Why is Web Development Subject to Texas Sales Tax?

At Smooth Fusion, we are sometimes asked to explain why we are collecting Texas Sales Tax or asking for an exemption or resale certificate for a service that should not be subject to sales tax. The fact is that the State of Texas considers the design and development of websites and web applications to be a taxable service.

The tax rule itself was written before the web became the mature platform for software that it is today. In the early days, websites were primarily static documents that were coded into HTML for distribution over the web. Therefore the State of Texas viewed the activity of converting data into HTML as a data processing service. Other examples of taxable data processing are data entry, data conversion services, and manipulation of client data. There was very little in the way of software development involved in web pages in those early days. Today, the state continues to maintain this interpretation of web development as data processing.

The rule can be viewed at:

https://texreg.sos.state.tx.us/public/readtac$ext.TacPage?sl=R&app=9&p_dir=&p_rloc=&p_tloc=&p_ploc=&pg=1&p_tac=&ti=34&pt=1&ch=3&rl=330

Even though the web has matured and now there is almost no difference between software development and web development other than the front-end interface, the state of Texas has not changed its interpretation. So as it stands now, any software development that uses a browser as a user interface is considered web development and is subject to sales tax.

Additionally, any services attached to the delivery of that taxable service are also taxable. So, for example, project management of a taxable service becomes taxable.

Yes. Smooth Fusion has been audited by the State of Texas twice in our many years of performing these services and has had the interpretation confirmed by auditors.

Here are some other links that provide additional supporting evidence:

https://www.avalara.com/taxrates/en/blog/2014/03/texas-taxable-data-processing-services.html

https://smallbusiness.chron.com/there-sales-tax-design-68031.html

Smooth Fusion cannot provide definitive judgment on whether you are exempt, but there are basically four ways that our customers can claim exemption.

Guidelines for Texas Tax Exemptions can be found at:  https://comptroller.texas.gov/taxes/publications/96-1045.php

The forms for both Exemption and Resale are in the PDF at  https://comptroller.texas.gov/forms/01-339.pdf

Tax-Exempt Organizations

Some organizations, including certain nonprofit organizations, have a tax-exempt status that makes them eligible for exemption from Texas Sales Tax. If your organization is eligible, you can provide a Texas Sales Tax Exemption Certificate to Smooth Fusion to claim that exemption.

See  https://comptroller.texas.gov/taxes/publications/96-122.php

Organizations with No Nexus in Texas

Smooth Fusion cannot provide guidance on your eligibility for this exemption, but if you are taking delivery of our work outside of Texas and you have no nexus in Texas, you may be able to claim an exemption from Texas Sales Tax by providing a Texas Sales Tax Exemption Certificate.

Claiming Multi-State Benefit

If a customer with a presence in multiple states claims that part of the services performed by Smooth Fusion benefit multiple locations of the customer’s business, an exemption certificate can be provided to Smooth Fusion claiming multi-state benefit. A customer claiming multi-state benefit is accepting responsibility to report the tax to the State of Texas for the portion of the services that benefit Texas locations. This is a complicated exemption and Smooth Fusion cannot provide guidance on your eligibility for this exemption.

Resale

If you are reselling our services to another organization, you can claim a resale exemption. For example, a marketing agency hiring Smooth Fusion to complete services that are then resold to the final purchaser of the services could claim a resale exemption.

Regardless of your location or whether you are exempt, Smooth Fusion is required by law to assess appropriate sales tax to all customers unless we have a signed resale or exemption certificate on file. So if you don’t provide a certificate, we will have to apply the appropriate sales tax.

When it comes to website and web application design and development, Texas Sales Tax rules can be complicated and confusing. Part of the confusion comes from the fact that there is a 20% exemption from tax for some services, effectively creating two tax rates.

The 20% Exemption

We are not sure why, but Texas law exempts 20% of the value of data processing services from the sales tax, which effectively creates a rate for data processing that is 80% of the full sales tax rate. And because the state considers both web development and web hosting to be forms of data processing, both services are taxed at a rate that is 80% of the full sales tax rate.

Other Taxable Services

Other Smooth Fusion services are also subject to Texas Sales Tax but at the full sales tax rate.

Graphic design is a taxable service at the full rate.

Some services—that would not normally be taxable—become taxable because they are associated with web development. Project management, quality assurance testing, and web server setup are notable examples. These services do not have the 20% exemption and are therefore taxable at the full rate when part of a web project.

Blended-Rate Block Hours

If you purchase blended-rate block hours for the purpose of web development or maintenance, the full tax rate is applied because there is no way to distinguish between the two types of services in a blended-rate block of hours.

Questions?

We are not tax experts, but if you have any questions, please reach out to your account manager and we will do our best to explain what we have learned and point you to the resources we have.

Thank you for allowing Smooth Fusion to be your friendly, trusted partner.