Is Software as a Service (SaaS) Taxable in Tennessee?

Software as a Service (SaaS) has transformed how businesses and individuals access technology, moving from traditional software installations to cloud-based subscriptions. This shift introduces complexities concerning sales tax obligations, especially in states like Tennessee. This article clarifies the tax implications of SaaS in Tennessee for businesses operating within or selling to customers in the state, addressing common inquiries about its taxability and specific conditions.

Understanding Software as a Service for Tax Purposes

Software as a Service (SaaS) refers to software applications hosted by a vendor and made available to customers over the internet, typically on a subscription basis. Unlike traditional software, which is downloaded and installed on a user’s device, SaaS remains on the provider’s servers, accessible remotely. The vendor is responsible for maintaining the software, including updates and infrastructure.

Tennessee’s tax framework generally categorizes “software” as tangible personal property, especially when delivered electronically. This classification is important because the sale or lease of tangible personal property is typically subject to sales tax. While SaaS provides a service, its underlying nature as software often influences its tax treatment.

SaaS differs from pure professional services, such as consulting, where the primary object is human expertise rather than access to a digital product. However, the distinction can become nuanced, particularly when a service includes an incidental software component. The state’s approach often considers whether the software itself is the true object of the transaction or merely a tool used to deliver a non-taxable service. Both prewritten and custom computer software are generally subject to sales tax in Tennessee.

Tennessee’s Sales Tax Application to SaaS

Tennessee broadly applies its sales and use tax laws to Software as a Service. The state expanded its taxation of cloud computing, including SaaS, through the Revenue Modernization Act of 2015, with provisions effective July 1, 2015. Under these rules, amounts charged for remotely accessed software that remains in the seller’s possession are subject to sales and use tax if accessed from a location within Tennessee. This tax applies regardless of whether the charge is per use, per user, per license, or on a subscription basis.

Tennessee Code Section 67-6-231 specifically taxes the sale, lease, license, and use of computer software when provided to customers in the state. The “use of computer software” explicitly includes access and use where the seller retains possession of the software. This statutory language forms the basis for taxing SaaS transactions.

The state employs a “true object test” to determine the taxability of transactions that involve both taxable and non-taxable components. If the primary purpose, or “true object,” of a transaction is a non-taxable service, and the software access is merely incidental to that service, the entire transaction may not be subject to sales tax. Conversely, if the software itself is the essential element, the transaction is taxable.

For example, services such as information or data processing, payment processing, payroll processing, billing, and internet access are generally not taxable services in Tennessee. If a SaaS offering is primarily one of these non-taxable services, and the software access is only a means to deliver it, the “true object test” could deem the transaction non-taxable. However, if the online platform provides direct functionality and is the core offering, it is likely considered taxable remotely accessed software.

Specific Exemptions and Non-Taxable Scenarios

While Software as a Service is generally taxable in Tennessee, certain exemptions and non-taxable scenarios can apply.

Sales for Resale

One common exemption is for sales made for resale. If a business purchases SaaS with the explicit intent to resell access to it, and provides a valid Tennessee resale certificate, the initial purchase may be exempt from sales tax. This exemption typically requires proper documentation to be maintained by the seller.

Exempt Organizations

Another significant area of exemption involves sales to qualifying exempt organizations. Governmental entities, educational institutions, and certain nonprofit organizations are often exempt from Tennessee sales tax on their purchases, including SaaS. These organizations typically need to apply for and obtain an official exemption certificate from the Tennessee Department of Revenue to qualify for tax-exempt purchases.

Incidental Services

Beyond organizational exemptions, some scenarios are considered non-taxable based on the nature of the service provided. If the SaaS is merely incidental to a larger, non-taxable professional service, the transaction may not be subject to sales tax. For instance, if a company provides data analytics services, and access to a software platform is solely for viewing the results of those services rather than directly manipulating the software’s functionality, it might be non-taxable.

Internal Software Development

Tennessee offers an exemption for the fabrication, installation, and repair of computer software by a person, including their agent or direct employee, for that person’s own use and consumption. This also extends to the access and use of software that remains in the possession of the dealer or a third party, if it is exclusively used by a person or their agent/employee for the purpose of fabricating other software that is owned by and for that person’s own use. This specific exemption aims to avoid taxing internal software development efforts.

Calculating and Remitting Tennessee Sales Tax

Businesses selling taxable Software as a Service in Tennessee must correctly calculate and remit the sales tax due. The sales tax applies to the total taxable sales price of the SaaS subscription, whether it involves monthly fees, annual contracts, or other payment structures. For services accessed in multiple states, Tennessee allows for the allocation of the sales price based on the percentage of users located within Tennessee, ensuring only the portion used in the state is taxed.

The statewide sales tax rate in Tennessee is 7%. In addition to the state rate, local sales taxes are also imposed, which vary by jurisdiction. These local rates can bring the combined state and local sales tax rate to an average of around 9.55% or potentially up to 9.75% or even 10% in some areas.

Before collecting sales tax, businesses must register for a sales tax permit with the Tennessee Department of Revenue. This is required for any business that has a physical presence or an economic nexus in the state. Economic nexus is established if a business exceeds $100,000 in gross sales to Tennessee customers within a calendar year. Registration can typically be completed online through the Tennessee Taxpayer Access Point (TNTAP) and generally does not involve a fee.

Once registered, businesses are required to file periodic sales tax returns, typically on a monthly, quarterly, or annual basis, with the frequency determined by their sales volume. Returns and payments are generally due by the 20th of the month following the reporting period. Businesses can file and remit collected sales tax electronically through the TNTAP portal, which is the preferred method, or by mailing in the appropriate form. Accurate record-keeping of all sales, invoices, and any claimed exemptions is necessary for compliance and should be maintained for at least three preceding tax years.