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An Overview of Cloud Computing Trends

As the internet becomes essential to our everyday lives, states are consistently inconsistent in their attempt to tax cloud computing systems. Cloud computing is “the practice of using a network of remote servers hosted on the Internet to store, manage, and process data, rather than a local server or a personal computer.” Essentially, the term “Cloud” is a metaphor for the internet. Cloud computing allows the user to access data over the internet without storing data on a hard drive. In fact, most internet users rely on these cloud computing systems as an essential tool in their everyday lives.

How should a cloud computing provider determine whether their object is subject to sales tax? A simple two-part test may allow a cloud computing provider a proper vantage point on whether they are subject to sales tax. First, apply a test. Second, ask whether the product is a software or a service? Think of this test as a simple flow chart.

Step 1: Apply Test: There are three traditional tests that are typically used–True Object, Dominant Purpose, and Essence of the Transaction. All three tests are exactly as they read. Primarily, the True Object test is the test that most states use as the first step in their analysis as to whether cloud computing is subject to sales tax. The True Object test asks whether the transaction was for taxable tangible property or a nontaxable service.

Although cloud computing may be a relatively new concept, the issue of digital data has been an ongoing issue–while technology may change, the overarching concepts has remained the same. In a case brilliantly argued by Joe Moffa–Moffa, Gainor, & Sutton, P.A.–the Agency Final Order stated “magnetic tapes containing mailing lists, stored as digital data, are not clearly and unambiguously within the statutory definition of “tangible personal property,” and thus taxpayers` leases of mailing lists on magnetic tapes not subject to sales/use tax.”

In the context of cloud computing, the proper inquiry is whether the provider is offering a service or if they are providing software
Step 2: Is the product a software or a service?: Once you have determined whether the transaction is for a non-taxable service or potentially taxable software, states take different routes to determine whether cloud computing is taxable. Some states simply define all software as taxable TPP. Other states think it matters whether the software is canned, or generic, or if its custom software. A third group of states seem to hinge their conclusion in the method in which the software is delivered.

While states may slightly differ in their statutory definition of tangible personal property, a typical definition reads similar to Florida’s definition–“‘Tangible personal property'” means and includes personal property which may be seen, weighed, measured, or touched or is in any manner perceptible to the senses.” Many states have changed their TPP definition to explicitly include software. Watch out for those !

If the object is not tangible personal property, is the object canned or custom software? Canned software is a software product or solution, usually purchased from a software company, which cannot be modified or altered beyond the original functionality. Custom software may be created to meet the needs of a particular customer. In most states canned software is taxable while custom software is not. However, it depends on the state.

Finally, some states determine taxability on the method of software delivery. The general rule of thumb is that software downloaded electronically is not taxable, but other states say it is irrelevant.

Take a few examples where states use different language to treat electronic delivery as a non-taxable object:

• Missouri – Taxable only if sold in a tangible form.
• Iowa – Not taxable if substance of the transactions is delivered in electronic means.
• Colorado – Taxable only if delivered in a tangible medium.
• Florida – Not taxable if not delivered in tangible form.

Conversely, New Mexico’s rule reads so that “receipts from the licensing of an intangible are taxable gross receipts.”

It is clear that the taxability of software, namely cloud computing can be very different depending on the state. When in doubt, contact a tax professional who may offer advice on the consistently inconsistent attempts by various states to tax cloud computing. It is quite difficult to state one general trend that the states are moving towards in an attempt to tax cloud computing providers. Despite the trends to remain inconsistent, by utilizing the two-part test, the taxation of cloud computing may be easier to determine moving forward.

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 obtained his LL.M. in Taxation at NYU. If you have any questions please do not hesitate to contact him via email or phone at 954-642-9390.

Mr. Appel is a law clerk with a Moffa, Gainor, & Sutton, PA based in Fort Lauderdale, Florida. Mr. Appel’s primary practice areas are Florida sales and use tax and multi-state sales and use tax. Mr. Appel earned a B.S. in Accounting and a Minor in Legal Environment of Business from The Pennsylvania State University. Mr. Appel is currently a Juris Doctorate Candidate at Nova Southeastern University Law School with an expected graduation in May 2016. Presently, Mr. Appel is the Executive Editor of ILSA Journal of International and Comparative Law, a Student-Coach and Advocate for Phillip C. Jessup International Law Moot Court, and a member of Nova Trial Association.

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