think the impact of the decision is it avoids the necessity of other taxpayers having to litigate these issues,” said McGinnity. “In this case the state mistakenly collected taxes, and now has to give it back.”

The case is Wisconsin Department of Revenue v. Menasha Corporation, 2004AP3239.

Portions of this story came from the Associated Press.

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