States starting to tax the cloud

Cloud computing is worth a lot, and states want a piece of the action

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Cloud computing, particularly public software as a service (SaaS), may have an unlooked-for advantage over "shrink-wrapped" software--freedom from the tax man. But that advantage may not last forever.

Many states in the US have particular rules about sales taxes that mostly revolve around the pre-Internet rule of thumb that runs along the lines of "if the business does not have a presence in the state, then they don't need to pay sales taxes."

This is one of the reasons that (until recently) Amazon could get away with selling goods so cheaply: they didn't have to pay sales tax because for the most part they weren't a physical presence most states. As various state lawmakers clued into the fact that there was indeed a lot of untaxed commerce being done within their borders, they began to impose sales tax on Amazon's sales.

Initially Amazon fought the legislation as it came up in individual states, closing down affiliate programs and threatening to move distributions centers out of state just to avoid having to pay taxes. But as the writing on the wall became clearer, Amazon is now getting ready for the idea of paying sales taxes, and may soon adjust its sales model to introduce hyper-local same-day delivery of goods.

But what about services that don't involve physical goods at all? How does cloud computing fit into the sales tax model? Or can it?

This is a question that Massachusetts recently tried to solve, but the Commonwealth's lawmakers may have left us all with more questions than answers. In a letter ruling that worked to interpret the taxability of SaaS and other cloud services, the Massachusetts Department of Revenue rules that sale of SaaS to Massachusetts end-users that doesn't require software to be delivered to the end-user (such as using a public cloud offering like Office 365 or Salesforce.com) isn't taxable.

But if there is any kind of software that has to be received by the user in order to use the service, then sales tax can apply. It can be downloaded or physically installed, but the end result is still the same: the taxman will cometh for these SaaS vendors.

This would seem to give "pure" public cloud vendors a significant advantage over any SaaS vendor that required a software download to use the service. But that advantage isn't that great: the sales tax can still only be applied to SaaS vendors that have a significant physical presence in Massachusetts. Plus, there is enough ambiguity in the ruling to give the Department of Revenue quite a bit of leeway to stick a tax on a vendor if they feel that sales tax will apply.

Other states have different approaches to the issue of SaaS taxation. New York, for instance, only charges tax on cloud services that require a download of software, too. But they can get taxes from other cloud service vendors, too.

According to accountant firm BlumShapiro, "[t]he taxation of remotely-housed software is not specifically taxed by statute, but rather New York finds an indirect way to tax it via its regulations. New York Regulation 20 NYCRR §526.7(e)(4) provides that the actual or 'constructive possession' of property, as well as 'the right to use, or control, or direct the use of tangible personal property,' constitutes a transfer of possession that is subject to sales and use taxation. Accordingly, the vast majority of the dozen of advisory opinions issued by the New York Department of Taxation and Finance have held that accessing prewritten software that is housed remotely constitutes a transfer of software, because the New York purchaser gains 'constructive possession' of the software, and gains the 'right to use, or control or direct the use' of the software within New York."

In other words, if you use SaaS in New York, that service will probably have sales tax worked in.

As more states figure out a way to tax SaaS, it will be interesting to see how SaaS vendors react to the changes. If physical presence remains a lynchpin in these new sales tax laws and rulings, we could see some physical relocation of companies' data centers and sales offices. Depending on what your state does, it could become harder than ever to meet a face behind the cloud.

Read more of Brian Proffitt's Open for Discussion blog and follow the latest IT news at ITworld. Drop Brian a line or follow Brian on Twitter at @TheTechScribe. For the latest IT news, analysis and how-tos, follow ITworld on Twitter and Facebook.

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