When are cloud computing services taxed and when are they not? It's a question that many states across the country are tackling, and Massachusetts is the latest to rule on the issue.
The Bay State -- which some call "Taxachusetts" -- issued a ruling this month that falls in line with what a handful of other states have found: Cloud-based software as a service (SaaS) is taxable in certain circumstances when a license is needed to run the program and a Massachusetts resident consumes the service. If the software is open source or available for free, then it is not taxable, the state's Department of Revenue ruled.
BACKGROUND: Cloud services face taxing dilemma
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Kelley Miller of the law firm Reed Smith, who specializes in technology law and specifically tracks how states have been enforcing cloud taxes, says it's been a tough issue for states. The DOR says in its ruling that the market is evolving "at a rapid pace." Traditionally tax laws just don't work for this new era of cloud computing, she says, because there is not a tangible transaction of a disc or piece of hardware. Massachusetts seems to have echoed findings from other states though, she says. "The essence of the question is, are you buying software that people bought in a box at the store 10 or 15 years ago," she says. If so, then Massachusetts, and other states, have claimed a right to tax it.
What is not taxable, Massachusetts has ruled, is if the service is available for free, without a license. Miller says this means that a broad range of cloud services, for example Google Docs or DropBox, would not be taxable. Massachusetts has left some services as taxable in that scenario though. The DOR states that if there are data transfer fees that are separately charged by the provider, then those are taxable under the telecommunications services law.
In the past year, Miller says, more than a dozen states have issued rulings on the tax status of cloud computing, representing a range of opinions on the subject. For example, the Bay State's ruling is consistent with one handed down in Utah this spring, which also found that licensed software is taxable but that some free, open source software is exempt. In many other states there have been no official rulings on when cloud services are taxed, which leaves service providers in an awkward position, she says. Miller works with clients to make inquiries to states asking for guidance on whether their services are taxable, which is how the Massachusetts ruling came down. The DOR issued the decision based on an inquiry by a company whose name was redacted when the ruling was released. "I think a lot of states are using this as an opportunity to provide some definitive guidance on the technology," she says, showing cloud computing's continued prominence in IT.
It will be interesting to watch how cloud providers respond to the rulings from Massachusetts and other states, Miller says. Companies can gain tax advantages in certain states by offering free or open source access to their software rather than licensing it. Miller says she'll be watching to see if any companies change their market offerings based on these new rulings.