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Cloud services face taxing dilemma

Brandon Butler | March 29, 2012
States are having a hard time keeping up with the cloud, especially when it comes to taxing it.

Still, other states have even more narrow definitions that are based on where the application is hosted by the provider and whether it has nexus in the state, meaning if it is subject to tax liability. Massachusetts seems to be an example of this. Nexus has traditionally been determined based on a company's physical presence in a state, so some states will tax cloud services if the application and user accessing the software are both within the state's borders. Miller and Waterfield say that can be a messy legal proposition because many cloud providers host applications in multiple states to ensure uptime during a disaster, for example.

"States are really all over the map, literally," Miller says related to their approaches for taxing cloud services. The nuanced differences in the regulations point to the trouble states are having regulating the cloud, says Annette Nellen, who specializes in 21st century taxation at San Jose State University.

"It used to be easy," she says. Customers would go a store, buy a CD with preloaded software on, get a license for the software and pay a sales tax on it. When downloading of software became commonplace, many states ruled that the transfer of the software - even if it is not a transfer of a physical object - still constitutes a sale, and therefore can be taxed. Utah's ruling seems to indicate that merely accessing that software, and not just downloading it, can create a tax liability. "I think states are just looking for any possible way they can fit the cloud into the current tax code," Nellen says.

When states try to squeeze cloud services into existing laws, it makes the jobs of Miller and Waterfield more difficult to analyze the rulings and intentions of the states. Some states, for example, tax data processing services and others tax information services. Does the cloud fall into those? Miller and Waterfield say each provider must look at the tax laws in the states not only where they are located, but also where end users access it. The sales tax, which usually ranges from 4% to 8%, is usually the responsibility of the service provider to assess on the customer.

Nellen says there's an easier way. Hawaii has taken the approach that simply all sales are taxed, including services, which would include cloud services. Only certain items are exempt, such as food and non-elective emergency care services. The more explicitly states can be in terms of outlining which services are taxed and which are not would make the rulings easier to understand, all three experts agree. But Miller says tax policy on a state level is a balancing act between states attempting to meet their revenue projections and officials not over taxing certain industries and emerging technologies.

"It's politics vs. the revenue needs of the state," she says. And if the Utah ruling is any indication, more states may be looking to capture some additional tax collections from cloud services.

 

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