US state ruling could set precedent on modified apps

A judge's refusal to order the state of Wisconsin to refund $500,000 (£271,000) in sales tax paid by the company on a customised...

A judge's refusal to order the state of Wisconsin to refund $500,000 (£271,000) in sales tax paid by the company on a customised SAP roll out may set a precedent that relieves the state from paying out more than a $250m in refunds to software users.

The short term issue is a $500,000 sales tax refund sought by pulp and paper manufacturer Menasha. The company's 1995 installation of SAP's R/3 enterprise resource planning application cost $23m, of which $5m was for a licence for the software. 

The rest of the money was spent on modifications and implementation, according to court documents issued by Judge Steven Ebert. 

After Menasha paid sales tax of $342,614 on the implementation to the state's Department of Revenue (DOR), the company tried to recover the money by petitioning the state tax appeals commission.

In its request, Menasha argued that the modifications it made to R/3 qualified it as a custom-written application. In Wisconsin, custom-written applications are tax-exempt; regular third-party software is not. 

Although the appeals commission agreed with Menasha, Ebert overturned that decision, ruling among other things that R/3 "was existing and prewritten" when SAP sold it to Menasha. 

For its part, the DOR "is pleased with the decision", said spokeswoman Eva Robelia. "It upholds our prior actions." 

She explained that had Menasha won, a precedent would have been set allowing other companies that paid sales tax on modified third-party applications to file similar appeals. If those appeals were successful, the state would have had to pay back an estimated $300m in taxes and interest. 

"Wisconsin has taken the position that all software is off the shelf unless it's written from scratch, which no one does anymore," said Leonard Sosnowski, an attorney at law firm Foley & Lardner, which represents the company.

The larger issue, he said, is that not only is the modified software itself taxable, but so are the services required to fix or reprogram it during the implementation. 

Sosnowski also said the case could be used as a precedent in other states. 

Andrew Nelson, another lawyer at the firm, viewed the case as important because the judge's definition of modified software could make the services around implementing it also taxable. That, he said, might push some companies to move their IT operations to states with more favourable tax laws. 

Explaining his ruling, Ebert said R/3 always requires substantial modification to adapt the system to a given customer's specifications. In this case, at SAP's recommendation, Menasha hired consultancy Deloitte & Touche to help it make the changes it needed.

The implementation team, which included SAP and Deloitte employees, used the R/3 tool kit, Development Workbench, to customise SAP's proprietary Advanced Business Application Programming code to fit Menasha's specific requirements. 

In total, the installation required 3,000 modifications, for which Menasha shelled out $2.5m to SAP, $13m to Deloitte and $775,000 to other outside consultants. 

Even so, wrote Ebert, "the court sees no reason why software that provides the building blocks upon which modifications specific to the particular purchaser are made should not be deemed prewritten software".

Given the fact that SAP made only minor modifications to R/3 in this case, the application cannot be deemed as having been custom-written, he added.

Marc L. Songini writes for Computerworld

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