Technical Information Release  TIR 23-8: Akamai Technologies, Inc. v. Commissioner of Revenue – Manufacturing Corporation Treatment for a Developer of Standardized Computer Software

Date:	07/12/2023
Referenced Sources:	Massachusetts General Laws

I. Introduction

On December 10, 2021, the Appellate Tax Board (“Board”) issued a decision in favor of the taxpayer in Akamai Technologies, Inc. v. Commissioner of Revenue, A.T.B. Docket Nos. C332360, C334907, C336909 (2021) (“Akamai”). At issue was whether Akamai Technologies, Inc. (“Taxpayer”) should have been classified as a manufacturing corporation for purposes of local property taxation, pursuant to G.L. c. 58, § 2 and G.L. c. 59, § 5, cl. 16(3), and should have been treated as engaged in manufacturing for purposes of the corporate excise, pursuant to G.L. c. 63, §§ 38 and 42B. While the Commissioner argued that the Taxpayer sold a content delivery service, the Board held that it instead sold remote access to software that it developed and was to be treated as a manufacturing corporation in each respect. This Technical Information Release (“TIR”) explains the position of the Department of Revenue (“Department”) regarding the Board’s decision.

II. Discussion

A.  Legal Background

Massachusetts tax law provides special rules for entities that are “manufacturing corporations.” A corporation that is classified as a manufacturing corporation by the Commissioner is entitled to an exemption of its machinery from local property taxation under G.L. c. 59, § 5, cl. 16(3), an investment tax credit under G.L. c. 63, § 31A, and an exemption from sales and use tax for certain property used in manufacturing under G.L. c. 64H, § 6(r) and (s), i.e., assuming the corporation meets the additional requirements for those exemptions. See 830 CMR 58.2.1(4), (11).  In addition, corporations that are engaged in manufacturing within the meaning of G.L. c. 63, § 38 and 42B that derive income from business activity that is taxable both in Massachusetts and in another state must apportion their taxable net income using a single-factor formula based entirely on their sales, rather than using the three-factor formula based upon property, payroll, and sales. G.L. c. 63, § 38(l)(2).

“Manufacturing” as defined for manufacturing classification purposes is “the process of substantially transforming raw or finished materials by hand or machinery, and through human knowledge, into a product possessing a new name, nature, and adopted to a new use.” 830 CMR 58.2.1(6)(b). Manufacturing is similarly defined for purposes of chapter 63. See G.L. c. 63, § 38(l)(1).

Manufacturing classification applies to corporations engaged in the development and sale of standardized software. See 830 CMR 58.2.1 (6)(c), Examples 6(a), 8(b). Chapter 63 similarly provides that “the development and sale of standardized computer software shall be considered a manufacturing activity, without regard to the manner of delivery of the software to the customer.” G.L. c. 63, § 42B(c).

A corporation is engaged in “substantial manufacturing” or engaged in manufacturing “in substantial part” if it meets one of four tests. 830 CMR 58.2.1(6)(d); G.L. c. 63, § 38(l)(1). A business corporation that develops and sells standardized computer software will be classified as a manufacturing corporation and must file as a manufacturing corporation for purposes of chapter 63 if these activities are “substantial” under these rules. See id; 830 CMR 63.38.1(10)(b).

B.  Factual Background

The Taxpayer was a technology company that developed and provided software-based solutions for accelerating, managing, and improving the delivery of web and media content over the internet. Akamai, at 425. Customers relied on the Taxpayer to make access to their websites, media, streaming content, and online products faster and more reliable for their end-users. Id. at 434-45.

The Taxpayer’s business was divided into several different units. The focus of the case was the Taxpayer’s Web Experience, Media, and Emerging Products/Enterprise business units (together, the “CDN business units”). Id. at 426. Throughout the periods at issue, the Taxpayer derived most of its revenue from its CDN business units. Id.

Customers did not download or install the Taxpayer’s software on their own computers. Instead, the software was housed on the Taxpayer’s servers (which were located throughout the world), and customers accessed it remotely. Id. at 429-30. Customers were able to use a portal to directly engage and manipulate the underlying operating software. Id. at 431. Using the portal, customers could control how their content would be delivered to end-users; plan and manage online events; identify and resolve website, application, and media delivery issues; and create reports of metrics such as traffic volume and audience demographics. Id.

Based upon the customers’ information entered into the portal, the Taxpayer’s software retrieved digital content and delivered it to end-users. Id. at 432. The software also determined the most efficient routing and delivery of the customer’s content in response to end-user requests, as well as the most appropriate server from which to retrieve a customer’s content. Id. Customers could also request that the software provide them with various types of reports and information, including diagnostic reports measuring end-user experience and software performance. Id.

The parties agreed that if the revenue from the CDN business units derived from the sale of Taxpayer’s standardized, remotely-accessed computer software, then the Taxpayer was engaged in manufacturing in substantial part, and should have been treated as a manufacturing corporation pursuant to G.L. c. 58, § 2 and G.L. c. 63, §§ 38 and 42B during the periods at issue. Id. at 448.

C.  The Board’s Decision

The issue in Akamai was whether the transactions at issue were sales of services or sales of standardized software, i.e., tangible personal property. The Board found that certain factors present in this case indicated a taxable transfer of standardized software, not a sale of services. These factors included that: the software operated almost automatically without the interaction of the Taxpayer’s employees; customers entered and manipulated their own information and set their own desired configurations before the software would respond to requests from the customer’s end-users; and the Taxpayer charged separately for its personalized services. The Board also noted that the Taxpayer’s software offered functionalities that were found in standardized software products offered by other vendors.

The Board questioned whether the “object of the transaction” test was relevant to the determination of whether the transaction was a sale of software. The Board noted the Supreme Judicial Court’s statement that the object of the transaction test applies when services and property are billed together and are inseparable because the services created the property. See Akamai, at 459 (citing Browning-Ferris Indus., Inc. v. State Tax Comm’n., 375 Mass. 326, 329 (1978)). See also Akamai, at 458 (citing Houghton Mifflin Co. v. State Tax Comm’n, 373 Mass. 772, 774 (1977)).[1] The Taxpayer’s services did not create the property sold, nor were the services integrated or bundled with the software in one transaction. Furthermore, even assuming that the object of the transaction test did apply, the Board found that purchasers of the Taxpayer’s products intended to buy standardized computer software, rather than services. Akamai, at 460.

Relying on these findings, the Board concluded that the Taxpayer was selling standardized computer software. The Board determined that customers did not pay the Taxpayer to perform a service; instead, they “interacted with the software in order to reach an objective . . . by navigating, choosing and using tools made available through the software.” Id. at 450-51, quoting Letter Ruling 12-10. The Board rejected the idea that the Taxpayer used its software and its worldwide network of server clusters to provide the service of delivering its customers’ online content faster and more dependably to end-users. Id. at 460. The case held that customers were purchasing remote access to the Taxpayer’s standardized software, not the performance of a service.

Because the Taxpayer’s customers purchased remote access to the Taxpayer’s software, not a content delivery service, the Board concluded that the Taxpayer’s revenue from the CDN business units derived from the development and sale of standardized computer software, i.e., tangible personal property. Therefore, the Taxpayer was engaged in manufacturing in substantial part and should have been treated as a manufacturing corporation during the periods at issue.

III. Conclusion

The determination as to whether a corporation is selling services or standardized software will depend upon the facts and circumstances of each case. Corporations that develop and sell access to software that allows customers to input their own information, manipulate the software, and run reports without interaction with the corporation or its employees, are engaged in the manufacture and sale of tangible personal property. Therefore, such corporations are entitled to be classified by the Commissioner as manufacturing corporations pursuant to G.L. c. 58, § 2 and must file as manufacturing corporations pursuant to G.L. c. 63, §§ 38 and 42B.

A corporation classified as a manufacturing corporation is entitled to a local property tax exemption on its machinery and other benefits such as the investment tax credit and certain sales tax exemptions if it otherwise meets the requirements for those exemptions. G.L. c. 59, § 5, cl. 16(3); G.L. c. 63, § 31A; G.L. c. 64H, §§ 6(r) and (s).  A corporation that is treated as a manufacturing corporation pursuant to G.L. c. 63, §§ 38 and 42B, including a corporation that develops and sells standardized software, is required to apportion its income using a single-factor formula based entirely on sales.

 

                                                                   /s/Geoffrey E. Snyder
                                                                   Geoffrey E. Snyder
                                                                   Commissioner of Revenue

GES:RHF:mc

July 12, 2023

TIR 23-8

[1] The Board noted the statement in Houghton Mifflin that “where the services and the property are inseparable, because of the integrated nature of the transaction, the character of the transaction must be analyzed to ascertain whether the buyer’s basic purpose was to acquire the property which was sold to it, or to obtain the services.” Akamai, at 458, citing Houghton Mifflin, 373 Mass. at 774.