Cloud Taxes: Are States Heading In Right Direction?

It is no surprise that several states and a few cities are looking to tax cloud computing transactions given the increasing popularity of the cloud among businesses.

Just look at one recent projection. Global cloud traffic will more than quadruple by the end of 2019, from 2.1 to 8.6 zettabytes, according to Cisco's recently released Global Cloud Index (2014-2019).

That growth means that state governments will have a reliable source of revenue to make up shortfalls in other sectors of the economy. But this can be a complex and controversial area with different states weighing in with different rules.

“Washington state has enacted legislation to impose sales and use tax on most cloud services,” Arthur Rosen, an attorney at McDermott Will & Emery, told our ALM sibling, Legaltech News .

“While the revenue agencies in New York, Arizona, Indiana, Pennsylvania, Michigan, Tennessee, Utah, and Vermont are asserting ' to different extents ' that cloud services are subject to their sales and use taxes, they are wrong,” Rosen says. “Their mistake is disregarding that the law requires there be a transfer of possession of the service provider's software to its customer ' case law in each of those states makes clear that the type of 'possession' over the software a buyer of cloud services receives is insufficient for there to be a taxable transfer.”

He points out that a Michigan court last month and a New Yok State Administrative Law Judge a few months ago agreed with this conclusion. Also, Chicago “initially took a similar position as the states ' above, but has largely retreated,” he adds.

On the other hand, the New Jersey Division of Taxation has taken the correct approach, Rosen says.

When it comes to the question if the only tax involved with cloud computing is the sales tax, Rosen explains: “That is everybody's primary concern. But there are income tax implications, as well.”

“These include nexus (Are the service provider's customers subject to tax where the service provider's computers are located?) and sourcing (Where should the service provider's receipts be assigned for apportionment purposes?),” he says.

When it comes to the national picture, there are no federal laws that directly impact these issues. However, some of the concerns are addressed by pending federal legislation such as two sales tax bills: the Digital Goods and Services Tax Fairness Bill, S.851 and the Business Activity Tax Simplification Bill, H.R.2584.

Moreover, cloud-based products and services delivered over the Internet “test the limits of existing sales tax rules,” Mary T. Benton, an attorney at Alston & Bird, says.

When asked if cloud transactions should be taxed, Benton says, “most people are comfortable that there is a rational basis to subject digital goods to tax, particularly when those items are taxable when purchased in tangible form.”

“However, when you move into the services that are provided through the cloud, it is not as straightforward,” she cautions. “At its core, whether cloud transactions are subject to tax is a policy question that should be decided by state legislatures. While many states have tackled the taxation of digital goods, very few have thoughtfully addressed whether to subject SaaS [software as a service] to taxation. This absence of direction from state general assemblies means that the taxation of these cloud transactions is being addressed individually by each state's taxing agency. However, the sales and use tax statutes, the constructs of which were developed decades ago, do not easily translate to this new technology. Applying these 20th-century laws to 21st-century technology is the epitome of trying to fit a square peg into a round hole,” Benton says.

In addition, she explains that sales tax is generally imposed “on the sale of tangible personal property and specifically enumerates services '. To subject cloud transactions to taxation, they must come within one of the taxable categories.”

There is also an issue for businesses which operate in multiple states. “A cloud transaction that is not taxable in one state in which you do business, may be taxable in another for one reason and taxable in a third state for a different reason. And even in states that don't subject cloud transactions to tax, the bases for that conclusion may vary. Thus, there are many complexities in trying to determine how these cloud transactions will be treated for tax purposes and many relevant laws, cases, rulings and polices that must be analyzed to make the determination,” Benton says.

Ed Silverstein writes for Legaltech News, an ALM sibling of this newsletter, in which this article originally appeared.

It is no surprise that several states and a few cities are looking to tax cloud computing transactions given the increasing popularity of the cloud among businesses.

Just look at one recent projection. Global cloud traffic will more than quadruple by the end of 2019, from 2.1 to 8.6 zettabytes, according to Cisco's recently released Global Cloud Index (2014-2019).

That growth means that state governments will have a reliable source of revenue to make up shortfalls in other sectors of the economy. But this can be a complex and controversial area with different states weighing in with different rules.

“Washington state has enacted legislation to impose sales and use tax on most cloud services,” Arthur Rosen, an attorney at McDermott Will & Emery, told our ALM sibling, Legaltech News .

“While the revenue agencies in New York, Arizona, Indiana, Pennsylvania, Michigan, Tennessee, Utah, and Vermont are asserting ' to different extents ' that cloud services are subject to their sales and use taxes, they are wrong,” Rosen says. “Their mistake is disregarding that the law requires there be a transfer of possession of the service provider's software to its customer ' case law in each of those states makes clear that the type of 'possession' over the software a buyer of cloud services receives is insufficient for there to be a taxable transfer.”

He points out that a Michigan court last month and a New Yok State Administrative Law Judge a few months ago agreed with this conclusion. Also, Chicago “initially took a similar position as the states ' above, but has largely retreated,” he adds.

On the other hand, the New Jersey Division of Taxation has taken the correct approach, Rosen says.

When it comes to the question if the only tax involved with cloud computing is the sales tax, Rosen explains: “That is everybody's primary concern. But there are income tax implications, as well.”

“These include nexus (Are the service provider's customers subject to tax where the service provider's computers are located?) and sourcing (Where should the service provider's receipts be assigned for apportionment purposes?),” he says.

When it comes to the national picture, there are no federal laws that directly impact these issues. However, some of the concerns are addressed by pending federal legislation such as two sales tax bills: the Digital Goods and Services Tax Fairness Bill, S.851 and the Business Activity Tax Simplification Bill, H.R.2584.

Moreover, cloud-based products and services delivered over the Internet “test the limits of existing sales tax rules,” Mary T. Benton, an attorney at Alston & Bird, says.

When asked if cloud transactions should be taxed, Benton says, “most people are comfortable that there is a rational basis to subject digital goods to tax, particularly when those items are taxable when purchased in tangible form.”

“However, when you move into the services that are provided through the cloud, it is not as straightforward,” she cautions. “At its core, whether cloud transactions are subject to tax is a policy question that should be decided by state legislatures. While many states have tackled the taxation of digital goods, very few have thoughtfully addressed whether to subject SaaS [software as a service] to taxation. This absence of direction from state general assemblies means that the taxation of these cloud transactions is being addressed individually by each state's taxing agency. However, the sales and use tax statutes, the constructs of which were developed decades ago, do not easily translate to this new technology. Applying these 20th-century laws to 21st-century technology is the epitome of trying to fit a square peg into a round hole,” Benton says.

In addition, she explains that sales tax is generally imposed “on the sale of tangible personal property and specifically enumerates services '. To subject cloud transactions to taxation, they must come within one of the taxable categories.”

There is also an issue for businesses which operate in multiple states. “A cloud transaction that is not taxable in one state in which you do business, may be taxable in another for one reason and taxable in a third state for a different reason. And even in states that don't subject cloud transactions to tax, the bases for that conclusion may vary. Thus, there are many complexities in trying to determine how these cloud transactions will be treated for tax purposes and many relevant laws, cases, rulings and polices that must be analyzed to make the determination,” Benton says.

Ed Silverstein writes for Legaltech News, an ALM sibling of this newsletter, in which this article originally appeared.