The sales and use tax forecast: The cloud and a chance of confusion
Views on the sales tax treatment of cloud solutions and digital goods
INSIGHT ARTICLE |
This article was orginally published on September 30, 2014
A few years ago, you'd probably never heard of the cloud. Now you can't escape it. Increasingly, everything from consumer services like Netflix to core business software solutions are sold, accessed and used through the cloud. Products and services that are increasingly vital to both our business and personal lives are now often bought and used without any physical product changing hands, sometimes even without any personal interaction between the buyer and seller. With both business and personal consumers now able to make purchases from anywhere at any time from their laptops, tablets and smartphones, the basics of even relatively simple transactions grow, well, cloudy. Flights have WiFi now. So suppose you purchase something that you will use exclusively through the cloud using your smartphone during a cross-country flight, and you begin to use it immediately. Could you even say for sure what state you were in (or over) when you made the purchase or when you used it for the first time?
All of this raises difficult issues from a sales and use tax perspective.
What's taxable where?
An individual consumer buying an app or some music to enjoy on a flight is one thing. But far bigger and more problematic transactions are happening in the cloud. Picture a deal where a national company buys 100 seat licenses for a software package. No discs or other physical products are delivered. Nothing is loaded on the customer's servers. The software will be accessed in the cloud, and any documents created will be stored in the cloud. The 100 users are scattered all over the country in dozens of different states. How should that transaction be treated for sales tax purposes–should the seller collect and remit sales taxes?
To answer that question, you have to answer more questions. Is the seller selling property, a service or both? If part of the deal is determined to be property, is that property tangible or intangible? Are sales or use taxes owed? If so, does the seller have nexus requiring it to collect sales taxes on the transaction, or should the buyer pay use taxes? In either case, which state has claim to those taxes? The state in which the deal was concluded? The state in which the first user is located?
Unfortunately, right now there are no easy answers to any of these questions.
So what are companies with cloud-based products and services to do?
Four steps to clear up the cloud
First, understand the laws in the states where you are doing business, because different states have taken different positions. In a 2011 bulletin, Indiana issued guidance that it considered most cloud computing arrangements to be taxable because customers gain "constructive possession and the right to use, control or direct the use of the software." Yet a 2012 opinion letter issued by Kansas found such transactions not taxable because "software that is installed on a remote server isn't delivered to consumers or installed on their computers."1
Second, think carefully about your offering and how it should be described in any contracts or other communications with your customers. Software has proven to be a difficult area for state tax authorities because of its intangible nature, but state laws, guidance from state taxing authorities, and a substantial number of court cases have clarified the sales and use tax treatment of software in many jurisdictions. You may, however, have solid reasons to define your offering as a nontaxable service. If so, be sure it is defined as such, and only as such, in your contracts and other communications. If you define your offering as a service for sales and use tax purposes yet describe it as a product when communicating with customers, you are providing taxing authorities with ammunition to challenge your position.
Third, build audit-ready files. Because so many of the issues around how cloud-based transactions will be taxed remain uncertain, you should be ready to respond to questions and challenges from tax authorities. Identify what you are selling, know where you are selling it, and make your best, most informed judgment regarding how and where it should be taxed. Then keep consistent and detailed records supporting all of your conclusions.
Finally, be proactive. Many companies find the best solution is to define a sensible sales and use tax position and negotiate the position with the appropriate taxing authorities, thus removing uncertainty around sales and use taxes and taking the risk of future tax disputes out of the business equation.
Due to the cloud, the sales and use tax forecast is overcast. Do what you can to clear up your situation.