Back to the Future? Taxation of New Technologies in Tennessee - Using the Same Old Sales Tax Laws

Marty McFly and “Doc” Brown used the infamous DeLorean in the 1980s hit, Back to the Future, to go back in time to find out that while many things had changed, some things had also stayed the same. That can be true in the tax world in Tennessee as well as we see all kinds of new technologies and digital products that are emerging into the marketplace every day. Even though the technologies are new, some of the same old sales tax law still apply.

We have come across several of those situations this year as we see businesses collecting sales tax on various transactions that we have to step back a minute and analyze to understand why the tax is correctly being collected.

Peloton – The Case Study

I have this good friend Brooks who is pretty much on the cutting edge of most everything technology. Standing desk? Bam. Nissan Leaf? Boom. Four Computer Screens? Booyah. Tesla? Bazinga. And now… Peloton. In case you didn’t know, the Peloton is part of an exercise trend where bikers can train with a video-led trainer. No need to leave your house, go to an exercise club or endure the elements. All you need is the Peloton bike, a TV screen/monitor and you pay a subscription fee, and you are off.

How is this related to the @TNTaxLawyer? Well, while all of Brooks’ other transactions were clearly taxable, this one was a little different. The bike was plainly taxable, but what about the subscription fee for all the training videos that are used to train riders? Up until recently, no tax was collected or paid on the subscription fee in Tennessee. That is until Brooks received an email indicating that all future subscriptions fees would be subject to the sales tax.

In his email to me, he expressed outrage and dismay, and in fact, he blamed me. Oh, the life of a tax lawyer… Not representing Peloton and having some background in this area, I was a little confused at first and only speculated as to why the sales tax may be due or at least Peloton thought it was due. I promptly proceeded to forget about it and focus on other billable work.

But, not to be deterred, Brooks continued to remind me of this issue, so I had to dig in and figure it out. If I didn’t, Brooks wouldn’t leave me alone; he’d continue to whine about it, and I decided I had to put this to rest.

Why would it be taxable? I knew that Peloton wouldn’t be collecting the tax if they didn’t have a pretty good idea that it was taxable. There had to be a memo that some tax consultant had prepared somewhere that explained why the subscription fee was taxable. In thinking about it, I considered the following … Digital good? It could be taxable as a digital good, but was that really the true object of the transaction? Hmm. Amusement tax? The sales tax applies to recreation clubs, so it is possible that someone had concluded that the amusement tax applied, but I questioned that too because there is no “place of business,” which is generally part of the trigger for that tax. Was it a bundled transaction? Brooks had to buy the bike, so maybe they viewed it as a bundled transaction and it was all taxable. This seemed less likely since there seemed to be two separate parts of the transaction and seemed to be a stretch for bundling.

I puzzled over this awhile and then I happened to be perusing the Department’s website one day and came across … Tennessee Letter Ruling 17-18, released in December 2017. Dun Dun Duh! I remembered seeing it, but there often so many redactions in a ruling that you cannot figure out what the Department is even ruling, but this one became clear based on Brooks’ email and this ruling. I kind of felt like Frank or Joe Hardy… (Am I dating myself?)

Letter Ruling 17-18

In Letter Ruling 17-18, the Department addressed the applicability of the sales tax to a business that provided “access, via subscription, to online [REDACTED] training courses.” The courses were developed by a network of experts in [REDACTED] disciplines and primarily focused on the fields of [REDACTED]. The business created a virtual classroom that allows people to learn, teach, and connect. The businesses subscribers were able to enhance existing or obtain new [REDACTED] skills enabling them to improve their careers and productivity. The ruling goes on to provide additional details of the [REDACTED] online service. I could be wrong on this, and it doesn’t really matter if I’m correct or not, but if you replace [REDACTED] with cycling in each block, it makes sense that this ruling does or at least could apply to the subscription service offered by Peloton.

The question that the Ruling answered was whether the subscription fee for access to pre-recorded online training courses are subject to the sales and use tax, and the Department answered in the affirmative, citing to Tenn. Code Ann. §67-6-233 (the taxation of digital goods). When the digital goods tax was enacted, it was intended to extend the sales to digital goods that were previously in a taxable tangible form– books, video cassettes, DVDs, CDs, etc., so the rationale for extending the tax here to the subscription to online video courses is rooted in the idea that video cassettes/DVDs offering the same product under previous technology would also be taxable.

Letter Ruling 17-17

Interestingly, the Department also issued Letter Ruling 17-17 at about the same time as Ruling 17-18. Ruling 17-17 concluded that online training courses are also taxable as computer software while live, instructor-led webinars are not subject to sales and use tax because the student is paying to participate in a live class.

Take Away

The Department’s positions in these rulings should be closely examined by companies offering digital, video, or other instruction, training or information for a fee. It appears that the Department will consider most of these services as taxable under some subset of the sales tax unless the service is a live feed where the true object is the live instruction and not the recorded training video. In many cases, groups will record live events and then charge participants to view the recorded training session. In that instance, the live presentation is nontaxable while the recorded presentation is taxable according to the Department.

It's another example of how newer technologies are taxed under the modern sales and use tax, but it is really the application of long-standing sales tax principles. It’s kind of like Back to the Future, except, we are not wearing life preservers, and it didn’t take a DeLorean to get us there.

Brooks’ Question … ANSWERED!

The Dirt on Tennessee's Property Tax: Hot Issues from 2018

Property Tax continues to be the most significant tax that all Tennessee businesses pays annually whether it is on their real property holdings or on personal property that is used as part of the business operations. Considering this, it is always good to stay abreast of some of the hot issues in Tennessee property tax to make sure that businesses are not leaving tax dollars on the table.

Property tax appeals must be filed in early 2019 for the 2019 tax year, so now is a good time to do a review to determine whether you have any opportunity for savings. Common opportunities for savings involve valuation challenges, but there are other issues that can come up as well.

This post looks at some of the more important developments from 2018, which will be helpful in considering what opportunities may exist for appeals in 2019.

Dark Store Valuations

One of the emerging issues across the country and in Tennessee is the dark store assessment theory. The position in these appeals is that sales of vacant stores can be the best comparable for an occupied store. This can be a favorable result over an income approach with the shift in the economy from brick and mortar stores to online retailers and the continued growth of Amazon. These appeals are proceeding in Tennessee, so retailers should be reviewing these opportunities in Tennessee like in many other states.

Procedure, Procedure, Procedure

In a recent Court of Appeals decision, a taxpayer’s appeal was reversed and remanded because the appeal had been filed in the wrong Court. In Tennessee, Chancery Court is the court of jurisdiction for property tax appeals that are not resolved at the administrative level. In 200 Linden Avenue v. Johnson, W2017-02372-COA-R3-CV (September 24, 2018), the Court of Appeals reversed and remanded a case that had been appealed to the Circuit Court instead of the Chancery Court. The Court of Appeals did not even address the substantive property tax issue, instead deciding the case on procedural grounds. A valuable reminder for taxpayers that are unable to resolve cases at the administrative level.

More on Appeal Procedure -Change in Assessment Appeals Commission Authority to Review ALJ Decisions. 

Another important procedural update is that Tennessee has enacted a modification to the appeal process in property tax cases that limits the Assessment Appeals Commission’s (AAC) review authority to accept new evidence on appeal. Based on this change, the AAC’s review of administrative law judge (ALJ) decisions involving property tax will be limited to the proof submitted to the administrative law judge. No additional evidence will be allowed to be presented before the AAC. It will act like an appeals court. Notably, if a case goes to a further appeal to Chancery Court, additional evidence may be presented before the Chancery Court.

Publishing Company Qualifies for Nonstandard Valuation

Memphis Publishing challenged the denial of its nonstandard valuation request for its printing equipment through the administrative appeals process. The Company operated a publishing business and asserted that its equipment should be valued considering functional obsolescence in the printing industry. The ALJ and AAC agreed that a nonstandard valuation was proper but ultimately concluded that the taxpayer had failed to meet its burden of proof of establishing value. On appeal to Chancery Court, Memphis Publishing submitted a new expert appraisal, and the Court determined that the taxpayer could present new evidence on appeal to court. Based on that evidence, the Court awarded Memphis Publishing its nonstandard valuation. Memphis Publishing Co. v. State Board of Equalization, Davidson County Civil No. 15-1073-I (April 25, 2018). While the burden is on the taxpayer, additional proof in the form of a new appraisal may be submitted in a Court challenge. That is what Memphis Publishing did, and they finally were awarded their nonstandard valuation.

Proper Classification of Logging Company

The Taxpayer challenged the taxation of his logging business, arguing that he should be exempt under Tenn. Code Ann. §67-5-216 (farming exemption). In addition to the farming operation, he also transported logs. The State Board of Equalization (SBOE) concluded that because 80% of his revenue was from the sale of logs, he was properly classified under the farming exemption provisions of Tenn. Code Ann. §67-5-216. However, the SBOE noted that his trucking business should be reviewed for future periods by the Office of State Assessed Properties. In re: Revel Logging, LLC, Appeal No. 88076 (July 27, 2018). Farmers should take note of this decision and the future implications for Revel Logging.

Reasonable Cause for Late Filed Appeal Exists based on Chronic Mail Delivery Problems

The taxpayer challenged the valuation of the subject property but missed certain appeal deadlines. On appeal, the SBOE found that there was sufficient evidence of chronic mail delivery problems that substantiated the taxpayer’s claim that it did not receive the assessment change notice. Based on this proof, the SBOE determined that it had jurisdiction and granted a revised valuation of the subject property. In re: Air Serv Corp., Appeal No. 45960 (July 27, 2018). There are several cases decided each year on the failure of a taxpayer to timely appeal. There are some cases in which those appeals may still proceed under a reasonable cause exception, and this is one such case.

SBOE Rejects Assessor’s Correction as Unauthorized

The Assessor changed the valuation of the taxpayer’s property after the valuation date relying on Tenn. Code Ann. §67-5-509, which authorizes changes for clerical errors. The SBOE ultimately concluded that the change in this case was not a mere correction of a clerical error but was a change that required the assessor’s judgment and was therefore improperly changed under Tenn. Code Ann. §67-5-509. In re: Godsey Leasing Co., Appeal No. 47010 (April 16, 2018). Be wary of changes that come after the January 1 valuation date as there is limited authority of an assessor to change a valuation after the original assessment.

This is just a sample of some of the property tax issues that were litigated this year. We will try to periodically summarize some of these decisions, so that businesses can have a better perspective on what appeal opportunities and traps may be out there in Tennessee property tax.