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Cloud Computing: the Taxman Cometh (Maybe)
The challenges for end users dealing with most technology products and services contracts lie not in the quoted costs but in the actual terms. This is even more critical when the end user tends to focus on costs and NOT terms, and where the terms are often way, way, way more nefarious than any price quote appears.
Thanks to some creative language drafting as well as some (note the word "some") government mandates, these line items in agreements that cover communications equipment and services can run anywhere between 10 and 40% above rates quoted by the eager salesperson. That's right -- 40% of additional cost. And that's today.
As governments require additional funding to support themselves and the services they provide, it's not a big leap to determine that government-mandated charges will rise as expenses do. And that's before the line items that look like taxes but are actually provider revenue jump as well. Further, the rules about taxing at least two of the items that have thus far escaped tax, namely cloud and Internet services, are likely to change in a way that's not beneficial (directly at least) to consumers.
At the risk of going all "Little House on the Prairie," I'm compelled to state the obvious. Sales tax, which is driven from state and municipal governments, was, at one time, easy to calculate. Then we started shopping online. As such, where a consumer shops now can have a significant impact on his or her ultimate bottom line. This becomes even more complex when the item being purchased can't be physically touched or located.
Taxing the Cloud
Consider cloud computing. What's happening in the cloud involves not only data processes taking place somewhere "out there," but also includes the method for getting the data to and from wherever that spot is. Remember the word "vaporware," which refers to something that sounds great but isn't real? To non-techies, cloud computing is sort of like that, except it is real. And if it's real, how can it be taxed when knowing where the processing is actually taking place is difficult to impossible?
"Nexus" is the word used in tax circles to describe the level of business that a company must engage in before incurring taxes on its revenue or income. A determination of nexus is a highly fact-based process -- or series of possible processes -- and based upon the model in use, the determination can be very, very different, resulting in very different tax liabilities. Bear with me on the lawyer-speak; it's important to put these issues in context.
In 1992, the Supreme Court ruled in the case of Quill Corp. v. North Dakota that companies without a "substantial nexus" in the state where the company's customer resided -- or where its business had a presence -- at the time of purchase were not obligated to pay sales tax. In the Quill case, nexus determinations considered both the Due Process and Commerce Clauses of the U.S. Constitution. From a Due Process perspective, a business must have "minimum contacts" with a jurisdiction in order to establish nexus. Under the Commerce Clause, a "substantial nexus" has required a physical location within the taxing jurisdiction.
But the issue is much larger than just physical presence. Under a traditional analysis, Web-based hosted software, or software as a service (SaaS), will only reach the substantial nexus threshold if it has physically located devices in a given state, not necessarily where the provider has customers and no equipment. Interested in minimizing the loss of tax revenue, some states have tried to expand the definition to include what they've called "affiliate nexus" or "economic nexus." Some states have been successful, but nationwide we haven't seen a great deal of clear guidance.
All Eyes on New York
Bucking that national trend, New York took firm, bright-line action to define economic nexus within its borders. As of Jan. 1, 2015, New York considers an entity to have sufficient nexus within the state if receipts from activities provided in the state meet or exceed a $1 million threshold in a given tax year. Thus, an entity no longer needs to have a physical presence in the state to incur corporate income and franchise tax liabilities. Of course, once an entity assumes those tax liabilities, one way or another, it is invariably going to pass them on to the consumer, one way or another.
From the perspective of cloud computing, pricing that was once incredibly attractive and tax-free may be subject to change. It will fall to the terms of the signed provider's contract to know whether or not the end user's bill can jump to accommodate what was a previously unimaginable tax hit. But it's certainly worth paying careful attention. In communications technology, it's rarely about the quoted price and almost always about the terms.
The takeaway for enterprise users is that the tax-free days, if not over, may be nearing an end. And as always, when signing a new agreement, either read the small print or hire someone knowledgeable to do it. The costs that a professional salesperson quotes along with incentives and promotions while serving coffee and baked goods are one thing. But the devil really is in the details... particularly when taxing authorities change the rules midway through a contract's term.