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The Sale and Use Taxability of Cloud Services

  • Dec 11, 2015 | Suzanne Kearns

As more and more consumers and businesses move to the cloud to conduct business, one thing has become clear: States looking to make up for lost sales tax revenue on ecommerce sales are turning an eye to cloud services as a way to fill that hole.

But the issues surrounding cloud computing are complex, and many states are winging it because they haven’t yet enacted legislation to deal with the issue.

Let’s break down the taxability of cloud services to shed some light on the subject.

What is Cloud Computing?

That depends on whom you ask. There are many definitions of cloud services or cloud computing, but it basically amounts to storing information on remote hardware, such as a server, and accessing it via the Internet. For instance, if you use an email service, you are using cloud computing.

There are three main variations of this type of service:

  • Software as a Service (SaaS). Perhaps the most common, SaaS is when a business provides licensing and delivery of software on a subscription basis. This can be simple, such as the email service referenced above, or more complicated, such as contract management or human resources software. SaaS is also known as on-demand software, hosted software, or managed software.
  • Platform as a Service (PaaS). With this type of service, the seller provides a network, servers, and storage so buyers can use tools to create custom applications. Game developers often use this type of platform.
  • Infrastructure as a Service (IaaS). Also called Hardware as a Service (HaaS), this service offers consumers the chance to pay a subscription fee for storage space and processing power in order to run applications and operating systems. For example, a web host or cloud storage service might offer IaaS.

So it’s not Taxable, Right?

In the past, it was widely understood that apart from some exceptions such as food, only tangible personal property was subject to sales tax. In other words, if you could perceive it with your senses, it was likely taxable. Since software in the cloud isn’t typically thought of as tangible personal property, many assume it’s exempt from sales taxes.

But in an effort to keep up with technology, many departments of revenue are changing the way tangible personal property is defined. The following questions help them determine whether or not to tax cloud services.

  • Is software offered to the consumer in the cloud?
  • Is a service offered to the consumer in the cloud?
  • What products or services are offered to the consumer?
  • Which states are the servers located in?
  • How much control does the consumer have in operating the service?

Every state approaches the matter differently. For example, some states such as Texas have determined that if a consumer can access, manipulate, use, or work with software on the seller’s server, it’s the same thing as purchasing the software on a CD. Regulations based on this perspective affect the taxability of SaaS and PaaS platforms. On the other hand, Kansas ruled that because consumers don’t download or have access to the actual software, it’s not subject to sales tax.

And while those states can’t lump IaaS into the category of tangible personal property, some are equating it to the leasing of tangible personal property and demanding that sales tax be collected on it.

Others like Nebraska have ruled that the various cloud services are a service and subject to sales tax because they fall under the oft-taxed categories of data processing services or information services.

Cloud Computing Tax Issues

The biggest issue facing cloud computing is the cities and states inability to come together in any uniform manner. In fact, only 36 states have some governing guidance as to the taxability of cloud computing services.

The lack of coherent regulation was on display last July when Chicago grabbed national attention for applying old entertainment taxes to cloud services like Netflix. The new interpretation of the rule means consumers will have to pay a 9 percent sales tax every time they stream movies from the site.

On the other hand, consumers in Idaho got a break when the state ruled that because consumers didn’t have a permanent right to the content, it’s not taxable.

In Illinois, state legislatures have determined that canned software is taxable unless it’s custom software designed for the consumer -- then it may be exempt. But software transferred through the cloud is not subject to sales tax.

New Jersey charges sales tax on all cloud computing, but makes an exception for IaaS services. In its ruling, the state says that where the use of the software and supported network are the true object of the sale, it’s not subject to sales tax. But the services associated with IaaS are taxable when delivered into the state.

As you can see, the issue of the taxability of cloud services is complex, and rules vary widely from state to state. If you offer cloud services as part of your business model, or use them in your business, you need to understand the latest sales tax and use tax laws in each state in which you do business. A good sales tax compliance program can help you stay up-to-date on this complex issue.

Sales tax rates, rules, and regulations change frequently. Although we hope you'll find this information helpful, this blog is for informational purposes only and does not provide legal or tax advice.
Avalara Author
Suzanne Kearns
Avalara Author Suzanne Kearns