United States

Virginia department addresses taxation of cloud software provider

Excluded from sales and use tax, department caveats CNI exemption


On June 24, 2016, the Virginia Department of Taxation issued Ruling 16-135, addressing the application of the sales and use tax and corporate income tax to the purchase and sale of computer software and cloud-computing services.


The taxpayer requesting the ruling is located and headquartered outside of the Commonwealth of Virginia. The taxpayer entered into agreements with a software developer which allows the taxpayer to license software from the developer, customize the software and then sell the customized software to taxpayer’s customers.

All of the transactions between the taxpayer and the developer, and between the taxpayer and their customers, are performed through cloud-computing services with no exchange of tangible personal property, i.e., no tangible mediums are used to transfer or sell the software. Additionally, servers from where the software and data are hosted are owned and operated by the developer. The taxpayer remotely accesses the software on the servers, one of which is located in Virginia.

Application of sales and use tax

The department concluded that the taxpayer’s resale of the software to its customers would not be subject to sales and use tax based on the Commonwealth’s long-standing policy that excludes electronically downloaded software from sales and use tax. Additionally, the department noted that any cloud-computing services provided by the taxpayer would be treated in the same manner as the electronic download and transfer of software, and therefore would also not be subject to the tax.

Application of corporation income tax

The department begins the analysis stating that foreign corporations having positive Virginia apportionment factors will establish income from Virginia sources, and thus subject to the Virginia income tax. However, unlike most states, Virginia applies the protections of P.L. 86-272 to the sale of intangibles, which the department determined includes taxpayers’ software and cloud-based services. Further, in applying P.L. 86-272, Virginia looks to whether the taxpayer performed unprotected activities in Virginia that create more than a de minimis connection, considering the nature, continuity, frequency and regularity of the unprotected activities in Virginia compared with those same activities occurring outside of Virginia.

The department concluded that merely purchasing cloud-computing services from the developer and then reselling it to its customers would not be attributable to the taxpayer for purposes of nexus if the developer is considered an independent contractor, opposed to a representative. A representative would be considered to be providing services on behalf of the taxpayer to the taxpayer’s customers. Based on the facts provided by the taxpayer, the department was unable to determine whether the developer was an independent contractor or representative, but stated that if the taxpayer was merely purchasing cloud-computer services from the developer than those services would not be attributable to the taxpayer for purposes of nexus because those activities would be protected under Virginia’s application of P.L. 86-272 to intangibles.

The department further analyzed each apportionment factor, concluding that factual scenarios could exist that result in positive apportionment for the taxpayer.

Property factor

Without affirmatively concluding on whether the taxpayer had a positive property factor, the department noted that if the taxpayer rented the single server in Virginia as part of the subscription purchases, a positive property factor would result. The taxpayer’s lack of access or control of the servers would not exclude that finding.

Payroll factor

The department concluded that it was unlikely that the taxpayer had a positive payroll factor because the taxpayer stated it maintained no employees in Virginia. However, the department did caveat that determination by noting the taxpayer could have a withholding requirement under a scenario where a nonresident employee performs any activity in the Virginia for wages, if not also establishing nexus for income tax purposes by causing a positive payroll factor.

Sales factor

Virginia is a cost of performance state for sales factor purposes, and deems sales, other than tangible personal property, to be in Virginia if the income-producing activity is performed in Virginia, or the income-producing activity is performed both in and outside Virginia and a greater proportion of the income producing activity is performed in Virginia than in any other state, based on costs of performance.

It was clear to the department that the taxpayer generated some income-producing activity in Virginia because of the software and cloud-computing services provided to Virginia customers, but the department also noted that most of the taxpayer’s business activities including marketing and general business administration occurred outside of Virginia. The department noted that, based on Virginia regulations, case law and other rulings, the greater portion of income producing activities for some fees could occur in Virginia with regards to a particular subscription connected only to servers based in Virginia, thus could result in a positive sales factor for the taxpayer.


The department had no difficulty finding that the taxpayer’s activities in Virginia would not be subject to sales and use tax following well-established tax policy in the state. However, the department took great care in analyzing whether any of the taxpayer’s apportionment factors were positive—concluding affirmatively on none of them—and caveating potential scenarios that would result in taxable income to the taxpayer. Out-of-state businesses providing services in Virginia should take note of the extensive analysis required to determine whether a positive apportionment factor could result from those activities, and, whether those activities could qualify for protection under the application of P.L. 86-272 as applied to intangibles for Virginia purposes.


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