Court case offers new guidance for sales tax on data processing services in Washington

If your revenue involves digital goods and services, you’ve noticed more states are expecting you to collect and remit sales tax on them. But sometimes the legal language regarding what’s taxable or nontaxable becomes a gray area and a judge has to step in to decide what it means.

That’s what happened when a Washington Court of Appeals recently ruled that a company’s collection of data from electric and natural gas meters is a tax-exempt data processing service.

The company involved in the case collected the meter data of an energy company’s customers, converted the data, then transmitted it to an energy company so that it could be used for customer billing.

In the Evergreen State, the tax code defines data processing services – which are a noteworthy exception to otherwise taxable digital automated services – as “primarily automated services … where the primary object of the service is the systematic performance of operations by the service provider on data supplied in whole or in part by the customer to extract the required information in an appropriate form or to convert the data to usable information.”

However, the Department of Revenue (DOR) of Washington State told the company it owed retail sales tax because its services weren’t a tax-exempt form of data processing.

The DOR told the court the primary purpose or “true object of the services” was the collection and transmission of data, not data processing.

Meanwhile, the company argued that the primary purpose of its services was the manipulation and conversion of data into information that its customers could use, and is more complex than merely transmitting data.

Why the company didn’t have to pay sales tax

Relying on legal precedent, the court concluded that the company was indeed primarily providing data processing services. Under Washington law, transactions involving those services are exempt from retail sales tax.

When weighing the nuances of whether the digital services in question were just plain transmission of data or manipulation/conversion of data, the court determined it was the latter because the company:

1. converted the data into “an appropriate form” in a process that takes several hours to complete
2. quantified the information, and
3. identified patterns in the information.

Without the data conversion services that the company performed, the data would be useless to the customer, the court said.

Bottom line: Don’t pay for what you don’t have to. State revenue departments don’t know your products and services as well as you do. If you’re being assessed for something you know is exempt under that state’s tax laws, huddle with your legal department to see if it’s worth disputing.