Texas Data Processing Services Taxability: Key Changes with Ancillary Test

The Texas Comptroller revised and amended the sales and use tax rules for data processing services, introducing the ancillary test to determine whether services are taxable or non-taxable. The amendments expand the definition of data processing and include several examples of taxable and non-taxable data processing services, ultimately requiring those who provide taxable services to register for sales and use tax.

Impact on Taxable Persons

The amendments, which introduced the ancillary test for data processing service providers among other things, came into effect on April 2, 2025. The adopted rules emphasize that, in determining whether the provision of data processing services is taxable, the key point is what the seller is doing, rather than why the buyer needs the service. 

Therefore, as a general rule, if a seller is performing a routine or repetitive data processing, the activity is not ancillary and likely taxable. On the contrary, when the data processing involves the external knowledge and discretionary judgment of the seller, it is considered part of a larger, non-taxable service.

For example, when someone enters information into forms or loan documents, processing such data is considered a data processing service and is typically subject to taxation. This is because the main activity is handling and organizing data, although in some cases, judgment is required. On the other hand, writing a title opinion is based on legal knowledge and analysis. Therefore, it is not considered a taxable data processing service. 

Even though both services help achieve the same kind of goal, such as completing a real estate transaction, only the one that primarily involves repetitive data processing is taxable. In contrast, the one that requires legal expertise is not. Other taxable data processing services include search engine optimization, social media marketing, and lead generation.

Furthermore, the rules affecting marketplace providers will not take effect until October 1, 2025. However, some argued that many marketplace providers are already subject to sales and use tax for taxable goods or services, and subjecting them to taxes as data processing services would constitute double taxation. 

Nevertheless, the Tax Comptroller declined to make any changes to the amended rules, stating that the wording is precise and that marketplaces provide taxable data processing as their services involve computerized data storage and manipulation for their customers.

Conclusion

With the implemented amendments, the Texas Comptroller replaces the previous “essence of the transaction” test with the ancillary test. Taxable persons that provide data processing services must examine to what extent the new taxability rules apply to them. If they are subject to sales and use tax, they must register for tax purposes in Texas.

On the other hand, marketplace providers have a few additional months to determine their liabilities and responsibilities under the amended sales and use tax.

Source: EY, Texas Comptroller of Public Accounts