Arizona: Temporary Use of Digital Data Constitutes Lease of TPP

The Arizona Department of Revenue recently ruled that a taxpayer’s provision of a temporary, non-perpetual right to use digital data was subject to Arizona’s transaction privilege tax (TPT) under the personal property rental classification. The taxpayer, using its proprietary software, compiled public information and data from various resources into a centralized repository hosted on the taxpayer’s server outside Arizona. The taxpayer entered into contracts with its customers under which a customer could receive requested data in a spreadsheet format. The contracts allowed customers to select from among various filters and parameters specifying the data it wished to receive, the frequency of updates, cost, and length of time the customer will have control over the data. After a customer received the initial data, the taxpayer provided recurring updates on newly acquired data matching the customer’s criteria. Including the initial delivery of the data, all updates were automatic. At no point did the customer gain access to the taxpayer’s software. Upon termination of the agreement, the customer was contractually required to delete all data it received from the taxpayer.

Under Arizona law, the rental of tangible personal property is subject to TPT under the personal property rental classification. A rental is taxable when the lessee enjoys possession or control of the tangible personal property.  To determine whether the taxpayer’s income was subject to the TPT as a rental of tangible personal property or was a nontaxable service,  the Department noted that Arizona courts generally apply two tests: (1) the dominant purpose test and (2) the common understanding test. The Department concluded that the dominant purpose of the transaction at issue was the provision of unrestricted access to data. Under the “common understanding” test, the Department determined that taxpayer was primarily renting tangible personal property, rather than rendering a service. In the Department’s view, the taxpayer granted customers “the right to full ‘possession or control” of data (i.e., tangible personal property) that the taxpayer exercised ownership and control over. Upon termination of a contract, the Department noted that a customer lost its legal right to exercise use or control over the data. Thus, as an owner of tangible personal property, who, for consideration, loaned the data to customers for exclusive use and enjoyment during the contract period, the taxpayer was “commonly understood” to be engaged in the business of leasing and renting tangible personal property. The Department further noted that the data was not considered merely incidental to a non-taxable service and the use of the term “limited use license” in the contracts had no bearing on whether the transaction was a taxable lease or rental. As such, the Department concluded that based on Arizona’s broad interpretation of tangible personal property, the taxpayer’s rental of data was subject to TPT. For more information on Private Letter Ruling LR 21-003, please contact Stacey Matthew.