The Texas Comptroller has traditionally taken a broad view of what constitutes a taxable “data processing service.” However, one recent Texas Court of Appeals decision rebuked this interpretation with a ruling that presents wide-ranging implications in Texas. This decision, Hegar v. CheckFree Services Corp., No. 14-15-00027-CV (Tex. App.—Houston [14th Dist.], Apr. 19, 2016, no pet. h.), narrows the breadth of what constitutes taxable “data processing services” for Texas sales tax purposes.

Taxation of Services in Texas

Although Texas sales tax applies to most sales of tangible property in Texas, the only services taxed are those specifically enumerated in the Texas Tax Code. There are 17 of these taxable services listed in Tex. Tax Code Ann. § 151.0101. This list includes a wide range of different services, some of which are easily understood and others which are more amorphous. A few of the more easily understood services include cable television services, motor vehicle parking services, and insurance services; others, which are more difficult to define, include real property services, personal services and “data processing services.”

Under Texas law a “data processing service” includes “word processing, data entry, data retrieval, data search, information compilation, payroll and business accounting data production . . . and other computerized data and information storage or manipulation.” Tex. Tax Code Ann. § 151.0035. A “data processing service” is also considered to include “the use of a computer or computer time for data processing whether the processing is performed by the provider of the computer or computer time or by the beneficiary of the service.” The Comptroller has historically interpreted data processing services broadly on audit, which has been a source of consternation for many Texas taxpayers.

Interpretation of “Data Processing Services” Under CheckFree Services

In CheckFree Services the taxpayer, CheckFree Services (“CheckFree”), offered a suite of electronic financial services to banks, including an online bill pay service that enabled the banks’ customers to electronically transfer money to selected payees. These services included the preparation of numerous reports containing detailed information regarding the customer users and processed payments during report periods, as well as bill summaries. CheckFree retained users’ billing and payment data for user retrieval for 90 days, and stored the data for seven years in accordance with banking regulations. The Comptroller contended that these services were taxable data processing services and assessed sales tax on several services provided by CheckFree by imposing tax on CheckFree’s “invoiced charges for monthly infrastructure fees; fees for paper and electronic transactions; processing charges for new subscriber set-ups; processing charges for non-sufficient funds, stop payments, and claims; subscriber fees for active and inactive users; subscriber fees for banking and bill pay; monthly minimum charges; service hosting fees; processing charges for telecommunications minutes and VPN lines; and transaction fees for excess payments and excess sessions.”

At trial, the District Court was primarily concerned with whether CheckFree’s transactions should be considered non-taxable bill pay services or taxable data processing services. Ultimately, the court looked to “the ‘essence of the transaction’ at issue, rather than simply the involvement of a computer, to determine the nature of the services CheckFree provided” and reviewed whether CheckFree’s services were limited to compiling, entering, retrieving and maintaining information or if they were professional services that happened to use a computer in the course of performing those services. In ruling in favor of CheckFree, the court found that CheckFree employed a cadre of skilled professionals who performed professional services related to bill payment and noted that its finding that their services constituted more than simple data processing was supported by testimony that CheckFree’s employees “are not a minor part of the bill pay service delivery; instead, they are the ‘secret sauce’ of the service.” The court also found that the delivery platform used by CheckFree for the bill pay service is not the services sold by CheckFree and that the activities that the Comptroller contended to be data processing were merely incidental services to the non-taxable bill pay services sold by CheckFree.

On appeal, the Texas Court of Appeals affirmed the District Court’s decision, stating that although “the Comptroller has been granted exclusive jurisdiction to interpret what ‘taxable services,’ including ‘data processing services,’ means, the Comptroller may not interpret this term in a manner contrary to the tax code.” The Court of Appeals accepted the District Court’s findings and focused on the express language of the statute and regulations, pointing out that for a service to be taxable under 34 Tex. Admin. Code § 3.330(a), the processing of information must be “for the purpose of compiling and producing records of transactions, maintaining information, [or] entering and retrieving information.” The Court of Appeals rejected the Comptroller’s position that “because the users of the bill pay service input data into CheckFree’s system, which CheckFree relied on to ultimately pay their bills, CheckFree was selling taxable data processing services to the banks.” The Court of Appeals relied upon the District Court’s findings of fact and concluded CheckFree’s services did not constitute taxable data processing because the processing of information was an ancillary effect, rather than a primary purpose, of the services CheckFree provided.

Importance to Taxpayers

The decision is significant because by ruling that not every service involving a computer automatically falls under the taxable umbrella of “data processing services,” the Court has drawn a boundary around what is actually included in “data processing services.” The Texas Court of Appeals specifically pointed out that a taxable data service requires information to be processed for the intended purpose of compiling and producing records of information, maintaining information, and entering and retrieving information. Here, the Court found that “to the extent CheckFree provided any. . .[data processing services], they were ancillary to the professional bill pay services provided by CheckFree for the bank’s customers-the electronic commerce services that the bank purchased from CheckFree.” This finding that such services are not taxable is a far more narrow interpretation of Tex. Tax Code Ann. § 151.0101 than the Comptroller’s interpretation.

Under the Comptroller’s position, almost any type of information entered into a computer, for most purposes, constitutes a form of data entry that qualifies as a data processing service. The Court of Appeals strikes down that position, specifying that to qualify as a data processing service, the purpose of the data entry, i.e., the “essence of the transaction,” must be to specifically enter the data for the purpose of data input or compilation of data, rather than entering data as part of a broader service or suite of services.

The Court recognized that the act of transmitting an online payment was the ultimate service offered, and without entering data to complete a consumer’s transaction there is no way that the service could be provided. At the same time, the Court recognized that the primary purpose of this online payment and related data entry was not to enter or compile data on an electronic source, which would have triggered the sales tax on data processing services. This is an important distinction that narrows the applicability of the data processing services sales tax to services for the particular purpose of entering or compiling data. This ruling has not yet been appealed by the Comptroller. It will be interesting to see whether the Comptroller appeals the decision and if he continues to adopt an expansive view of data processing services after the final disposition of this case.

Contact the authors: Stephen Long, Jimmy Lucas

This article was originally published in the June 2016 edition of Tax News and Developments (Volume XVI, Issue 3) and is available under insights at