Vermont Reverses Course on Cloud Computing

A little over a year ago, we wrote in this space about the State of Vermont’s moratorium on the taxation of cloud computing in the form of software as a service, or SaaS (“pre-written software accessed remotely” in the state’s terminology). The moratorium had been enacted in the wake of outcry from Vermont-based software companies, who objected to assessments for unpaid taxes on SaaS charges going back to 2006, based on a technical bulletin issued by the Department of Taxes in 2010.

At the time the moratorium was passed in 2012, there was some support for permanently exempting SaaS from Vermont’s sales and use tax, and Vermont’s governor had come out in favor of an exemption. A special study committee set up to make recommendations to the legislature on the issue also supported exempting SaaS from taxation. However, legislators were ultimately unable to agree on cuts elsewhere in the budget to make up for loss of anticipated revenue from SaaS taxes. As a result, the moratorium was allowed to expire, meaning that, as of July 1, charges for SaaS are taxable in Vermont. Because the moratorium applied only to taxes on SaaS, its expiration does not affect the tax treatment of other types of cloud computing, such as infrastructure as a service or IaaS.

Because Vermont, like many states, continues to struggle with the application of old definitions to new technology, determining whether a given cloud computing transaction will be taxable under Vermont’s law requires a careful analysis of the individual transaction. The key issues in this determination are whether the object of the transaction can be characterized as a sale of taxable tangible personal property (including software) or whether it is really the sale of a service. If the transaction is a sale of software, it must then be determined whether it is prewritten or custom software. Vermont imposes its sales and use tax on prewritten computer software, whether accessed remotely as is the case with SaaS, downloaded, or purchased on a tangible medium such as a CD. Custom software, designed to the specifications of an individual purchaser, is not taxable. Additionally, while pre-written software is taxable, services are not. Merely using the term “Software as a Service” to describe a cloud computing transaction, however, will not transform the transaction from a sale of software into the sale of a service under Vermont law, since pre-written software is taxable, regardless of how it is accessed. Instead, vendors should determine whether what they are selling is properly characterized as not software at all, but instead is an exempt service such as data processing.

The Vermont Department of Taxes has stated its intention to promulgate formal regulations on the topic of cloud computing, but has in the meantime published an information sheet providing basic guidelines on its taxation. The information sheet includes a number of factors to consider in determining whether Vermont’s sales and use tax applies to a given transaction. Sellers would be wise to consult with their tax counsel regarding the tax and its impact on their businesses.

Not So Simple–Recent Developments in Taxing the Cloud

We write frequently about developments surrounding federal tax legislation such as the Marketplace Fairness Act, which is up for a vote before the Senate on May 6. One of the major issues critics have with the Act is that despite proponents’ claims, it fails to provide for real simplification of state and local tax regimes, such as a uniform tax base among the states. Without a uniform tax base, compliance is incredibly complex for even the savviest of retailers.  The problem is much worse with respect to computing services and digital products delivered over the Internet.

For instance, cloud computing has some of the murkiest tax rules – some states have issued clear statements regarding taxability of IaaS, SaaS, or PaaS, but few have addressed all types of cloud services and many have failed to address the issue at all. Retailers are left guessing at the proper tax treatment of their sales and hoping their interpretation of tax rules is the correct one. That tax rules are ever-changing does not help matters. A uniform tax base would lessen this problem. Instead, retailers must monitor developments in myriad jurisdictions to find some clarity, although tax treatment still varies from state to state.

Idaho, for instance, recently exempted SaaS from sales and use tax by amending its statute to exclude “software accessed over the internet or through wireless media” from the definition of tangible personal property. See Idaho Code § 63-3616(b). Previously, the statute included as taxable tangible personal property any non-custom computer program “regardless of the method by which the title, possession or right to use the software is transferred.” The Idaho State Tax Commission interpreted this language as imposing tax on SaaS, although it noted in its opinion that “Due to the complexity of the business models, it is not possible to provide an all inclusive list of taxable sales transactions or taxable uses. As this technology advances, it may introduce more rather than less certainty.” Cloud Computing and Related Software Sales and Use Tax Issues (10/22/2012) (emphasis added). Even when providing some now-moot clarity to the taxability of SaaS, the state had to admit that its interpretations could not be considered definitive or final.

Meanwhile, in Massachusetts, Governor Patrick’s proposed FY2014 budget would impose tax on certain computer and data processing services, including “provision of access to software or the storage of data on the seller’s or a third party’s server.” It is unclear whether this provision will pass, but as is common, the language is open to interpretation. (Note that Massachusetts already imposes tax on SaaS. See 830 CMR § 64H.1.3(14)(a).) True simplification and a uniform tax base would alleviate much of the difficulty retailers have in complying with ever changing tax rules.

As always, with tax bases varying among the states and being subject to constant revision, we advise businesses to consult with their tax professionals early and often.

Tennessee Ruling Provides Another Wrinkle for Cloud Computing Services

A recent ruling by the Tennessee Department of Revenue (Ruling #12-11) illustrates some of the anomalies and pitfalls in properly taxing cloud computing services. The request for ruling concerned a service that provided Tennessee users access to software maintained on remote servers located outside of Tennessee. This is otherwise known as an SaaS service. In addition, the charge for the service permitted users access to certain databases, including certain reference materials such as dictionaries and encyclopedias. It would appear that the users did not download the references to their computers.

One of the anomalies in the ruling is that the Department stated that the SaaS portion of the service was not taxable, but access to the databases was taxable because the Department deemed the access to include the right to license and use digital books. As of January 1, 2009, the right to license and use digital books is taxable pursuant to an amendment to the Tennessee sales and use tax statute adopting the Streamlined Sales and Use Tax Agreement (“SSUTA”).

The Department’s basis for this distinction in taxability appears to be that access to software is not taxable because “title, possession, and control” of the software always resides outside of Tennessee. On the other hand, the taxability of digital books is predicated on the following underscored clause from Tenn. Code Ann § 67-6-233(a), which provides for the taxation of digital books when there has been the “retail sale, lease, licensing, or use of specified digital products transferred to or accessed by subscribers or consumers in this state.” (emphasis added). Section 67-6-231(a), providing for the taxation of software, includes only “software transferred by tangible storage media or delivered electronically,” but does not include access to the software. The difference between the two statutory provisions is subtle. On the one hand, digital books are taxable if the consumer in Tennessee has “access” to the books, without being required to download them. On the other hand, computer software is not taxable, even if the consumer has access to the software, so long as the consumer does not download the software to his or her computer in Tennessee.

Another anomaly pointed out in the ruling is the distinction between information services and digital books. The Department conceded in its ruling that data processing and information services are not taxable in Tennessee, and defined such nontaxable services as allowing “data to be generated, acquired, stored, processed or retrieved or delivered by electronic transmission.” Because the service at issue in the ruling included access not only to information maintained in a database by the service provider, but also access to reference materials such as a dictionary or encyclopedia, the non-taxable information service was transformed into access to digital books.

Finally, the “pitfall” is, as the Department ruled, because the charge was for the combined service of access to the software as well as access to the databases and the digital books, the entire transaction was taxable. This was the case even though the transaction fit within the definition of a “bundled” transaction (i.e., the sale of two or more services for one price), and some of the services were not taxable.  The ruling is in line with the old New York “cheeseboard” rule* and the proverbial expression that “one rotten apple spoils the bunch.” The lesson for a cloud service provider is that it should itemize charges for separate services; otherwise it stands the risk of taxation of the entire transaction. This is so, even in the SSUTA states, which only provide for “unbundling” services (i.e., permitting the showing of the portion of a bundled transaction that is not taxable) where the services consist of a bundled transaction of “telecommunications services, ancillary services, Internet access services, or audio or video programming services.” Most cloud computer service providers do not provide such components as part of their service offerings and so itemizing the services they actually provide is a constructive way to limit the tax hit.

* Under 20 NYCRR § 527.1(b), “Taxable and exempt items sold as a single unit. When tangible personal property, composed of taxable and exempt items is sold as a single unit, the tax shall be collected on the total price.  Example: A vendor sells a package containing assorted cheeses, a cheese board and a knife for $15. He is required to collect tax on $15.”

Is It Raining In Pennsylvania: Sales Tax on Cloud Computing Services?

I recently wrote a blog post on the new Vermont law on sales tax on cloud computing services, in which the state placed a moratorium on taxation of software as a service (“SaaS”). Pennsylvania, however, has decided to take a different approach to cloud computing. In Legal Letter Ruling No. SUT-12-001 (May 31, 2012), the Pennsylvania Department of Revenue announced a change in the existing law in Pennsylvania. In particular, the Department’s new approach is that SaaS is taxable in Pennsylvania to the extent that the users of the services are located in Pennsylvania. The Department took the position that the charge for electronically accessing taxable software is taxable because computer software is tangible personal property, and the user “is exercising a license to use the software” within the meaning of 72 P.S. § 7201(o)(1). That section of the statute provides that the exercise or right or power incidental to the ownership of tangible personal property constitutes a taxable “use.”

But this recent ruling, and basis therefor, is inconsistent with the prior ruling of the Pennsylvania Department of Revenue, Legal Letter Ruling No. SUT-10-005, in which the Department held that access to software solely through the internet from a data center located outside of Pennsylvania is not taxable because there is not a taxable transfer in Pennsylvania. Nowhere does the Department of Revenue in its 2012 ruling explain the basis for its ruling that a taxable transfer of the tangible personal property has occurred in Pennsylvania, other than the reference to “recent case law and technological advances.” In the case the Department identifies, Dechart, LLP v. Commonwealth, 998 A.2d 575 (Pa. 2010), the court found that electronically transmitted software downloaded to a computer in Pennsylvania constitutes the sale of tangible personal property in Pennsylvania.

However, there is no tangible personal property that is present in Pennsylvania for software that is accessed remotely from a data center located outside of Pennsylvania. Thus, as I wrote in my article on cloud computing, Let the Sunshine In: The Age of Cloud Computing, State Tax Notes November 28, 2011, and as other states (such as Kansas, Utah and Arizona) have ruled, SaaS should not be taxable in Pennsylvania because the tangible personal property is not transferred in Pennsylvania.

The 2012 ruling took yet another twist. The Department stated that if the customer is billed in Pennsylvania, all of the service will be deemed to be subject to the Pennsylvania sales tax, unless the customer is able to produce an exemption certificate in accordance with Form REV-1220, a form unique to Pennsylvania, that shows the percentage of users outside of Pennsylvania. The form (rev-1220, available here), however, says nothing about a statement of use outside of Pennsylvania. I assume that the “other” box should be filled in together with a statement of the number of non-Pennsylvania users.

This Pennsylvania ruling, therefore, presents another issue for cloud computing service providers who provide their services to customers located throughout the United States. Do they use the Pennsylvania-specific form (adapted as described above) when they have a Pennsylvania customer and a Multistate Points of Use Form, as found in Ohio (available as form STEC MPU, here), for all other customers? Or does the provider use both forms for each customer, regardless of location?

In short, it is prudent for any users billed in Pennsylvania for SaaS to issue an exemption certificate based upon the Pennsylvania Form REV-1220. A multistate cloud computing service provider, at a minimum, should use a form along the lines of the Ohio form and consider using the Pennsylvania form as well.

Internet Retailers and Digital Businesses Should Understand the State Tax Risks Associated with Telecommuting Employees

In the increasingly “officeless” environment of the digital workplace, Internet retailers, cloud computing providers and other remote sellers should be aware of the sometimes unexpected state tax consequences associated with employees who telecommute. Although there are few reported court decisions, a vast majority of the states assert that having employees located in the state engaged in non-sales activities who telecommute from home is a sufficient presence in the state to require a company to collect the state’s corporate income or franchise tax. It is also clear that having a telecommuting employee in the state creates meaningful sales and use tax nexus risk, but whether a telecommuting employee will create a "physical presence" in the state sufficient to require the company to collect state use tax may depend upon the nature of the employee’s in-state activities on behalf of the company.


The leading case in the still-developing decisional law on telecommuting is the recently-decided Telebright Corp. v. New Jersey Division of Taxation, 424 N.J.Super. 384, 38 A.3d 604 (App. Div. 2012). In Telebright, the Appellate Division of the Superior Court of New Jersey affirmed a Tax Court decision that the presence in the state of a software developer telecommuting on a daily basis for a Maryland company was sufficient to subject the company to an obligation to report New Jersey Business Corporation Tax (“CBT”). Id., 424 N.J.Super. at 395, 38 A.3d at 611. The employee in Telebright performed no sales functions on behalf of the company (indeed, the Tax Court noted that the company solicited no sales in New Jersey, at all), but she was involved in developing a web-based software application that the company marketed to its clients, a fact that the Appellate Division emphasized in finding that the company both was “engaged in business” under CBT statute and had sufficient nexus with the state for CBT purposes.

Of course, federal law P.L. 86-272 will still protect a company from an obligation to report a state’s corporate income tax, if the company’s in-state telecommuting employees are engaged solely in solicitation of sales for orders of tangible personal property that are approved and filled from outside the state. Many businesses that rely on telecommuting, however, are not protected by P.L. 86-272, because they sell services or computer software applications that may not be deemed “tangible personal property” under state law. Furthermore, employees telecommuting from a state engaged in activities other than solicitation (or activities strictly ancillary to solicitation), will not qualify for P.L. 86-272 immunity. Indeed, more than thirty-five state revenue departments have indicated in response to various surveys that the presence of non-sales, telecommuting employees will subject the company to an obligation to report state income tax.

With regard to state sales and use taxes a direct physical presence in a state through employees will also create a risk of use tax nexus. It is clear that if an in-state employee is engaged in sales solicitation or support activities with respect to in-state customers, s/he can create nexus under established Supreme Court precedent. See, e.g., Tyler Pipe Indus., Inc. v. Washington Dep’t of Revenue, 483 U.S. 231 (1987). Even the activities of non-sales employees, however, should be examined carefully to determine the level of nexus risk to the company when making a business decision about whether to engage telecommuting employees in the state employee to telecommute. In some states, a non-sales employee may not create nexus. For example, the California Board of Equalization has indicated in one Sale and Use Tax Annotation (SUTA 220.0256: “Telecommuting In-State”) (June 21, 1999) that a remote seller that had an employee engaged in web design who telecommuted from his home in California was not “engaged in business” in the state for purposes of California use tax because the telecommuter did not have any contact or involvement with customers in the state. Many other state revenue departments have, however, at least in response to informal surveys, taken a less permissive view. Remote sellers should consult carefully with their tax counsel to understands the use tax risks associated with particular telecommuting arrangements.