June 10, 2013

The Future of State and Local Tax: Look to the Stars ... I Mean the Clouds

by Jerry Donnini, Esq.

Aside from the Marketplace Fairness Act, cloud computing has dominated the sales tax world in 2013. With more and more companies using software as a service (SaaS), platform as a service ("PaaS"), and infrastructure as a service ("IaaS"), more and more uncertainty has arisen in the sales tax world.

Cloud.jpgCloud computing is a service that allows users or members of a business to access software from a remote server. It allows businesses to access the same integrated software without the expensive hardware costs because the software is internet based rather than physically based in an office.

Most states with a sales tax, tax software to some extent. Many states tax the purchase of canned software. Canned software is software produced by a manufacturer and not changed or altered for a specific company. If the software is altered, it is not canned software and not subject to sales tax in many states. Still, other states look to whether the customer receives something tangible like a disk with their purchase to determine whether software is taxable or not. But, how does this work if the canned software is accessed in the "cloud"? Is it a sale of tangible personal property? Is it the sale of canned software? A number of problems have been created by this fairly recent innovation, and states are struggling to keep pace.

On June 1, 2013, Jamie Yesnowitz drafted an excellent piece in the Tax Advisor that can be found here. In her article, she discusses how several states have tackled the problem, and I would like to point out a couple of notable decisions from her piece. While this article touches on some of the issues raised and some of the more recent rulings in the realm of cloud computing, it is worthwhile to research the issue in your specific state or reach out to a state and local tax attorney to determine if your particular situation warrants further investigation. Further, this article is intended to serve as a 50,000 foot view of the issue. If you would like more detail, I highly recommend Ms. Yesnowitz's piece or to view the individual rulings I linked to this article.

One state on the wrong side of the aisle is Pennsylvania. Pennsylvania is a state which treats the sale of computer software as tangible personal property regardless of its method of delivery. Relying on this premise, Pennsylvania took the position that the purchase of cloud services are subject to sales tax in Pa. Sales and Use Tax Ruling No. SUT-12-001 (May 31, 2012). Pennsylvania seemed to think the hosting location of the software was irrelevant, and, as long as the user was located in Pennsylvania, the use of the software was subject to tax. It is unclear how Pennsylvania can determine where the user is located, which creates a myriad of problems enforcing this position.

Relying on similar logic, Utah, in Utah Publication 64, Sales Tax information for Computer Service Providers (May 2012), believes the cloud computing service is subject to Utah tax. Utah seemed to take this a step further by discussing software which is accessed by multiple users in multiple locations. Specifically, Utah expects its taxpayers to provide a reasonable and consistent methodology for allocating use between the locations for sales tax purposes. Texas seemed to follow Utah and Pennsylvania in Tex Comptroller of Public Accounts Policy Letter Ruling No. 201207533L. Although the reasoning and statutory framework in Texas is very different from Utah and Pennsylvania, the result in Texas is the same in that the cloud software is taxable.

Colorado and Virginia are examples of two states that have went in favor of the Taxpayer. Colorado has a fairly straightforward rule: If a person purchases standardized or canned software, it's subject to tax, period. However, cloud computing is excluded from the tangible personal property definition and is not taxable. Virginia also believes that software accessed on the Internet is not tangible personal property and is therefore not taxable. If your company does a large amount of cloud computing, wouldn't it be worth at least considering moving to Colorado or Virginia?

Many states have taken the extremely helpful "it depends" approach from a sales tax perspective on cloud computing. Massachusetts thinks that "the object of the transaction test" (my personal favorite) should apply to this scenario. In short, if the cloud computing is for free software it is not subject to tax, but cloud computing for the use of canned software is subject to tax. Tennessee and Nebraska look to whether the title of the software is transferred to determine the cloud software's taxability. In South Carolina, if the cloud software is sold alone, it is subject to tax. However, if the "true object of the transaction" is for data processing, it is a nontaxable service. Wisconsin believes the answer lies in whether the server itself is controlled by the Taxpayer or not. However, if one downloads prewritten software in Wisconsin, then that would be taxable.

What has emerged from the differing positions of the various states (on essentially the same transaction) is that there is no predictability from state to state. If a company has operations in several states, it can be an administrative nightmare to reach a conclusion on whether it should be paying tax on its cloud computing services. As technology evolves, the administrative burden of remaining compliant in one of the some-9600 state and local jurisdictions will get more and more difficult. To make matters worse, states often change positions on a regular basis, so keeping up with the latest trends may turn into a full time job. If you have any questions please do not hesitate to contact me.

About the author: Mr. Donnini is a multi-state sales and use tax attorney and an associate in the law firm Moffa, Gainor, & Sutton, PA, based in Fort Lauderdale, Florida. Mr. Donnini's primary practice is multi-state sales and use tax as well as state corporate income tax controversy. Mr. Donnini also practices in the areas of federal tax controversy, federal estate planning, Florida probate, and all other state taxes including communication service tax, cigarette & tobacco tax, motor fuel tax, and Native American taxation. Mr. Donnini is currently pursuing his LL.M. in Taxation at NYU. If you have any questions please do not hesitate to contact him via email JerryDonnini@Floridasalestax.com or phone at 954-642-9390.

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