Getting a grasp on Software as a Service (SaaS) and sales tax is, at times, complicated. This is true, not only for taxpayers’ but for some states and localities as well.
What is SaaS?
SaaS has become a general term for a model where software is hosted or “sits on” a server of a provider and accessed by users in different locations. This is typically done through a subscription to use the software. It can take on several other forms, such as Infrastructure as a Service (IaaS) or Platform as a Service (PaaS).
Sales Tax on SaaS in Illinois
As with most software products, states as well as localities, have different interpretations of what SaaS is exactly. Is it a service or is it tangible software? For more information on which states charge sales tax on SaaS, check out our Sales Tax on SaaS Chart.
One state that has very complicated SaaS Laws is Illinois. Businesses must not only be aware of how their SaaS is being utilized and delivered but also where the users are located. This information will help determine which tax is applicable.
If the users accessing the SaaS are in the City of Chicago, there’s a tax that many are not aware of exists, the Chicago Personal Property Lease Transaction Tax.
In most cases, Illinois doesn’t tax SaaS or other Cloud products; they consider SaaS a service and not subject to the state sales tax. However, Chicago has a different approach to these services and products and considers SaaS a lease of personal property. The tax imposed by the City is not a sales tax, which is why many companies overlook it.
The upside, a taxpayer should only be required to pay one tax, either the State or the City. Unlike the treatment of SaaS, if the software is electronically delivered and/or housed on the user’s computer, it can be subject tax by the State (unless an exemption is available) but not the City (Chicago does not consider this a lease).
What is the City of Chicago Personal Property Lease Transaction Tax?
Chapter 3-32 of the Municipal Code of Chicago or the Lease Tax, as it was originally called, went into effect in 1974. It was retitled in 1992 as we know it today, the Chicago Personal Property Lease Transaction Tax. From the inception of this tax, Chicago has always applied it to leased time for the use of computers. But as we know, advancements in technology have made it difficult to define exactly what the use of a computer means. To provide some clarity, Chicago added a new term “nonpossessory computer lease” in 1994, which covers any payments for “access to and use of a provider’s computer and software to input, modify or retrieve data or information.”
The tax is imposed on the customer (the lessee), but the provider (the lessor) is required to collect it if they have sufficient contact with the City (Nexus). If not, the customer is responsible to self-assess the tax.
How Does the Chicago Lease Tax Apply to SaaS or Cloud-Based Products?
The tax rate for most lease transactions is 9%; however, as of January 1, 2016, the City imposed a lower rate of 5.25% for a nonpossessory computer lease (SaaS or Cloud-Based Products). This was increased on January 1, 2020 to 7.25%. The lower rate applies when a customer uses the provider’s computer and software to input, modify, or retrieve information supplied by the customer. If the lease allows the customer to input, modify, or retrieve data supplied by the provider, these are considered Database products and taxed at the 9% rate. This reduced rate and definition clarification was done with the issuance of Ruling #12 of Chapter 3-32.
One key aspect to the tax, and why user location is so important, it is only imposed on the users physically located in Chicago. Ruling #12 allows a taxpayer to apportion its users located outside of the City so tax will not apply to these users. This can be done by utilizing the: City of Chicago Department of Finance Affidavit for Apportionment of Use of Nonpossessory Computer Leases.
In addition, the City provides several exemptions. Some examples are, de minimis use of the SaaS, if you are a small new business, and re-leases.
When it comes to software in Illinois, you must be sure to be aware of how Illinois and the City of Chicago define the product or service being sold. The City and State both treat them differently and have tax implications associated.
If you would like to know more regarding the City of Chicago Personal Property Lease Tax and Illinois sales tax please feel free to contact us at email@example.com