state taxes and cloud computing: storms ahead! - baker tilly
TRANSCRIPT
© 2012 Baker Tilly Virchow Krause, LLP
Baker Tilly refers to Baker Tilly Virchow Krause, LLP,
an independently owned and managed member of Baker Tilly International.
State taxes and cloud computing:Storms ahead!
August 22, 2012
Presenters
Larry Ewing
Director
State and Local
Tax Services Practice
Matt Haller
Senior Principal
Consulting
Moderator/Panelist Panelist Panelist
Jon Skavlem
Director
State and Local
Tax Services Practice
2
Agenda
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> Cloud computing – Background
> Sales and use tax considerations
> Sales and use tax: Specific states
> Income, franchise, and business entity tax
considerations
> The cloud computing tax ―to do‖ list
Cloud computing – Background
Background
> Definition of cloud computing
> Five essential characteristics
> Types of cloud computing
– SaaS
– PaaS
– IaaS
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Background
> What the heck is ―the cloud‖? – a question asked by
Larry Ellison of Oracle
> Worldwide cloud computing sales are expected to
reach $150 billion by 2014
> The federal government has announced a plan to
allocate $20 billion of its $80 billion annual IT budget
to cloud computing
> IBM white paper on cloud computing investments
shows average annual ROI ranging from 75.78% for a
small manufacturer to 156.58% for a large bank
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Drivers˃ IT is too complex and costly, causing distraction from
core business focus
˃ IT is not agile enough/long development cycles, unable
to react to business needs with speed
Benefits˃ Scalable solution that supports rapid business growth
˃ Increased speed and agility to serve customers or gain
operational efficiencies
˃ Enable business to focus on core competencies by
outsourcing noncore functions
˃ Provide ―Enterprise Class‖ infrastructure to small-
medium companies
˃ Pay-as-you-go model/ease of licensing
˃ Cost transparency to the end-user/business
:
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Large economies of
scale
Access to better
infrastructure
What are the benefits?
˃ ―Cloud computing is a model for enabling ubiquitous,
convenient, on-demand network access to a shared pool of
configurable computing resources (e.g., networks, servers,
storage, applications, and services) that can be rapidly
provisioned and released with minimal management effort or
service provider interaction‖
˃ Three ―service models‖: software, platform, and infrastructure
˃ Four ―deployment models‖—private, community, public, and
hybrid—categorize ways to deliver cloud services
˃ Five essential characteristics of cloud computing: on-demand
self-service, broad network access, resource pooling, rapid
elasticity or expansion, and measured service
Source: The NIST Definition of Cloud Computing
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What is cloud computing?
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What is cloud computing?
Three service models
˃ Multi-tenant architecture for SaaS is important for economies of scale
Source: The NIST Definition of Cloud Computing
10
What is cloud computing?
Four deployment models
1. Private: Hosted
2. Community: SaaS provider
3. Public: Amazon, Rackspace
4. Hybrid: Combinations of 1,2,3
Five key elements
1. On-demand self-service: Get it when you need it
2. Measured service: Pay for what you use
3. Rapid elasticity: Increase and decrease capacity quickly
4. Broad network access: Access it from any Internet connection
5. Resource pooling: Share fixed costs, which lowers individual costs
Source: The NIST Definition of Cloud Computing
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What is cloud computing?
Key elements
Source: The NIST Definition of Cloud Computing
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What is cloud computing?
Models and characteristics are not
mutually exclusive
Example:A SaaS ERP vendor, with its own cloud infrastructure serving its community of subscribers, providing a development platform and integration tools. Enabling broad access and rapid scale for its customers.
IT strategy implications:
> Business objectives
– Serve customers better
– Operate more efficiently
> What do you put in the cloud?
– Core applications
– Development and prototyping
– Sensitive information
> Risk management
– Business continuity
– Information security
Tax implications?
Often overlooked
Sales and use tax considerations
The more things change,
the more they stay the same
In 1976, the first state supreme court case
considered the taxability of computer software for
sales tax purposes in Tennessee. The court held
that furnishing computer software did not constitute
a sale of tangible personal property. Disregarding
the form of the transaction, it stated ―…no product
is created. What is created and sold is information.‖
Commerce Union Bank, 538 SW2d 405, 406 (Tenn. 1976)
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“Host” of issues
> The sales and use tax treatment of ―cloud
computing‖ poses significant problems for tax
authorities and taxpayers
– Nexus standards: How much presence is enough?
– Defining the tax base: tangible person property (TPP), ―digital product,‖ service, or intangible?
– Taxable situs of the transaction
– Local taxes
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Nexus
> States aggressively asserting nexus to fill a
$55 billion budget gap for FY 2012
> Physical presence test of ―Quill‖ decision in
question: affiliate, click-through, agency nexus laws
> If SaaS is prewritten/canned software, is it tangible
personal property that creates a taxable presence?
> PaaS – Amazon example of leasing a server;
arguably, fails Quill test
16
Defining tax base
> Many states have not ruled on the taxability of ―cloud
computing‖ applications
> They do not neatly fit in Streamlined Sales and Use
Tax Agreement (SSUTA) framework as prewritten
software or a ―digital product‖
> Array of different fees: software license, app usage,
server rental, data handling, processing/analysis,
e-mail service, CBT training
> Sales/use tax treatment of each ―cloud computing‖
application varies within and among states
17
Defining tax base
> Is SaaS a software license or a service?
> Is IaaS a lease of TPP, e.g., server? If so, it would
appear that the lessee does not enjoy the normal
contractual rights to use the hardware
> In states where services are not taxed, there is a
strong argument that cloud computing applications
are not part of the sales and use tax base
> Bundled software, hardware, and services: Apply
SSUTA bundled transaction rules?
18
Sourcing – A nightmare?
> Sourcing will be influenced by classification of a
cloud computing transaction. Factors:
– Location of the server: What if multiple servers are involved?
– Seller location: Where application is developed and maintained
– Customer billing address
– User location: Allocation of contracts/licenses for users in multiple locations?
19
Sales and use tax: Specific states
Colorado: Ruling on
Web-based IT solution
> Letter Ruling PLR-11-007 (Dec. 20, 2011): Fees related
to Web-based file transfer and tracking solution are not
subject to sales or use tax
> Similar to Google email services
> ―Essence of the transaction‖: Not the license of software
or use of hardware but obtaining a nontaxable service
> Rental of hardware: Customer did not have sufficient
degree of control, e.g., seller retained custody of servers
21
Iowa – Hosted software
and training
> IDOR Policy Letter 12300002 (Jan. 11, 2012): Hosted
software and training fees are not subject to Iowa
sales or use tax
> Cited the National Institute for Standards and
Technology’s definition of ―cloud computing‖
> Noted that no software is downloaded or delivered to
customers; title/possession to not transferred
> Fees meet definition of ―cloud computing‖ services
> No statutory Iowa authority to tax such services
22
New York – SaaS
> ―Constructive possession‖ of software
– Use of out-of-state ASP software is taxable even absent delivery of the software to the user. Software is deemed to be ―constructively received‖ in New York.
– On Demand ASP Software (TSB-A-08(62)S): Involved a software product that allowed a customer to upload an image onto the petitioner’s servers and manipulate the image to show various colors and views (for example, a clothing item – front, back). Software resides on servers located outside New York. Held: taxable license to use software.
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New York – SaaS
> ―Constructive possession‖ of software
– Use of out-of-state payroll processing service is taxable absent delivery of software because the software is deemed to be ―constructively received‖ in New York
– National Football League ((TSB-A-09(37)S), Aug. 25, 2009): Related to a software product allowing a customer to upload payroll data to a server in Michigan. Application aids in processing payroll data.
– Held: ―the location of the code is irrelevant because the software can be used‖ even without a download. Service component nontaxable.
24
New York –
Bundled software/services
> ―Primary objective‖: service or software?
– Online educational services: Tower Innovative Learning Solutions (TSB-A-06(5)S (Feb. 2, 2006)). Taxpayer provided software to customers for professional development skills. Upon completion of the Internet course, it awarded a certificate of completion from a learning subsidiary of Cornell University. Academic support (hosting online discussions) offered as a service.
– Held nontaxable: Rationale was that the students’ primary objective is to attend a course of study. Students were not purchasing software.
25
Texas – Hosted software
creates nexus
> Texas Comptroller of Public Accounts, Doc. 36237,
July 21, 1998: Software licensed in Texas held to be
―tangible personal property‖ owned by the licensor
> Minnesota software provider had no direct physical
presence in Texas
> Software hosted on a server in the state
> Nexus arose from licensor’s in-state presence of
software (―tangible personal property‖) even where
license fees are generated by activities primarily
outside of Texas
26
Washington –
Remote access software
> 2009 ESHB: clarified the application of Washington
sales and use tax to digital products
> Remote Access Software (RAS) held to be taxable
> RAS defined as ―prewritten software‖ provided
remotely; buyer pays for the right to access and
use the software which resides on the seller’s or a
third-party’s server (example: ASP software vendor)
> SSUTA sourcing rules apply
27
Wisconsin – ASP software
> Letter Ruling W1025002 (WTB No. 168): Charges
related to ASP software are not subject to Wisconsin
sales or use tax
> Fees are not for the license of software but rather a
nontaxable service
> Degree of control by buyer insufficient
> Nontaxable charges include amounts paid for:
application service, support, set-up, training, data
migration, and forms programming
> Tax applies to software purchased by the ASP service
provider if placed on a server in Wisconsin
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Other states
> Massachusetts: Cloud computing charges for the use
of a provider’s software by Massachusetts customers
are taxable as a sale of prewritten software. Fees for
data transfer (but not storage) are taxable as a
telecommunication service. MA Letter Ruling 12-8
(July 16, 2012)
> Michigan: ASP and SaaS charges to access
prewritten software are equivalent to licensing such
software and are taxable. Michigan Dept. of Treasury
letter ruling issued April 20, 2009.
29
Other states
> Missouri: A sale of software hosted on
out-of-state servers is not subject to sales or use tax
when accessed from an in-state location. Missouri Dept.
of Rev., Letter Ruling No. LR5753 (July 16, 2009)
> Nebraska: ASP charges for services that allow
customer remote access to software are not taxable if
ASP retains title to software and does not grant a
license with ownership rights to customer. Nebraska
Information Guide No. 6-511-2011, July 2011
30
Other states
> Pennsylvania: Cloud computing software is ―tangible
personal property.‖ Access fees to Pennsylvania
customers are taxable because they exercise a right to
use the software as well as control. Pennsylvania
Ruling SUT -12-001 (May 31, 2012)
> Utah: License fees for remotely accessed prewritten
software are taxable if it is used by an in-state
customer. If the software is used both within and
outside of Utah, seller must allocate the fees among
the locations. Utah Informational Publication 64
(effective July 1, 2012)
31
Federal action on cloud
computing taxes?
> Hodge-podge of state tax laws affecting cloud
computing and related transactions has stirred action
at the federal level.
> Digital Goods and Services Fairness Act (H.R. 1860),
introduced by Rep. Smith. Prohibits multiple and
discriminatory taxes on digital goods and services
delivered or access electronically (including ASP,
SaaS). Must be sourced to state of customer location.
> Surprise! SSUTA opposes the legislation.
32
Sales and use tax conclusions
> States are relying on a variety of legal approaches to
analyze cloud computing
> Notably, SSUTA has not come out with an opinion of
SaaS or related cloud computing products/services
> Creates sales tax exposure for sellers and use tax
exposure for purchasers
> Nexus is a factor for sellers (must exist for state to
require registration and collection of tax)
> Consider materiality of cloud transaction in making use
tax determinations
33
Income, franchise, and business entity tax considerations
View of income/franchise taxes
from the cloud
> Most of the attention on ―cloud computing‖ has been
devoted to sales and use taxes
> While there are some tentative connections between
the two bodies of tax law, sales and use tax
classifications are not dispositive
> In general, federal tax law treats software as an
intangible asset regardless of whether it is custom or
canned
> Again, result is confusion and uncertainty
35
Clouding the issues
> Nexus – current theories of economic nexus suggest
selling cloud computing services can create a filing
obligation without physical presence
> If SaaS and ASP transaction involves canned software,
does P.L. 86-272 apply?
> For non-income taxes like commercial activity tax (CAT)
and business and occupation tax (B&O), state could
assert nexus under bright-line concepts and on other
grounds
36
Clouding the issues
> Apportionment: How do state rules apply for cloud
computing transactions?
> IaaS: Allows use of a service provider’s hardware,
e.g., servers. Include payments as rent in property
factor?
> SaaS/ASP: For prewritten software, capitalize
software in property factor as rent?
Most states are silent with respect to treatment of
software in the property factor. Not TPP?
37
Clouding the issues
> Apportionment: Sales factor is primary factor to
consider in analyzing the treatment of cloud
computing transactions and businesses
> Classifications:
– Service: SaaS, EaaS
– Tangible personal property: prewritten software, IaaS?
– Intangible: software license payments?
38
Clouding the issues
> States that classify cloud computing as a service will
either apply the Cost of Performance (COP) or
Market Approach (benefits received) to assign a
situs to receipts in the sales factor
> States moving to market-based allocation of revenue
to determine sales factor (see list on slide 45 of
states now employing some version)
> COP: Traditional approach
39
COP: The basics
> Receipts are sourced to a state:
– if the income-producing activity is performed there (or)
– if the activity occurs in more than one state, to the state where the greatest proportion of the costs of performing the activity are incurred
> In practice, COP method has two variants:
– Preponderance (all or nothing)
– Pro rata
40
States following COP
Alaska Massachusetts North Carolina
Arizona* Missouri North Dakota
California Mississippi Oregon
District of Columbia Montana Pennsylvania
Florida Nebraska** Rhode Island
Hawaii New Hampshire Tennessee
Idaho New Jersey Utah
Indiana New Mexico Vermont
Kansas New York West Virginia
Kentucky
* Some taxpayers can elect market approach after 2013
** Through 2013
41
COP: Perceived problems
> Generally, COP fails to capture income or valued
added from services performed outside the state that
benefit in-state customers
> Difficult to apply in practice and clear guidelines are
lacking in most states
> Does not lend itself to sourcing receipts from license
fees and other charges from cloud computing
> Lack of uniformity can lead to ―nowhere income‖ or
over-apportionment
> Sales and use tax rules for services and digital goods
diverging from COP to market sourcing
42
Market-based sourcing:
Perceived advantages
> Market approach better adapted to capture income or
valued added from services performed outside the
state and from intangibles
> Dovetails well with ―economic nexus‖ standards
> Attempted reliance on ―black and white‖ allocation rules
> Thought to reduce ―nowhere income‖
43
Market sourcing in practice
> Considerable variation among states, from general
standards to detailed rules
> Special software allocation rules in some states, e.g.,
Michigan
Do these rules cover SaaS, PaaS, etc.?
> General approach – Oklahoma: Receipts from
services included in the numerator of the sales factor if
the receipts are derived from customers within the
state or if the receipts are otherwise attributable to
Oklahoma’s marketplace
44
States that recently adopted
market-based sourcing
> Alabama
> California
> Georgia
> Illinois
> Iowa
> Maine
> Maryland
> Michigan
> Minnesota
> Nebraska*
> New York
> Ohio**
> Oklahoma
> Utah
> Washington**
> Wisconsin
45
* After 2013
** Does not have corporate income tax
Income/franchise tax conclusions
> Absent specific rules for software, receipts from cloud transactions can likely be sourced under state-specific COP or market sourcing rules
> For prewritten/canned software, consider treating as TPP; customer destination determines situs
> TPP argument for IaaS and PaaS?
> Consider impact of ―throwback‖
46
Cloud computing tax ―to do‖ list
> Financial & Tax– Move from CAPEX to OPEX affects operational considerations
for the CFO – Source of service changes impact tax considerations– Costs and ROI should look out far enough to factor upgrade
impact
> Structuring Agreements– The subscribing entity bears the state tax burden– Pay attention to future module costs and increases to
subscriptions– Significant software development may bring R&E credit
opportunities– Some implementation costs can be capitalized
> International– Can bring additional regulatory requirements– There are solutions
48
What does it mean to my business?
> Research nature of specific cloud computing transactions. Talk with IT personnel.
> Examine the software/service contract carefully: license, rental or service agreement?
> Does state have cloud computing or software rules that are on point?
> Nexus determinations are critical: sales, income/franchise, and non-income business entity taxes, e.g., Ohio CAT, Washington B&O tax
Cloud computing:
Tax “to do” list
49
Cloud computing:
Tax “to do” list
> Sourcing: Can transaction be sitused in a nontaxable jurisdiction, e.g., Oregon?
> Unbundle mixed transactions by separately invoicing taxable and nontaxable portions
> Determine exposure and materiality aspects (ASC 740 and ASC 450) of cloud computing transactions
> Federal tax considerations: Capitalize or expense ―cloud computing‖ charges?
50
Conclusion
Cloud computing
provides a
modern platform for
delivering cost
effective enterprise
technology
51
What’s at stake:> Cloud computing can create new opportunities for your business
> Tax impacts and structuring agreements
Questions?Questions?
Contact information
Larry Ewing
Director
State and Local Tax
312 729 8019
Matt Haller
Senior Principal
Consulting
612 876 4754
Moderator/Panelist Panelist Panelist
Jon Skavlem
Director
State and Local Tax
414 777 5333
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