The Art of Racing in the Rain

For those of you unfamiliar with this Garth Stein novel, an aspiring Formula I driver, Denny Swift, adopts an adorable golden retriever puppy he aptly names Enzo (of Ferrari fame) and describes the premise underlying the title to Enzo as follows:

“Drivers are afraid of the rain. Rain amplifies your mistakes, and water on the track can make your car handle unpredictably. When something unpredictable happens you have to react to it; if you’re racing at speed, you’re reacting too late. And so you should be afraid.”

The story can apply directly to issues currently facing Minnesota taxpayers. Said directly, we will have “unpredictable elements” in life. And, while those elements can be insurmountable when surfacing on their own schedule, we can have a positive impact when exercising deliberate foresight. As Enzo says, ”a racer should not be afraid of rain; a racer should embrace the rain. I alone could manifest a change in that which was around me.”

And so, how does this apply to tax? Minnesota taxpayers have been on a three-year journey of “racing in the rain,” as it relates to Department of Revenue policies pertaining to the sale and implementation of software. Unfortunately, rather than embracing the rain and manifesting change, we have focused on the present turn rather than on the next obstacle. “Your car goes where your eyes go. Simply another way of saying that you make your own destiny.”

In 2018, the Department of Revenue convened an Advisory Committee, comprised of Revenue employees, legislative research personnel, and interested taxpayers and taxpayer representatives. The stated purpose of this committee was to discuss revisions to Minn. R. 8130.9910, which contains guidance on the taxability of computer software. After numerous meetings, and discussions pertaining to taxpayer concerns over the revised language, efforts seemed to stall.

In 2021, rather than going through the formal rulemaking process, the Minnesota Department of Revenue introduced two separate Revenue Notices,*and again invited taxpayer commentary. The first, circulated on January 29, pertains to services deemed “necessary to complete the sale.” Under the guise of simply revoking and replacing Revenue Notice #06-06 (pertaining to interior design services), the Department took the position that services “necessary to complete the sale” of a taxable good or service become taxable upon the subsequent taxable transaction. Here, the Department strips away any real “standard” for the timing between the initial service and the taxable transaction, and fails to clarify how this might apply to situations where the initial service and the taxable transaction are provided by different parties, or even under different and discrete contracts by affiliates.

The second proposed Revenue Notice, circulated on February 10, pertains to the taxability of “third-party installation services,” which are taxable under Minn. Stat. § 297A.61, subd. 3(j) if the item being installed was subject to sales tax when purchased. With regard to software, the Revenue Notice provides by way of example:

Company A sells Customer B prewritten computer software but does not sell installation or any other service. The sale is sourced as required under Minnesota Statutes, section 297A.668, subdivision 2, and the appropriate sales tax is paid. Three months later, Customer B hires Company C to install the prewritten computer software purchased from Company A. The sale of software installation by the third-party, Company C, is subject to sales tax because if Company A had installed the software, the installation would have been taxable.

The timing of this proposed revenue notice in conjunction with the other one, pertaining to “services necessary to complete the sale,” is a bit too ironic.

The formal rulemaking process appears to have stalled. However, it seems the Department may have taken the commentary from that 2018 committee and created an audit approach that looks to implement the two notices. The Department has its eye on the next turn, while taxpayers and their representatives are focused only on the current unpredictable element – which should make us afraid.

We cannot continue to sit idly by as the Department of Revenue continues administratively to take these inherently legislative steps while ignoring Minnesota Tax Court precedent. “That which you manifest is before you. Create your own conditions, and rain is just rain.”

Repeatedly during public appearances, the Minnesota Department of Revenue has invited taxpayer commentary, going as far as suggesting that taxpayers should propose revenue notices.

It is time for our taxpayer community to accept that invitation.

*Revenue Notices do not have the force and effect of law. Rather, they set forth the Department’s position or interpretation of Minnesota law. Taxpayers may rely on Revenue Notices until they are revoked or modified.

  • Kyle M. Brehm

    Kyle is a State and Local Tax practitioner, focused on providing value to clients across a variety of industries: healthcare, financial services, construction, manufacturing and retail. He develops the tax departments with which ...

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