Editor: Jamie Yesnowitz, J.D., LL.M.
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.
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.
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 user, 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.
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
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 taxable.
The Friendly Skies
While some states are looking for ways to tax cloud service offerings, other states have decided not to tax SaaS products. The following are a few examples of these efforts, which may serve to encourage cloud service providers to relocate to these states.
Effective March 1, 2010, through June 30, 2012, standardized software was subject to sales and use tax in Colorado, regardless of how the software was acquired by the purchaser or downloaded to the purchaser’s computer.13
Effective July 1, 2012, the tangible personal property definition excludes standardized software that is not delivered via a tangible medium.14 Software provided through an application service provider, delivered by electronic software delivery, or transferred by a load-and-leave software delivery is not considered delivered to the customer in a tangible medium.15 The legislation effectively reinstates an exemption for electronically delivered software that was in effect prior to March 1, 2010.16 In addition, there has been some uncertainty about how Colorado taxed SaaS during the brief period that electronically delivered software was subject to tax. This is a perfect illustration of how difficult it is for taxpayers to track the numerous changes in the sales tax treatment of these items, even changes that happen in a single state. It should be noted that, although Colorado does not tax SaaS at the state level, this may not be true locally, as discussed later.
In April 2012, Virginia issued a ruling supporting its long-established exemption from retail sales and use tax for “services not involving an exchange of tangible personal property which provide access to or use of the Internet and any other related electronic communication service, including software, data, content and other information services delivered electronically via the Internet.”17 In the ruling, the Department of Taxation ruled that a taxpayer providing access to a web-based portal via the internet is not providing tangible personal property.18 As such, charges for access to a web-based portal that the taxpayer refers to as cloud-computing services are not subject to the Virginia retail sales and use tax.19
Many states that tax cloud service offerings have issued rulings that hinge on specific fact patterns. In those states, determining SaaS taxability must be done on a case-by-case basis. Several tests have developed in the analysis of the applicability of sales tax to SaaS, including the transfer of ownership and control, the transfer of title, and the true object test.
In Massachusetts, several fact-specific rulings have been issued over the past several years, many dependent on the true object of the transaction. In addition to these, the commonwealth recently issued a ruling outlining various cloud scenarios and their taxability. For example, sales of cloud computing may result in two different tax outcomes based on whether the customers are using their own software or open-source (free) software provided by third parties or using the software licensed by the provider:
- Sales of cloud-computing services using the customer’s own software or software available free on the internet are not taxable when sold to customers in Massachusetts.20
- However, sales of cloud-computing services that use the provider’s software licenses are taxable when sold to customers in Massachusetts, whether or not there is a separately stated charge for the software and whether or not the customer sublicenses the software.21
Further, on Feb. 7, Massachusetts issued a draft directive for public comments that were due by Feb. 22.22 The directive was drafted in response to a large number of ruling requests pertaining to the computer industry and addressed the application of the Massachusetts sales and use tax to sales of software- and computer-related services. Specifically, the directive addressed sales of SaaS, cloud-computing, and business solutions, all of which involve software, sometimes bundled with services that are not subject to sales tax.
The directive states that a transaction will be considered a taxable transfer of prewritten software, based on a list of factors, which will be considered cumulatively with no one factor being determinative, including the following: a transfer of ownership; the ability of a customer to access the software at any time, enter and manipulate its own information, and run reports; little intervention in the functionality of the software by the seller; the seller’s use of the term ASP in describing itself or SaaS in describing its product; and granting a customer access to the software even when no software is transferred to the customer.23
For a transaction to be treated as a nontaxable service, factors that will be considered include: the seller is providing data-processing services or information services; the customer does not interface with the prewritten software; the seller provides a personal or professional service; and the seller provides custom software. Taxpayers and practitioners should follow any updates from the Department of Revenue resulting from the feedback to the directive.
Nebraska recently focused on the transfer of title as a determining factor in taxation. In a July 2011 information guide, the Department of Revenue stated that an ASP’s charges for services that allow Nebraska customers remote access to software applications via the internet or other online connection are not taxable when the ASP retains title to the software and does not grant a license with ownership rights to the customer.24 This is true regardless of whether the software is located on a server in Nebraska or outside the state.25 The ASP is responsible, however, for paying use tax on its purchase of software if the software resides on a computer in Nebraska.26
South Carolina is unique in that it taxes ASP services, including them as a subset of tangible personal property—communications. Nonetheless, the state recently issued a taxpayer-favorable ruling. In this ruling, a medical practice’s nonitemized monthly charge for a medical billing service and a software product accessed via an ASP in South Carolina was not subject to sales and use tax because the transaction was considered a sale of nontaxable data processing.27 As a general rule, software accessed via an ASP is subject to the South Carolina sales tax when sold alone.28 In this case, however, the state looked to the true object of the transaction. Consequently, the portion of the charge for software was not taxable, since the true object of the transaction in which the software and billing service were sold for one nonitemized monthly charge was data processing.29
Tennessee rulings on taxability give significant weight to the control over the software. In one ruling, a taxpayer’s charges for customer referrals, website advertising space, customer tracking services, and website services were not subject to Tennessee sales and use tax.30 The taxpayer operated a website where customers could choose a vendor and access information about the vendor. Customer referrals, advertising services, and customer tracking services are not among the enumerated services subject to sales tax in Tennessee.31 In addition, the services are not taxable telecommunications services because telecommunications services are only an incidental means of providing the services.32 The monthly fee for providing a vendor with a website is also a nontaxable service because the taxpayer does not transfer title, possession, or control of the website or any software to the vendor.33
The reasoning applied in the ruling described above seems to prevail in Tennessee private letter rulings addressing the taxability of cloud computing as well. A monthly fee a software vendor charged for online access to customer relationship management software was not subject to Tennessee sales and use tax.34 No sale or use of tangible personal property occurs in Tennessee when a taxpayer accesses the software application via the internet, because the vendor does not transfer title, possession, or control of the software application to the taxpayer.35
Data-hosting, storage, and project management services a taxpayer provided are not subject to Tennessee sales and use tax because these are not taxable services and they are not provided in conjunction with a transfer of tangible personal property.36 No part of the transactions could be described as the furnishing of an otherwise nontaxable service sold as part of the sale of a taxable good or service, because no tangible personal property was transferred and the taxpayer does not sell, lease, license, or otherwise provide the use of computer software to its clients in conjunction with these services.37
Instead of looking at the control of the actual software, Wisconsin focuses on where the server itself is controlled. In frequently asked questions (FAQs) issued in January 2013, charges for accessing prewritten computer software located on a vendor’s server are not taxable if a customer in Wisconsin does not have access to or control over the vendor’s server.38 However, charges for accessing a prewritten computer software that is downloaded to the customer’s equipment, or equipment that the customer has control over, are taxable in Wisconsin.39 The consideration of whether a customer has control over the server could raise potential issues for other cloud service offerings such as IaaS and PaaS.
PaaS and IaaS Taxability
Although many states have specifically addressed the taxability of SaaS, most states are silent about the taxability of IaaS and PaaS. Similar to SaaS, the determination depends on whether the states consider a particular cloud-computing offering to be tangible personal property, a taxable service, or a transaction not subject to tax.
In a recent set of FAQs, the Wisconsin Department of Revenue addressed the taxability of IaaS and PaaS.40 In an IaaS offering, charges for storage on another person’s server over which the customer does not have control or the ability to physically access are not taxable in Wisconsin. As a general rule, an IaaS service provider owns, maintains, operates, and houses the equipment, such as hardware, servers, and network components, and the customer uses (but does not have control over) the equipment over the internet.41
PaaS, although specifically addressed in the FAQs, received very little guidance. According to the FAQs, since PaaS contains elements of both SaaS and IaaS, taxability will depend on the facts and circumstances.42
In addition to struggling with determining the taxability of various service offerings, taxpayers should also be aware of some of the trends that are emerging via all of the rulings that have been issued. These trends include the importance of accurate and complete documentation, home rule tax issues, retroactive moratoriums, and aggressive nexus positions.
Although the taxability of cloud computing still lacks clarity in many states, many times the determination is made on a case-by-case basis through considering all available facts and documentation. Taxpayers should be prudent in maintaining readily retrievable records with a detailed product description, as well as books and records breaking down the charges made into product categories. Though cumbersome, in an audit situation a good set of supporting facts may favorably shift the taxability determination or at least reduce some penalties due to a good-faith error.
For instance, a Texas taxpayer was unable to establish by clear and convincing evidence the number and type of nontaxable software transferred to customers for their use. Even though the taxpayer could prove by clear and convincing evidence that the software transferred was not subject to sales tax, an assessment was affirmed due to lack of support of the exact amounts of the transfers. In addition, the taxpayer failed to show by a preponderance of the evidence that it exercised due diligence in determining the products’ taxability and, as a result, was not entitled to a waiver of penalties.43
Two rulings in Indiana also provide good examples of the importance of having support documentation. Although Indiana taxes SaaS, it does not tax prewritten software. Last year, the state issued two rulings with two different tax consequences. In one ruling, software license purchases made by a legal services provider in Indiana were not exempt from the Indiana use tax because they were purchases of tangible personal property.44 The taxpayer claimed that the purchases were exempt because the provider acquired a license to retrieve and store information, and additional users could only access the information.45 The taxpayer also argued that the software license purchases did not involve a transfer of tangible personal property and therefore should not be subject to the Indiana sales and use tax.46 The state relied on the broad definition of tangible personal property to impose Indiana use tax.47 For Indiana sales tax purposes, tangible personal property includes prewritten computer software.48 Only custom software specifically designed for the purchaser is not subject to sales tax.49 Further influencing the ruling, the taxpayer’s position was hurt because the taxpayer could not provide documentation supporting its position.
In the other ruling, an Indiana retailer was not liable for sales and use tax on its charges for the sale of “Automation Services” and “Tracker Services.” Indiana initially determined that these “web-based computer programs” involved prewritten computer software and, therefore, were taxable. However, the taxpayer provided enough support (service contracts, brochures, and other information about the services) to establish that the “Automation Services” and “Tracker Services” sold did not involve the right to use prewritten computer software.50
Home Rule Localities
Taxpayers and practitioners need to be cautious when determining the taxability of cloud services in home rule localities where local governments impose their own sales and use taxes. The Colorado Court of Appeals held that a technology company’s purchase of downloaded computer software was subject to the Boulder City use tax because the tax applies to all downloaded software regardless of the method of conveyance. In addition, the court concluded that remote access to online data services and software is subject to the municipal use tax.51 At the same time, software provided through an application service provider in Colorado, delivered to a Colorado customer by electronic software delivery, or transferred by load-and-leave is not considered delivered to the customer in a tangible medium and, therefore, is not subject to the Colorado sales tax.52
In various renditions of one of its tax bulletins, Vermont addresses the taxability of various services that are similar to, or may be viewed as, components of cloud computing. Originally, the state took the position that the sale of computer memory storage for large volumes of computer data, either created through the customer’s use of a computer program on a remote computer or downloaded from the customer or third party’s computer to the remote server, was subject to sales tax as the sale of tangible personal property.53 The bulletin was later revised to remove computer memory storage as taxable.54 To take this position even further, Vermont statutorily enacted a temporary moratorium on taxation of sales of prewritten software accessed remotely, effective retroactively for sales made after Dec. 31, 2006, and before July 1, 2013. Taxpayers may apply for refunds of those sales taxes,55 which will be refunded if the requests are made within the statute of limitation and documented to the state commissioner’s satisfaction.
With many states considering the remote access of software to be the use of tangible personal property, it is not a far stretch for states to assert that the use of that property in a state could create nexus for a SaaS provider. Recently, in a New Mexico ruling about a web-based tool, the Taxation and Revenue Department concluded that an out-of-state taxpayer was engaged in business in New Mexico due to having subscribers in the state because it was selling a license to use the web-based tool and the license was a form of property in the state.56 For gross receipts tax purposes, the location of the license is the place where it will normally be used. Since the location of the license was presumed to be the end user’s business location, the out-of-state taxpayer was deemed to have property in the state.57 This aggressive approach not only subjects the transaction to sales tax, but also may create income tax nexus in the state.
As the above discussion highlights, the tax issues around cloud computing are far from being resolved. In approximately 20 states, determining cloud taxability relies on the existing rules around the taxability of software or enumerated services, such as data processing. Other states have taken the position that cloud offerings are not tangible personal property or enumerated services and are, therefore, not subject to tax in those states. However, as cloud-computing technology continues to evolve, so will state tax positions. The challenge for taxpayers is to stay current on the changes in the various tax jurisdictions.
1Jensen, “How Does One Tax a Cloud?” 42 The Tax Adviser 850 (December 2011).
272 Pa. Cons. Stat. §§7201(k)(1) and 7202(a).
3Pa. Sales and Use Tax Ruling No. SUT-12-001 (5/31/12).
4Pa. Sales and Use Tax Ruling No. SUT-10-005 (11/8/10).
5Tex. Comptroller of Public Accounts Policy Letter Ruling No. 201207533L (7/31/12).
6Tex. Tax Code §151.0035.
7Tex. Comptroller of Public Accounts Policy Letter Ruling No. 201207533L (7/31/12).
8Tex. Tax Code §151.351; Tex. Admin. Code §3.330(b).
9Utah Publication 64, Sales Tax Information for Computer Service Providers (May 2012).
13Colo. FYI Tax Publication Sales 89, Computer Software (3/1/12).
14Colo. Rev. Stat. §§39-26-102(13.5) and (15)(c)(I). See also Colo. FYI Tax Publication Sales 89, Computer Software (3/1/12).
15Colo. Rev. Stat. §39-26-102(15)(c)(I)(C).
16Colo. L. 2011, c. 299, §4 (eff. 7/1/12).
17Va. Code §58.1-609.5(1).
18Va. Ruling Doc. No. 12-191 (11/29/12).
20Mass. Dep’t of Rev., Letter Ruling 12-8: Cloud Computing (7/16/12).
22Massachusetts Dep’t of Rev., Working Draft Directive 13-XX (2/7/13).
24Neb. Dep’t of Rev., Information Guide 6-511-2011, Nebraska Sales and Use Tax Guide for Computer Software (7/27/11).
27S.C. Dep’t of Rev., Letter Ruling 12-2 (6/11/12).
28S.C. Dep’t of Rev., Rev. Rul. 5-13 (8/21/05).
29S.C. Dep’t of Rev., Letter Ruling 12-2 (6/11/12).
30Tenn. Dep’t of Rev., Rev. Rul. 11-22 (6/10/11).
31Tenn. Code §67-6-102.
32Tenn. Code §§67-6-102(93)(B)(i), (iv), and (vi); Equifax Check Servs., Inc. v. Johnson, No. M1999-00782-COA-R3-CV (Tenn. Ct. App. 6/27/00); see also Tenn. Dep’t of Rev., Rev. Rul. 11-22 (6/10/2011).
33Tenn. Dep’t of Rev., Rev. Rul. 11-22 (6/10/11).
34Tenn. Dep’t of Rev., Letter Ruling 11-58 (10/10/11).
36Tenn. Dep’t of Rev., Letter Ruling 11-38 (7/29/11).
38Wis. Dep’t of Rev., Frequently Asked Questions—Sales and Use Tax Treatment—Computer Hardware, Software, Services (1/25/13).
43Tex. Comptroller of Public Accounts, Decision No. 201212650H (12/20/12).
44Ind. Dep’t of Rev., Letter of Findings No. 04-20110421 (4/25/12).
47Ind. Code §6-2.5-1-27.
49Ind. Dep’t of Rev., Sales Tax Information Bulletin 8 (November 2011).
50Ind. Dep’t of Rev., Letter of Findings No. 04-20110291 (3/28/12).
51Ball Aerospace and Technologies Corp. v. City of Boulder, No. 11CA2129 (Colo. App. 9/13/12).
52Colo. Rev. Stat. §39-26-102(15)(c)(I)(C).
53Vt. Dep’t of Taxes, Technical Bulletin TB-54 (11/19/10).
54Vt. Dep’t of Taxes, Technical Bulletin TB-54 (4/11/11).
55Vermont Information Sheet: Refunds on Tax Paid on Prewritten Software Accessed Remotely Pursuant to Act 143 of 2012; see also Section 52 of Act 143 of 2012, titled Temporary Moratorium on Enforcement of Sales Tax on Prewritten Software Accessed Remotely.
56N.M. Ruling 401-13-1 (1/13/13).
Jamie Yesnowitz is a principal with Grant Thornton LLP in Washington, D.C., and is the firm’s State and Local Tax—National Tax Office practice leader. Jennifer Jensen is a director with PwC in Washington, D.C. Alesia Parfiryeva is a state and local tax senior associate with PwC in McLean, Va. For more information about this article, please contact Ms. Jensen at email@example.com.