cloud computing: the answer is ‘no’ · 2014-05-19 · cloud computing: the answer is ‘no’...

Cloud Computing: The Answer Is ‘No’by Arthur R. Rosen, Leah Robinson, and Hayes R. Holderness

Although tax practitioners have seen quite a fewarticles published in the tax press regarding thestate and local tax effects of cloud computing (espe-cially sales and use tax concerns), there has been anotable paucity of any conclusions regarding what iscorrect under today’s laws. This article hopes to fillpart of that gap by analyzing the laws of those statesin which the revenue departments have administra-tively determined that the purchase of a serviceoffered in or through the cloud is subject to sales anduse taxes — a very real concern of not only sellers ofthose services but also of purchasers of the services(virtually every business in the United States) —and reaches conclusions on the validity of thoseadministrative rulings. States with specific statutesthat explicitly — directly or indirectly — impose taxon data processing are not part of this study.Furthermore, normative policy issues (that is, what‘‘should be’’ taxed) are also not discussed here.

Several state revenue departments — those inNew York, Arizona, Indiana, Pennsylvania, andUtah — and a state appellate court in Colorado havedetermined that obtaining a service from the cloudis obtaining constructive possession of the pre-written (or ‘‘canned’’) software that resides on theservice provider’s server. And because prewrittensoftware is considered tangible personal property(through statutes or case law), the central questionin determining taxability is whether the purchaserof that service really has a degree of control over thesoftware so as to constitute possession as intendedby the relevant sales and use tax statutes.

Although the relevant state statutes are not iden-tical, they all have similar goals. New York imposessales tax on receipts from transfers of possession oftangible personal property.1 Arizona likewise im-

poses a transaction privilege tax on any transfer ofpossession of tangible personal property.2 Indianaimposes a gross retail sales tax on transfer of pos-session or control of tangible personal property,3 andPennsylvania imposes sales tax on each transfer ofthe possession of tangible personal property.4 Utahimposes sales tax on any transaction under whichright to possession, operation, or use of tangiblepersonal property is granted.5 Finally, the local salestax ordinance at issue in the Colorado Court ofAppeals decision imposes sales tax on any transferof possession to tangible personal property.6 Regard-ing these sales taxes, it appears that possession is,in fact, ten-tenths of the law.

Key Terminology

What Do ‘Application Service Provider’ and‘Software as a Service’ Mean?

It is now common for businesses to provide tradi-tional and newly developed services to customersthrough a computer network, usually the Internet.At the onset of the Internet age, these businesseswere called application service providers (ASPs).Now, their services are often referred to — in asomewhat less than tax-careful manner — as ‘‘soft-ware as a service’’ (SaaS, usually pronounced‘‘sass’’).7 Generally speaking, SaaS involves an ASP’suse of its own hardware infrastructure (terminals,

1N.Y. Tax Law section 1105(a); N.Y. Tax Law section1101(b)(5).

2Ariz. Rev. Stat. section 42-5008(A); Ariz. Rev. Stat. section42-5071; Ariz. Rev. Stat. section 42-5001(13).

3Ind. Code section 6-2.5-2-1(a); Ind. Code section 6-2.5-1-21(a).

4Pa. Stat. Ann. section 7202(a); Pa. Stat. Ann. section7201(k)(1); Pa. Code section 31.1(1).

5Utah Code section 59-12-103(1)(a); Utah Code section59-12-102(104).

6City of Boulder Code section 3-2-2; City of Boulder Codesection 3-1-1.

7SaaS is a category within the realm of ‘‘cloud computing,’’but the term cloud computing encompasses more activitiesthan just SaaS. ‘‘Infrastructure as a service’’ (IaaS) and‘‘platform as a service’’ (PaaS) are other categories of cloudcomputing. While SaaS is used on a daily basis by millions ofbusinesses and individuals, only a limited set of businessesuse IaaS, and PaaS is generally used by computer program-mers and developers. Thus, IaaS and PaaS are not addressedin this article.

Arthur R. Rosen and Leah Robinson are partners atMcDermott Will & Emery LLC, New York. Hayes R.Holderness is an associate at the firm’s New York office.

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computer servers, and so on) and its own software(usually proprietary) to provide some service tocustomers that access the ASP’s front-end portal (aWeb page) using the customers’ own computer hard-ware and software. Customers can access data orcan request that the ASP perform various functionsto produce the desired result. Some ASPs require acustomer to download some minor communicationssoftware onto the customer’s own computer to allowreceipt of the ASP’s service, while other ASPs do not.

SaaS is generally available on the basis of aper-transaction fee or on a subscription or otherlong-term contractual basis.

Although some ASPs provide remote access toWeb-based services that are similar to prewrittensoftware that a customer could purchase in a shrink-wrapped box, others provide unique services. Anexample of the former are ASPs that provide remoteaccess to word processing programs similar toMicrosoft’s Word software that can be purchased atan office supply store. An example of the latter areASPs that provide Web-based services that cannotbe purchased ‘‘in a box,’’ often because various con-stantly changing data points are required for theservices (such as check verification services thataccess several third-party data sources in real timeto determine the likelihood that a check will behonored by a bank); because customer data will bestored on the ASP’s server and connection to thatserver is required; or because — as is common —significant ASP employee involvement is required.Thus, although the function of some SaaS is essen-tially the same as canned software, other types ofSaaS could never be sold off the shelf. Most of thisarticle focuses on the latter type of ASPs — thosethat provide functionality above and beyond what is,or could be, available in a shrink-wrapped box.

How Do ASP Services Work?Unless a person is a highly sophisticated com-

puter hacker, he has absolutely no ability to accessthe software used by the ASP’s servers. Customerscan and do access the ASP’s external portal in theform of a Web page, through either the Internet or aprivate network, through which the customers sub-mit data and order various services from the ASP.

Once a customer is logged on to the website, shesends a request to the ASP to verify that customer’sinformation and to allow the customer access to thesubscription-only portions of the website. Once thatis accomplished, the ASP redirects the customer toanother Web page that often contains a variety ofblank data fields in which the customer enters datafor use by the ASP. Under some arrangements, theASP’s software automatically pulls data from thecustomer’s databases.

Once the customer enters data into the searchfields, the data is transmitted to the ASP by, forexample, the customer clicking ‘‘enter.’’ By clicking

‘‘enter,’’ the customer is merely requesting that theASP use the ASP’s own software either to perform asearch of the various databases (either the ASP’s orthird parties’) to find information that meets thecustomer’s need or to process the data, or both. TheASP may or may not accept the customer’s request.For example, if the ASP’s server is experiencing toohigh a demand for services, the customer may haveto wait to get her request fulfilled. Other reasonsthat may cause an ASP to reject a customer’s requestinclude the customer having entered incorrect, in-complete, or inconsistent data, or the ASP’s systemshaving trouble operating or undergoing systemmaintenance.

Once the ASP begins performing the service, thecustomer is usually unable to stop the service (infact, even if she logs off or even turns off hercomputer, the ASP usually continues processing therequest). If there is a problem with the software, thecustomer cannot access it to correct that problem. Insum, a customer has absolutely no ability to access,alter, copy, or delete the ASP’s software.

With that limited operational framework, we nowanalyze the various states’ positions, beginning withthe ringleader, New York.

New York

PossessionNew York imposes sales tax on receipts from

transfers of ‘‘title or possession’’ to items of tangiblepersonal property.8 Tangible personal property in-cludes prewritten software.9 No New York statute orregulation explains when a license to use existsregarding software. However, the regulation defin-ing the terms ‘‘rentals, leases, and licenses to use’’states that ‘‘the terms ‘rental, lease and license touse’ refer to all transactions in which there is atransfer for a consideration of possession of tangiblepersonal property without a transfer of title to theproperty.’’10

The New York State Department of Taxation andFinance has taken the position that cloud computingsales made by ASPs are taxable licenses to remotelyuse prewritten software. In its opinions, the depart-ment concludes that the ASP’s receipts are derivedfrom providing customers with access and control ofsoftware (that is, a license to use tangible personalproperty) rather than from the ASP itself using itssoftware in conjunction with the provision of itsservices. The ‘‘license’’ is based on the purchaser’spresumed ability to ‘‘use, direct, or control’’ thesoftware on a remote basis.

8N.Y. Tax Law section 1105(a); N.Y. Tax Law section1101(b)(5).

9N.Y. Tax Law section 1101(b)(6).10N.Y. Comp. Codes R. & Regs. tit. 20 section 526.7(c)(1).

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However, the department’s advisory opinions donot address whether the ASP’s customers actuallyuse, direct, or control the ASP’s software. Rather, theopinions appear to assume that a customer’s use ofan ASP’s services is the same as the customer usingthe ASP’s software, thus creating constructivepossession of and sufficient control over the softwarefor the transaction to be a taxable license to useprewritten software. However, the relevant — andabundant — New York legal authority does notsupport the department’s assumptions. In mostsituations, ASPs’ customers do not receive a licenseto use the ASPs’ software because they never haveconstructive possession of or control over the soft-ware.

Under the New York sales tax regulations, atransfer of possession for a ‘‘license to use’’ hasoccurred when ‘‘one of the following attributes ofownership has been transferred: (i) custody or pos-session of the tangible personal property, actual orconstructive; (ii) the right to custody or possession ofthe tangible personal property; [or] (iii) the right touse or control or direct the use of tangible personalproperty.’’11 That aligns perfectly with the propertylaw concept of a possessory interest, such as a feesimple absolute or a leasehold — constructive pos-session or control is necessary in both situations.

In most situations, ASPs’customers do not receive a licenseto use the ASPs’ software becausethey never have constructivepossession of or control over thesoftware.

If possession or control is required for a transac-tion to be a taxable license to use, how muchpossession or control is needed? The departmentapparently assumes that almost any possession orcontrol is sufficient. But under controlling law, pos-session must be ‘‘exclusive’’ and for more than afleeting moment and control must mean actual con-trol.

In In re Darien Lake Fun Country Inc. v. New YorkState Tax Comm’n.,12 the department asserted thatamusement park admission tickets were actuallytaxable licenses to use the amusement park rides.The department argued that park visitors had pos-session of the rides while they rode on or in them.However, holding for the taxpayer, the New YorkCourt of Appeals said that ‘‘it has long been the rule

that something more than temporary possession isrequired before there is, within the meaning ofsection 1105(b), a ‘license to use’ taxable as a retailsale.’’ Thus, park visitors lacked sufficient posses-sion over the park rides for the admission tickets toconstitute taxable licenses to use the rides. Simi-larly, in In re Smarte Carte Inc.,13 a New Yorkadministrative law judge, relying on Darien LakeFun Country, determined that providing access toluggage carts at airports for a fee was a taxablelicense to use the carts because there was no timelimitation on use and no use restrictions that inter-fered with the intended purpose of the carts (that is,possession was more than merely fleeting).

Darien Lake Fun Country and its progeny areclear: Temporary possession of property is insuffi-cient to constitute a license to use that property. Inthe ASP model, customers are not granted actual,physical possession of the software. Indeed, thedepartment concedes as much.14 However, the de-partment asserts that the customer obtains con-structive possession of the software because thedepartment assumes that the customer controls theASP’s software. In so asserting, the department failsto recognize that the ASP is the entity using andcontrolling the software. Clearly, a customer ‘‘uses’’an ASP’s service, but that is a far cry from control-ling the ASP’s software.

The Court of Appeals recognized the distinctionbetween ‘‘use’’ and ‘‘control’’ in American Locker Co.v. New York City.15 In that case, a locker companyargued that the rentals of its lockers did not consti-tute a ‘‘transfer of title or possession or both, ex-change or barter, license to use, license to consume,conditional or otherwise, in any manner or by anymeans whatsoever for a consideration, or any agree-ment therefore,’’ and thus were not subject to NewYork City’s sales tax.

The court agreed, stating, ‘‘the purpose of thesales tax law is not to impose a tax on all transac-tions, but only on transactions which involve thepassage of title . . . or transactions in which theactual, exclusive possession is transferred.’’16 Afterindicating that it was clear that title to the lockers

11N.Y. Comp. Codes R. & Regs. tit. 20 section 526.7(e)(4).12In re Darien Lake Fun Country Inc. v. New York State

Tax Comm’n., 496 N.E.2d 217 (N.Y. 1985).

13In re Smarte Carte Inc., Dkt. No. 812942 (N.Y. Tax App.Trib. 1996).

14See, e.g., TSB-A-10(28)S (July 2, 2010).15American Locker Co. v. New York City, 125 N.E.2d 421

(N.Y. 1955). American Locker involved a sales tax imposed byNew York City under N.Y.C. Admin. Code sections N41-1.0(5)and N41-2.0. The tax was similar to the current sales tax andwas imposed ‘‘upon the amount of the receipts from every saleof tangible personal property sold at retail’’ and defined a saleas ‘‘any transfer of title or possession or both, exchange orbarter, license to use, license to consume, conditional orotherwise, in any manner or by any means whatsoever for aconsideration, or any agreement therefore.’’

16Id.

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did not pass to the customers, the court stated that‘‘neither can there be said to be a transfer of actualphysical possession of the lockers to the patrons. Thelockers are physically and permanently attached toeach other, having been manufactured so as tocomprise a cabinet unit. The patron has no right tomove any of the lockers.’’ Even so, the city arguedthat customers were in constructive possession ofthe lockers and that constructive possession wasenough to render the transaction taxable. The courtrejected that position because the customers, al-though able to use the lockers, did not have controlover them:

It is true, of course, that the patron may keephis baggage on the locker for a period up to 24hours and that during that period he mayexclude all others from use of the locker. How-ever, that is, at best, a limited type of construc-tive possession. The patron has the right onlyto lock and unlock the locker once during aperiod not in excess of 24 hours. After the doorhas been locked, the patron may not open thelocker without ending his right to its furtheruse. If the transaction were one in which real,exclusive possession were transferred, it seemsto us that the patron would have the right orprivilege of opening and closing the door asmany times as he wanted during the 24 hourperiod.17

Thus, mere ‘‘use’’ without ‘‘control’’ — includingthe ability to exclude others — does not constituteconstructive possession sufficient to create a taxablelicense to use.18 Smarte Carte, described above,provides a good example of a transaction in which acustomer enjoyed both use of and control over prop-erty (airport luggage carts). In such a case, thetransaction is properly classified as a taxable rental,lease, or license to use.

The distinction between use and control is dem-onstrated well by the operation of a jukebox. Acustomer inserts coins and requests songs to beplayed by the jukebox. However, the customer doesnot actually control the jukebox; for example, hecannot cause the machine to play a song backwardsand cannot delete a song from the jukebox’s library.

Indeed, a New York appellate court concluded thatbecause the customer’s control and possession over ajukebox is so limited, using a jukebox — insertingcoins and selecting songs — clearly fails to create ataxable license to use tangible personal property.19

Mere ‘use’ without ‘control’ —including the ability to excludeothers — does not constituteconstructive possession sufficientto create a taxable license to use.

The department certainly recognizes — or, atleast, used to recognize — the use and controldistinction. For example, in McKelvey (AdvisoryOpinion),20 the department addressed a transactionin which a customer hired a truck to move asphalt.The customer had the ability to instruct the truckdriver when and where to load and unload theasphalt but could not instruct the truck driver howto do so or what routes to take between locations.The advisory opinion concluded that the truckingcompany had ‘‘exclusive possession of the trucks anda sufficient degree of control over them while per-forming the service paid for by the customer so as tobe furnishing a transportation service and not rent-ing, leasing, or licensing trucks.’’ Thus, although thecustomer used the trucks to move its asphalt, it didnot control them and therefore did not rent, lease, orlicense them.

Furthermore, in TSB-M-86(3)S,21 the departmentdetermined that a storage unit customer only has‘‘control’’ over the storage unit when the ‘‘lessor [has]relinquish[ed] all control of the space rented. Thelessee’s possession and control of the space must beto the complete exclusion of the lessor’’ to be taxable.

Although ASP customers submit data through anASP’s website and request that the ASP performspecific tasks, the customers have absolutely nocontrol over the ASP’s software; for example, thesoftware relies on the ASP’s underlying operatingsystem and computer server hardware (operatedand monitored by the ASP), customers cannot forcethe software to perform, customers cannot stop thesoftware once it has begun performing, and cus-tomers cannot copy or alter the software or correct a

17Id.18See, e.g., Shanty Hollow Corp. v. New York State Tax

Comm’n., 111 A.D.2d 968 (N.Y. App. Div. 1985) (relying onAmerican Locker for ‘‘the firmly established principle thatonly transactions involving passage of title or of actualexclusive possession constitute sales’’); Bathrick EnterprisesInc. v. New York State Tax Comm’n., 27 A.D.2d 215 (N.Y. App.Div. 3d Dep’t. 1967) (the ability to make a jukebox play musicwas not the result of a license to use the jukebox because ‘‘itwas never intended that there be (nor was there) any passageor transfer of title nor were they such that actual, exclusivepossession was transferred. . . . No title ever passed nor wasany possession ever transferred.’’).

19See Bathrick Enterprises Inc. v. New York State TaxComm’n., 27 A.D.2d 215 (the ability to make a jukebox playmusic was not the result of a license to use the jukeboxbecause ‘‘it was never intended that there be (nor was there)any passage or transfer of title nor were they such that actual,exclusive possession was transferred. . . . No title ever passednor was any possession ever transferred.’’).

20McKelvey (Advisory Opinion), TSB-A-97(1)S (Jan. 23,1997).

21TSB-M-86(3)S (Jan. 16, 1986).

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problem with the software. All the customers areable to do is send a request to the ASP, which may ormay not be accepted. Control would necessitate thatthe customer be able to access the underlying com-puter code, force the software to perform or to stopits performance, alter the way the software func-tions, correct a flaw or virus in the software, ormodify the software. An ASP customer can do noneof those things. Moreover, an ASP customer cannotprevent the ASP from doing any of those activities.Simply put, ASP customers have an insufficientamount — indeed, a nil amount in most cases — ofcontrol over the software to be treated as construc-tively possessing it.

New York regulations further support the conclu-sion that an ASP does not transfer control of itssoftware to its customers. Specifically, the regula-tions provide the following example of a situation inwhich there has not been a transfer of possession:

Example 13: A corporation contracts with acomputer center to use the computer on thecenter’s premises for 10 hours weekly. Thecorporation provides its own materials and thecomputer center provides and directs the op-erator. During the 10 hour period, no one elsemay use the machine. In this case, there is notransfer of possession to the corporation as ithas no control over the operation of the com-puter. However, the transaction may be taxable[as an information service].22

The situation presented in this example is analo-gous to an ASP scenario. For example, customersmight retain an ASP to provide them with certainelectronic banking services. The ASP, like the com-puter center in the example, ‘‘provides and directs’’the operation of its electronic services, because theoperating systems and the hardware on which thesoftware operates are not under the constructivepossession or control of the ASP’s customers. Unlikein Smarte Carte, the ASP’s customers cannot do asthey wish within the software’s ‘‘parameters’’ (ascould the luggage cart patrons within the airport’s‘‘perimeter’’). Rather, the ASP software is useless tothe customers without the active coordination andessential concurrent activities performed by theASP’s employees operating and maintaining thesoftware, operating systems, and hardware. TheASP’s customers have no control over the underlyingoperations of the ASP’s business.23

Similarly, the regulations provide a second ex-ample of a situation where there has not been atransfer of possession:

Example 14: A corporation contracts with acomputer center for access time on the com-puter center’s equipment through the use of aterminal located in the corporation’s office. Theterminal is connected to the computer by tele-phone. The corporation’s access to the computerthrough the terminal is not deemed to be atransfer of possession of the computer subject totax. However, the transaction may be taxable[as an information service].24

That example further demonstrates that use ofanother entity’s computer systems, without more, isinsufficient to constitute a taxable sale. Remote useof the computer was simply insufficient to constitutea transfer of possession. Clearly, the corporation hadno right to control or operate the underlying com-puter systems. That is exactly the case with respectto an ASP. An ASP’s customers enter data into aWeb-based application form and click ‘‘enter.’’ Thecustomers’ actions stop there. Those actions aresimply insufficient to constitute control over theASP’s software. Therefore, the department’s posi-tion regarding the taxability of ASP services is notsustainable.

Primary Purpose TestInstead of demonstrating that ASP services do not

fit within the statutory and regulatory definitions ofa taxable license to use, one could simply argue thatthe ‘‘primary purpose’’ or ‘‘true object’’ of the trans-action is to receive services and not to receivetangible personal property (that is, the software).That is the test the New York Tax Appeals Tribunalhas traditionally used when uncertainty exists re-garding what has actually been purchased.25 Underthe test, if the customer’s primary purpose or trueobject for making the purchase is to receive a serv-ice, the purchase is a purchase of services and not apurchase of tangible personal property.26

That test certainly has appeal here, particularlysince — we suspect — ASP customers likely viewtheir purchases as purchases of services and wouldbe surprised to learn that the department believesthey are actually leasing tangible personal propertywhen they use an ASP’s services.27 After all, as thetribunal said:

22N.Y. Comp. Codes R. & Regs. tit. 20 section 526.7(e)(5).23Compare N.Y. Comp. Codes R. & Regs. tit. 20 section

526.7(e)(5) (example 12) (in which the corporation — not thecomputer center as in example 13 above — provides its ownoperator, then a taxable sale is deemed to have occurred).

24N.Y. Comp. Codes R. & Regs. tit. 20 section 526.7(e)(5)(emphasis added).

25See, e.g, SSOV 81 Ltd. d/b/a People Resources, DTA No.810966 (N.Y. Tax. App. Trib. 1995); In re Principal Connec-tions, Ltd., DTA No. 818212 (N.Y. Tax App. Trib. 2004).

26See Marriott Int’l. Inc., DTA No. 821078, etc. (N.Y. TaxApp. Trib. 2010). (‘‘For tax to apply, there has to be a separatetransaction that has as its primary purpose the furnishing ofsomething that is taxable.’’)

27Indeed, the department apparently shares the view thatthe primary purpose test requires that cloud computingtransactions are exempt from tax where the primary purpose

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[T]he proper focus should be on the primaryfunction itself and not upon whether theservice might, as an incident thereof, involvethe provision of [some taxable service]. . . . Toneglect the primary function of petitioner’sbusiness in order to dissect the service it pro-vides into what appears to be taxable eventsstretches the application of [the sales taxstatute] far beyond that contemplated by theLegislature.28

However, because the primary purpose wascreated judicially and is not contained in statute, thetest should be asserted in conjunction with thestatutory and regulatory arguments presentedabove.

Arizona

PossessionArizona imposes a transaction privilege tax on

the privilege of doing business in the state, and thetax is applied to various classifications of business.29

The retail classification is composed of businessesselling tangible personal property at retail and thepersonal property rental classification is composedof businesses leasing or renting tangible personalproperty for a consideration.30 ‘‘Sale’’ means anytransfer of title or possession, or both, exchange,barter, lease or rental, conditional or otherwise, inany manner or by any means whatever, of tangiblepersonal property.31 The statute does not defineeither leasing or renting.

Although the Arizona Department of Revenue’sregulations provide that ‘‘gross receipts derived fromthe sale of computer software programs are taxable,regardless of the method that a retail business usesto transfer the programs to its customers,’’32 neitherthe regulations nor the statute offer a definition of

possession for the purposes of the transaction privi-lege tax. However, the department has determinedthat ASPs’ services are taxable under the personalproperty rental classification as leases of computersoftware.33

The Arizona Supreme Court has determined thatbecause the statute does not define either leasing orrenting, the ordinary meaning of the terms must beused.34 In reaching the conclusion that the use ofcoin-operated laundry equipment and car washingequipment were taxable rentals of tangible personalproperty, the court stated:

Webster’s Third International Dictionary de-fines the verb ‘‘to rent’’ as ‘‘(1) to take and holdunder an agreement to pay rent,’’ or ‘‘(2) toobtain the possession and use of a place orarticle for rent.’’ There is no question that whencustomers use the equipment on the premisesof the plaintiffs herein, such customers have anexclusive use of the equipment for a fixedperiod of time and for payment of a fixedamount of money. It is also true that thecustomers themselves exclusively control allmanual operations necessary to run themachines. In our view such exclusive use andcontrol comes within the meaning of the term‘‘renting’’ as used in the statute.35

In City of Phoenix v. Bentley-Dille GradallRentals, Inc.,36 the Arizona Court of Appeals, follow-ing Peck, stated that ‘‘the principal characteristic ofa rental or lease is the giving up of possession to thelessee so that he, as opposed to the lessor, exercisescontrol over and uses the leased or rented prop-erty.’’37 Also, in Energy Squared, Inc. v. Ariz. Dep’t. ofRev.,38 the Arizona Court of Appeals stated that thepersonal property rental classification ‘‘hinges onthe degree of control over the property in questionthat is ceded to its putative ‘lessee’ or ‘renter.’’’39 InEnergy Squared, customers paid to use the tanningequipment of a tanning salon, but because thetanning salon’s employees limited the use based onvarious factors — thus exercising control over theequipment — the court found that the customerswere not renting the equipment, rather they werepurchasing a service.40

The department has recognized and followedthose decisions in its rulings in areas other than

is to obtain an ASP’s services. See TSB-A-12(22)S (Aug. 29,2012) (finding that online access to software and directory ofconsultants was not taxable where the primary purpose of thetransaction was obtaining a nontaxable service and the use ofthe software was not necessary to receive the service).

28In re Telecheck Svcs. Inc., DTA No. 822275 (N.Y. Tax App.Trib. 2009) (citing SSOV 81 Ltd. d/b/a People Resources,DTA No. 810966 (N.Y. Tax App. Trib. 1995)).

29Ariz. Rev. Stat. section 42-5008(A); Ariz. Rev. Stat. sec-tion 42-5071.

30Ariz. Rev. Stat. section 42-5061(A).31Ariz. Rev. Stat. section 42-5001(13).32Ariz. Admin. Code R15-5-154(B). Arizona exempts ‘‘ap-

plication services that are designed to assess or test studentlearning or to promote curriculum design or enhancementpurchased by or for any school district, charter school, com-munity college or state university. For the purposes of thisparagraph: (a) ‘‘Application services’’ means software applica-tions provided remotely using hypertext transfer protocol oranother network protocol.’’ Ariz. Rev. Stat. Ann. section 42-5061(A)(55). That may imply that other application servicesare taxable under the retail classification.

33Arizona Private Taxpayer Ruling LR09-007 (Dec. 3,2009).

34State Tax Comm’n v. Peck, 476 P.2d 849 (Ariz. 1970).35Id. (emphasis added).36City of Phoenix v. Bentley-Dille Gradall Rentals, Inc.,

665 P.2d 1011 (Ariz. Ct. App. 1983).37Id.38Energy Squared, Inc. v. Ariz. Dep’t. of Rev., 56 P.3d 686

(Ariz. Ct. App. 2002).39Id.40Id.

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cloud computing.41 As previously discussed, con-sumers of ASP services do not exercise exclusive useor exclusive control over the software of the ASP.Therefore, in line with Arizona authority, purchasesof those services cannot be considered the lease orrental of personal property as the department con-tends. Thus, the department’s position regardingthe taxability of cloud computing is wrong.

Primary Purpose TestSimilar to New York, Arizona applies a primary

purpose test to determine the taxability of a trans-action when it may be unclear what exactly wasintended to be purchased, such as when the trans-action involves a mix of taxable property andnontaxable services. Also, the Arizona courtsapply a ‘‘common understanding’’ test that considerswhether a particular business is commonly under-stood to sell property or services. The Arizona Courtof Appeals has explained both tests recently inVal-Pak East Valley, Inc. v. Ariz. Dep’t. of Rev.:42

To decide whether a transaction fits in the firstor second scenario, we apply two tests: the‘‘dominant purpose,’’ also known as the ‘‘trueobject’’ test, and the ‘‘common understanding’’test.

. . . .

As its name suggests, under the ‘‘dominantpurpose’’ test, a court decides whether thetransaction is all taxable or all nontaxable byidentifying the dominant purpose of the trans-action.

. . . .

Under the ‘‘common understanding’’ test,whether a mixed transaction is all taxable orall nontaxable is determined by the ‘‘commonunderstanding of whether a trade, business, oroccupation involves selling products, on the onehand, or rendering services . . . on the other.’’43

In Val-Pak, the company had contracted withanother company to provide it with coupons that itplanned to distribute. The Arizona DOR argued thatVal-Pak had purchased tangible personal propertybecause the coupons were printed on paper providedto Val-Pak. However, the court, applying the domi-nant purpose test, determined that Val-Pak hadactually purchased printing and design services,because ‘‘simply put, by itself, the paper is of little

practical value to Val-Pak without [the] design,printing, and mailing services.’’44

Furthermore, the court also found that Val-Pakhad purchased services by applying the commonunderstanding test. After explaining that in apply-ing the common understanding test, ‘‘we attempt toidentify characteristics of the transaction at issuethat make it either more analogous to what isreasonably and commonly understood to be a sale ofgoods, or more analogous to what is generallyunderstood to be the purchase of a service or intan-gible right,’’ the court determined that ‘‘no one wouldthink Val-Pak is in the business of buying paper.’’45

Thus, the transaction could not be properly identi-fied as a taxable sale of tangible personal property.

As argued earlier, ASP customers would likelyview their purchases as purchases of services andnot the lease of software. Indeed, the software is oflittle practical value to the ASP customers, and noone would think ASP customers are in the businessof buying software. Thus, under the dominantpurpose and common understanding tests used inArizona, cloud computing is correctly identified asthe provision of nontaxable services, not taxabletangible personal property as the department ar-gues.

Indiana

PossessionIndiana imposes a gross retail sales tax on retail

transactions made in Indiana.46 For the purposes ofthe tax, a ‘‘retail transaction’’ means a transaction ofa retail merchant that constitutes selling at retail.47

A person is engaged in selling at retail when, in theordinary course of his regularly conducted trade orbusiness, he transfers tangible personal property toanother person for consideration.48 Renting or leas-ing tangible personal property is considered engag-ing in selling at retail.49 ‘‘Lease’’ or ‘‘rental’’ meansany transfer of possession or control of tangiblepersonal property for a fixed or indeterminate termfor consideration and may include future options topurchase or extend.50

The Indiana Department of Revenue has deter-mined that purchases of ASP services are taxable assales of prewritten computer software because ‘‘itappears that when Taxpayer’s customers access the[ASP service], the customers are purchasing accessto prewritten computer software for which they, the

41See, e.g., Arizona Taxpayer Information Ruling LR10-006 (Mar. 5, 2010); Arizona Transaction Privilege Tax Ruling93-4 (Feb. 19, 1993).

42Val-Pak East Valley, Inc. v. Ariz. Dep’t. of Rev., 272 P.3d1055 (Ariz. Ct. App. 2012).

43Id. (citing Qwest Dex, Inc. v. Ariz. Dep’t. of Rev., 109 P.3d118 (Ariz. Ct. App. 2005)).

44Id.45Id.46Ind. Code section 6-2.5-2-1(a).47Ind. Code section 6-2.5-1-2.48Ind. Code section 6-2.5-4-1(b).49Ind. Code section 6-2.5-4-10; Ind. Admin. Code 2.2-4-27.50Ind. Code section 6-2.5-1-21(a).

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customers, have a possessory interest.’’51 Presum-ably because the department believes that the cus-tomer has a possessory interest in software that isused in providing ASP services, it has concluded that‘‘the fact that a computer software program isaccessed via the Internet as opposed to on thecustomer’s own computer is irrelevant to the tax-ability of the program; the program in whateverform constitutes tangible personal property, and thecompany’s charges for access to the program issubject to sales and use tax.’’52

In Indiana Dep’t of State Rev. v. IndianapolisTransit System, Inc.,53 the Indiana Court of Appealsconsidered, in the context of determining whether ataxable lease had occurred, what it meant to havepossession and the ‘‘right of control’’ over a bus thathad been chartered:

In the case at bar [the bus company] furnishedthe drivers with the bus, it retained the right todirect the movement of the buses, it was obli-gated to pay all costs and repairs as well as fuelcosts. [The bus company] had the responsibilityto garage the vehicle and make all insurancepayments, license payments as well as pay-ments for any damages caused by the bus. It isapparent that [the bus company] retained the‘‘right to control.’’54

As can be seen from this discussion, possession —or the ‘‘right to control’’ — something in Indianadepends on who has the responsibility for the objectin terms of maintaining it and which party is able todirect how the object will be used.

The department has also considered what consti-tutes possession and control in its rulings. In thecontext of the lease of heavy equipment along withan operator,55 the department makes the followingobservations:

The Taxpayer owns the equipment and em-ploys the drivers of the equipment. The twoshareholders of Taxpayer are the only opera-

tors of the equipment. Taxpayer determineshow to perform the job and prepare the site forconstruction to the specifications of the lesseecorporation. Taxpayer exercises control overthe equipment. And directs the movement ofthe equipment. None of the employees of lesseecorporation ever operate the equipment. Tax-payer also pays sales tax at the time of thepurchase of the equipment. Lessee does nothave exclusive use of the property. Further thelessee does not have the right to control themachinery or direct the manner of the use ofthe property. Therefore, Lessor is leasing theservice of an operator and equipment to per-form a specific function for lessee.56

In Indiana Letter of Finding No. 96-0067 ST,57 thedepartment determined that the supplying of photo-copying equipment and operators was not the tax-able rental of tangible personal property but theprovision of nontaxable services. Relying on thesame logic as in the heavy equipment ruling, thedepartment noted that ‘‘in this case, the vendor hascontrol over the equipment. The vendor’s personneloperate, maintain and supervise the duplication ofdocuments for the taxpayer. The taxpayer maintainsno exclusive control over the tangible personal prop-erty used by the vendor. Thus, taxpayer is notrenting tangible personal property.’’58

The department considered the meaning of‘‘possession’’ in Indiana Letter of Finding No. 02-047859 and Indiana Letter of Finding No. 08-0580,60

concerning the provision of propane tanks to cus-tomers:

Taxpayer’s agreements with both the smalland large tank customers do not constitutelease agreements because the customers do notcome into ‘‘possession’’ of the tanks. ‘‘Posses-sion’’ means the right to ‘‘exercise control oversomething to the exclusion of all others.’’Black’s Law Dictionary 1183 (7th ed. 1999). Bythe terms of the agreement, the customer is notentitled to move the tanks or to allow anothersupplier to fill the tanks with the competitor’s

51Indiana Revenue Ruling ST 11-05 (Oct. 11, 2011).52Indiana Letter of Finding No. 09-0418 (Jan. 1, 2010);

Indiana Revenue Ruling ST 09-03 (Mar. 30, 2009).53Indiana Dep’t of State Rev. v. Indianapolis Transit Sys-

tem, Inc., 356 N.E.2d 1204 (Ind. Tax Ct. 1976); see also MasonMetals Company, Inc. v. Indiana Dep’t of State Rev., 590N.E.2d 672 (Ind. Tax Ct. 1992).

54Id.55There is admittedly a regulation on point: 45 IAC 2.2-4-

27(d)(3)(B) concerns the lease of tangible personal propertywith an operator. That regulation states:

The rental of tangible personal property together withan operator as part of a contract to perform a specificjob in a manner to be determined by the owner of theproperty or the operator shall be considered the per-formance of a service rather than a rental or leaseprovided the lessee cannot exercise control over suchproperty and operator.

56Id., Indiana Letter of Finding No. 98-0081 ST (May 1,1999).

57Indiana Letter of Finding No. 96-0067 ST (July 1, 1999).58Indiana Letter of Finding No. 96-0067 ST (July 1, 1999).

For other operator rulings, see also Indiana Letter of FindingNo. 00-0467 (Nov. 1, 2002); Indiana Letter of Finding No.09-0540 (Jan. 1, 2010); but see Indiana Letter of Finding No.04-0037 (July 1, 2005). (‘‘The regulation is written to addressthe rental of heavy equipment that is used by the operator ofthe equipment in a manner determined by the operator. . . . Aceremonial casket is not a piece of heavy equipment thatrequires an operator in order for the function and the use ofthe ceremonial casket to be fulfilled.’’)

59Indiana Letter of Finding No. 02-0478 (Aug. 1, 2004).60Indiana Letter of Finding No. 08-0580 (Mar. 1, 2009).

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propane supply. Of course, the tanks are lo-cated on the customers’ property, but that doesnot mean that the customers have ‘‘posses-sion.’’ Although the tank is located on thecustomer’s property, taxpayer retains most ofthe rights to control the tank. Unlike an actuallease agreement, the customer does not acquirethe usual rights to control the object of thelease. Instead the tanks are merely an exten-sion of the agreement by which taxpayer pro-vides propane to its customers with the cus-tomer assessed an additional cost for the use ofthe storage container which — by nature of thetransaction — is necessarily located on thecustomer’s property. The fact that the parties’agreement is called a ‘‘lease’’ does not changethe fact that taxpayer is not in the business ofleasing propane tanks nor the fact that thecustomers are not interested in leasing pro-pane tanks. Taxpayer’s interest lies in sellingits product to its customers and receiving com-pensation for the cost of doing so. The cus-tomers’ interest is in obtaining that fuel. Giventhe fact that the tanks have a limited decora-tive or utilitarian value outside of their capa-bility of storing taxpayer’s propane, it is ap-parent that the object of the parties’ agreementis the delivery, storage, and consumption ofpropane.61

The department also considered the meaning of‘‘possession’’ in Indiana Letter of Finding No. 04-0444,62 concerning the rental of golf simulators:

The Department is unable to agree that tax-payer transfers ‘‘possession’’ of the simulatorsto its customers. ‘‘Possession’’ means ‘‘The factof having or holding property in one’s power;the exercise of dominion over property.’’ Black’sLaw Dictionary 1183 (7th ed. 1999). ‘‘Posses-sion . . . is evidence of ownership; the possessorof a thing is presumed to be the owner of it, andmay put all other claimants to proof of theirtitle.’’ Id. The simulator customers do not take‘‘possession’’ of the simulators, they merelyhave the right to use the simulators for a fixedperiod of time. In that sense, the simulators areanalogous to the electronic games found invideo arcades. The video game customer paysfor the privilege of using the game withoutinterference from other customers and controlsthe manner in which the game is played. Thevideo game customer may have the exclusiveright to use the video game for a short period,but the video game customer does not take‘‘possession’’ of the device. Both taxpayer andthe arcade owner would look askance at any

customer who backed up a truck and at-tempted to take possession of either the simu-lator or the video game.

In contrast, a person who rents or leases a caris entitled to take possession of the car and tocontinue to exercise that possessory interestfor a fixed period of time. The person who visitsa local rental store and arranges to rent a lawnmower over the weekend, takes ‘‘possession’’ ofthe lawn mower for the weekend. The automo-bile rental business and the local rental storepurchase the car and the lawn mower withoutpaying sales tax pursuant to IC 6-2.5-5-8 butmust thereafter collect sales tax from theircustomers each time the car or lawn mower isrented. (See IC 6-2.5-4-10).

Taxpayer is in the business of providing aservice to its simulator customers; that serviceconsists of permitting its customers to use —not truly possess — the golf simulators for afixed period of time. Although the transitory‘‘use’’ of the simulators possesses qualitieswhich mimic the attributes of ‘‘possession,’’nevertheless, the simulator customers do notacquire uninhibited possession of the simula-tors.63

Following all those cases and rulings, it is clearthat under Indiana law, in cloud computing trans-actions between an ASP and its customers, thecustomers do not typically receive possession orcontrol over the software, so no taxable sale oftangible personal property can be deemed to haveoccurred. In the case of ASP services, the ASP hasthe responsibility for maintaining the software andis the only party able to direct how the softwareoperates. Furthermore, the provision of ASP servicesis analogous to the equipment rentals, propane tankrentals, and leasing of the golf simulators. The ASPowns the software. The software operates on itsservers. The ASP determines how to perform therequested services and exercises control over thesoftware that the customer does not. Customers donot operate the software but rather make requests ofit. Customers do not have the exclusive use of thesoftware and have no right to control or direct themanner in which the software operates. Therefore,the customers are purchasing services from theASPs, not tangible personal property. As in the caseof the golf simulators, the ASP customers merelyhave the right to use the software for a fixed period.Neither the ASP nor the customer expects the cus-tomer to ‘‘take’’ the software for itself, that is to say,remove it from the ASP’s server so that no one elsecan access it. Thus, the department’s position that

61Id.; Indiana Letter of Finding No. 02-0478 (Aug. 1, 2004).62Indiana Letter of Finding No. 04-0444 (Apr. 1, 2006). 63Id.

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the ASP customers take possession of the software,creating a taxable sale of tangible personal property,is untenable.

Primary Purpose TestIndiana also applies a true object test to deter-

mine the taxability of a transaction that mightinclude both nontaxable services and taxable prop-erty. This test has been developed through case lawand also has been written into the Indiana DOR’sregulations regarding bundled transactions. Thoseregulations provide that ‘‘[a] ‘bundled transaction’does not include a retail sale that is . . . comprised ofa service that is the true object of the transaction,and tangible personal property that is essential tothe use of the service and is provided exclusively inconnection with the service.’’64

The Indiana Supreme Court developed the trueobject test in 1952 in Samper v. Indiana Dep’t. ofRev.,65 when it held that parts sold as a necessaryincident to the repair of a radio were exempt fromsales tax because the actual purpose of the trans-action was to have the radio repaired, a service, andnot the retail sale of parts. In so holding, the courtstated that ‘‘the nature and purpose of such acontract contemplates and intends that, if new partsare needed in the repair, this part of the contract is. . . [dependent on] that part of the contract whichcalls for the labor and services necessary tocomplete the repair. Such a contract could not becompleted in part only . . . by performing the laborand services required without furnishing . . . neces-sary [parts].’’66

In Chrome Deposit Corp. v. Indiana Dep’t. of StateRev.,67 the Indiana Tax Court developed a ‘‘but for’’test to determine the true object of a mixed transac-tion, stating that ‘‘but for its customers’ desire topurchase the chromium sleeve, Chrome Depositwould not render the incidental services of attachingthe sleeve to the work roll . . . on behalf of itscustomers.’’ Thus, the court found that the contractat issue was for the sale of a chromium sleeve andservices provided to attach that sleeve to iron rollswere merely incidental to the sale.

Again, ASP customers would likely view theirpurchases as purchases of services and not leases ofsoftware. Indeed, ‘‘but for’’ the services, the cus-tomers would not seek any access to the software.

Therefore, the software is merely a necessary inci-dent to the services of the ASP and under Indiana’strue object test, cloud computing is correctly identi-fied as the provision of nontaxable services, nottaxable tangible personal property as the depart-ment argues.

Pennsylvania

PossessionPennsylvania imposes sales tax upon each sepa-

rate sale at retail of tangible personal property orservices within the state.68 Sale at retail is definedas ‘‘any transfer, for a consideration, of the owner-ship, custody or possession of tangible personalproperty, including the grant of a license to use orconsume whether such transfer be absolute or con-ditional.’’69

Without explanation of how a consumer exercisescontrol or power over the software used in providingthe ASP’s services, the Pennsylvania Department ofRevenue has determined that remote access of ASPservices are taxable because ‘‘in accessing taxablesoftware the user is exercising a license to use thesoftware, as well as control or power over the soft-ware, at the user’s location.’’70

Interestingly, the department had previously held— and there has been no relevant change to thecontrolling statute — that access to software ‘‘solelythrough the Internet’’ was not a taxable transfer ofsoftware.71 In that earlier decision, the departmentnoted that:

Other than an applet necessary to access theservice, the service does not entail the transferof any Taxpayer software to the subscriber anddoes not allow subscribers to access the Tax-payer software code or manipulate the soft-ware in any way. Rather, the service is pro-vided through the Taxpayer’s own data centerson its proprietary equipment and software,which is at all times owned by and under thecontrol of the Taxpayer.

It is difficult to reconcile those two decisions,which are separated from each other by only twoyears. Furthermore, considering the relevantauthority in Pennsylvania, it is clear that the de-partment’s original position was correct.

Although the Pennsylvania statutes do not definecontrol for the purposes of determining whether ataxable transaction has occurred, court decisionsprovide guidance regarding the meaning of the term.64Ind. Code section 6-2.5-1-11.5(d).

65Samper v. Indiana Dep’t. of Rev., 106 N.E.2d 797 (Ind.1952). See also Ind. Dep’t. of State Rev. v. Klink, 112 N.E.2d581 (Ind. 1953).

66Id.67Chrome Deposit Corp. v. Indiana Dep’t. of State Rev., 557

N.E.2d 1110 (Ind. Tax Ct. 1990). See also Mid-AmericaPublishing, Inc. v. Ind. Dep’t. of State Rev., No. 49T10-9912-TA-239 (Ind. Tax Ct. 2004); Cowden & Sons Trucking, Inc. v.Ind. Dep’t. of State Rev., 575 N.E.2d 718 (Ind. Tax Ct. 1991).

68Pa. Stat. Ann. section 7202(a).69Pa. Stat. Ann. section 7201(k)(1); Pa. Code 31.1(1).70Pennsylvania Sales and Use Tax Ruling No. SUT-12-001

(May 31, 2012).71Pennsylvania Sales and Use Tax Ruling No. SUT-10-005

(Nov. 8, 2010).

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Perhaps one of the more thorough discussions of theconcept of control was given by the PennsylvaniaCourt of Common Pleas in Commonwealth v. SunShipbuilding & Dry Dock Co.,72 concerning the salesof five tankers constructed in Pennsylvania to out-of-state-purchasers. In holding that the sales hadnot occurred in Pennsylvania, and thus were notsubject to the Pennsylvania sales tax, the courtdetermined that the shipbuilder retained controlover the tankers up until the points of delivery —which occurred outside the state — at which timethe sales were made. The court based its holding onthe following facts:

[The shipbuilder] had complete possession andcontrol of the vessel[s] and of the construction,and was responsible for all injuries, damagesand repairs due to any cause whatever. Theinspectors for the purchaser were to haveaccess to the shipyard and to the materialsthroughout construction, but were required topromptly accept or reject all work andmaterials. The [shipbuilder] was required topay all fees and royalties in connection withconstruction and classification. All expenses ofthe trial trip were to be born by the [ship-builder]. The [shipbuilder] guaranteed that thevessel would have a certain carrying capacityand was to be penalized if the vessel uponcompletion was found not to reach thatcapacity . . . [the shipbuilder] agreed to pay alltaxes imposed on the vessel prior to deliveryand any taxes on the sale of the vessel.73

The essence of the court’s discussion is that theshipbuilder had control over the tankers beforedelivery because it was ultimately responsible forhow they were constructed, their maintenance, andany liabilities arising from them. After delivery,those responsibilities would presumably fall to thepurchasers.

That understanding of control has been adoptedin other contexts as well. In City of Philadelphia v.City of Philadelphia Tax Review Board,74 the Penn-sylvania Commonwealth Court determined that Ex-pedia, which operates a website through which cus-tomers can reserve hotel rooms, was not an‘‘operator’’ of a hotel — the definition of which thecourt determined inferred ‘‘ownership or control ofthe premises’’ — because it had ‘‘no control overwhich room is furnished to the traveler[,] . . . doesnot own the brick and mortar hotel, has no physical

presence at the hotel, and has no responsibility forthe operation or management of the hotel.’’ Thecommonwealth court has also said that a manu-facturer retains control over personal propertywhere there is ‘‘the possibility that the propertycould undergo further changes, the property is stillwithin the production cycle.’’75 In House of Lloyd v.Commonwealth,76 the court held that ‘‘House ofLloyd transfers only custody of the kits (tangiblepersonal property) and continues to exercise controluntil the end of a selling season’’ when:

Salespeople are instructed to carry the samplekit to every home party; not to take anysamples from the kit until the last party; toprepare labels for each sample product show-ing its name, item number, and price; to mini-mize wear and tear on the boxes; and to saveunused packing in order to enhance the valueof the kit for when the salesperson returns orsells it at the end of the season. Under theterms of their contracts, each district manager,supervisor, and demonstrator is entitled tokeep a sample kit when $1,500 of demonstratorcommissionable sales have been paid for andshipped. District managers must account forall sample kits at the end of a selling seasonand must either return or pay for any kits not‘‘earned’’ by the salesperson.77

Finally, the Pennsylvania Supreme Court notedthat when an individual ‘‘assumes control over theoperation of [a] vehicle,’’ a taxable lease would occur;however, if the operation of the ‘‘vehicle [would] beunder the control of the owner,’’ the transactionwould not be taxable.78

In all those court decisions, the concept of controlis developed to include the ultimate responsibilityfor the way property is used, maintained, or oper-ated. Essentially, the person who controls propertyhas the ability to change the property and is respon-sible for any liabilities arising from the property.

When those authorities are taken into con-sideration, it cannot be contended that in the con-text of cloud computing the customers achievecontrol over the ASP’s software. As has been dis-cussed, the customers have no ability to change ormanipulate the underlying software and are notresponsible for any liabilities arising from the soft-ware. Only the ASPs have the responsibility formaintaining the software and the ability to change

72Commonwealth v. Sun Shipbuilding & Dry Dock Co., 75Dauph. 1 (Pa. Common Pleas, 1960).

73Id.74City of Philadelphia v. City of Philadelphia Tax Review

Board, 37 A.3d 15 (Pa. Cmwlth. 2012). See also Marwood RestHome, Inc. v. City of Philadelphia Tax Review Board, 535 A.2d281 (Pa. Cmwlth. 1987).

75Lancaster Laboratories, Inc. v. Commonwealth, 578 A.2d988 (Pa. Cmwlth. 1990), exceptions denied in part, granted inpart, 611 A.2d 815 (Pa. Cmwlth. 1992).

76House of Lloyd v. Commonwealth, 684 A.2d 213 (Pa.Cmwlth. 1996), aff’d, 694 A.2d 375 (Pa. Cmwlth. 1997).

77Id.78In re J & R Transport Co. (Pa. Sup. Ct. July 24, 1962).

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the software as they see fit. Therefore, the depart-ment’s current position that the customers are givencontrol over the software is incorrect.

Primary Purpose TestPennsylvania applies an essence of the trans-

action test to determine whether a transaction in-volving both taxable property and nontaxableservices should be classified as a taxable sale ofproperty or a nontaxable sale of services. The Penn-sylvania Commonwealth Court explained the test inGraham Packaging Co., LP v. Commonwealth:79

The test focuses on whether the essence or trueobject of the sale is tangible personal propertyor intangible property or a service with tan-gible property serving only as the medium oftransmission. If the essence of the transactionor true object of the transaction is the intan-gible property or service, the intangible object/service does not assume the taxable characterof the tangible property serving as the mediumof transfer.80

In the case of cloud computing, the essence of thetransaction is not the purchase of software, but theprovision of services. Therefore, under the Pennsyl-vania test, the transactions between ASPs and theircustomers are correctly classified as nontaxablesales of services. That software is used as themedium of the transfer of the services does not affectthat conclusion.

Utah

PossessionUtah imposes sales tax on the purchaser for

amounts paid or charged for retail sales of tangiblepersonal property made within the state.81 Sale isdefined to include ‘‘any transfer of title, conditionalor otherwise, in any manner, of tangible personalproperty’’ and ‘‘any transaction under which right topossession, operation, or use of any article of tan-gible personal property is granted under a lease orcontract and the transfer of possession would betaxable if an outright sale were made.’’82

Though the Utah Department of Revenue origi-nally determined that ASP services were not taxablebecause there was no transfer of possession to thecustomer,83 it has since changed its mind afterchanges to the state’s sales tax statute:

The transfer of the Web Services for a fee meetsthe broad definition of sale found in section59-12-102(99). . . . When the Company sellsWeb Services, it in substance grants Sub-scribers the right to use the Company’s pro-prietary software under a lease or contract.The Company is not using the proprietarysoftware to sell services.84

The changes to the statute are found in UtahCode section 59-12-102(113), defining tangible per-sonal property to include ‘‘prewritten computersoftware, regardless of the manner in which theprewritten computer software is transferred,’’85 andin Utah Code section 59-12-211(12), providing thelocation of sales specifically when ‘‘a purchaser usescomputer software and there is not a transfer of acopy of that software to the purchaser.’’86 However,the department apparently fails to recognize thatthe new laws still require a transfer of the pre-written software, and in the case of ASP services,there is no such transfer.

The seminal case in Utah regarding the type ofpossession needed to effect a transfer of property isSnarr Advertising, Inc. v. Utah State Tax Comm’n.87

In that case, involving the lease of a billboard, thelessee neither owned the property where the bill-board was located nor had the right to access thebillboard. Therefore, the Utah Supreme Court con-cluded that the lease was not taxable because ‘‘theLegislature meant to tax those pieces of personalproperty the possession or use of which was givenover to the lessee.’’88 Indeed, the department fol-lowed Snarr Advertising in ruling that a lease ofproperty would not be subject to sales tax when thelessee neither owned the property where the per-sonal property was located nor had the ability toaccess or control the leased property.89 The essenceof those rulings, similar to those in the other statesdiscussed, is an ability to manipulate the underlyingproperty, to be able to personally change the prop-erty however the person wishes.

ASP services should likewise not constitute tax-able leases of tangible personal property because thecustomers cannot be said to have been grantedpossession or control over the software used by theASP. The customers neither possess the servers thatthe software is located on nor have the right orability to access or control the software code. Theycan do nothing to change the software. Those rightsremain with the ASP, and the transactions between

79Graham Packaging Co., LP v. Commonwealth, 882 A.2d1076 (Pa. Cmwlth. 2005). See also Dechert LLP v. Common-wealth, 922 A.2d 87 (Pa. Cmwlth. 2007).

80Graham Packaging, 882 A.2d 1076.81Utah Code section 59-12-103(1)(a).82Utah Code section 59-12-102(104).83See Utah Private Letter Rulings No. 08-012 (Jan. 21,

2009); Utah Private Letter Rulings No. 09-003 (Apr. 7, 2009);Utah Private Letter Rulings No. 01-027 (Oct. 31, 2001).

84Utah Private Letter Rulings No. 10-011 (Feb. 24, 2012).85Utah Code section 59-12-102(113) (emphasis added).86Utah Code section 59-12-211(12) (emphasis added).87Snarr Advertising, Inc. v. Utah State Tax Comm’n, 432

P.2d 882 (Utah S. Ct. 1967).88Id.89Utah Advisory Opinion No. 00-009 (Aug. 29, 2000).

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the ASPs and their customers are thus services, notleases of tangible personal property. The additions tothe Utah statutes do not change this fact and shouldnot have changed the department’s approach to ASPservices. The department fails to comprehend thatthe additions do nothing to change the type ofpossession needed to create taxable transfers.Though in fairness, and perhaps in anticipation ofthe type of criticism this article offers, the depart-ment has left itself some wiggle room by declaringthat the seller in the transaction in its most recentruling was ‘‘not using the proprietary software to sellservices.’’

Primary Purpose TestUtah applies a primary purpose, or true object,

test to determine whether a transaction is taxable.The test is codified in Utah Code Ann. section59-12-102(18)(b)(iv) defining bundled transactions:‘‘bundled transaction’’ does not include . . . the retailsale of tangible personal property and a service if thetangible personal property is essential to the use ofthe service and is provided exclusively in connectionwith the service and the service is the true object ofthe transaction.’’90 Furthermore, the Utah tax regu-lations provide that ‘‘computer generated output istaxable if the primary object of the sale is the sale ofthe output and not the services rendered in produc-ing the output.’’91

In BJ-Titan Services v. Utah State Tax Comm’n,92

the Utah Supreme Court, in considering the tax-ability of a transaction, found it necessary ‘‘to deter-mine if the essence of the transaction is one forservices or for tangible personal property.’’ The courtcontinued:

The analysis typically requires a determina-tion either that the services provided aremerely incidental to an essentially personalproperty transaction or that the property pro-vided is merely incidental to an essentiallyservice transaction. Since the law imposes atax only on the sale of tangible personal prop-erty, transactions that are essentially servicesare not taxable.93

The court described several factors to considerunder the test, including:

• (1) the value of the tangible property to thecustomer in relation to that of the services;

• (2) the cost of the property to the seller;• (3) the customer’s rights to possession or

ownership of the property;• (4) the ability to separately itemize charges for

the property and services;• (5) the extent to which the services increase the

value of the property or to which the propertyincreases the value of the services; and

• (6) the extent that such services are rendered insimilar transactions.94

The primary purpose and essence of the trans-actions between the ASPs and their customers arethe provision of services, not the sale of tangiblepersonal property. The customers likely put a rela-tively small, if not a zero, value on the ASP’ssoftware, but a high value on the services theyreceive. Simply put, it is unlikely that the ASPcustomers care what software is used, only that thejob they need done gets done. Furthermore, thecustomers have no rights of ownership over thesoftware, as discussed previously. Also, the value ofthe services is what drives the price of the trans-action with the ASP, not the value of the software.Finally, ASPs are all providing services, not trans-fers of tangible personal property. There is no con-cern that one oddball is trying to cheat the system byclaiming that a random service it provides with thesale of tangible property is the primary purpose ofthe transaction. Under the Utah authorities, theprimary purpose or essence of cloud computingtransactions is the provision of services, not thetransfer of tangible personal property, and as suchthese transactions are not properly taxable.

Colorado

PossessionThe city of Boulder, Colo., imposes a sales tax on

all retail sales of tangible personal property withinthe city.95 ‘‘Sale’’ means ‘‘the acquisition for anyconsideration by any person of tangible personalproperty or taxable services that are purchased,leased, sold, used, stored, distributed, or consumed’’and includes any ‘‘[t]ransfer, either conditionally orabsolutely, of title or possession or both to tangiblepersonal property.’’96 ‘‘Use’’ means ‘‘the exercise, forany length of time, by any person with the City ofany right, power, dominion, or control over tangiblepersonal property or taxable services when leased orpurchased at retail.’’97 The sales tax specificallyapplies to ‘‘each transfer of ownership, possession,and control’’ of tangible personal property within thecity.98

90Utah Code Ann. section 59-12-102(18)(b)(iv) (emphasisadded).

91Utah Admin. R. section R865-19S-92(3) (emphasisadded). ‘‘Computer-generated output’’ is microfiche, micro-film, paper, discs, tapes, molds, or other tangible personalproperty generated by a computer. Utah Admin. R. sectionR865-19S-92(1).

92BJ-Titan Services v. Utah State Tax Comm’n, 842 P.2d822 (Utah S. Ct. 1992).

93Id.

94Id.95City of Boulder Code section 3-2-2.96City of Boulder Code section 3-1-1.97Id.98City of Boulder Code section 3-2-1.

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Although the city of Boulder’s tax regulationsprovide that a ‘‘lease, lease purchase agreement,rental or the grant of a license to use software issubject to sales/use tax,’’99 neither the regulationsnor the code define ownership, possession, or controlfor the purposes of the sales tax. However, theColorado Court of Appeals has determined that, inpurchasing an ASP’s services, a company had pur-chased a taxable right to use the ASP’s software.100

The court provided no insight into what ownership,possession, or control the company had over theASP’s software, despite noting that for the sales taxto apply, ‘‘the buyer [must be granted] any right,power, dominion, or control’’ over the software.101

Though authority from the Colorado courts re-garding the definition of possession for the purposesof sales taxation is noticeably lacking, the ColoradoSupreme Court has considered the definition ofownership evidencing a person’s ‘‘right to posses-sion, use, enjoyment, and profits of [] property’’ withrespect to the taxation of possessory interests in realproperty.102 The court stated that three factors mustbe considered when determining whether a personhad a sufficient ownership interest to be taxed: (1)the interest provides a revenue-generating capa-bility to the possessory interest owner independentof the property owner; (2) the possessory interestowner has the ability to exclude others from makingthe same use of the interest; and (3) the possessoryinterest is of sufficient duration to realize a privatebenefit therefrom.103

The Colorado Department of Revenue has offeredsome guidance as to what constitutes possession forpurposes of the sales tax. In a General InformationLetter, the department considered the example of apurchaser leasing a tractor with an operator. Thedepartment said that, in determining whether thetransaction would be for a taxale lease of the tractoror for the nontaxable services of the operator, the‘‘true object’’ of the transaction would be considered,determined at least in part by ‘‘whether the lesseehas obligations normally associated with someonewho has a possessory interest in the property (forexample, obligations for risk of loss and insurance),and whether the operation of the property requiresspecial skills not possessed by the lessee.’’104

The department applied the same test in a pri-vate letter ruling regarding whether or not sales ofmedical catheters were exempt under the sales taxas sales for resale. In determining that the saleswere not sales for resale, the department said:

[T]he healthcare provider is specially trainedto perform this invasive medical procedure andthe procedure is typically performed at theprovider’s facility. The person with the specialtraining is often viewed as the user and con-sumer of the goods.

In addition to the provider’s special training,the patient does not exercise any meaningfulcontrol over the catheter. The healthcare pro-vider places the catheter into the patient,operates both the catheter and generator dur-ing treatment, and removes the catheter whenthe treatment is completed. The catheter doesnot leave with the patient after the treatment.Although it is not necessary that a purchaserhave control of property in order to constitute asale, the absence of control is indicative of aservice transaction.

Moreover, the fact that the system is sold toproviders and not patients, that providers aretrained to operate the system and patients arenot, and that the provider has exclusive controlof the catheter, at least suggests that the use ofthe catheter is inseparably linked to the serviceprovided by the healthcare provider. This closerelationship between the service performed bythe provider and use of the catheter suggeststhat the provider’s service is the dominant andcontrolling component of this transaction. Wemight have a different view of this transactionif Company also sold or leased the systemdirectly to a patient and if the patient couldoeprate the system without employing ahealthcare provider.105

As odd as the comparison may seem, consumers ofASP’s services are analogous to the patients receiv-ing medical catheters. The ASP’s employees arespecifically trained to operate the software backingthe ASP’s services; the software is run at the ASP’sfacilities (that is, servers); the consumer does notexercise any meaningful control over the softwareand does not retain the software after the service iscompleted; and consumers cannot operate the soft-ware without employing the ASP. Furthermore, con-sumers of ASPs’ services do not possess any obliga-tions for rik or loss associated with the software anddo not possess the software to the exclusion of othersor for their own benefit. Therefore, the Colorado

99City of Boulder Tax Reg. 11.100Ball Aerospace & Tech. Corp. v. City of Boulder, 2012

COA 153 (Colo. Ct. App. Sept. 13, 2012).101Id. However, it appears as though the company pur-

chasing the ASP’s services in this case did not dispute that ithad purchased the right to use the ASP’s software.

102See Bd. of County Comm’rs v. Vail Assocs., Inc., 19 P.3d1263 (Colo. 2001) (citing Mesa Verde Co. v. Bd. of CountyComm’rs, 495 P.2d 229 (Colo. 1972)).

103Id.104Colo. General Information Letter No. GIL-09-29 (June

23, 2009).

105Colo. Private Letter Ruling No. PLR-10-4 (Aug. 17,2010).

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Court of Appeals in Ball Technologies has mis-applied the relevant authorities in Colorado. Theprovision of an ASP’s services does not represent thetaxable transfer of a right to use the underlyingsoftware.

Primary Purpose TestAdditionally, Colorado applies a ‘‘true object’’ or

primary purpose test (as mentioned above) to deter-mine whether a transaction is for the transer oftaxable property or services or for the transfer ofnontaxable services.106 Indeed, the city of Bouldertax regulations specifically adopt the test: ‘‘[t]o de-termine if a transaction is a sale of tangible personalproperty or the transfer of tangible personal prop-erty incidental to the performance of a service, onemust look to the true nature of the transaction.’’107

The Colorado Supreme Court, in discussing thetrue object test, has noted that the underlyingobjective of the test is to ‘‘identify characteristics ofthe transaction at issue that make it either moreanalogous to what is reasonably and commonlyunderstood to be a sale of goods, or more analogousto what generally understood to be the purchase of aservice or intangible right.108

As discussed, the transactions between an ASP’scustomer and the ASP have the characteristics of thepurchase of a service, not tangible personal property.Thus, under the Colorado true object test, thesetransactions are not subject to sales tax.

SourcingThough this article is concerned only with the

various state tax authorities’ interpretations regard-ing the taxability of cloud computing transactionsunder their various sales tax statutes, a quick ob-servation on the sourcing of those transactions inNew York sheds light on the inherent incorrectnessof the tax authorities’ positions.

The New York tax department’sapproach to sourcing is, at best,schizophrenic or, more accurately,exposes the fundamental flaw inthe department’s position.

The New York tax department’s approach tosourcing is, at best, schizophrenic or, more accu-rately, exposes the fundamental flaw in the depart-ment’s position. On the one hand, the departmenttakes the position that a customer is ‘‘using’’ soft-

ware that actually resides on and is used only by theASP’s server — that very well may be locatedoutside New York; but on the other hand, the depart-ment takes the position that the software is beingused by the customer at the customer’s location inNew York. That is clearly internally inconsistent.

According to the department:The location of the code embodying the soft-ware is irrelevant, because the software can beused just as effectively by the customer, eventhough the customer never receives the code ona tangible medium or by download. The access-ing of [an ASP’s] software by [its customer]constitutes a transfer of possession of the soft-ware, because [the customer] gains construc-tive possession of the software and gains the‘‘right to use, or control or direct the use of ’’ thesoftware. Therefore, [the ASP] should collecttax from [its customer] where the software isbeing used.109

If, as the department contends, the customer hasconstructive possession of software residing on anASP’s server, that is where the software (taxed astangible personal property) is located. The depart-ment asserts, however, that the software (that is,the tangible personal property) is transferred at thelocation from where the customer remotely accessesthe software. The department seems to be taking theposition that correct ‘‘sourcing’’ for the transaction iswhere the benefit is received. However, that is aconcept applicable to sales of services, not sales oftangible personal property!

Where does one remotely use tangible personalproperty? Consider a U.S. military drone flying inAfghanistan. Suppose the drone is operated from themilitary base in Rome, N.Y., while the drone is inAfghanistan. Where is the drone being used? Thedepartment’s position would lead to the conclusionthat the drone is being used in New York becausethat is where the operator is located. That conclu-sion makes no sense — the drone is being used inAfghanistan. The department seems to be focusingon where the benefit of the use of the remotelycontrolled tangible personal property is enjoyed.That, however, is a test for some taxable services,but never for the sale or license of tangible personalproperty. The department’s approach to sourcingreveals the reality of the situation — an ASP pro-vides a service.

Thus, if the department continues to insist thatASPs are in the business of licensing prewrittensoftware, the department — if it is forced to useproper, consistent sourcing rules — seems to beinadvertently laying the groundwork for unsoundtax policy for New York. State taxing authorities106See Colo. General Information Letter No. GIL-09-29

(June 23, 2009).107City of Boulder Tax Reg. 40.108City of Boulder v. Leanin’ Tree, Inc., 72 P.3d 361 (Colo.

2003). 109TSB-A-10(28)S (July 2, 2010).

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must consider the actual type of possession, use, orcontrol of the ASPs’ software the customers arereceiving in order to determine the taxability of thetransactions. Merely claiming that the customersare granted sufficient possession, use, or control, orrelying on contract language between the ASP andthe customer that may refer to a license will notsuffice. If the use of software to deliver a service isdeemed a taxable sale of tangible personal property,savvy taxpayers can simply defeat the tax by movingtheir servers outside New York.

If the department were to abandon its schizo-phrenic approach to sourcing, its ASP position wouldhave little effect. There is no question that abso-lutely no software is delivered to ASP customers inthe normal ASP scenario (the department concedesthat point) and so, if an ASP’s servers are locatedoutside New York, none of the software would be‘‘used’’ by the customer in New York. Thus, no salestax would be due from ASPs whose servers areoutside New York. Only by disregarding that realityand conflating tangible personal property sourcingwith services sourcing does the department actuallyraise a meaningful amount of revenue from its newposition.

In other words, if it is appropriate to treat acustomer’s use of an ASP’s software as a license touse, then the department, if it wants to be intellec-tually consistent, has to concede that the software isbeing used on the ASP’s server and the receipts fromthe sale should be sourced to wherever the server islocated (even if that is outside New York).

ConclusionThis article has examined the troubling approach

of a handful of states toward the classification ofcloud computing for sales and use tax purposes. Thetax authorities of those states, through administra-tive rulings, and one state appellate court havedisregarded the relevant legal authorities in theirstates and are inappropriately subjecting cloud com-puting transactions to their sales taxes under theguise that the transactions are the transfers oftaxable tangible personal property rather than theprovision of nontaxable services.

This article passes no judgment on whether cloudcomputing transactions should be taxable, and thatis the point of the article. Those types of judgmentsare for state legislatures to make, not tax adminis-trators or us.110 When state legislatures have notexpressed an intent to tax ASP services, state taxauthorities should not ignore the facts of the trans-actions in order to fit them into the definition ofother taxable transactions merely because the taxauthorities believe that such transactions should betaxable. In so doing, those tax authorities haveoverstepped their bounds. Taxpayers affected bythose rulings should challenge them as invalid ex-ercises of administrative power, and state courtsshould strike the rulings down. ✰

110Arthur R. Rosen and Mark W. Eidman, ‘‘Non-LegislatedTax Legislation,’’ State Tax Notes, Jan. 24, 2011, p. 301, Doc2010-27224, or 2011 STT 15-3.

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