This blog was last updated on June 26, 2021
*This is Part 2 of a 4-part blog series addressing the issues associated with sales tax and cloud computing. In Part 1, we addressed what the cloud is. The following discussion will address why you should care about the cloud. A detailed explanation of Cloud Computing including SaaS, PaaS, or IaaS (which are referenced below) can be found in Part 1 of this series. Businesses and The Cloud In today’s world of “instant everything” businesses and consumers are becoming more dependent and more accustomed to the cloud. Every day more and more people are accessing and using cloud technologies to do things as simple as listen music and things as complex as calculating the correct sales tax across all jurisdictions in the U.S. As the cloud grows and replaces old technologies (i.e. software sold on disc) taxing jurisdictions are crafting ways to tax cloud-based transactions. In those jurisdictions that levy a sales tax, the tax is generally imposed on sales of tangible personal property and a specified list of services (this a summary of the rule in a majority of states). In most circumstances, tangible personal property is defined as property, except real property, that can be seen, weighed, measured, felt, touched, or otherwise perceived by the senses. Tangible personal property does not generally include intangible goods (i.e. copyrights, deeds, licenses, etc…). After a cursory review of the general rules governing sales tax one may get the impression that cloud-based transactions are generally exempt from sales tax because a cloud-based transaction is not a sale of tangible personal property as it is generally understood. There is no transfer of goods tangible, digital, or otherwise; and the cloud is not considered a taxable service. If a cloud-based transaction is not any of the things we understand as being subject to sales tax why should taxpayers care? Although taxes may be one of the only sure things in life, it also a sure thing that when it comes to sales tax that the laws and rules that govern are constantly racing to catchup with technology. In today’s world of “instant everything” businesses and consumers are becoming more dependent and more accustomed to the cloud. Every day more and more people are accessing and using cloud technologies to do things as simple as listen music and things as complex as calculating the correct sales tax across all jurisdictions in the US. Cloud-based businesses are seeing increased revenues as the Cloud grows and replaces old technologies (i.e. software sold on disc). However, taxing jurisdictions are working on ways to tax cloud-based transactions. How Can Cloud Transactions Be Categorized and Taxed? Generally, as you have probably read about in the new, both taxpayers and taxing jurisdictions have difficulty identifying and categorizing cloud-based transactions. One of the most important questions for those attempting to determine the taxability of any cloud-based transaction to answer is the threshold question of whether the transaction is categorized as a sale of tangible personal property, a taxable service, or a non-taxable service. Cloud-based transactions pose several challenges when determining taxation based on the traditional sales tax schemes discussed above. As with most new technologies, the cloud does not fit neatly into existing categories of taxable transactions. Some of the questions surrounding cloud-based transactions that are difficult for taxing jurisdictions to answer include:
- What goods or services are included? (think SaaS, IaaS, PaaS)
- Is the cloud software?
- Is the cloud a service?
- What exactly is the purchaser/client/customer receiving?
- Where are the servers located? (this is becoming less important (discussion in upcoming Part 3))
- What amount of control over the transaction do the parties exert?
While cloud providers may contend that what they provide is simply a service (generally a non-taxable service), such a simple approach does not usually work and excludes alternative approaches that many jurisdictions view as a viable reason for collecting tax. Simply calling or marketing cloud transactions as a service does not provide immunity from sales tax as taxing jurisdictions look deeper into these transactions in order to get to the true nature of the sale. Taxable as Tangible Personal Property: Today businesses are aware that many jurisdictions already have laws and rules in place that specifically address the sale of tangible software and electronically delivered software. Many jurisdictions that address the sale of software take the approach that traditional software delivered via tangible media is taxable tangible personal property and that the electronic delivery of the same software should be treated equally and therefore is also taxable. Although cloud-based transactions allow users to access, manipulate, use, store, and work with software, there is no transfer of software, electronic or otherwise, to the user’s computer, server, etc. The lack of software transfer is used as a sticking point when arguing against taxing cloud transactions as software. Some taxing jurisdictions syill take the position that accessing, using, manipulating, storing, or otherwise working with software on their service provider’s servers is equivalent to the sale of software and deem it as such regardless of whether or not the software is physically or electronically transferred. Taxing cloud transactions as software would generally effect SaaS transactions as well as PaaS transactions. PaaS transactions, however, could avoid such treatment as the amount of software involved is minimal if any. Additionally, although it would be difficult to classify IaaS as the sale of software, the infrastructure provided by IaaS transactions could be viewed as a lease of tangible personal property. Similar to the software dilemma, an issue with classifying IaaS as the lease of tangible personal property arises when you look at whether or not there is any transfer of tangible personal property (physically or electronically), there is not. Also similar to software, taxing jurisdictions may look at IaaS as a service that is equal to the lease of tangible personal property because the vendor can be viewed as renting out space on its servers for the storage of digital information. This is especially true for IaaS data storage (i.e. cloud storage, cloud drive). Taxable as a Service: As stated previously the majority of states only impose sales tax on a specified list of services. These lists of services can and do change but changes are generally slow. Two existing taxable service categories that exist in some states include data-processing services and information services. These categories are often used to tax cloud-based transactions. Whether or not cloud-based transactions amount to taxable data-processing or information services often depends on a variety of factors such as: how much control over the process the parties exercise, how the service is sold, and/or what is included with the service. Some jurisdictions, such as Texas, look at cloud-based transactions as equivalent to data-processing or information services because it involves the manipulation of data and the provision of information over the internet or other electronic means. Generally speaking, jurisdictions have used rule making in order to fit the “square peg” that is cloud computing into the “round hole” that is data-processing and information service. You may ask, is this right? That is a continuous debate for those who sell and those who purchase the cloud. Jurisdictions that tax the cloud as a data-processing or information service take varying approaches to doing so, which will be discussed in further detail in Part 4 of this series. Once you determine whether a cloud-based transaction is a sale of tangible personal property or the sale of a taxable service, you next determine whether the seller has taxable nexus. The issue of nexus will be addressed in Part 3 of this series. Subscribe to the Taxware Blog to Read the entire series on this topic. In Part 3 we will discuss sourcing issues and related rules for cloud-based transactions. Finally, we will wrap things up in Part 4 with an in-depth review of state tax schemes being applied to cloud-based transactions, specifically focusing on key states such as New York and Illinois. Be sure to subscribe to the Taxware blog so you don’t miss any of this great information.
