BY ETHAN FORMAN
---- — DANVERS — For John McDougall, the founder of McDougall Interactive Marketing on Cherry Hill Drive, the extension of the sales tax to certain computer software services meant a call to his accountant to see if it applied to his business.
Like a computer virus, the little-known tax was tucked into the recent passage of the state Transportation Finance Bill. The tax went into effect July 31, and some say it has the potential to become a big bug for software companies on the North Shore and elsewhere in the state.
The new tax, according to the state Department of Revenue, extends the 6.25 percent sales tax “to certain services relating to computer system design and to modification, integration, enhancement, installation, or configuration of standardized or prewritten software” for a customer.
Those definitions are broad and ambiguous, some say, and there are complicated rules as to when a sale is taxable and should be collected.
“I think it’s nerve-wracking as a small business,” McDougall said, “and I think businesses are already struggling, why add to that?”
Software sales and licenses have long been taxed. Since 2006, software downloaded from the Internet has also been taxed. According to a memo from the state Department of Revenue, the tax does not extend to a service technician going to a home to determine why a computer is not working. If the technician sells the homeowner software, it would be taxed as it has in the past. But now, the labor to install the new software is also taxable.
“Not all services related to software will be taxable,” said Ann Dufresne, a spokesperson for the Department of Revenue. “The sales and use tax will not apply to personal or professional services that are not directly related to a systems integration project of purchased computer hardware or software.”
The state expects the tax to bring in about $161 million, but the nonprofit Massachusetts Taxpayers Foundation estimates it could wind up vacuuming up $500 million. Some in the IT industry say that number could actually reach $1 billion, said Andrew Bagley, the foundation’s director of research and public affairs.
State Sen. Joan Lovely said the tax was part of a compromise between the governor’s $2 billion tax plan and the Legislature’s more modest plan to fix the state’s transportation infrastructure, which also raised taxes on gas and cigarettes. The intent, Lovely said, “is not to raise any more than” the tax was intended to raise.
“If it’s more than that, the Legislature vows to revisit it,” Lovely said.
While the sales tax does not cover all software services, such as training, it is broad enough that it is hard to tell when certain services may or may not be taxed. According to the state Department of Revenue, if a website designer is modifying prewritten software for a customer, the job is taxed. But if the designer creates custom software for a customer, that job is not taxed. Website hosting, data storage and disaster recovery and backup services are also not being taxed.
“This is confusing to me,” McDougall said. “That is the frustrating thing for a business owner. Now do I have to go and look into maybe not a website design but who knows if that is even on the table?”
Generally, a vendor should collect the new tax when the purchaser is a customer in Massachusetts, but because software companies do business all over, this too can be a source of confusion.
Michael Widmer, president of the Massachusetts Taxpayers Foundation, said his group tried to warn legislative leaders of the enormity of the bill back in May, “but they did not respond.”
“What we explained to them, this is the most far-reaching tax on software services in the nation,” Widmer said. In a state that prides itself on innovation, Widmer said the sales tax could stifle it.
“The groundswell is building, and it’s going to become a tidal wave,” he said.
The computer services tax has created such an uproar in the IT business community that the North Shore Chamber of Commerce has scheduled a task force with members on Aug. 15 with state Sen. Bruce Tarr, R-Gloucester, to discuss it.
“From a broader perspective, I think we have enough taxes, and we don’t need any more,” said Robert Lutz, chairman of the North Shore Chamber of Commerce and president of Cabot Money Management of Salem. “This tax goes directly to the innovation ... area of the economy.”
The problem is the imposition of a sales tax on a service industry, said Salem attorney William Tinti, a past chamber chairman. “The distinction is very important. It’s like stepping into another world” as far as taxation is concerned.
“I don’t think it was very well thought out,” said David Gravel, a Peabody city councilor and CEO of GraVoc Associates, a small computer consulting firm on Main Street in Peabody. Sometimes the company writes its own software, sometimes it uses prewritten software, and sometimes it integrates many pieces of software to solve a business problem, Gravel said.
So, the question for him is, what services does he collect taxes on?
What riled Gravel was the short time frame — about a week — the state gave companies to implement and collect the tax, adding that companies have to reconfigure accounting systems to account for it. Gravel said the added confusion makes it hard on small companies just trying to get through the day.
“This is like, in the middle of a battle, learning how to use a machine gun,” Gravel said.
The Department of Revenue is seeking more input from the computer software services industry and has issued a “frequently asked questions” document based on feedback it has already received. The agency is also planning to meet with affected taxpayers.
“We want to know how their businesses operate,” said spokesperson Dufresne in an email. “During this period, we are still defining and issuing guidance.”
The confusion, the timing of the tax and the tax itself are far from ideal, McDougall said.
“Maybe it’s going to stifle innovation in Massachusetts,” he said. “I think that’s a real shame.”
Staff writer Ethan Forman can be reached at 978-338-2673, by email at email@example.com or on Twitter at @DanverSalemNews.