FAQ: What you need to know about cloud computing's hidden tax hit

KPMG LLP tax expert Reid Okimoto speaks to state tax burden of cloud computing and questions you should ask before buying

Cloud computing services, whether software as a service (SaaS) or infrastructure as a service (IaaS), are subject to taxes, whether your cloud provider tells you or not when you purchase them. Reid Okimoto, senior manager in the state and local tax practice at KPMG, shares tips to help you understand the real cost of cloud computing.

Cloud computing services, both software as a service (SaaS) and infrastructure as a service (IaaS), are subject to taxes, whether your cloud provider tells you or not when you purchase them. Reid Okimoto, senior manager in the state and local tax practice at KPMG, shares tips to help you understand the real cost of cloud computing.

Q: What questions should companies buying cloud services be asking about state and local taxes?

Reid Okimoto

Reid Okimoto, senior manager, state and local tax practice, KPMG

A: One major question is, "Is it subject to sales tax?" If sales tax isn't clearly charged by the cloud provider, the customer may still be subject to 'use tax.' IT-focused professionals and their enterprises are consuming and purchasing cloud services and they're normally dealing with sellers and vendors of cloud services, not necessarily those familiar with the "taxability of services." Questions to ask the seller of the cloud services: "Are you charging sales tax or not?" If the answer is no, the next question is, "Why not?" It could be either that the provider does not have nexus or that the service is not taxable. This answer makes a difference to the consumer.

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Q: So what happens with taxation and "nexus," which means a connection or link?

A: The concept of "nexus" determines who has the obligation of collecting and remitting a sales tax. Nexus is not synonymous with taxability. If the vendor has nexus in the state and the cloud service is taxable in the state, it should collect the sales tax. If not, the consumer will be responsible for self-accruing and remitting.

Q: State taxes vary, with some at 8% or even more. You note that state policies regarding taxation of cloud services also vary. Would you give us some examples?

A: New York imposes sales tax on many cloud services. California, in the majority of cases, does not tax cloud services. By contrast, a state like Washington shifts the burden of self-accruing and remitting the use tax from the cloud service provider to the consumer. States that offer multiple points of use exemptions for multi-state users of cloud services are preferred to those that impose sales tax of 100% of the purchase price based on the billing address. Imposing sales tax on 100% of the purchase price based on a billing address makes it likely that more than 100% will be taxed or nothing will be taxed. Taxpayers are always concerned about getting "whipsawed" by two competing states' taxing policies.

Q: If you don't go into this fully understanding the tax situation with cloud services, what might come back to haunt you later?

A: A state auditor does periodic audits of companies and they will require you to prove that sales tax was charged and paid appropriately. You may need to prove this by showing them your invoices. Also, your financial statement auditors may inquire about contingent sales or use tax liabilities on the sale or purchase of cloud services. This could result in a contingent liability being placed on the balance sheet. Another reason to keep straight on the cloud-tax issue is that when companies are sold or recapitalized, they typically go through a "due diligence" process with the buyer to "scrub" companies for all liabilities, including tax liability. If there's a lot of liability, there will be a "failed process" question.

Q: What more do business professionals need to think about here?

A: Clear guidance on taxability and sourcing of cloud services creates predictability from a business investment standpoint. States that do not provide clear guidance put cloud service providers in an awkward position, stuck between a possible state tax audit or False Claims Act allegation for under-collecting and a possible class action lawsuit for over-collecting.

Ellen Messmer is senior editor at Network World, an IDG publication and website, where she covers news and technology trends related to information security. Twitter: @MessmerE. Email: emessmer@nww.com.

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