Tax Update Blog: Permalink

« Previous · Tax Update Blog Home · Next »

HOW SOFTWARE DEVELOPERS FIND THEMSELVES TAXED IN IOWA

June 29, 2006

The Iowa Department of Revenue this week released a letter responding to a software developer's questions about Iowa taxes. It shows how little contact a company needs in Iowa to be taxable here. It's also worth looking at because other states apply similar standards to drag companies into their income tax system. Public Law 86-272 is the federal statute that sets the bar for when you are subject to income tax in the state. The way Iowa applies the rules, taking care of your Iowa customers can have unpleasant tax side effects.

The facts:

Your scenarios assume that the software developer does not have an office in Iowa or a permanent sales staff in Iowa. The software is not sold, but the developer licenses the right to use software to an end user. As part of the transaction, the software developer may or may not send someone to the user’s office for installing the software and training the user on the software. The developer also contracts to provide continuous support and maintenance to each customer, and the contract typically breaks out a separate fee for each service.

So - does simply licensing software for use in Iowa make you taxable here? No:

The mere grant of the right to use the developer’s software does not, by itself, create Iowa corporation income tax nexus.

OK, what if you actually provide service to a customer? Bad news:

Sending an employee into Iowa to install and/or train the use does create Iowa corporation income tax nexus. As noted previously, the protection of Public Law 86-272 does not apply in this instance, so any physical presence in Iowa by an employee of the software developer is sufficient to create corporation income tax nexus.

Even if you only send them in for a day?

There is no minimum period of time needed to be in Iowa to create corporation income tax nexus. As noted previously, the de minimus exception in Public Law 86-272 does not apply in this instance, so any period of time spent in Iowa is sufficient to create nexus.

This can create unpleasant results. Iowa apportions taxable income here based solely on sales; most states also take property and payroll into account. That's a great formula for Iowa-based companies, but it can make non-Iowa companies taxable quickly at rates up to 12% - the highest in the nation.

The entire contract with an Iowa customer will be considered an Iowa receipt for corporation income tax purposes. Once nexus is established, the entire amount of income received from an Iowa customer will be considered Iowa receipts.

Well, Mr. Software Company won't ever make that blunder again; they'll avoid us forever. Do they ever get off the hook here?

Nexus for corporation income tax is determined on a year-to-year basis, and if a nexus activity occurs during the year, then the corporation has nexus for the entire year. For example, if on-going service and maintenance is performed by employees in Iowa, then the software developer has nexus in Iowa for that year. Also, if the service and maintenance occurred outside Iowa for a particular year, but nexus was created in that year due to installation, any income received from the on-going service and maintenance would be considered an Iowa receipt.

So if they steer clear of the land between the rivers from now on, they're off the hook. But it's not easy.

 • Iowa Tax Law       Bookmark: del.icio.us • Digg • reddit