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Taxation of Cloud Based Transactions – What do you see?

By: Sonali Fournier Ryan McKenzie Lauren Ansley |

On August 14, 2019, the IRS released Proposed Treasury Regulation (“Prop. Treas. Reg.”) § 1.861-19 to provide rules for classifying a cloud based transaction (“CBT”) as either a lease of property or sale of services. This classification is critical to determine whether income and deductions are U.S.- or foreign-source, and it also has consequences for the calculation of the BEAT tax under Code section 59A (services are generally excluded from BEAT) and the FDII deduction under section 250 (particularly with regard to documentation). While Code section  7701(e)(1) and case law provide general factors for classifying transactions as a service or a lease, those rules focus on physical factors, which are not useful when applied to CBTs.

Common CBTs are Software as a Service (“SaaS”), Platform as a Service (PaaS”), and Infrastructure as a Service (“IaaS”).

  • SaaS: customers access applications on a provider’s cloud infrastructure through a browser
  • PaaS: customers deploy their applications onto a cloud infrastructure using programming languages, libraries, services and tools supported by the provider
  • IaaS: customers access processing, storage, networks, and other infrastructure on a provider’s cloud infrastructure

In addition to these transactions, CBTs also include on-demand network access to technological resources such as streaming music, videos, data, and other applications through remotely hosted software. At first blush, “service” is in the name of these common transactions and without further inspection, treating these transactions as a service would seem like the default approach from a tax perspective.  But as is common in the tax law, first impressions do not provide sufficient answers to important questions.

Prop. Treas. Reg. § 1.861-19(b) defines a CBT as a “transaction through which a person obtains on-demand network access to computer hardware, digital content … or other similar resources, other than on-demand network access that is de minimis taking into account the overall arrangement and the surrounding facts and circumstances.” Once we’ve determined that the SaaS, PaaS, IaaS, and other on-demand transactions qualify as a CBT, we look to Prop. Treas. Reg. § 1.861(c)(2) which provides the following nine factors to consider in determining if the CBT is a provision of services rather than a lease of property:

  1. The customer is not in physical possession of the property;
  2. The customer does not control the property, beyond the customer’s network access and use of the property;
  3. The provider has the right to determine the specific property used in the cloud transaction and replace such property with comparable property;
  4. The property is a component of an integrated operation in which the provider has other responsibilities, including ensuring the property is maintained and updated;
  5. The customer does not have a significant economic or possessory interest in the property;
  6. The provider bears any risk of substantially diminished receipts or substantially increased expenditures if there is nonperformance under the contract;
  7. The provider uses the property concurrently to provide significant services to entities unrelated to the customer;
  8. The provider’s fee is primarily based on a measure of work performed or the level of the customer’s use rather than the mere passage of time; and
  9. The total contract price substantially exceeds the rental value of the property for the contract period.

The presence of any one factor would not cause a CBT to be treated as a lease of property, but all relevant factors should be weighed in making this determination, including but not limited to the nine listed factors in the proposed regulation.

The IRS is requesting comments on the proposed regulations.  The Government is particularly interested in hearing about realistic examples of CBTs that are treated as leases, administrable rules for sourcing income from CBTs consistent with the Code sections 861 – 865, and potential bases for allocating income in arrangements that include both CBTs and non-CBTs.

Pareidolia is the tendency to perceive faces, images or shapes in random visual patterns (e.g. seeing faces or animals in clouds).  Different parties often see different shapes while looking at the same visual pattern/cloud.  The same is true for CBTs before the issuance of this guidance.  A CBT could have been interpreted as a sale of service or lease of property by different parties.  While Prop. Treas. Reg. § 1.861-19 provides some clarity, there is a measure of interpretation remaining based on specific facts and circumstances and there are no true bright lines.  CBTs can be complex arrangements and may remain difficult to classify as a sale of services or a lease of property due to the weight of relevant facts and circumstances.  So in the end, pareidolia will remain a fact of cloud based transactions, as they are with clouds, but the interpretation, at least, will never be a face or animal.

TPC can help you navigate this new landscape through data analytics and technical analysis.  

The team at True Partners Consulting offers a combination of highly experienced tax advisors who can help your company understand the impact of the proposed regulations for CBTs as well as other tax law changes.  We are prepared to work closely with clients to identify opportunities and to develop successful strategies to avoid the inevitable pitfalls that come with implementing various aspects of these and other new rules.

Please contact Ryan McKenzie,, Sonali Fournier,, or Lauren Ansley,