Cloud Computing: Part 4 – Cloudy With a Chance of Sales Tax – An Overview of State Tax Schemes Being Applied to Cloud Based Transactions
This is the fourth and final part of our blog series addressing issues related to the taxation of cloud based transactions. Previously, we addressed what the cloud is, why businesses should concern themselves with cloud based transactions and the nexus and sourcing issues associated with sales tax and cloud computing. The following discussion will take a more in-depth review of state tax schemes being applied to cloud based transactions, specifically focusing on a cross section of states: Illinois, Massachusetts, Nebraska, New Jersey and South Dakota. A detailed explanation of Cloud computing including SaaS, PaaS, or IaaS (which are referenced below) can be found in Part 1 of this series.
Through the first three parts of this four part series we discussed generally and in broad strokes how sales tax principles apply to transactions which apply to quasi-software/service transactions known as the cloud. We now turn our focus to how specific states view such transactions and how such transactions are analyzed under such laws.
As Cloud based services have become more prevalent and widespread, taxing jurisdictions have been rushing to catch up to the technology. Many states would have treated such transactions as exempt services (in states where only enumerated services are taxable). Today roughly 36 states have some guidance (statutory, regulatory, rulings/policy statements, unofficial guidance) that addresses issues relating to cloud computing. However, most of the guidance only relates to SaaS, the guidance available relating to IaaS and PaaS are still in the early stages and are somewhat limited. Below you will find a cross section of states that have addressed cloud computing and the different approaches and frameworks that apply to such transactions.
The state of Massachusetts has addressed some of the confusion regarding cloud computing through Letter Ruling 12-8 which was revised on 11/8/13. This letter ruling states that a taxpayer’s (cloud provider) charges for cloud computing are exempt when the purchaser uses its own application software or open-source (free) operating system software. Additionally, charges for cloud computing service which include operating system software licensed by the taxpayer (cloud provider) from a third party are also exempt. Finally, this letter clarifies that remote cloud storage services are exempt in the state of Massachusetts.
Massachusetts came to the exempt conclusions above based on the applicability of the “true object” test. The department of Revenue determined that the use of operating system software was merely incidental to the use of cloud computing services.
In Illinois General Information Letter ST 13-0074-GIL, the Department of Revenue stated that charges for the storage of data or information for subsequent retrieval or the processing of data or information intended to change its form or content did not constitute “gross charges” for the purpose of the telecommunications tax. The more relevant portion of General Information Letter ST 13-0074-GIL relates to cloud computing, in part the letter reads “in Illinois, information or data that is electronically transferred or downloaded is not considered the transfer of tangible personal property in this State… canned computer software is considered taxable tangible personal property regardless of the form in which it is transferred or transmitted, including tape, disc, card, electronic means or other media… if the computer software consists of custom computer programs, then the sales of such software may not be taxable retail sales…. custom computer programs or software must be prepared to the special order of the customer.” In other words, if the software provided by the taxpayer (cloud provider) consists of canned software the transaction will be taxable. However, if the software is a custom computer program, then the sales are not taxable retail sales. The custom computer program must be prepared for the customer by special order in order to be exempt.
Unlike many states, Nebraska has taken a proactive approach when it comes to providing a clear framework for which taxability decisions relating to cloud based transactions can be modeled around. Nebraska defines “Cloud Computing” as services which allow customers to access and use computer software, servers, operating systems, databases, and other computing resources via the Internet. Cloud computing includes services known as Software as a Service (SaaS), Platform as a Service (PaaS), and Infrastructure as a Service (IaaS).
In Information Guide 6-511-2011, the Nebraska Department of Revenue lays out clean bright line rules that apply to the taxation of “Cloud Computing.” Charges for services which allow customers to remotely access software applications, operating systems, servers, and other network components via the Internet or other online connections are not taxable. This is true regardless of whether the software, hardware, or network components are located in Nebraska or outside the state. The service provider is responsible, however, for paying sales or use tax on its purchases of software, hardware, and network components if these items are used in Nebraska.
In Technical Bulletin TB-72 the New Jersey Division of Taxation discusses the taxability of each of the 3 major cloud based transaction services (SaaS, PaaS, & IaaS). This treatment is somewhat unique in that many states lump cloud transactions into a single type of service concentrating mainly on SaaS based cloud transactions.
SaaS: Where use of the software does not relate to the provision of information services, SaaS is exempt from sales tax. The SaaS provider is the owner of the underlying software and is selling access to the software rather than the software itself. As such, the SaaS provider must pay sales tax on the purchase of any software used to provide the service, except where the business use exemption is applicable.
PaaS: A PaaS provider is not treated as a reseller of a license to use the software. Therefore, the sale of PaaS is not a sale of tangible personal property. Rather it is the sale of a service. Services delivered into New Jersey are taxable when they are specifically listed under N.J.S.A. 54:32B-3. Use of a software application or platform is not listed as a taxable service. Where use of the software is the true object of the sale, PaaS is not subject to sales tax. So long as the use and access to PaaS does not include the transfer of tangible personal property, the sale of PaaS is not subject to sales tax. This is true whether the software is located on a server in New Jersey or on a server outside the State. The PaaS provider is the owner of the underlying software and is selling access to the software rather than the software itself. As such, the PaaS provider must pay sales tax on the purchase of any software used to provide the service, except where the business use exemption is applicable. The PaaS provider must also pay tax on the purchase of any hardware or other equipment used to perform the service.
IaaS: Unlike the other cloud computing providers, IaaS providers may provide separately stated charges for the use or rental of hardware related to the service. As there is no exchange of title or possession, these charges are not treated as rentals. These charges generally reflect choices made by the customer as to type, capacity, speed, or size. At times, these charges are for hardware which will be dedicated to a single customer. Although these charges may be separately stated, they are merely add-ons to the customer’s IaaS arrangement and are therefore, part of the sales price that make up the underlying receipt for the service. Services delivered into New Jersey are taxable when they are specifically listed under N.J.S.A.54:32B-3. IaaS is not listed as a taxable service. Where use of the software and supported
network is the true object of the sale, IaaS is not subject to sales tax.
The IaaS provider must pay tax on any purchases of tangible goods, telecommunications services, utilities, charges for servicing or repairing, etc., for use in the performance of their service contracts. The IaaS provider is not deemed to be a reseller of these goods and services even if these purchases are passed on as a separate line item to the customer. When an agreement for IaaS does not provide for the transfer of tangible personal property or provide for taxable services to any property owned by the customer , sales tax is not applicable.
The State of South Dakota is one of the only States which tax all services unless a service is specifically enumerated as exempt from sales tax. In a publication called “Tax Facts-Internet” the South Dakota Department of Revenue addresses internet services. Although unless specifically exempt, a service is taxable, the department chose to elaborate on the issue of internet services. The sales of internet-related services are taxable in South Dakota. Internet related services would include: e-mail; internet access fees; webinars; tech support; website development and maintenance; web hosting; streaming services and although not specifically mentioned all Cloud services (and also because such services are not specifically mentioned).
This is an area of law that will continue to grow and evolve and at this point there are no signs that new approaches and law changes are becoming less frequent. There are different articulations of cloud computing each can trigger different tax results across multiple jurisdictions. In Closing when considering entering into a cloud based service agreement or engaging in any cloud based transaction one would be well advised to thoroughly research the most recent articulation of the law as it relates to such transactions.