TEI – Nebraska Chapter
February 21, 2012
Eric Tresh
Jonathan Feldman
State Taxation of Digital Goods and
Cloud Computing
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Agenda
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What is Cloud Computing?
Characterization/Taxability
Sourcing
Specific State Treatment
Nexus
A National Framework
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What is Cloud
Computing?
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What is Cloud Computing?
• There is really no one definition – it is a manner of
providing a service.
• Cloud computing generally means using multiple
service computers via a digital network (usually the
Internet) as through they were one computer.
• Without a “cloud,” a web server runs a single
computer or group of privately networked computers.
Capacity may be limited or may go underutilized in
times of low load.
• Cloud application allows thousands of users to share
application and server resources, optimizing capacity
and costs through a “pay-as-you-go” pricing model
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Application Service Providers
(“ASPs”)
• An entity retains custody over (or “hosts”) software for
use by third parties.
• Users of the software hosted by the ASP typically will
access the software via the Internet.
• The ASP may or may not own or license the software,
but generally will own or maintain the hardware and
networking equipment required for the user to access
the software.
• The ASP may charge the user a license fee for the
software (in instances where the ASP owns the
software) and/or a fee for maintaining the
software/hardware used by its customer.
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Software as a Service (“SaaS”)
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The SaaS model allows the consumer to use the provider’s
software applications running on a cloud infrastructure.
The applications are accessible from various client devices
through a client interface such as a web browser (e.g., webbased email).
The consumer does not manage or control the underlying cloud
infrastructure including networks, servers, operating systems,
storage, or application capabilities.
Under the SaaS model a service agreement is almost always
executed (vs. a software license agreement or services
agreement for an ASP).
SaaS model is familiar to most Internet users, and includes such
offerings as web-based email, calendars, word processing, and
digital photo applications.
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Platform as a Service (“PaaS”)
• The PaaS model allows the consumer to run
consumer-created or acquired applications on the
cloud provider’s platform.
• The consumer does not manage or control the
underlying cloud infrastructure including network,
servers, operating systems, or storage, but has
control over the deployed applications and possibly
the application hosting environment configurations.
• An example of a PaaS model includes web hosting
and managed services.
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Infrastructure as a Service (“IaaS”)
• The IaaS model provides the consumer the ability to
outsource or rent storage, processing, network, and
other computer resources upon which the consumer
is able to deploy and run software, which can include
operating systems and applications.
• The consumer does not manage or control the
underlying cloud infrastructure but has control over
operating systems, storage, deployed applications,
and possibly limited control of select networking
components (e.g., host firewall).
• An example of an IaaS model includes co-location
services.
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Service Provider
Customer
Cloud Service – Division of
Ownership
IaaS – Co-location
PaaS - Managed
Hosting
SaaS
Users
Users
Users
Applications
Applications
Applications
Tools
Tools
Tools
OS
OS
OS
Hardware
Hardware
Hardware
Network
Network
Network
Physical
Physical
Physical
Indicates separation between Provider and Customer
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Characterization &
Taxability
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Characterization – Important
Considerations
• Right to use technology?
• Right to access software?
• Right to use tangible personal property (software or
hardware)? Exclusive use?
• Right to own or possess?
• Receipts from a service, including
telecommunications?
• Internet access included?
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Why Does Characterization Matter?
• Taxability
 Many states tax sales of tangible personal property and a
variety of services. As states look for more revenue, the tax
base is expanding to include more and more services.
• Exemptions
 Does it qualify for a resale exemption
 Are there any other exemptions: Manufacturing. R&D, etc.?
• Sourcing
 Services and tangible personal property are usually sourced
differently, the characterization can create issues
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Taxation of Digital Goods
WA
AK
ME
MT
ND
MN
OR
ID
WY
PA
IA
IL
CO
KS
OK
NM
MO
TX
OH
IN
RI
NJ
MD DE
WV
VA
DC
KY
NC
TN
SC
AR
MS
HI
MA
CT
MI
UT
AZ
NH
NY
SD
NE
NV
CA
VT
WI
AL
GA
LA
FL
Digital Goods Taxed by
DOR Position or
Case law
Digital Goods
Non-Taxable
Digital Goods Taxed
by Statute
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Digital Goods – Legislative Activity
Possible Activity in 2012
AK
ND
VT
MN
MA
NY
RI
MI
IA
PA
NV
IL
CA
CO
KS
OK
IN
NJ
MD
OH
WV
VA
MO
AR
SC
GA
HI
FL
Digital Goods Bill possibly to be
Introduced in 2012
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How do you determine the character
of the transaction?
• Review Contracts
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How is the product being billed?
 Review invoices, bills, etc.
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How is the product being marketed?
 Promotional materials, marketing documentation
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How is the product priced?
 Bundling, true object test, composition of the different
components
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Is it software or a service?
 Is a License granted?
 Price difference for the license?
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Taxability of New Technology
Models
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With new technology models evolving, states are making every
attempt to tax these new models under existing provisions.
 Method of delivery
 Custom vs. canned
 Data processing?
 Information service?
 Telecommunications?
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State taxing authorities continue to rely on letter rulings and
informal administrative guidance to set forth their policies in
regards to cloud computing services.
Such rulings and notices provide limited guidance to the
business community and can also cause more uncertainty.
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Taxability of SaaS
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State taxability positions range from:
 Not an enumerated service
 Not a sale of software (tpp) because no transfer/delivery/control
 Taxable service
 Information service – NY
 Data processing service – TX, OH
 Digital automatic service – WA
 Computer-related services – CT
 Communication service – FL, SC
 Tangible personal property
 License to use – MI
 Non-possessory use or constructive possession – NY
 Lease – Chicago
 Rental if software resides on a server in the state – KS, PA, TN
 Not taxable because server is not in state
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Taxability of Paas
• Service has experienced tremendous growth because
of cost savings associated with outsourcing
technology needs.
• Popular among software developers because they
can use their own applications and the tools,
infrastructure and computing power of the PaaS.
• Little state guidance
• Because many PaaS service providers provide both
applications and tools, likely that states will attempt to
characterize as the sale of software
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Taxability of IaaS
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Service has experienced tremendous growth because of
technological advances
Look to state’s taxability of various services
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Hardware maintenance
Software maintenance
Repair labor
Security services
Electricity
Data maintenance
Limited State Guidance
 Vermont – Web hosting services are not taxable
 Texas – Web hosting and remote storage services are taxable data
processing services
 Texas – Data backup services including server imaging and routine
tape backups are taxable data processing services
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ITFA Preemption?
• Does ITFA preempt states from taxing certain digital
services?
 In 2007, the definition of “internet access” under ITFA was
expanded to include “a homepage, electronic mail and
instant messaging (including voice- and video-capable
electronic mail and instant messaging), video clips, and
personal electronic storage capacity, that are provided
independently or not packaged with Internet access.” ITFA
section 1105(5)(E).
• What does the word “personal” mean?
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Bundling
• As Cloud Computing offerings contain multiple types
of services, taxpayers should be aware of state
bundling rules.
• The Streamlined Sales Tax Agreement provides that
a bundled transaction occurs when two or more
distinct products are sold together with one itemized
bill.
• States may impose tax on the full sales price of the
bundles transaction if any part of the bundle is
taxable, or may look to use a “true object” or “primary
function” test to determine whether the true object of
the transaction is taxable. (CA & NY)
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Sourcing
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Sourcing Overview
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The sourcing of a digital item is dependent upon its
characterization. For interstate sales, if taxable as:
 Tangible Personal Property
 Generally destination
 Consider subsequent use
 Consider concurrent use (prewritten computer software)
 Services
 Varies by state. May be:
 Benefit (Market Sourcing)
 Performance (COP)
 Consider multistate benefit
 Digital Goods
 Not clearly defined. May be:
 Destination
 Benefit
 Consider multistate use
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Sourcing Issues
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What are the problems?
 For sales tax, concepts of destination and benefit are not easily
applied to digital items. Seller may have no idea where the receipt
of the items takes place, or where the item is used.
 For purchasers, location of use may not always be known – or may
be from multiple locations.
 Is “Use” at server location or user location? States vary, by
way of example:
 Alabama – Server location
 New York – User location
 Trend towards user location, but be mindful of states that
include software or digital products in their definition of
tangible personal property – these states may take a more
traditional view of where these items should be sourced –
one location.
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The Problem
Step 1: A Customer at
Dulles Airport uses her WiFi to access the Apple
store. The Apple store
server is located in TX.
Step 2: She downloads three movies
which are charged to her Apple
account – her billing address is in
CO.
Which state has the right to tax?
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Multiple Points of Use (“MPU”)
• The MPU provisions were repealed from the SST
Agreement. Member states required to repeal by
January 1, 2008.
• The Multiple Points of Use (“MPU”) Exemption
permitted a business purchaser of computer software,
digital goods and services, which are concurrently
used, to apportion, self assess, and remit use tax in
all jurisdictions in which it will be used.
• Generally, purchasers are allowed to use an
apportionment method so long as it is reasonable,
consistent, uniform, and can be supported by their
books and records.
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Sourcing Approach
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State law and regulations often does not provide an
answer/approach. Rather, a “range” of sensible/acceptable
answers is the norm.
 Washington – Special exemption
 Business must report and pay use tax on that portion of the
digital products, digital code, prewritten software, or remote
access software used in Washington.
 Taxable amount determined by ratio of in-state users.
 Generally, digital products and remote access software are
used in Washington when the buyer first accesses, downloads,
possesses, opens, stores, enjoys, or receives the benefit of the
service in this state.
 A buyer may not claim a multiple points of use exemption for
personal use.
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Most auditors will look for a sensible approach that reflects a
system of assigning sales to locations where the service is being
“received.”
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Specific State Treatment
of Cloud Computing
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Nebraska
• Nebraska has little guidance with respect to cloud
computing
• Tangible personal property includes prewritten
computer software. Neb. Rev. Stat. Sec. 77-2701.39.
• Receipts from prewritten computer software are
taxable “regardless of the manner in which it is
conveyed.” 216 Neb. Admin. Code Sec. 1-088.01.
• Nebraska Information Guide No. 6-511-2011 (7/2011)
 Nebraska DOR has opined that cloud computing services
were not taxable as a rental of tpp if vendor retains title to
software and user gets no ownership rights
 True regardless of location of server
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Iowa
• Recently, the Iowa Department of Revenue issued a
Policy Letter stating that hosted software isn’t taxable.
 The service provider sells software to physician practices.
 The software is located on servers outside of Iowa and
accessed over the Internet.
 Software is not downloaded or transferred, and there is no
transfer of title.
• The hosted software is not taxable because there is
an exemption in the Iowa code for electronic transfer,
and thus the service provider’s services fell under the
exemption under Iowa Code Sec. 423.3(67).
 Iowa Policy Letter 12300002 (January 11, 2012).
©2012 Sutherland Asbill & Brennan LLP
Kansas
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Kansas recently issued an Opinion Letter reaffirming its stance
that cloud computing isn’t taxable.
 Kansas Opinion Letter No. O-2012-001 (February 6, 2012)
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The facts were the same as the facts of the Iowa service provider
described above, likely the same taxpayer.
Because the services are not enumerated as taxable services
under Kansas statute, the services are not subject to sales tax.
 This is consistent with the Kansas Department of Revenue’s
historical position. See Private Letter Ruling No. P-2009-005 (June
26, 2009); Information Guide EDU-71R, Revised Sales Tax
Guidelines: Taxing Charges for Computer Products and Services
and Internet Related Sales and Services (July 23, 2010)
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Illinois
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Illinois DOR recently explained the tax treatment of hosted
software transactions
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ST 12-0002-GIL 1/06/2012
Facts
 Company provides Internet based hosted marketing services to
clients to help evaluate and perform direct marketing
 Product developing and hosting performed in headquarter state
 Company grants only right to use software platform on its server
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Ruling
 No sales tax on software license if:
 Evidenced by signed agreement;
 Agreement restricts customer duplication;
 Agreement restricts sublicensing or transfers
 Online acceptance by clicking box not sufficient
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Nexus
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Nexus
• In order for state to force an out-of-state vendor to
collect and remit sales tax, there must be a
substantial nexus between the vendor and the state
 Quill “physical presence” rule
• Although many states and the SSTP have defined
canned software as tangible personal property, does
not necessarily mean that meet physical presence
• Most states’ law are not equipped to handle nexus
issues related to remote access
• Texas – No nexus from Texas based Internet hosting
services for customer (Tex. Tax Code 151.108)
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A National Framework
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The Solution – Federal Legislation
• Digital Goods and Services Tax Fairness Act of 2011
(HR 1860/S 971).
• A measure seeking to establish a national framework
for the state and local taxation of digital goods and
services (downloaded apps, cloud computing
services, etc.).
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Federal Legislation
• Why a national framework is needed
 States and localities, desperate for new revenue sources,
are already eyeing this expanding part of the economy as a
source of new tax revenues, without first ensuring that digital
goods and services will not be subject to multiple and
discriminatory levels of taxation. Failure to establish a
national framework will invariably lead to costly and wasteful
litigation.
 Congress has a clear role to act in tax matters impacting
interstate and international commerce – digital commerce is
sold over global networks crossing numerous state
boundaries.
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Federal Legislation
• What the measure does
 Ensures digital goods are taxed only once, precluding
multiple states from claiming the right to tax same
transaction or multiple taxation in the course of production.
 Ensures only generally applicable taxes can be imposed
(i.e., general sales taxes) and that it must be done
legislatively.
 Precludes discriminatory telecom/utility taxes from applying
to digital commerce solely because these goods and
services are riding over broadband/communication
networks.
 Ensures that digital commerce is subject to same rules as
comparable tangible goods.
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 Provides certainty in how segments of the new economy
can be taxed for state and local tax purposes.
©2012 Sutherland Asbill & Brennan LLP
Questions?
• Eric S. Tresh
 Phone: (404) 853-8579
 Email: eric.tresh@sutherland.com
• Jonathan A. Feldman
 Phone: (404) 853-8189
 Email: jonathan.feldman@sutherland.com
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