Patrick’s Software Tax Plan Opposed by Tech Industry

A new proposal by Gov. Deval Patrick to broaden the types of software services that can be taxed is already running into opposition from the tech industry.

In his budget proposal for the state’s next fiscal year, Patrick proposes taxing a range of software services that are not currently taxed by the state’s Department of Revenue, to raise at least $265 million a year in new revenue.

If the Legislature agrees, a sales tax would be imposed on standardized software that is modified or customized. For example, if a company called Deloitte and asked for a software solution that was customized to its business, that would be a taxable service. In addition, disaster recovery services, data storage and data processing services would be taxed. Downloaded books, music, videos or ring tones as well as computer facilities management services would remain tax-free, under Patrick’s plan.

The new proposal’s goal would be to simplify what state officials consider a confusing area of tax law known as software-as-a-service, said David E. Sullivan, general counsel at the Executive Office for Administration and Finance.

The state Department of Revenue proposed the new taxes on software services to button up areas of the law that currently raise many questions among software vendors and clients, Sullivan said. In the same vein, the DOR last month issued a draft directive, attempting to explain what software services are already taxable under current law, and software industry leaders have been grappling to digest it.

But the new proposal to broaden the tax umbrella is what has them concerned, even though state officials call it an effort to bring Massachusetts’ tax laws up-to-date with technology.

“That provision is overwhelmingly opposed by the tech community,” said Christopher Anderson, president of the Massachusetts High Technology Council.

The organization polled its members about the governor’s entire tax proposal, including the provision to broaden the tax on software-as-a-service, last month. Anderson said 77 percent of respondents said they were opposed to Patrick’s expansion of software-as-a-service taxes, and 85 percent said that they generally think of Massachusetts as a less competitive state to do business than other states.

“On balance, I think we’re taxing software employers (in Massachusetts) to a greater extent,” Anderson said.

Sullivan said that a related proposal from Patrick to reduce sales tax from 6.25 percent to 4.5 percent should offset any perceived increase in taxes on the software industry. In addition, Sullivan said, the governor’s proposal includes a change in the way such services are taxed in other states, in a way that could benefit the software industry.

With this, a software company headquartered in Massachusetts and selling software services to customers in another state would only be taxed in the other state. Currently, companies headquartered in Massachusetts are taxed in both states, Anderson said.

“This would be a positive development for Massachusetts-headquartered companies,” Anderson said. “The value for a stronger economy is to support companies that are headquartered in Massachusetts.”

Meanwhile, software companies and others in the industry are grappling with the DOR’s draft directive, which clarifies current state regulations covering the software industry.

The draft directive came at the request of many in the industry who were not clear about how the DOR decides whether certain software services should be taxed, according to a spokeswoman for the department.

For example, is cloud computing taxed or not? Under current tax regulations, the mere storage of data “in the cloud” would not be taxed. But if a vendor provides software in a cloud-computing environment for clients to perform calculations, that service would be taxable, according to the DOR.

Under the governor’s budget proposal, data storage would be taxed moving forward.

David Moran, who represents software companies as a lawyer at Boston-based Gesmer Updegrove, called the department’s approach a “self-serving approach to technology.”

“They make it up as they go along and they try to catch more and more companies’ transactions in a way that they analyze in their own best interest,” Moran said.