Treasury issues proposed guidance on cloud computing

Aug 16, 2019
Aug 16, 2019
0 min. read

On Aug. 9, Treasury released long-awaited proposed guidance on the classification of cloud computing and the sourcing of digital transactions, specifically in the international tax context. If and when finalized, the rules of Reg. section 1.861-19 will classify a cloud computing transaction as either the provision of a service or a lease of property. Further, proposed changes to Reg. section 1.861-18 would expand the applicability of that regulation to a broader scope of “digital content” and would source transactions transferring copyrighted articles to the location of download or installation.


The proposed regulations define a cloud transaction as a transaction through which a person obtains non-de minimis on-demand network access to computer hardware, digital content or other similar resources. While the proposed regulations direct taxpayers to consider all relevant factors when determining whether a cloud transaction is a lease of property or the provision of services, they do provide further guidance by laying out nine specific factors for taxpayers to consider.

Notably, the classification options under the proposed regulations do not include the “sale” classification available to transactions involving computer programs under current Reg. section 1.861-18. Cloud computing generally falls outside the transactions contemplated by that regulation (transfers of computer programs or the provision of development services or know-how related thereto). As stated in the preamble, Treasury’s view is that “a cloud transaction involves access to property or use of property, instead of the sale, exchange, or license of property, and therefore typically would be classified as either a lease of property or a provision of services.”

Altering whether a transaction is a service or a lease would affect the potential sourcing of the transaction for U.S. tax purposes. If a transaction were determined to be a service, then the country in which the service is performed would have taxing rights on the income generated from the cloud transaction. As there is no human being performing the services, where the services are being performed will need to be determined. In the event that the transaction is a lease, companies could be subject to a withholding tax of up to 30%. Income tax treaties, if applicable, could reduce or eliminate any withholding.

Any accounting method changes made necessary because of these regulations are subject to the typical rules and procedures that govern voluntary accounting method changes under section 446.


The proposed regulations also address sourcing considerations for transactions involving transfers of copyrighted articles. Specifically, transactions involving the sale and transfer of copyrighted materials through an electronic medium are sourced at the location of download or installation. If such location is unknown, the sale is deemed to occur at the location of the customer based on the taxpayer’s recorded sales data.


Taxpayers may not yet rely on these proposed regulations. They can, however, glean valuable evidence as to the IRS’s changing perception of international digital transactions and, perhaps, even wholly domestic ones. These proposed regulations suggest a marked divergence from, and modernization of, traditional analyses that contemplate computer programming as an inventoriable good sold in tangible form.

Taxpayers offering digital services, or participating in other cloud computing based transactions, should speak with their tax advisors to understand the potential impact the proposed regulations may have on their business model should the proposed regulations be finalized.

Subscribe to tax updates and insights

Choose from timely legislation and compliance alerts to monthly perspectives on the tax topics important to you.