Data processing gets top billing in Texas regarding internet taxation, but it is not the only relevant taxable service in this context. If data processing is Batman, information services has long been its Robin.
The two are often thought of together because of their similarities. Both taxable services are defined broadly and potentially catch a wide range of services in their nets. Both were also enacted simultaneously in the same legislation. In fact, while the Texas sales tax had existed since 1961, it was expanded to information services and data processing in 1987.[1] The applicability of both taxes later broadened exponentially with the creation and widespread adoption of the internet and the digital economy. Further, the Texas Legislature allows a 20 percent exemption from both types of tax, which is only applicable to these two taxes.[2] Moreover, information services qualify for the multistate customer service benefit location, like data processing services.[3] And like data processing services, information services are eligible to be resold and are presumed to be taxable when sold with other services. Suffice to say, the comptroller treats information services and data processing services the same in many respects.
What Is an Information Service?
While information services and data processing services are often lumped together, they can be easily distinguished based on who is providing the data. If the buyer is providing data to the seller, then it is critical to determine whether the seller is providing a data processing service to the buyer. If the buyer is purchasing data from the seller, an information service analysis is required.
Texas Tax Code section 151.0038 describes an information service as âfurnishing general or specialized news or other current information, including financial information,â as well as âelectronic data retrieval or research.â In other words, if you are purchasing access to information that is generally available, you may be buying an information service.
In 34 Tex. Admin. Code section 3.588(a)(6), a list of offerings that the comptroller considers to be information services is provided:
- newsletters;
- scouting reports and surveys;
- mailing lists and bad check lists;
- real estate listings;
- financial, investment, stock market, bond rating, or other financial reports;
- news clipping and wire services; and
- title abstracts and title plant information.
What do these services have in common? Generally, the proprietor keeps a fixed database of information or a summary of that information and makes it available for a price.
Of course, while it is essential to know what an information service is, it is equally important to understand what an information service is not. Generally, a service is not an information service if the provider is selling information to the customer that the provider cannot resell to other customers. These are considered proprietary information services and are determined to be nontaxable by rule.
Constitutionality of the Tax
The constitutionality of the tax on information services was pressure tested soon after its codification. However, the issue may not be as settled as it first appears.
The Texas Court of Appeals considered the issue in Reuters, holding that the tax on information services does not infringe on First Amendment rights.[4]
Reuters, which provided electronic news to its subscribers, challenged the constitutionality of the tax on information services on First Amendment grounds, both as applied to Reuters (because it was arguably the only service providing electronic news[5]), and also facially as unconstitutionally content-based and on equal protection clause grounds. Ultimately, the court concluded that the tax on information services did not infringe on the First Amendment because it neither posed a threat to suppressing ideas or viewpoints nor was based on the content of speech, but rather on formatting requirements. The courtâs reasoning on this point is sound.
Interestingly, the court went on to say that the Legislature was permitted to tax the Reuters news service differently than traditional newspapers, which are tax exempt in Texas. There is a real question whether this is still true. In 1998 Congress enacted the Internet Tax Freedom Act, which prohibits treating electronic and nonelectronic commerce differently. According to the Congressional Research Service, the prohibition on discriminatory taxes âmeans that the same tax obligations and tax rates must apply to electronic commerce transactions and nonelectronic commerce transactions (e.g., mail-order and brick-and-mortar store sales) involving the same, or similar, property, goods, services, or information.â[6] It would be hard to argue that an electronic news service is not the electronic equivalent of a traditional newspaper, and for that reason, there is a federal requirement that the two should be taxed (or not taxed) in the same manner.
That issue was not before the appellate court in Reuters, as ITFA wouldnât be adopted for another four years. However, most newspapers are still exempt from sales tax in Texas under Tex. Tax Code section 151.319. Would Reuters still be decided the same way if the reviewing court were required to consider the ITFA implications? That may be a challenge still to come.
The Proprietary Information Exclusion
When information services are raised on audit, the debate often centers on whether the seller is providing proprietary information, which is excluded from the definition of information service under Tex. Admin. Code 3.342. Under the comptrollerâs rules, proprietary information âmay not be sold to others by the person who gathered or compiled the information.â
This seems straightforward enough, but the contours of this exclusion are not as obvious as they first appear. Under the comptrollerâs interpretation of the definition, two requirements must be met for the service to qualify as a nontaxable sale of proprietary information: (i) the information must be gathered from a source that is private (or proprietary) to the service provider or to the particular client, and (ii) the client must also have the right of ownership over the information or the right to control future use of the information by the service provider.
The first requirement goes to the source of the information. In sum, this requirement states that the seller cannot simply be providing the buyer publicly available information. Texas Policy Letter Ruling No. 200709611L illustrates this rule well. In that ruling, the seller was operating a business that performed competitive price audits for other businesses, primarily supermarkets and convenience stores. The seller sent its field representatives to the store or stores identified by the customer to collect information regarding competitor item pricing. The seller then provided the information to the buyer in an agreed format, and the seller was prohibited by contract from reusing any of the collected information. The ruling held that the service provided was a taxable information service because âany consumer, competitor or other person has access to the same information that the Taxpayer is compiling for its clients.â Thus, the ruling concludes, the information was not proprietary.
This source requirement is not found in the statute or even the language of the rule. Rather, it is based on the administrative interpretations of the term âproprietary.â The interpretation, as far as we know, has never been considered or endorsed by a court, which makes one wonder whether a court would enforce it. Taxpayers could creditably argue that while the raw information is public, the product delivered by the seller becomes valuable because the information is aggregated and presented in a useful way. The compiled information, when considered as a whole, could have a proprietary character.
The second requirement speaks to the purchaserâs rights regarding the data. This means that the comptroller will require that the purchaser hold some type of affirmative right to preclude the sellerâs ability to use the data. Typically, this will take the form of a clause in the agreement between the parties. Sometimes the agreement between the parties will not address the relative ownership rights regarding the data. In our experience, the comptroller will construe silence on this topic as an indicia that the purchase does not relate to proprietary information.
The comptrollerâs rules cite opinion polls and management consultant reports as examples of proprietary information. These deliverables typically have a heavy analytical component that is intended for only the purchaser. There is typically no debate that these services are tax exempt. However, this analytical component is not required to claim that information is proprietary. Generally, taxpayers need only meet the source and data rights requirements.
Practical Advice for the Texas Taxpayer
At this point, you may be asking what you can do to ensure that, if audited, your services are not determined to be taxable information services. First and foremost, you should make clear in your signed contract, statement of work, or master agreement that the information you are providing is confidential and may not be sold to other parties. That proprietary information clause is absolutely essential to ensure that your services are nontaxable.
Second, you must review the nature of the services you provide. Because the definition for data processing services in Texas is so broad, there are many times services could arguably be classified as either information or data processing services. While looking at which way the data are flowing is a helpful starting point to performing this analysis, in real life data can be flowing in both directions, which can complicate things. The best way to establish the partiesâ intention is to make sure that intention is clearly delineated in the contract. We have found that many times, taxpayers may have a contract, statement of work, or invoice that provides little clear language on what exactly is being offered to the client.
[1] Acts 1987, 70th Leg., 2nd C.S., ch. 5, art. 1, pt. 4.
[2] Tex. Tax Code section 151.351.
[3] 34 Tex. Admin. Code section 3.588(g). Please note that the comptroller has currently proposed revised language regarding the multistate customer service location.
[4] Reuters America Inc. v. Sharp, 889 S.W.2d 646 (Tex. App. 1994 ) (pet. overruled, 1995).
[5] And similar grounds under the Texas Constitution.
[6] Congressional Research Service, âThe Internet Tax Freedom Act and Federal Preemptionâ (Oct. 18, 2021).
