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Cloud services face taxing dilemma

States struggle with how to tax cloud services

By , Network World
March 28, 2012 02:37 PM ET

Network World - States are having a hard time keeping up with the cloud, especially when it comes to taxing it.

There have been a bevy of rulings by various states in the past few years related to how cloud services are taxed, but a recent ruling in Utah could be one of the furthest reaching decisions on the topic to date. And experts say it could begin a wave of more states looking to expand their policies of how taxes are collected on the fast-growing adoption of cloud services.

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States are increasingly looking to tax the cloud for a simple reason: The rise in e-commerce and cloud computing services have eroded their traditional forms of tax collections they have relied on in the past, says Joel Waterfield, a senior manager at consultancy and accounting firm Grant Thornton. It's amounted to what Waterfield calls a game of catch up by the states now. "When they're losing multiple millions of dollars in transactions, they feel they need to recoup some of that tax revenue," he says.

More and more states are issuing rulings on taxing the cloud, says Kelley Miller, of the firm law firm Reed Smith and a writer for the firm's TaxingTech blog. In July of last year, there were only four states that had regulations regarding how cloud services would be taxed. By the end of the year that number had doubled and this year already there have been a half-dozen rulings.

Utah is the latest example. In 2010, an undisclosed provider of business conferencing and desktop access tools inquired with the Utah State Tax Commission asking if its cloud-based business collaboration and online meeting SaaS offerings were subject to sales tax. The product requires end users to download a thin client application to access the cloud-based services. In February 2012 the state ruled that web services that charge a fee constitute a sale of a service, and are therefore subject to sales tax. It seems to imply that simply accessing the SaaS application is enough to subject it to a tax liability. "This could really be a harbinger for cloud computing taxation," says Miller. "Many states may look to Utah's ruling as a template of how to tax cloud services into the future."

The Utah ruling is different from how other states have approached taxing cloud services because it includes services that charge users a fee for accessing a software. Other states have had a narrower definition that hinges more on the actual transfer of software from the provider to the user. Kansas, for example, in a series of rulings from the past few years, has noted that when a SaaS application of some sort is downloaded to access the application, then it can be taxed because there is a transfer of software.

Still, other states have even more narrow definitions that are based on where the application is hosted by the provider and whether it has nexus in the state, meaning if it is subject to tax liability. Massachusetts seems to be an example of this. Nexus has traditionally been determined based on a company's physical presence in a state, so some states will tax cloud services if the application and user accessing the software are both within the state's borders. Miller and Waterfield say that can be a messy legal proposition because many cloud providers host applications in multiple states to ensure uptime during a disaster, for example.

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