United States

Arizona department modifies taxability of cloud storage services

Determines receipts from storage are taxable under rental classification


An ever-increasing number of state legislatures and tax authorities are providing taxpayer guidance on the treatment of various digital goods and services. As the prevalence of cloud transactions grows, various tax policies and informal guidance have slowly become more formal statutes and regulations. Taxpayers benefit as states begin to develop and formulate concrete positions, creating more certainty regarding the sales and use taxation of the cloud. As state positions evolve, however, taxpayers must remain cognizant of pivotal developments in approaches to cloud taxation and be equipped to respond quickly when necessary. For example, the Arizona Department of Revenue recently modified a revenue ruling reversing their position that cloud storage was exempt from the transaction privilege tax.

The ruling in question, Private Tax Payer Ruling LR13-006, modified on March 23, 2016, determined cloud storage services subject to the transaction privilege tax under the personal property rental classification. The department originally ruled, on June 25, 2013, that cloud storage services did not meet the criteria for the renting of tangible personal property because there was no “control or possession” involved in storing the software.

The taxpayer that requested LR13-006 provided cloud storage services including the storage, retrieval and maintenance of content, data applications and software on its servers. The taxpayer could not use, sell or license any of the stored customer data, but rather provided the infrastructure for customers to store their own digital content.

On revisiting the ruling, the department’s analysis focused on whether the software involved in storing the customer’s data was tangible personal property and, if so, whether customers gain sufficient possession and control over that property to constitute the rental of tangible personal property under the transaction privilege tax.

The department determined the cloud storage software to be tangible personal property by citing to existing Arizona case law applying the broad definition of tangible personal property to physical goods and the electronic delivery of software. The data uploaded to taxpayer’s servers was encrypted and decrypted using complex algorithms forming ‘virtual containers’ that only the customer could access. The department concluded those virtual containers were tangible personal property to the extent they traveled to and from data storage locations and in doing so, secured the customer’s data through the use of encryption.

The department then analyzed whether the customers had sufficient possession and control over the data by citing two cases addressing whether an activity qualifies as a personal property rental. In State Tax Commission v. Peck, the Arizona Supreme Court analyzed whether the business of coin-operated self-service laundry and car washes constituted rental of tangible personal property. The court found those activities were rentals because the customers had exclusive use of the equipment for a fixed period of time, i.e., possession of the equipment. In Energy Squared v. Arizona Department of Revenue, the court rejected the rental classification for the use of tanning salons because the service provider remained in control of the machines, determining how and when they were operated, thus the customer did not have requisite possession.

Based on those decisions, the department found that the customers had full control over their accounts through a username and password, and that the customer decided when and what data was uploaded or downloaded, therefore controlling the encryption and decryption of the files. Moreover, customers had optional software development kits that allowed for more efficient use of the data storage. Finally, the department determined that the control over the storage was reinforced because part of the customer’s monthly fee was based on activity while using the storage. Therefore, the customers maintained sufficient control over the cloud storage data to constitute personal property rental.

The ruling serves as an example of how a state’s policy or position may change over time and a reminder to taxpayers to keep a close watch on cloud-related developments, especially in those jurisdictions that limit guidance to policy or rulings. This ruling is limited to the facts presented by the requesting taxpayer and may not be representative of the activities of other cloud storage providers. Taxpayers providing cloud-storage services in Arizona should review whether the modified ruling creates an obligation to collect transaction privilege tax on their sales of cloud storage services. 


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