Extending Online Tax to the Cloud

How do cloud-based services fit into the online sales tax debate?

How do cloud-based services fit into the online sales tax debate?

We’ve written about online sales tax multiple times before, but it’s a complicated topic without a simple solution. And that’s why we keep coming back to it! In the past we’ve discussed how states are attempting to extend the definition of nexus to broaden their online tax reach, or potential legislation coming through Congress. But one area we haven’t really taken a look at is the question of cloud-based services. How do they fit into the online sales tax debate?

About Cloud-Based Services

More and more, consumers are opting for digital versions of software, music, DVDs and games over physical copies. They purchase the rights to use these goods online and stream them directly from the “cloud” to their computer, tablet or smartphone without ever holding a tangible item that can be taxed in the traditional manner.

Consumers aren’t the only ones relying on the cloud. Businesses are continuing to move their company’s storage to the ominous “cloud,” hiring third-party cloud-based organizations rather than needing to rely on their own data-management. Many companies are therefore entering the software-as-a-service (“SaaS”) models.

As this trend continues for both consumers and businesses, states are looking for ways to tax online cloud-based services to make up the lost revenue. Think about it – just the term “software as a service” is confusing, particularly in the state tax world, where we spend a lot of time answering the question, “What is the product you’re selling?” That’s because the next question is often, “Is there an exemption for such a product?” If we can’t define WHAT it is, how can we define whether it’s taxable or not, or whether a state offers an exemption for it?

Online Tax & The Cloud

So, the nature of cloud services (or SaaS type products) brings up a lot of questions:

  • Are items stored in the cloud a tangible “good,” which would likely be subject to sales tax
  • Are they a “service,” which might be subject to sales tax if specifically delineated as a taxable service?
  • Or are cloud-based services something entirely different that should be subject to another type of online tax?

As we might expect, states are approaching the issue in different ways. Generally, for sales tax purposes, we still always start with nexus. Does the company have nexus with the state, and THEN, is the product taxable? Let’s assume that the company does have nexus in a given state. Here are just some variations on how states are thinking about taxing the cloud based revenue model:

  • The service is akin to downloading software. Some states do not tax the electronic download of software, so they don’t tax SaaS. (Example: California)
  • The service is akin to downloading software. Several states do tax the electronic download of software under the premise that canned software is taxable regardless of how it is delivered. (Example: New York)
  • Cloud based services are akin to data processing. If data processing is a service that is deemed taxable in the state, then the SaaS model is taxable. (Example: Texas)

Note that many states have not yet taken a specific position or are relying on notices or internal rulings to stake their positions, rather than statutes. That, of course, makes our job all the more interesting! The author of a recent article also points out some state specifics here.

As you can tell, how online sales tax relates to the cloud is a complicated issue. We’ll continue to share updates as they emerge, but in the meantime please contact us if you have any questions about how this issue may affect your business!

Miles Consulting Group, Inc. is a professional service firm in San Jose, California specializing in multi-state tax solutions. Our firm addresses state and local tax issues for our clients, including general state tax consulting, nexus reviews, tax credit and tax incentive maximization, income tax and sales/use tax planning and other special projects, including the new California Partial Manufacturer’s Exemption for Sales Tax. To learn more, contact us today at www.MilesConsultingGroup.com.

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