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Taxing the Cloud has to start somewhere

Taxing the Cloud has to start somewhere

16844896197_402e7e0ecb_oWhile business may be booming in the cloud as organizations look to drive innovation, improve time-to-market, and lower costs, many companies are apparently lost when it comes to the associated tax implications.

Cloud computing is borderless, so location is usually irrelevant. It shouldn’t matter that a company is in Nevada, a software user in New York, and the servers on which the company runs its application in Texas. However, sales and use taxation is based on location. So until reality sets in, companies must continue to monitor the ways in which states try to embed cloud computing into existing laws.

While state taxing statutes have traditionally failed to keep pace with technological developments, a number of states have their eyes on potential revenue that can be tapped by taxing cloud based services.

Chicago taxes cloud and streaming services

Earlier this month, a new “cloud tax” took effect in the city of Chicago, targeting online databases and streaming entertainment services. Chicago’s new tax is actually composed of two recent rulings made by the city’s Department of Finance: one covering “electronically delivered amusements” and another covering “nonpossessory computer leases.”

Each one takes an existing tax law and extends it to collect an extra 9 percent tax on certain types of online services. The first ruling presumably covers streaming media services like Netflix and Spotify, while the second would cover remote database or computing platforms like Amazon Web Services or Lexis Nexis. Basically, under the new law, what passes as $100 of server time in Springfield would cost $109 if you’re conducting it from an office in Chicago.

The result for services is both higher prices and a new focus on localization. For the web services portion, the most likely effect is simply moving servers outside of the city limits — and, where possible, the offices that use them. Once implemented, streaming services will also have to keep closer track of which subscribers fall under the new tax, whether through billing addresses or more restrictive methods like IP tracking, which is already used to enforce rights restrictions.

Some lawyers have already taken issue with the city’s change. After the rulings were announced, Reed Smith partner Michael Wynne argued the taxes violate both the Federal Telecommunications Act and, in the case of the second ruling, 1998’s Internet Tax Freedom Act, intended to prevent discrimination against services delivered over the internet.

CIOs need to be prepared

When it comes to cloud taxation, many CEOs and CIOs have not grasped the full impact on their organizations. One important area of oversight is the potential impact on the global tax position of the company.

The three key areas of tax uncertainty in today’s environment are:

  1. assessment of global withholding taxes on cross-border payments
  2. creation of taxable nexus in one jurisdiction when conducting business via the cloud from another jurisdiction
  3. the broad area of indirect taxation (global VAT, US sales and use taxation, etc.)

These tax concepts can, if unaddressed, adversely impact tax liabilities, risk profiles and overall profitability of cloud computing arrangements.

As companies continue to embrace the cloud, there is a growing need for tax departments to identify and understand the unique tax issues that arise when utilizing the cloud. There are a number of challenges and opportunities that come into play when adopting a cloud business model, and considering the tax implications may improve a company’s bottom line performance and operating effectiveness.

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