Washington businesses could soon start paying the same tax buying custom software that they shell out on a trip to the mini-mart.

A tax bill under consideration in the final days of the legislative session this week, House Bill 3191, proposes to charge standard retail sales tax on custom software along with candy, gum and bottled water.

The software tax alone would generate an extra $257.5 million in revenue statewide over the next three years to be applied toward education, health care and social services, according to the Washington Department of Revenue.

But software companies and opponents of the tax say it would unfairly burden small software developers and Web-design consultants, which aren’t typically equipped to handle credit card transactions like most retailers, for example, or report sales tax to the state. Under current state law, custom software developers are considered service providers — similar to engineers, accountants and lawyers.

Clark County has a large and growing software industry of mostly small firms. As of June 2009, some 196 computer design firms with an average size of five workers employed 1,024 workers in the county, according to the Washington Employment Security Department.

“I can guarantee you that if we have to charge sales tax for services that we perform, it will add enough cost to significantly damage our business because customers will no longer find the pricing attractive,” said Ian Crane, vice president of development at Event1 Software, which relocated its business providing software for construction companies from Portland to Vancouver in 2006.

“Taxes of these magnitudes are significant enough for a small and mobile company to seriously consider relocating to a more favorable business climate,” added Crane, whose company provides software for construction companies.

As a border county with close proximity to Portland, Clark County could lose some software companies that choose to flee rather than endure the hassle of setting up a new retail system.

Some benefits possible

But proponents of the tax proposal say it’s simply an extension of a digital goods bill, passed by the Legislature last year, which requires companies to charge sales tax on software purchased online or housed in data centers and accessed via subscription — also known as “Software as a Service.”

The new bill further defines software as custom, any application developed specifically for one customer, or pre-written and sold to multiple customers who buy the same version.

Bottom line: “If you’re writing software you’re going to be remitting tax the same way no matter what your methodology is,” said Dylan Waits, a tax policy specialist at the Washington Department of Revenue.

That means many software companies that made the digital products transition for online products, or are large enough to absorb the costs, will already be equipped to handle the changes. “From our standpoint it wouldn’t have a huge impact; our systems are sophisticated enough that we can handle it,” said Clint Page, president and chief executive officer of Dotster, a Web hosting and design firm in Vancouver.

The legislation may even benefit some companies that already sell pre-written software to multiple customers, such as Microsoft Corp., and do a majority of their business outside of Washington.

Classified as service providers, these companies are charged a business and occupation tax of 1.5 percent of gross revenues. The proposed law would drop the B&O rate to 0.471 percent for developers.

The companies would instead be required to charge their customers a state sales tax of 6.5 percent plus local sales tax. In Clark County, state and local sales tax total 8.2 percent.

Only Washington residents and businesses would be subject to the new tax.

“If you make sales outside the state you don’t pay anything so there’s some benefit in it to the software providers,” Waits said. “But the customers inside Washington would have to pay more.”

Other disadvantages

The Washington Technology Industry Association, however, argues that any benefits the new sales tax would create are offset by the competitive disadvantage it would create for Washington software companies.

WTIA also opposes the bill in spite of the potential benefits it would provide to the organization’s higher education initiatives by adding $76.5 million to state coffers through June 30 of 2011, and $181 million in the next biennium.

The bill would have “unintended consequences” by placing the tax burden on large software customers such as banks, hospitals and utilities, said Lewis McMurran, a lobbyist for the WTIA in Seattle.

“If you’re a large customer doing a lot of custom programming, it could drive that incentive to look for offshore providers even more,” McMurran said.

Clark County's total sales tax rate was wrong in an earlier version of the online story. The correct rate is 8.2 percent.

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