May 4, 2017



We received the Letter Ruling request you submitted on behalf of your client, xxxxxxxxxxxxx (the “Company”). You have requested a ruling on whether the sale of Company’s xxxxxxx Extended Warranty Contract” (Hereinafter “Extended Warranty Contract”), as described in your request, is subject to the sales and use tax imposed under G.L. c. 64H, §§ 1 and 2.  The following is your representation of the facts upon which we base this ruling.
 

I.  FACTS

Company designs, manufactures and markets consumer electronics, software and personal computers.  Among Company’s most popular consumer electronics products is the xxxxxxx Smartphone (Hereinafter “SmartPhone”).

The SmartPhone combines a mobile phone, a tablet and a mobile Internet communications device in a single handheld device.  It runs on Company’s proprietary operating system and includes a user-friendly touch screen for performing functions such as surfing the Internet, dialing telephone numbers and text messaging.  SmartPhones are available for purchase from Company (on-line, in retail stores or from authorized retailers).  With the purchase of a SmartPhone, customers receive one year of hardware repair coverage through Company’s manufacturer’s warranty and up to 90-days of complementary technical support from Company.  Customers may also purchase an optional Extended Warranty Contract for a set price of $ xxxx.  When a customer purchases the Extended Warranty Contract, hardware repair coverage is extended for two years from the date of the original purchase and up to two incidents of accidental damage coverage.

The Extended Warranty Contract provides repair and/or replacement coverage, both parts and labor, from Company-authorized technicians, and includes the phone, the battery and included earphones and accessories.  Coverage available under the Extended Warranty Contract entitles the purchaser to the following: direct access to Company experts for technical support and troubleshooting; mail-in repair; carry-in repair at Company retail stores or other authorized service providers; and express replacement service.  The purchase of the Extended Warranty Contract does not entitle the purchaser to any additional software upgrades.  Any updates to Company’s software operating system are generally available free-of-charge to SmartPhone owners without regard to whether a particular unit is under warranty or covered by an Extended Warranty Contract.

In addition to the Extended Warranty Contract, Company seeks guidance with respect to its SmartPhone Upgrade Program (“Upgrade Program”).  The Upgrade Program is designed for customers who want to obtain the newest model of SmartPhone as soon as it is released.  When a customer enrolls in the Upgrade Program, he or she is required to enter into an installment loan to purchase and activate an eligible SmartPhone (“Financed SmartPhone”).  Also, the upgrade option requires a trade-in of the Financed SmartPhone, in good condition, to receive a newer model SmartPhone.

By enrolling in the Upgrade Program, customers bind themselves to specific terms and conditions governing the program.  In order to enroll, customers must meet certain eligibility requirements and conditions, including owning a valid U.S. credit card; applying for and obtaining a 24-month, 0% APR installment loan (“Installment Loan”) with Company’s bank partner (“Bank”) (an unrelated party); purchasing an Extended Warranty Contract applicable to the Financed SmartPhone (the cost of which is added to the principal amount of the Installment Loan); and activating the Financed SmartPhone on a new or existing wireless service plan with an eligible carrier under the carrier’s terms.  The cost of the Financed SmartPhone is separately stated from the cost of the Extended Warranty Contract on the customer’s invoice.  The Upgrade Program is not separately stated on the customer’s invoice as there is no cost to enroll in the program.  The Upgrade Program simply affords the customer the option to terminate an existing contract and trade in his or her SmartPhone, in satisfaction of any outstanding loan associated with that phone, without incurring any monetary penalties.  Enrollment in the Upgrade Program does not reduce either the customer’s cost of a new SmartPhone or the sales tax due from the customer upon the purchase of a new SmartPhone.

Thus, when a customer chooses to exercise his or her option to terminate an existing contract under the Upgrade Program, the trade-in value of the original Financed SmartPhone is used to repay any remaining installment payments due.  Under the terms of the Upgrade Program, all applicable taxes and fees relating to the program for the newer model SmartPhone are paid in their entirety in the first payment of the new installment loan on the newer model SmartPhone.  The customer invoice at the time of purchase will separately state the cost of the Financed SmartPhone at its full unsubsidized retail price.  Separately, the invoice will state the cost of the Extended Warranty Contract.  Additionally, when a customer chooses to exercise the upgrade option, he or she must re-enroll in a new SmartPhone Upgrade Program, which includes applying for and entering into a new 24-month 0% APR installment loan with Bank.
 

II.  ISSUES

1.  Whether Company’s sale of an optional Extended Warranty Contract, in connection with the sale of a Financed SmartPhone is subject to the Massachusetts sales/use tax under G.L. c. 64H or 64I?

2.  Whether enrollment by a customer in Company’s SmartPhone Upgrade Program affects the taxability of an Extended Warranty Contract?

III.  RULINGS

1.   The Department rules that Company’s Extended Warranty Contract is an optional maintenance service contract that does not include software upgrades and therefore, if it is separately stated on a customer’s invoice, an Extended Warranty Contract is not subject to the Massachusetts sales/use tax.

2.   The Department rules that if an Extended Warranty Contract is sold to a customer as a condition to enrollment in the SmartPhone Upgrade Program, the Massachusetts sales/use tax is not imposed on the Extended Warranty Contract if the Extended Warranty Contract is separately stated on the customer’s invoice and both the contract and the Upgrade Program are optional.

IV.  LAW AND ANALYSIS

Massachusetts imposes a 6.25% sales tax on sales of telecommunication services and tangible personal property in the Commonwealth, including sales of prewritten (also called “canned” or “standardized”) software regardless of the method of delivery.  G.L. c. 64H, § 1.  The rules relating to tax on computer hardware and software are set forth in the Computer Industry Services and Products Regulation, 830 CMR 64H.1.3.  Section (3) of that regulation provides the following:

            (3)  General Rules.
 

(a)  Sales Tax.  Sales in Massachusetts of computer hardware, computer equipment, and prewritten computer software, regardless of the method of delivery, and reports of standard information in tangible form are generally subject to the Massachusetts sales tax.  Taxable transfers of prewritten software include sales effected in any of the following ways regardless of the method of delivery, including electronic delivery or load and leave: licenses and leases, transfers of rights to use software installed on a remote server, upgrades, and license upgrades.  The vendor collects sales tax from the purchaser and pays the sales tax to the Commissioner.  Generally, where the object of a transaction is to obtain services other than (a) the use of software or (b) standard reports of information on tangible media, the transaction is not subject to tax.
 

In addition, sales of prewritten software, computer hardware, and hardware and software maintenance contracts involving software updates, upgrades and fixes are generally subject to the Massachusetts sales and use tax under the rules provided in the regulation.  830 CMR 64H.1.3.  Specific rules relating to maintenance contracts are set forth at 830 CMR 64H.1.3(4),(7).  Generally, sales of optional maintenance service contracts that do not include software upgrades or updates are not taxable.  830 CMR 64H.1.3(7)(a).  If a customer purchases an optional software maintenance contract that offers additional optional updates/upgrades, and the customer does not choose to purchase the separately stated updates/upgrades, then the charge for the optional maintenance services contract is generally not taxable.  830 CMR 64H.1.3(7)(b).  Where charges for upgrades and services are not separately stated, tax applies to 50% of the sales price of the maintenance contract.  830 CMR 64H.1.3(7)(c)(1).

The regulation further provides that “the term computer software maintenance contract means an agreement to furnish maintenance services, upgrades, enhancements or updates of prewritten software, which may include an agreement for service, repair, and maint[enance of] computer hardware.”  830 CMR 64H.1.3(7)(a).  Maintenance services may include technical assistance and consultation.  Id.  To avoid taxation, the agreement must be optional, as described in 830 CMR 64H.1.3(4)(h)2.  Id.  An optional contract is one that the customer is not obligated to purchase as a condition to acquiring the software or hardware.  830 CMR 64H.1.3(b).

To be treated as a nontaxable sale, charges for an optional maintenance contract must be separately stated on the invoice to the customer.  Id.  If charges for upgrades and services are not separately stated on the customer’s invoice, tax applies to 50% of the sales price of the maintenance contract.  830 CMR 64H.1.3(c)1.  If an upgrades plus service contract separately and reasonably states charges for the services and upgrades portion of the contract, charges for the upgrades portion are taxable and charges for the service portion are not taxable.  830 CMR 64H.1.3(7)(c)2.

Company’s SmartPhones are sold with a manufacturer’s warranty that includes one year of hardware repair coverage and up to 90-days of complementary technical support.  This one year warranty is not optional and is included in the sales price of the phone; therefore it is subject to sales tax.  The Extended Warranty Contract extends repair and/or replacement coverage on the SmartPhone to two years from the original purchase date and also includes up to two incidents of accidental damage coverage.  We conclude that the Extended Warranty Contract is akin to a maintenance service contract rather than a warranty, as it covers defects and malfunctions and certain types of damage for an extended time period, and also includes express replacement coverage, as well as direct access to Company experts for technical support and troubleshooting.  Accordingly, if, as you represent, the contract is separately stated, optional, and does not include software upgrades, then sales of the contract are not subject to the Massachusetts sales/use tax.

With respect to the SmartPhone Upgrade Program, the issue is whether enrollment in the program by a customer at the time of purchase of a SmartPhone and Extended Warranty Contract transforms the sale of the optional, separately stated Extended Warranty Contract from a nontaxable sale to a taxable sale.[1]

The SmartPhone Upgrade Program is unique.  It provides a customer with the option to terminate his or her existing contract and trade in a SmartPhone for a newer model at an earlier time than a customer who purchases a SmartPhone without enrolling in the Upgrade Program.  There is no extra cost for enrolling in the Upgrade Program, although certain conditions and eligibility requirements must be met.  No tangible personal property is obtained through the Upgrade Program until the customer exercises the option to upgrade to a new SmartPhone, and no cost or tax savings are received for enrolling in the Upgrade Program.  Company collects sales tax on the full retail price of the first SmartPhone at the time of the initial sale, and

Company collects sales tax on the full retail price of the newer model SmartPhone at the time of the upgrade, if the upgrade option is exercised.

Therefore, enrollment in the Upgrade Program provides the customer with an intangible right to terminate an existing contract on a Financed SmartPhone, without incurring monetary penalties, and to upgrade to the newest SmartPhone at some future date.  While the purchase of the Extended Warranty Contract is a pre-requisite to enroll in the program, enrollment in the program does not alter the characterization of the Extended Warranty Contract as a maintenance service contract.

V.  CONCLUSION

For the foregoing reasons, the Department rules that Company’s Extended Warranty Contract is an optional  maintenance service contract and, therefore, as long as it is separately stated on a customer’s invoice, the sale of the contract is not subject to the Massachusetts sales/use tax under G.L. c. 64H or c. 6HI.  The Department further rules that when a customer purchases a SmartPhone and elects to enroll in the SmartPhone Upgrade Program, the cost of the Extended Warranty Contract is excluded from the sales price subject to tax, if the Extended Warranty Contract is separately stated on the customer’s invoice.  Enrollment in the SmartPhone Upgrade Program is entirely optional, therefore the Extended Warranty Contract remains optional under these circumstances and is a nontaxable sale pursuant to 830 CMR 64H.1.3(7).

Very truly yours,

/s/Michael J. Heffernan

Michael J. Heffernan
Commissioner of Revenue


MJH:RHF:wem

LR 17-2



[1] The SmartPhone Upgrade Program is not separately subject to the sales/use tax because there is no charge to customers for enrolling in the program.