State and Local Tax: Up in the Air: Sales Taxation of Cloud Computing. National State and Local Tax Practice

State and Local Tax:

Up in the Air: Sales Taxation of Cloud Computing

Craig Williams Marshal Kline

Managing Director Managing Director National State and Local Tax Practice

Objectives

• Provide an overview of cloud computing and summarize the different types of cloud computing models

• Describe the complexity and issues surrounding the state taxation of cloud computing

• Describe a methodology to determine taxability of cloud computing

• Describe cloud computing issues in a few selected states

• Provide on overview of pending federal legislation

affecting state sales tax

What is Cloud Computing?

• Most widely accepted definition:

– Cloud computing is “a model for enabling convenient, on demand network access to a shared pool of configurable computing resources (e.g. networks, servers, storage

applications, and services) that can be rapidly provisioned and released with minimal management effort or service provider interaction.”

Source: National Institute of Standards and Technology (“NIST”)

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What is Cloud Computing?

• Arguably the States’ definition:

– Cloud computing is any use of technology, data processing and information via the Internet

What is Cloud Computing?

• Has become a marketing buzzword for doing business over the Internet

• The “cloud” refers to an infrastructure from which

businesses and users are able to access information

• Allows businesses to outsource certain functions in a cost effective manner

• Improve data security and reliability through centralization

• Scalability available to handle fluctuations in activity

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Cloud Computing Service Models

• Overview

– Application Service Provider (“ASP”) – Software as a Service (“SaaS”)

– Platform as a Service (“PaaS”)

– Infrastructure as a Service (“IaaS”)

Cloud Computing Service Models

• Application Service Provider (ASP)

– ASP hosts third party commercial software in a centrally- controlled place where it is accessed by the customers over remote links (generally the Internet)

– Emerged during the late 90s

– ASP has a license to the software but does not have control over the features and development of the software

– ASP typically owns, operates and maintains the servers that support the software

– Consumers have no control over software or underlying cloud infrastructure

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Cloud Computing Service Models

• Software as a Service (SaaS)

– Allows consumers to access a vendor’s software application that is running on a cloud infrastructure

– The software resides exclusively on the vendor's server and is accessed by the consumer via the Internet.

– Consumers have no control over the application software

• Cannot install, transfer or download to their computers

• Cannot manage or control underlying cloud infrastructure

– i.e. the network, servers, operating systems, storage, or application capabilities

– The SaaS provider owns and operates the software applications and manages/controls server

Cloud Computing Service Models

• Platform as a Service (PaaS)

– Provides tools for design, development, deployment and management of a consumer’s application software

• The platform is hosted on the cloud and accessed through a browser

• Ideal for programmers, developers and web designers

– Allows consumers to develop applications without having the

constraints to purchase and manage the hardware, software and hosting capacities and allows for deployment without any

specialized administration skills

– Consumers do not manage or control underlying cloud infrastructure but do control the deployed applications and

perhaps some of the hosting environment configuration settings

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Cloud Computing Service Models

• Infrastructure as a Service (IaaS)

– Provides consumers with access to storage and IT computing resources on the provider’s computers

• Gives consumers processing, storage, network capabilities and the resources necessary to deploy and run software including operating systems and applications

– Consumers do not manage or control underlying cloud

infrastructure but do control the operating systems, storage,

deployed applications and have limited control of select network components

– Typically used by businesses to outsource IT infrastructure needs

Cloud Computing Deployment Models

• Private Cloud

– Operated solely for an organization

• Public Cloud

– Made available to the general public or a large industry group

• Community Cloud

– Shared by several organizations and supports a specific community that has shared concerns

– Ex: Affiliated entities with a common parent

• Hybrid Cloud

– Combines two or more clouds

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Taxation of Cloud Computing Transactions

What is at stake?

Revenue from Cloud Computing is Large and Growing

Source: TMCnet.com

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What is at stake?

• State governments are still experiencing fiscal difficulties

– 2008-2010 represented one of the worst fiscal recessions in modern history

– While revenue collection is up in most states, many have not recovered to their post-inflation 2007 levels

• States still have financial issues and are looking for new sources of revenue

Source: NCSL Fiscal Brief: Projected State Tax Growth in FY 2012 and Beyond

Issues with the Taxation of Cloud Computing

• State laws do not adequately address the taxation of emerging technologies

• Uncertainty regarding states’ interpretation of current laws relating to emerging technologies

• How to characterize cloud computing?

– Is it a service?

– A license of intangible property?

– Deemed transfer of tangible property?

– Cloud computing does not always neatly fit into any one category

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Taxation of Cloud Computing

Methodology – How best to analyze taxability?

• State’s definition of what’s subject to sales tax

– Georgia imposes sales tax on the sale and tangible personal property and enumerated services

• O.C.G.A 48-8-30(a): There is levied and imposed a tax on the retail purchase, retail sale, rental, storage, use, or consumption of

tangible personal property and on the services described in this article.

• Enumerated taxable services

– Georgia taxes the following services:

• Cell phone services (Ga. Comp. R. & Regs. 560-12-2-.24(2)(a)(1))

• Linen services (Ga. Comp. R. & Regs. 560-12-2-.58)

• Printing services (Ga. Comp. R. & Regs. 560-12-2-.75(1)(b))

Taxation of Cloud Computing

Good Starting Point

– Analyze whether the state has exempted electronic delivery from sales tax

– Examples:

• CA

• FL

• GA

• MO

• VA

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Streamlined Sales & Use Tax Governing Board

• Informal survey of 31 member and nonmember states found varying treatment of digital services among the states

– 12 states indicated that they would tax remote access to pre- written computer software

• 7 would treat as a tangible personal property transaction

• 5 would treat as a taxable service

• Will review establishing guidelines on how member states can tax digital transactions conducted through cloud technology and accessed remotely by the

consumer

45 State Discussion

Arizona

• SaaS – Taxable to customers with Arizona billing or service addresses. Private Ltr. Ruling LR 10-007

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Discussion of Selected States

• California

• New York

• Massachusetts

• Pennsylvania

• Kansas

• Vermont

California

• Cal. Rev. & Tax Code § 6051

– Sales of tangible personal property are presumed taxable

• Cal. Rev. & Tax Code § 6006; Cal. Code Regs. § 1501

– Sales of services are exempt unless specifically enumerated

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California

• The transfer of software or information by electronic means is not taxable

• Cal. Code Regs. 18 § 1502(f)(1)(D)

– The sale or lease of a prewritten program is not a taxable transaction if the program is transferred by remote

telecommunications from the seller's place of business, to or through the purchaser's computer and the purchaser does not obtain possession of any tangible personal property, such as storage media, in the transaction. Likewise, the sale of a

prewritten program is not a taxable transaction if the program is installed by the seller on the customer's computer except when the seller transfers title to or possession of storage media or the installation of the program is a part of the sale of the computer.

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New York

• N.Y. Tax Law § 1133; 20 NYCRR § 525.2(a)

– New York imposes a statewide sales tax on sales of tangible personal property and certain enumerated services.

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New York

• New York Tax Law 1105(c)

– (c)(1):

• The furnishing of information by printed, mimeographed or multigraphed matter or by duplicating written or printed matter in any other manner,

including the services of collecting, compiling or analyzing information of any kind or nature and furnishing reports thereof to other persons, but excluding the furnishing of information which is personal or individual in nature and which is not or may not be substantially incorporated in reports furnished to other persons, and excluding the services of advertising or other agents, or other persons acting in a representative capacity, and information services used by newspapers, radio broadcasters and television broadcasters in the collection and dissemination of news, and excluding meteorological services.

New York

• New York Tax Law 1105(c)

– (c)(9)(i):

• The furnishing or provision of … an information service (but not an information service subject to tax under [(c)1]…), which is furnished,

provided, or delivered by means of [electronic] service (whether intrastate or interstate) of whatever nature, ... Provided, however, that in no event (i) shall the furnishing or provision of an information service be taxed under this

paragraph unless it would otherwise be subject to taxation under [(c)1] … if it were furnished by printed, mimeographed or multigraphed matter or by

duplicating written or printed matter in any other manner....

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New York

• Based on NY Tax Law § 1105 & 20 NYCRR 527.3

– The Department defines information services as:

• Collecting,

• Compiling, or

• Analyzing information

– Of any kind or nature

– That is furnished to other people

– The Tax Department has used very broad language in its technical memorandums and advisory opinions relating to information services.

New York

• TSB-M-10(7)S

– The following are considered taxable information services:

• Consumer product reports, such as product evaluations

• Credit monitoring services

• Information furnished by credit reporting bureaus

• Internet-based data and Web search services

• Investment reports and services

• Matching or networking services

• Public records furnished (electronically or in paper format) by a private entity, such as a document retrieval service

• Real property information databases

• Reporting services that compile news stories or issues related to a certain topic

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New York

• NY Tax Law § 1101(b)(6)

– The sale of prewritten computer software is considered tangible personal property “regardless of the means by which it is

conveyed to a purchaser.”

• Includes any transfer of title or possession or both and license to use.

• 20 NYCRR § 526.7 (e)(4)

– For purposes of a “license to use,” a transfer of possession has occurred if the customer obtains actual or constructive

possession, or if there has been “a transfer of the right to use, or control or direct the use of tangible personal property.”

Massachusetts

• 830 CMR 64H, § 1

– Sales in Massachusetts of computer hardware, computer

equipment, and prewritten computer software, regardless of the method of delivery, and reports of standard information in

tangible form are generally subject to the Massachusetts sales tax. Taxable transfers of prewritten software include sales

effected in any of the following ways regardless of the method of delivery, including electronic delivery or load and leave: licenses and leases, transfers of rights to use software installed on a

remote server, upgrades, and license upgrades.

• 830 CMR 64H.1.3(3)(a)

– The sale, license, lease or other transfer of a right to use software on a server hosted by the taxpayer or a third party generally is taxable.

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Massachusetts

• MA Letter Ruling No. 12-8 (July 16, 2012)

– Sales of cloud computing that involve the customer's use of its own software or software available free on the Internet are not taxable when sold to customers in Massachusetts

– Sales of cloud computing that use software licensed by company are taxable when sold to customers in Massachusetts

– Separately stated data transfer fees are taxable

telecommunications services when sold to customers in Massachusetts

– Sales of remote storage service are not taxable when sold to customers in Massachusetts

– The marketing description of a product either as “software-as-a- service” or “cloud computing” or a “business solution” does not determine the taxability of that product

Pennsylvania

• 72 P.S. § 7202(a)

– The retail sale of tangible personal property and certain services are taxable

• Dechert, LLP v. Commonwealth, 998 A.2d 575 (Pa.

2010); Graham Packaging Co. v. Commonwealth, 882 A.2d 1076 (Cmwlth. Ct. 2005)

– For sales and use tax purposes, the sale, including a license to use, canned computer software is subject to tax, even if

delivered electronically

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Pennsylvania

• PA Sales & Use Tax No. SUT-12-001 (May 31, 2012)

– Taxable canned software accessed remotely that is sold to taxpayer's customers - taxpayer is required to collect sales tax from customers when the user is located in Pennsylvania.

– The software is subject to use tax in Pennsylvania when the software is used by employees in Pennsylvania.

– If the billing address for canned software accessed remotely is a Pennsylvania address, then the presumption is that all users are located in the Commonwealth.

– In order to rebut this presumption, the purchaser would need to complete an exemption certificate (REV-1220). On Line No. 7 of the exemption certificate, the purchaser must state the

percentage of users of the software who are located in Pennsylvania.

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Kansas

• Kan. Stat. Ann. § 79-3603

– Sales tax imposed on the privilege of engaging in the business of selling tangible personal property at retail in this state or

rendering or furnishing any of the services taxable under this act.

• Kan. Stat. Ann. § 79-3603(s)

– the gross receipts received from the sale of prewritten computer software and the sale of the services of modifying, altering,

updating or maintaining prewritten computer software are

taxable, whether the prewritten computer software is installed or delivered electronically by tangible storage media physically

transferred to the purchaser or by load and leave

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Kansas

• Letter No. O-2012-001 (February 6, 2012)

– A company's gross receipts from a hosted software product transferred to customers electronically are not subject to sales tax because the software is installed on a remote server and not delivered to customers or installed on their computers.

– K.S.A. 79-3603 § does not list hosted software services, services provided by an ASP, or SaaS services as enumerated taxable services

– Not sales of pre-written software because the software that is installed on a remote server isn't delivered to subscribers or

installed on their computers and service provider retains title and possession of the software

Vermont

• HB 782 – Moratorium on Sales Tax for Cloud Computing

– The DOT cannot assess sales and use tax on charges for

remotely accessed software made after December 31, 2006, and before July 1, 2013.

– "Charges for remotely accessed software" is defined as "charges for the right to access and use prewritten software run on

underlying infrastructure that is not managed or controlled by the consumer or a related company."

– Digital audio visual works, digital audio works, digital books and ringtones are not affected by this provision.

– Establish a committee to study these issues.

– Compromise to the retroactive ban that was approved by the Senate. Governor Shumlin wants a ban approved next year.

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One Situsing Example

• A multi-state company based in California has a shared- services group in upstate New York

• All invoices from various vendors are sent to New York

• The “services” are used by the Company through-out the United States

– Consequences – Reverse the facts

Pending Federal Legislation

Federal Legislation Affecting State Sales Tax

• Two bills with momentum

– Marketplace Equity Act of 2011 (HR 3179)

• June 24, 2012 - House Judiciary Committee Hearing

– The Marketplace Fairness Act (S 1832)

• August 1, 2012 – Commerce Committee Hearing

• The Main Street Fairness Act (S 1452/HR 2701) is also being considered

• Each bill would permit states to require remote sellers that lack physical presence within the state to collect sales or use tax on taxable transactions with in-state residents

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Pending Federal Legislation

Federal Legislation Affecting State Sales Tax

• What impact might these bills have?

– Set precedent for significant federal intrusion into matters of state taxation?

– Create uniformity?

– Create simplification?

– Save the world?

Pending Federal Legislation

Federal Legislation Affecting State Sales Tax

• What should you do?

– Read the bills

– Understand their impact on your business – Consider getting involved

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Questions?

Thank You

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