Software developers face new tax classification in Massachusetts

Massachusetts announced a change to its corporate tax code that could carry significant implications for software developers located in the state.

The Massachusetts Department of Revenue recently issued Technical information release (TIR) 23-8, which classifies computer software developers as manufacturing companies for corporate excise tax purposes, impacting the apportionment formula applicable to such operations.

Learn important information about the change that could impact your business and its tax filings below.

Who is affected?

In the TIR, Massachusetts identifies 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” as engaging in the sale of tangible personal property.

Any such corporation that files a corporate excise tax return in Massachusetts should utilize a single-sales factor method of apportionment, rather than the three-factor method that utilizes property, payroll, and sales.

Statutory history

Under Massachusetts General Law (Mass. Gen. Law) Section 38, a corporation that has income from business activity taxable within and without Massachusetts must apportion its income in accordance with an identified apportionment formula.

Corporations that don’t engage in certain activities or industries are required to apportion their income based on their in-state property, payroll, and sales to generate a Massachusetts apportionment factor, with the sales factor being double-weighted. However, if a corporation is classified as a manufacturing corporation, it must utilize a single-sales factor apportionment method.

Under Mass. Gen. L. Section 38(l)(1), a manufacturing corporation is a corporation that, in substantial part, transforms “raw or finished physical materials by hand or machinery, and through human skill and knowledge, into a new product possessing a new name, nature, and adapted to a new use.”

The development and sale of standardized computer software is specifically recognized as this type of manufacturing activity in Mass. Gen. L. Section 42B(c), regardless of the manner of delivery.

What’s changed?

In late 2021, a ruling regarding the application of the manufacturing corporation definition was issued in Akamai Technologies, Inc. v. Commissioner of Revenue, A.T.B. Docket Nos. C332360, C334907, C336909 (2021).

In Akamai, the Massachusetts Appellate Tax Board (Board) held that Akamai Technologies, Inc. (Akamai) should be considered a manufacturing corporation, based on the revenue it generated from the development and sale of standardized computer software, which Akamai delivered to its customers solely in the form of remote-access software.

The Massachusetts Commissioner argued that Akamai shouldn’t be viewed as a manufacturing corporation due to its inability to sell the software to customers. The Board found that, while Akamai’s customers weren’t afforded privileges to download software and instead were only granted permission to access the software housed on Akamai’s servers, the method of transfer wasn’t a crucial element.

As provided in the decision, “the Legislature contemplated diverse methods of transfer.” As a result, Akamai was found to be a manufacturing corporation for apportionment purposes.

On July 12, 2023, in TIR 23-8, Massachusetts incorporated the Akamai decision into a formal opinion on what activities would make a computer software developer a manufacturing corporation.

As a result, it’s important that corporations that substantially engage in the development and sale of standardized computer software licenses, whether downloaded on-premise or accessed via the cloud or Internet, review their corporate excise tax returns to ensure the proper apportionment methodology is utilized. This can have a large impact on the tax ultimately owed to Massachusetts.