A business relationship that involves both the provision of services and the transfer of tangible personal property is classified either as a service or a tangible personal property transaction based on the application of the "incidental to service" test, not the "real object" test, the Michigan Supreme Court held in Catalina Marketing Corp. v. Department of Treasury.

The taxpayer, Catalina, provides its clients with a "Checkout Coupon" program whereby it delivers a coupon or advertising message to certain specified shoppers as they check out at a grocery store on the basis of what they are currently purchasing.

For example, a shopper that buys a manufacturer-client's product, or a product produced by one of the client's competitors, would receive a coupon for the client's product at the time of check out.

Catalina developed hardware and software that collects data from the grocery stores' products as they are being scanned at the checkout register. The collected data is transferred to one of Catalina's centralized databases, where Catalina's software analyzes the product information and determines the desired response. The centralized database then sends the data back to a printer located in the store near the checkout scanner, which produces a manufacturer's redeemable coupon on thermal paper.

The Department of Treasury conducted a sales and use tax audit for the period from January 1, 1991 through June 30, 1993 and concluded that Catalina was liable for tax and interest based on the fees charged under the Checkout Coupon program. Catalina filed petitions with the Tax Tribunal, which found Catalina liable for the sales tax. The Court of Appeals affirmed in an unpublished opinion.

The Supreme Court found that the Tribunal was in error when it adopted the Department's policy, set forth in Revenue Administrative Bulletin 1995-01, of whether, "from the perspective of the manufacturer-clients," the "real object" sought by them was tangible coupons or nontaxable computer and information services.

The court noted the Court of Appeals issued a published opinion, University of Mich. Bd. of Regents v. Department of Treasury, holding that when tangible goods are provided as an "incidental" part of a service, the goods are not subject to sales tax. The incidental to service test adopted by the court "looks objectively at the entire transaction to determine whether the transaction is principally a transfer of tangible personal property or provisions of a service."

In applying this test a court should examine "what the buyer sought as the object of the transaction, what the seller or service provider is in the business of doing, whether the goods were provided as a retail enterprise with a profit-making motive, whether the tangible goods were available for sale without the service, the extent to which intangible services have contributed to the value of the physical item that is transferred, and any other factors relevant to the particular transactions."

"In this case the Tax Tribunal and the Court of Appeals erred in following RAB 1995-1 rather than the 'incidental to service' test set forth in Bd. of Regents," the Supreme Court concluded, finding the1996 Court of Appeals opinion is binding precedent not only on the lower courts, but on subsequent panels of the Court of Appeals.

The court rejected "the department's narrow reading of the real object test," finding that the real object test is inconsistent with the statutory definition of sale at retail because the test focuses exclusively on the perspective of the purchaser. "Instead, the statute's perspective is more broadly focused and requires a more detailed analysis that weighs not only the perspectives of the parties to the sale, but also the nature of the product and service."

While one may speculate the Supreme Court’s reversal indicates they could reach a different outcome under the facts in Catalina, the court remanded to the Tribunal for application of the incidental to service test to the facts of the case, so it will be necessary to wait for the Tribunal’s decision on remand to determine whether the new test compels a different result.

In response to the Supreme Court ruling in Catalina, the Department released RAB 2004-3, which replaces RAB 1995-1. The RAB states, “The ‘real object test’ advocated by RAB 1995-1 is rescinded and should no longer be used.”

The new RAB also states the “real object test” is replaced by the “incidental to service test” as supported by the Supreme Court ruling in Catalina, but does not provide any examples or other guidance regarding the application of this test. Taxpayers will therefore have to wait the Tribunal’s decision on remand or further guidance from the Department in applying this test.

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