By Shane Ratigan, JD LLM
For accounting professionals and many of their clients, the software or other digital services they use daily are no longer stored on local hard drives or overheated servers stuffed in a back closet. The professional world has moved on to using the cloud, but most states have still not affirmatively recognized this new-ish elephant in the computing room. In terms of the sales and use tax treatment for cloud-based services, many regional governments leave vendors, purchasers, and their advisors in a haze when searching for answers about accounting for cloud services.
Buying and Selling Cloud-Based Services
In dealing with sales tax, one of the principal tasks for any vendor is to determine the proper tax treatment for the items or services they sell in the jurisdictions where they are obligated to comply. This process is rarely simple, even with established products or services. The U.S. sales and use tax universe of 46 states and hundreds of localities often prefer to put their own stamp on the taxation of specific transactions. Cloud-based services have certainly established themselves in the marketplace, but they remain identified as specifically taxable or exempt in less than a quarter of the sales tax states.
The dearth of direct guidance on the treatment of cloud-based services for sales and use tax affects sellers and buyers. Vendors struggle to determine with certainty whether cloud-based services should be taxed at all, while purchasers are left wondering if they are being overcharged or, especially in the case of business consumers, is there a use tax obligation that must be accrued?
What are States Doing About Cloud-Based Services?
As we alluded to above, there are really three varieties of states in this area: states who affirmatively identify cloud-based services, states who use existing rules to shoehorn some cloud services into existing categories of other taxable goods or services, and states who seem to ignore the existence of the cloud all together.
Since lack of clarity creates fear, uncertainty, and doubt, we commend the minority of states who are on the record when it comes to sales tax and the cloud. It is important to note here that when a state affirmatively defines cloud-based services, they do not automatically apply the tax to them; some states define and impose, others define and exempt.
In New Jersey, for example, the state has defined SaaS, PaaS, and IaaS, finding that none of these cloud-based service types are subject to sales tax. Indiana recently followed a similar path for SaaS. On the other hand, Washington defines “remote access software” as a SaaS type model and finds sales of it are taxable, while “digital automated services” are construed as to describe most cloud-based services and are also taxable in the Evergreen State.
More commonly, states have addressed only limited factual circumstances with regards to the cloud, and many of the states in this category have only addressed SaaS. For example, Connecticut finds a service that provides remote access to information includes the provision of SaaS and is taxable as a data processing service. In West Virginia, where most services are taxable generally, the delivery of cloud-based services enjoys no specific exemption and is likely taxable at the general rate.
Finally, a portion of states do not define cloud services but have yet to apply existing rules to determine taxability. For example, in Nevada, since almost no services are taxed at all, the state’s silence on the cloud implies these services are exempt as well.
A Friendly Use Tax Reminder to Cloud Loving Businesses and Professionals
As your company adopts more and more cloud-based solutions, it also runs the risk of incurring use tax obligations on those expenditures. These purchases are for services that are “consumed” in the furtherance of your company’s operations, they are typically not bought for resale. Use tax compliance should not be a new thing (if it is a new thing, the following message is even more vital), but use tax obligations regarding cloud-based services come with a twist. Many providers of cloud-based services are not collecting sales taxes, even when the services are taxable in your state.
Cloud-based or not, we can all agree that vendors who don’t collect sales taxes avoid doing so for their own special reasons. With cloud-based services, the reason they don’t collect is often related to the nature of the cloud itself: the delivery of cloud-based services can be made without traditional indicia of sales tax nexus.
This hearkens back to Sales Tax 101: without a physical presence, a vendor is not obligated to collect sales taxes, leaving the purchaser to self-remit use tax. One of the main selling points of the cloud is its lack of physicality in the hands of its users, so providers of cloud services often lack the physical presence in states where they sell that would otherwise obligate them to collect.
The pace of legislative and administrative progress is plodding mainly by design. Deliberative bodies and bureaucrats are rarely able or advised to rush into new territory; the slow march to recognition of the cloud is only another chapter in this book. That said, the risk and consequences of poor compliance remain very real for vendors and purchasers as sales of cloud-based services continue to grow.
For companies with the resources and experience to plot this minefield, carry on and keep watching for the incremental but inevitable march to clarity. If marching to the beat of the sales tax band is not your thing, consider finding a specialist who can help you and your clients avoid tripping over their own feet on the sales tax dance floor.
Clark Nuber has experienced staff on hand to help you sort out cloud-based (or other types of) sales tax headaches. Contact us via our website for professional insight into your company’s situation.
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