A Texas court of appeals recently held that online bill pay services sold to banks were nontaxable professional services and were not taxable data processing services. Hegar vs. Check Free Services Corp., No. 14-15-00027-CV (Tex. App—Austin April 19, 2016). Check Free Services Corporation contracted with three banks to provide bill pay services through the banks’ on-line banking services portal to the banks’ customers. The Texas Comptroller’s Audit Division concluded that these bill pay services were taxable data processing services under the Texas Tax Code and the Comptroller’s Administrative Rules. Services to the banks for which taxes were assessed included 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.
The court of appeals held that Check Free provided a nontaxable professional bill pay service, facilitated by the use of computers and an electronic commerce system. The court of appeals concluded that, to the extent that Check Free provided any data processing services, such services were ancillary to the nontaxable professional bill pay services provided by Check Free for the bank’s customers. In reaching this conclusion, the court of appeals relied on Comptroller’s Rule 3.330(a)(1) and the “essence of the transaction” test. Comptroller’s Rule 3.330(a)(1) provides in relevant part: “Data processing does not include the use of a computer by a provider of other services when the computer is used to facilitate the performance of the service or the application of the knowledge of the physical sciences, accounting principles, and tax laws, e.g., the use of a computer to provide interpretive or enhancement geophysical services or the use of a computer by a CPA firm, enrolled agent, or bookkeeping firm to produce a financial report, prepare federal income tax, state franchise tax, or sales tax returns . . .” Under the essence of the transaction test, the focus is on the “essence” or “object” of a transaction to determine whether tax is due. According to the court of appeals, under this test, the relevant inquiry was whether Check Free provided something more than “compiling and producing records of transactions, maintaining information, and entering and retrieving information,” namely, providing professional services that are facilitated by the use of a computer.
In determining that the essence of this transaction was nontaxable professional bill pay services, the court of appeals examined in detail the specific nature of Check Free’s services and relied on the following trial court fact findings: (1) Bill pay service was a professional service requiring accredited or certified professionals across several areas including ACH processing. financial crime investigation, treasury, anti-money laundering and accounting; (2) Check Free had thousands of skilled and/or certified professionals who collaborated in the performance of these professional services centered around bill payment; (3) these professionals managed the actual bill pay process and made decisions at multiple stages of the bill pay process; (4) these professionals were responsible for critical monitoring and detection of fraud, money laundering and other financial risks; and (5) these professionals were not a minor part of the bill pay service delivery, instead they were the “secret sauce” of the service.This decision represents a departure from the Texas Comptroller’s traditional analysis of mixed services transactions, where the transaction is comprised of a mixture of taxable data processing services and nontaxable services. The Comptroller historically has parsed such transactions into multiple components and taxed those elements that can be characterized as data processing when viewed in isolation. The court of appeals took a broader view, classifying the service in its entirety as nontaxable based on the overall nature of what was being sold. Accordingly, purchasers in mixed services transactions should carefully analyze this decision and compare it to their facts to determine whether a Texas sales tax refund opportunity may exist.
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