Texas updates data processing services tax rule

On March 28, 2025, the Texas Register published the final version of the amended rule addressing the sales and use tax treatment of data processing services as adopted by the Texas Comptroller of Public Accounts.¹ Generally effective April 2, 2025, the expansive rule provides key definitions, lists examples of activities that are included in and excluded from taxable data processing services, the tax treatment of data processing services sold with other services, the application of the tax to marketplace providers, and the sourcing of sales.

Data processing services 

Texas law imposes sales and use tax on data processing services, though a 20% exemption from the tax is provided.² As amended, the rule broadly defines a “data processing service” as “the computerized entry, retrieval, search, compilation, manipulation, or storage of data or information.”³ The amended rule provides examples of activities that are taxable data processing services, such as:

• Payroll services, including maintaining records of employee work time, computing and preparing payroll checks, filing payroll tax returns, and completing pre-printed employee-related forms, because they involve the routine application of the same process to different data;⁴
• The production of business accounting data, such as inventory reports;⁵
• The insertion of data into form title or loan documents for a client (in contrast to the preparation of a title opinion, which is not taxable data processing);⁶
• Internet hosting if the user stores data on the service provider’s hardware, or processes data on software that is owned, licensed, or leased by the user or provider;⁷
• Data migration services that transfer data from one storage device to another;⁸ and
• Website creation, repair, and maintenance, when such services involve the storage, manipulation, compilation, and entry of data (in contrast to developing a blueprint or plan for a website, which is not taxable data processing).⁹

The rule provides the following examples of activities that are not taxable data processing services:

• The preparation of financial statements kept in accordance with generally accepted accounting principles because the categorization and characterization of the data is variable and depends on the discretion and certified opinion of an accounting professional;¹⁰
• Streaming video subscriptions are taxable as a cable television service, and streaming video games are taxable as an amusement service instead of data processing services;¹¹ and
• The compilation of information that a service provider acquires from unrelated third parties through nontaxable opinion polls and surveys if the data processing is ancillary to the main service of data acquisition and the data processing does not have a separate value.¹²

Data processing sold with other services 

The definition of “data processing service” excludes data processing that is sold for a single charge with another service if the data processing service does not have a separate value and is ancillary to the other service.¹³ The taxpayer has the burden of showing that the data processing service does not have a separate value and is ancillary to the other service. If the data processing service is sold for a single charge with another service that does not have a separate value, and the other service is ancillary to the data processing service, the entire charge is taxable as a data processing service.¹⁴

Similar to the existing rule, the amended rule also addresses nontaxable related services.¹⁵ A service is considered a nontaxable related service if: (i) it is neither a data processing service nor an otherwise taxable service; (ii) each service provided is of a type commonly provided on a standalone basis; and (iii) the performance of the service is distinct and identifiable.¹⁶ When nontaxable related services and taxable services are sold for a single charge, and the portion relating to taxable services represents more than 5% of the total charge, the total charge is presumed to be taxable.¹⁷

Marketplace provider services 

Effective Oct. 1, 2025, marketplace provider services may be included in taxable data processing services if they involve the computerized entry, retrieval, search, compilation, manipulation, or storage of data or information provided by the purchaser or the purchaser’s designee.¹⁸ For example, the services of a marketplace provider to its marketplace seller that store product listings and photographs, maintain records of transactions, and compile analytics are taxable data processing services.

Imposition of tax 

Applicable state and local sales and use tax is imposed on each sale or use of a data processing service in Texas.¹⁹ Except for small remote sellers, a seller of data processing services must obtain a Texas sales and use tax permit and collect and remit tax on charges for data processing services, or accept properly completed resale, exemption, or direct pay permit certificates in lieu of collecting tax.²⁰ As provided in the underlying statute, 20% of the amount charged for data processing services is exempt from tax.²¹

Sourcing of sales 

If both the data processing provider and the customer are located in Texas, then Texas sales tax is due.²² The sale of a data processing service delivered in Texas is presumed to be a sale for storage, use, or consumption in Texas.²³ If a data processing service is performed in Texas, taxability depends on where the service is used (unless an exemption applies). If the data processing service performed in Texas is used entirely outside the state, it is exempt from sales tax.²⁴ If the data processing service performed in Texas is used both within and outside Texas, it is exempt to the extent the service is used outside Texas.²⁵ A data processing service performed outside Texas is subject to the Texas use tax to the extent the service is for use in Texas, unless an exemption applies.²⁶ A purchaser asserting the use of a data processing service at its business locations in multiple states may issue to the service provider a multiple points of use document (either via a form promulgated by the Comptroller or a substantially similar document), asserting the purchaser’s concurrent multistate business use and representing that the purchaser will report and pay the state and local tax on the portion that is taxable.²⁷

Local sales tax is due in a local jurisdiction where the sale is consummated.²⁸ Local use tax may also be due in a local jurisdiction where a benefit from the service is derived if the 2% local tax cap has not been exceeded.²⁹ An in-state customer purchasing data processing services for the benefit of more than one taxing locality is responsible for issuing to the data processing service provider an exemption certificate claiming a multi-city benefit and for determining the extent of benefit for each locality.³⁰ A data processing service provider that accepts an exemption certificate claiming a multi-city benefit is relieved of responsibility for collecting and remitting local tax on transactions to which the certificate relates.

Commentary

The extensive amendments to the Texas data processing services rule have received considerable attention and are intended to expand the scope of services that are subject to sales and use tax. The proposed rule originally was released on Sept. 13, 2024, for public comment. At that time, the Texas Comptroller issued a statement explaining the proposed amendments to the rule.³¹ The Comptroller noted that the statute imposing sales tax on data processing services was enacted by Texas in 1987. The amendments to the rule were intended to reflect the substantial changes in business transactions due to the internet and to assist online marketplaces in determining their tax obligation. The proposed rule received numerous comments, and some revisions were implemented before the final rule was adopted.

One of the more controversial provisions of the amended rule concerns the exclusion of data processing that is sold for a single charge with another service if the data processing service does not have a separate value, and the data processing service is ancillary to the other service. The “ancillary” language has received extensive comments because it is replacing the “essence of the transaction” standard adopted in Texas case law.³² The comments express concern that this change was not approved by the Texas legislature, may expand the scope of the tax, and may violate the Internet Tax Freedom Act in some instances. In determining whether the data processing service is ancillary to a nontaxable service, it is clear that the Comptroller will decide the “ancillary” issue by focusing on whether the service provider’s activities in performing the service are considered routine (leading to a taxable result) or specialized (leading to a nontaxable result).

Another provision that has received criticism is that marketplace provider services may be included in taxable data processing services when they involve the computerized entry, retrieval, search, compilation, manipulation, or storage of data or information provided by the purchaser or the purchaser’s designee. This provision, effective Oct. 1, 2025, expands the tax to certain marketplaces. Given the potential breadth of this change, the delayed implementation date has been provided in order to provide the Texas legislature an opportunity to consider and perhaps overturn this policy before it becomes effective. The Comptroller explained that his staff drafted legislation in 2023 that would have made online marketplace fees exempt from sales tax, but the Texas legislature did not approve the exemption during that legislative session.

Many of the changes in the amended regulations are not surprising because they are consistent with the Comptroller’s existing rulings or positions. However, there is a possibility that litigation may be pursued that challenges the Comptroller’s authority to make some of these changes because they may overstep the purview of the legislature. In the meantime, this rule should be carefully examined to determine if specific services offered and performed by businesses are now characterized as data processing services that are subject to sales and use tax. This evaluation should be made immediately since the amended rule is now in effect. 

1 34 TEX. ADMIN. CODE § 3.330.
2 TEX. TAX CODE ANN. §§ 151.0101(a)(12); 151.351. Under Texas law, a “data processing service” includes: (i) “word processing, data entry, data retrieval, data search, information compilation, payroll and business accounting data production, and other computerized data and information storage or manipulation;” (ii) the performance of a totalizator service with the use of computational equipment required under the Texas Racing Act; and (iii) the use of a computer or computer time for data processing whether the processing is performed by the provider of the computer or computer time or by the purchaser or other beneficiary of the service. TEX. TAX CODE ANN. § 151.0035(a). Also, the statute includes a list of services that are excluded from the definition, including the settling of electronic payment transactions under certain conditions. TEX. TAX CODE ANN. § 151.0035(b).
3 34 TEX. ADMIN. CODE § 3.330(a)(1). The rule also provides lists of specific activities that are included and excluded from the definition. 34 TEX. ADMIN. CODE § 3.330(a)(1)(A), (B).
4 34 TEX. ADMIN. CODE § 3.330(b)(1).
5 34 TEX. ADMIN. CODE § 3.330(b)(2).
6 34 TEX. ADMIN. CODE § 3.330(b)(4).
7 34 TEX. ADMIN. CODE § 3.330(b)(6).
8 34 TEX. ADMIN. CODE § 3.330(b)(11).
9 34 TEX. ADMIN. CODE § 3.330(b)(12).
10 34 TEX. ADMIN. CODE § 3.330(b)(3).
11 34 TEX. ADMIN. CODE § 3.330(b)(7), (8).
12 34 TEX. ADMIN. CODE § 3.330(b)(9). If the service provider acquires and compiles data from the customer or the customer's designees, and the service provider's expertise is in managing the data, such as in inventory management, the main service is data processing that is taxable.
13 34 TEX. ADMIN. CODE § 3.330(a)(1)(C). In determining separate value, the Comptroller will consider whether the services are distinct and identifiable and whether each service is of a type that is commonly provided on a stand-alone basis or provided as an additional service for a greater single charge. 34 TEX. ADMIN. CODE § 3.330(a)(1)(C)(iii). The focus is on what the service provider is doing, not on what the customer wants. For example, in determining whether services are ancillary, the Comptroller may consider the extent to which the service provider exercises discretion or judgment in individual applications of the processed data based on knowledge of the physical sciences, accounting principles, law, or other fields of study. In such cases, when the service provider is using external knowledge and exercising discretionary judgment in individual applications, it may be more likely that the service is not classified as a data processing service. In contrast, the routine or repetitive manipulation of data by the seller suggests that the data processing activity is not ancillary to another service and should be taxable as a data processing service. 34 TEX. ADMIN. CODE § 3.330(a)(1)(C)(iv).
14 34 TEX. ADMIN. CODE § 3.330(a)(1)(C)(i).
15 34 TEX. ADMIN. CODE § 3.330(e).
16 34 TEX. ADMIN. CODE § 3.330(e)(1). Examples of this type of service include consultation, development of and preparation of feasibility studies, design and development, or training.
17 34 TEX. ADMIN. CODE § 3.330(e)(2). A data service provider may overcome this presumption by separately stating a reasonable charge for the taxable services. However, if the charge for the taxable portion of the services is not separately stated at the time of the transaction, the service provider or the purchaser may later establish, through documentary evidence, the percentage of the total charge that relates to nontaxable related services.
18 34 TEX. ADMIN. CODE § 3.330(b)(5).
19 34 TEX. ADMIN. CODE § 3.330(c)(1).
20 34 TEX. ADMIN. CODE § 3.330(c)(2).
21 34 TEX. ADMIN. CODE § 3.330(c)(4). If the data processing service also is taxable as another type of service other than an information service, the 20% exemption does not apply.
22 34 TEX. ADMIN. CODE § 3.330(f).
23 34 TEX. ADMIN. CODE § 3.330(g)(2).
24 34 TEX. ADMIN. CODE § 3.330(g)(3)(A).
25 34 TEX. ADMIN. CODE § 3.330(g)(3)(B).
26 34 TEX. ADMIN. CODE § 3.330(g)(4). A purchaser of a data processing service performed outside Texas for use in Texas may claim a credit for a similar tax paid in another state if that state provides a similar credit for a taxpayer in Texas. 34 TEX. ADMIN. CODE § 3.330(g)(5).
27 34 TEX. ADMIN. CODE § 3.330(g)(6). The multistate purchaser may use a reasonable and consistent method supported by its business records to allocate the service between its business locations. A service provider that accepts a multistate use certificate in good faith is relieved of responsibility for collecting and remitting Texas state and local sales and use taxes on transactions subject to the certificate.
28 34 TEX. ADMIN. CODE § 3.330(h)(1). The sale may be consummated at the seller’s place of business where the order is received or fulfilled, or at the location to which the service is delivered.
29 34 TEX. ADMIN. CODE § 3.330(h)(2).
30 34 TEX. ADMIN. CODE § 3.330(h)(3). The customer must pay, report, and allocate the local use tax for each entity.
31 From the Desk of Glenn Hegar: Rule update would bring clarity to taxing online marketplaces in Texas, Texas Comptroller of Public Accounts, Sept. 2024.
32 Hegar v. CheckFree Services Corp., Texas Court of Appeals, 14th District, No. 14-15-00027-CV, April 19, 2016.