Massachusetts Channel Partners Struggling With Services Tax Proposal

Channel partners in Massachusetts are concerned that a proposed tax on IT services will interrupt the commonwealth's economic recovery, drive business across the border and add a thick layer of complexity across future transactions.

If it becomes law, the proposed tax would impose a 4.5 percent levy against a wide variety of business-to-business IT services, and it would generate an estimated $265 million in revenue.

"This really frosts me," said Mont Phelps, CEO of NWN Corporation, a Boston-based channel partner. "IT is part of the solution, not part of the problem. They want to take money out of this industry to show that they can."

[Related: Massachusetts Governor Proposes Tax On Computer Services ]

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According to a document from the Massachusetts Department of Revenue, targeted IT and data processing services would likely include services around code development, modification or testing of existing programs, feasibility studies, the design and installation of computer systems that integrate computer hardware, software and communication technologies, disaster recovery, and similar functions.

Momchil "Memo" Michailov, co-founder and CEO of Waltham, Mass.-based data management and protection software vendor Sanbolic, called the new tax "ridiculous" because of the potential to drive part of the IT industry out of the state.

Michailov said he is far from being an anti-tax person, noting that he appreciates government services such as funding the schools where his three children study or building and maintaining the roads he and his colleagues use.

However, he said, the new IT services tax, like the upcoming Internet sales tax scheduled to go into effect in November, are obvious plays by the State of Massachusetts to tax businesses while not taxing individual consumers.

Because of Amazon's acquisition of a Massachusetts-based data robotics company Kiva, sales of Amazon's products and services will be subject to tax. However, he said, there are exceptions for music, videos and the Kindle.

"If they charged taxes on everything, users would be up in arms," he said. "These are very 'loop-holish' taxes. The state is not taxing users for Internet service, even though most bandwidth is used for users' pictures and videos."

The proposed IT services tax, coming on top of the Internet sales tax and a host of other taxes Massachusetts has recently implemented, make doing business in the state complicated, Michailov said.

"Our customers and partners are staring at the computer screen wondering what will happen," he said. "The advantage of the cloud is, people can run a lot of applications efficiently, but it's hard to know where the data and services are."

As an example, Michailov said his 20 GB of email in the cloud would be hard to define for tax purposes.

"How would you tax it?" he said. "I access it from the office, from home and from mobile devices. Data does not sit in one device. It's moving. I have data, pictures and videos. What is the impact? The new tax is not designed to impact consumers. But, I have to figure out how the State of Massachusetts will skim off another 4.5 percent of my business."

NEXT: Driving Business Across The Border?

Those questions also ring true for Allen Falcon, CEO of Cumulus Global, a Westborough, Mass.-based cloud services company focused on the SMB segment.

"It's unclear exactly what's subject to tax and what isn't," he said. We know that Web hosting services would be taxed. But, the problem stems from a variety of different specifics. For example, if I am an out-of-state company that has web hosting in a data center in Massachusetts, do I need to collect sales tax on that, even if I'm located out of state? If I have to increase my costs by 4.5 percent, I become uncompetitive with resellers in 49 other states. Most margins on cloud services fall between 15 and 30 percent. The majority seem to land somewhere around 20 percent. So if I need to absorb the tax to be price competitive, then I've just cut my gross margin by 25 percent. And at that point, it really becomes a question of whether I can make money."

Falcon also noted that such a tax could impact the Commonwealth's position in attracting innovative technology companies.

"Massachusetts has been very aggressive in attracting startups and innovative companies," he said. "Certainly, we want to hold onto the talent that we develop at MIT and at other institutions. But this proposed tax would set up a situation that encourages them to drive an hour north into New Hampshire, and hours south into Rhode Island, and over to New York to retain greater profitability. I also think it will chill venture capital."

In the software design and development sector, the language of the proposal is far too vague, according to Jon Follett, principal of Involution Studios in Arlington, Mass. [Disclosure: Follett is the spouse of Jennifer Hagendorf Follett, executive editor, online, at CRN.]

"A red flag goes up for me every time there is broad language that can be interpreted a couple of different ways," he said. "And I guess you could say that the jury is out in terms of which services would actually be impacted by it. I'm all for paying a fair share of taxes, but this needs a lot more clarification. And it really begs the questions around the definition of customization, what is covered by this tax, and who is interpreting the legislation. There are a lot of open questions here."

Other Massachusetts businesspeople expressed concern over the logistics of collecting the tax.

"I don't know how it's going to affect buying patterns, but my biggest concern is how we are supposed to execute on it," said Timothy Shea, CEO of Alpha NetSolutions, a Millbury, Mass.-based channel partner. "I operate in five states, so I'm already tracking different tax rates in different states." Shea went on to cite other issues, such as the ambiguity surrounding what is taxed and what is not, the additional administrative work the tax may create and the disconnect between legislation and the "real world."