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January 17, 2013 The Tax Lawyer

Sales Taxes and the Shadow of Cloud Computing: Searching the Horizon for a Workable, National Solution

Vol. 65, No. 4 - Summer 2012

Raffi Melanson


    Cloud computing presents the next battle for tax policy makers in their continuing struggle to tax new Internet-based technologies. At its foundation, the cloud promises business and consumers the ability to sync, store, and share content across a panoply of places and electronic devices. For tax purposes, though, cloud computing also promises uncertainty. Despite the rapid integration and consumption platforms by a variety of users, the state tax treatment of cloud transactions remains difficult to predict.

    Rather than creating new tax policy through the legislative process, budget-crunched states have hastily taxed the cloud through informal adjudications. Looking to the facts and, occasionally, to the essence of these transactions, these states’ tax agencies attempt to analogize cloud computing to software for tax purposes. Cloud computing, however, is more complex. Although the cloud utilizes software at its base, cloud software merely acts as a means to offer the variety of remote services sought by users. Furthermore, uncertainty remains as to whether current tax statutes may be read broadly to tax these transactions, which states may lay claim to revenues generated by cloud transactions, and to what extent cloud providers are liable in each jurisdiction. In simpler terms, a storm is brewing and the states are ill-equipped to respond.

    In the absence of workable state-based solutions, this Comment argues that federal legislation is necessary to create and to implement a ubiquitous framework for the state tax treatment of cloud computing transactions. To provide notice to multistate actors, this framework must require states to enact legislation that clearly delineates cloud computing as a taxable service in order to collect revenues. In addition, this framework must provide a consistent sourcing regime for states to follow and must restrict states’ ability to discriminate against cloud commerce or to impose multiple taxes on the same service.

    Part II of this Note begins by reviewing the origins of sales and use taxes and exploring how states first struggled to apply these taxes to traditional software. Part III defines cloud computing and explores how one particular model differs from traditional software. Part IV critiques the states’ current tax treatment of cloud transactions with regard to three questions: how does cloud computing fit under existing tax precedent, is it taxable, and to which jurisdictions can the transaction be sourced? Through a number of examples, this Part illustrates how the answers to these questions vary by state, resulting in an inconsistent patchwork of rules that provides little guidance for practitioners.

    Part V demonstrates why state-based solutions are unlikely to achieve comprehensive reform. Finally, Part VI concludes by discussing how a federal solution is better suited for prescribing guidelines that will adequately address the problems currently plaguing this nebulous tax climate.

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