State & local taxes: taxation of the cloud still hazy.

• Author: Yesnowitz, Jamie

WHILE THE COINED TERM "CLOUD COMPUTING" no longer sounds foreign to consumers or businesses, and most certainly not to tax professionals, taxpayers continue to struggle when trying to identify the sales tax issues surrounding the cloud. Taxpayers are increasingly seeking guidance from tax advisers or from state revenue departments via letter rulings to determine the taxability of their products. Often, taxpayers are taken by surprise when a product they have been providing to their customers has morphed into a taxable item due to software elements or enhancements.

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Tax challenges stretch across the three major cloud service offerings: software as a service (SaaS), platform as a service (PaaS), and infrastructure as a service (IaaS). As far as state-issued guidance is concerned, over the last few years, SaaS has seen a wide variety of responses across many states. However, with limited, fact-driven guidance from the states, there is still a great deal of uncertainty about whether variations of SaaS offerings are subject to sales tax in a number of states, and many states still lag in providing clear statutory or regulatory guidance. In addition, how sales tax applies to SaaS sales is just a small piece of the unknown territory of cloud taxability. Most states are still silent as to how PaaS and IaaS are taxed both for state income and sales and use tax purposes, with minimal guidance available on the nexus and sourcing issues surrounding any cloud services.

This column does not discuss basic cloud computing and the tax issues surrounding it but, instead, updates readers on some recent state guidance on cloud service offerings. This discussion is by no means an all-inclusive or exhaustive list of guidance that has been issued to date. Rather, this column highlights a few examples of the trends appearing at the state level. The State & Local Taxes column in the December 2011 issue of The Tax Adviser contains a more comprehensive discussion of the initial guidance set forth by the states in this area. (1)

Storm Clouds Ahead

As noted above, in recent years, many states have begun to specifically address the taxability of the SaaS product model through administrative and regulatory guidance. Below are a few notable examples.

Pennsylvania

In May 2012, Pennsylvania publicly reversed its prior position on the sourcing of SaaS for tax purposes. Per a 2012 letter ruling, a SaaS provider was purchasing and installing software on servers that was accessible by both its employees and its customers for a fee. The Department of Revenue ruled that the provider was subject to use tax on software used by its employees, while the charges to the customers for electronically accessing the same software were subject to sales tax. Since Pennsylvania defines computer software as tangible personal property, it is subject to sales and use tax. In accessing the software, the use; whether the employee or the customer, is exercising a license to use it and has control or power over the software at the user's location, not where the server hosting the software is located. (2) Consequently, canned software accessed remotely is subject to sales and use tax when the end user is located in Pennsylvania. (3) Earlier, the commonwealth had issued a ruling indicating that the location of the server was paramount in determining whether SaaS was subject to tax. (4) With this more recent ruling, Pennsylvania alerted taxpayers that, for sales tax to apply, it was no longer taking the position that the server hosting the application must be located in the commonwealth.

Texas

In July 2012, Texas issued a detailed ruling on cloud computing. The topics addressed included (1) data-processing services, including data storage, manipulation, and retrieval; (2) data transfer fees and incidental usage fees; (3) bulk and transactional email-sending services for businesses and developers; (4) taxable information services, such as gathering data from around the web and making it available to customers in the form of lists and searchable data; (5) the sourcing of data-processing and information services for local tax purposes; and (6) determining the proper local sales tax rate in the event a sales office, technology development office, or data center is created in the state.

The state continues to tax most cloud-computing services as data-processing services with a few of the other services being taxed as information services or telecommunications. (5) The definition of data-processing services includes computerized data and information storage or manipulation, as well as use of computer time for data processing. (6) In addition to discussing common cloud offerings, incidental usage fees associated with cloud computing are also highlighted as subject to tax as data processing. (7) It should be noted that Texas exempts 20% of data-processing and information services charges from sales tax. (8)

Utah

Per a May 2012 ruling, taxable "[r]emotely accessed software includes hosted software, application service provider (ASP) software, software-as-a-service (SaaS), and cloud computing applications." (9) License fees for remotely accessed prewritten software are taxable if the purchased software is used in Utah. (10) If remotely accessed software is used at more than one location and, at the time of the transaction, the buyer provides the seller a reasonable and consistent method for allocating the transaction between those locations, the seller must source the transaction to those locations. (11) If the buyer does not provide the seller with this information, the seller must source the transaction to the buyer's address. (12) Utah is one of the few states that discuss the ability to use a multiple-points-of-use methodology to source revenue from cloud service offerings. It should be noted that Utah had previously followed Pennsylvania's historic position of looking at the server location in determining which SaaS transactions were...