By Leonard J. Nitti, CPA
New Jersey CPA November / December 2014 Issue
The Taxation of Cloud Computing
As technology continues to rapidly improve and change, states struggle to keep up with how to tax new products and services. New technologies typically do not fit into a predefined product or service for which the states have provided guidance. One of these recent technological areas is cloud computing. The question of how cloud computing is taxed is a challenging one for businesses and practitioners, since there is no uniformity between the states on how to tax these items. This leads to potentially drastic differences from state to state.
Cloud Computing Defined
The National Institute of Standards and Technology (NIST) defines cloud computing as a “model for enabling ubiquitous, convenient, on-demand network access to a shared pool of configurable computing resources that can be rapidly provisioned and released with minimal management effort or service provider interaction.”
A Trio of Service Models
The NIST also discusses the three service models for cloud computing. The first is Software as a Service (SaaS) where the purchaser uses the seller’s software through a cloud computing infrastructure (e.g., QuickBooks Online). The second is Platform as a Service (PaaS) where the purchaser uses selfcreated or acquired applications on the cloud utilizing programs supported by the seller. The third is Infrastructure as a Service (IaaS) where the purchaser is provided fundamental computing resources to deploy and run arbitrary software, such as operating systems and applications.
For a business to determine how cloud computing is taxed, it needs to consider a number of questions. Is the property, service or intangible subject to sales and use tax? Which state has the right to tax the sale? Does the activity give rise to nexus for the business to be subject to either income or sales and use tax?
Is the Property, Service or Intangible Subject to Sales and Use Tax?
We must first determine how a state defines cloud computing. States like New Jersey view cloud computing as a service, while other states, such as New York and Missouri, view it as a sale of tangible personal property. New Mexico is an example of a state that considers cloud computing an intangible asset. Other states, including Kentucky and Maine, have still not provided any guidance for taxing cloud computing, leaving the business or practitioner to interpret how to categorize it. Once you understand the state’s classification of cloud computing, then you can conclude if it is subject to sales or use tax. Let’s now examine the general rules for sales tax. Sales of tangible personal property are generally taxable, unless an exception applies. Sales of services and intangibles are generally not subject to tax, unless specifically identified as taxable. Unfortunately, there are many exceptions to the general rules, so we must continue to dig further to determine if cloud computing is subject to sales tax in a particular state. Missouri defines cloud computing as prewritten computer software that is considered tangible personal property, but exempts it from sales tax based on its electronic delivery. New Jersey looks at each model separately and only subjects certain SaaS transactions to tax as an information service. An example of SaaS models subject to tax are the tax research services utilized by many practitioners. New Mexico provides an exception for intangibles, as the state’s law defines sales of intangible assets as taxable.
Which State Has theRight to Tax the Sale?
The majority of the states have not provided sufficient guidance to determine which state has the right to tax a particular cloud computing transaction, whether for income or sales and use tax purposes. For states that have provided guidance, the determination is generally focused on the location of the server or the purchaser. Pennsylvania and Tennessee are two states that source the sale to the location of the server, while Arizona and Utah source the sale to the location of the purchaser. New York sources the sale to where the purchaser’s employee is using the property. When addressing states that do not provide specific guidance for sourcing of sales for cloud computing, practitioners may consider the general rules each state provides. Generally, for sales of tangible personal property, the sale would be to source where the customer is located. Each state should be reviewed as some states have “throwout” or “throwback” rules for income tax purposes. For services, sourcing is generally determined by cost of performance (where the work is performed) or by a market-based approach (where the benefit is received) depending upon the state.
Does the Activity Give Rise to Nexus?
The final question to consider is whether or not cloud computing will create nexus in a state that a taxpayer has not previously established nexus for either income or sales and use tax based on other activities of the business. Generally, a taxpayer is required to have a physical presence in a state to create nexus, although guidance has created certain protected activities, such as P.L. 86-272 and court rulings. Some states have also been moving to try to establish nexus for a business based on other considerations, including economic and affiliate nexus. Unfortunately, very few states have provided any guidance when it comes to cloud computing and nexus, leading to difficult decisions needing to be made as to whether or not cloud computing by itself creates nexus in any state for a purchaser or a seller. While cloud computing has become a popular model for conducting business, the states’ slow response to providing guidance in this area has been frustrating to many businesses and practitioners. The taxation of cloud computing is an area that should continue to be monitored because the states will provide additional guidance in the future.
Published: November / December 2014
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