Cloud Computing and Sales Tax

February 21, 2013 01:34 PM

 Cloud computing is transforming the IT business environment—affecting profoundly how IT is provisioned, managed, and protected.  Moreover, the transformation is challenging traditional sales tax concepts related to sourcing, i.e., determining the location from which and to which tangible personal property and services are delivered, and, thus, how states effectively assess and collect sales taxes related to the services performed within, or software provided from, the cloud.

Cloud computing is seen as a pool of hardware and software resources using “virtualization technologies” to allow computing functions, storage applications, network resources, and security to be provisioned over public (i.e., the worldwide web) or private networks.  It involves an analysis of services wherein the purchaser is able to access on demand from its terminal (or mobile device) computer data and other IT resources monitored by the provider on servers at its data center.  The software is never downloaded onto the user’s computer.

Defining Cloud Computing

There are generally considered to be three types of cloud computing.  The first is known as “Software as a Service (SaaS),” wherein businesses use a fully-managed software application over a public or private network.  The software remains under the ownership, possession, and control of the vendor (an application software provider or “ASP”) and sold on a subscription, service agreement, or software-licensed basis.  It is paid for per usage, by periodic renewal charges, or by a one-time license fee.  SaaS is the most widespread type of cloud computing.  Some examples of its use include email, calendars, word processing, and contact lists.

The second type of cloud computing is known as “Infrastructure as a Service (IaaS),” wherein computer infrastructure is provided on an on-demand basis by an ASP.  IaaS allows the user (the buyer) to develop and deploy its own software and database capabilities while using the ASP’s infrastructure to which the ASP continues to hold title, possess, and control.  IaaS is often sold through a service agreement, subscription, or software license.  The ASP either performs paid services for a buyer or allows the buyer to run the system.  Examples of IaaS use include data processing, storage, search, retrieval, and hosting.

Finally, there is “Platform as a Service (PaaS)” which enables customers to deploy on the cloud infrastructure applications using the ASP’s tools, languages, libraries, databases, and servers to create for those customers their own customized IT environment.  PaaS closely approximates a service performed by the ASP for which the consumer absorbs the costs.  Examples of PaaS include ASP-provided software applications and tools run by the customer or the ASP.

Cloud computing is becoming very popular with businesses for several reasons: 

  • It supports a business’s core focus.
  • It saves businesses significant costs by allowing them to outsource non-core IT  maintenance infrastructure.
  • Scalability:  businesses do not pay for services and manpower that they are not currently using.
  • Resiliency:  businesses avoid system downtime—single points of system failure.
  • Businesses optimize computer power and the management of IT costs by paying for services only on demand. 

Indeed, cloud computing is estimated to reach $150 billion in worldwide sales by 2014.

Sales Tax Complexities of Cloud Computing

Cloud computing is a state-of-the art information technology taxed or exempted from tax by states often relying, unfortunately, upon outmoded tax concepts.  Accordingly, there are a number of problems associated with how or whether states should tax it.  There is often a lack of authoritative support in the form of statutes, case law, or state department of revenue regulations to help guide providers or their clients on how these transactions should be taxed. Further, cash-hungry states often take an aggressive stance when it comes to framing their positions on taxability.  In addition, cloud computing transactions often appear ambiguous.  It is problematic whether they involve a sale of service or the license of software.  This is because it is unclear whether it is the provider or its client who possesses, controls, manages, or owns the database or software upon which the transaction is centered and upon whom the tax should be levied.  Sourcing issues also emerge.  As the database or software is accessed remotely, it is unclear where a transaction takes place, at the provider’s server located in one state or the client’s terminal located in another.  Similarly, if a transaction is considered the sale of a service, it is difficult to determine where the service is performed, especially when the server is in one state and the benefit of the service received by the customer is in another state.  In many cases, these difficulties lead to the emergence of allocation concepts which do make possible the sourcing of a transaction to multiple locations even though a particular state’s allocation rules regarding multiple sourcing are often non-existent or unclear.  Finally, evolving concepts of nexus (that physical connection to a state that allows that state to tax a cloud computing provider or user) call into question heretofore settled notions of taxing responsibilities and risk measurement.

Our Expertise

To conclude, businesses need to control tax risk—the risk of either underpaying or overpaying their sales tax obligations.  True Partners Consulting’s Sales and Use Team can assist providers of cloud computing and its users in navigating the complexities of this topic.  Our professionals provide advice and perform services related to voluntary disclosure agreements, audit defense, nexus determinations, and the construction of the taxability matrices that lay out states’ more current positions on the taxability of cloud computing transactions. 

Bruce Davis

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