Cloud Computing Primer

Transcription

1 Cloud Computing Primer November 9, 2010 Brett Weaver Partner International Tax - KPMG Rocky Cummings Partner National Multistate Tax Services BDO Seidman Paul Sallomi Partner - U.S. Tax Industry Leader Technology - Deloitte

2 Objectives Define Cloud Computing technology and distinguishing characteristics of a Cloud Outline reasons for and barriers to adoption Discuss activities moving to the Cloud Explore available tax technical guidance and key tax areas of uncertainty or opportunity in moving to the Cloud Q&A 1

3 What is Cloud Computing? a pool of highly scalable, abstracted infrastructure, capable of hosting end-customer applications, that is billed by consumption. James Staten, Principal Analyst, Forrester Research a style of computing where massively scalable IT-enabled capabilities are delivered as a service to external customers using internet technologies. Robert P. Desisto, Daryl C. Plummer, David Mitchel, Gartner Analysts 2

4 What is Cloud computing? (cont.) a model for enabling convenient, on-demand network access to a shared pool of configurable resources (e.g., networks, servers, storage, applications, and services) that can be rapidly provisioned and released with minimal effort or service provider interaction. Peter Mell and Tim Grance, National Institute of Standards and Technology, Information Technology Laboratory. 3

5 Cloud computing can be grouped into several types of services based on their characteristics Cloud computing technology is deployed in three general types, based on the level of internal or external ownership and technical merits Public Cloud (External) Private Cloud (Internal) Hybrid Cloud Cloud computing services from vendors that can be accessed across the Internet or a private network, using systems in one or more data centers, shared among multiple customers, with varying degrees of data privacy control. Sometimes called public Cloud computing. Computing architectures modeled after vendor Clouds, yet built, managed, and used internally by an enterprise; uses a shared services model with variable usage of a common pool of virtualized computing resources. Data is controlled within the enterprise. (Note: there can be the equivalent of a private Cloud provided by an external source and will be discussed later in the discussion.) A mix of vendor Cloud services, internal Cloud computing architectures, and classic IT infrastructure, forming a hybrid model that uses the best-of-breed technologies to meet specific needs. 4

6 Cloud computing service types have different advantages and constraints consistent with their architecture The optimal Cloud computing architecture depends on specific business needs, which can be met by different services capabilities, technology, and vendors Public Cloud (external) Quick startup time; no capital investment required Allows outsourcing of noncore functions to a service provider; yet enterprises may not be ready to turn over control of technical architecture Leverage highly scalable vendor infrastructure. Use a standardized software stack Lower initial fees, variable costs, billed by usage; however, beware of vendor lock-in Private Cloud (internal) Quick startup and flexibility of resource allocation; requires capital investment On-premise data and systems; allows direct support of governance and compliance, security, data privacy, etc; limited opportunities for reduction of staffing Good choice when possible to leverage existing staff and investments; allows control of service levels and operational reporting Hybrid Cloud (mixed) Quick startup, but integration of vendor and private Cloud adds complexity Allows best of both worlds for control of data and reduction of noncore focus Allows selection of scalable vendor infrastructure when needed; can allow internal control when required Allows fine-grained sourcing of most appropriate technology and cost profiles; integration may constrain savings potential 5

7 Cloud computing service types have different advantages and constraints consistent with their architecture Public Cloud (external) Private Cloud (internal) Cost savings through leveraging virtualization and grid technology to increase resource utilization and lower internal costs Hybrid Cloud (mixed) 6

8 Major Cloud computing categories: Infrastructure, platform and software services Cloud computing categories can be segmented by type into specific functions Service type category as a Service (SaaS) Platform as a Service (PaaS) Infrastructure as a Service (IaaS) Description of service and IT Function SaaS covers the range of application that are licensed for use as services provided to customers on demand typically across the Web. The PaaS model makes all of the facilities required to support the complete life cycle of building and delivering Web applications and services entirely available from the Internet. IaaS is the delivery of computer infrastructure as a service. Rather than purchasing servers, software, data center space, or network equipment, clients instead buy those resources as a fully outsourced service. 7

9 Infrastructure as a Service (IaaS) is a cost-effective approach for rapidly enabling IT services IaaS vendor capabilities will advance pricing as a driving factor Service offering attributes IaaS is a Cloud computing offering facilitating the delivery of computer resources as a service. IaaS enables a client to buy resources as a fully outsourced service rather than purchasing servers, software, data center space, or network equipment with the advantage of near instantaneous scalability, upward or downward, providing cost-effective and flexible solutions. Elasticity and scalability Ability to continue to retain the same level of service while quickly allowing infrastructure components to be scaled upward or downward in a timely fashion throughout the entire software development lifecycle ( SDLC ) Standardized IT-based capability Ability to provide the same quality of service as existing on-site infrastructure, such as communication infrastructure, help desk availability, servers, storage, etc, so that service level to end users are not impacted Service offering attributes Elasticity and scalability Standardized IT-based capability Service Industry Leaders (per Forrester) Amazon Web Services Amazon Web Services IBM and HP 8

10 Platform as a Service (PaaS) is a cost-effective approach for application development and deployment Developer affinity, tools, and requirements will be a driving factor in determining the solution approach Service offering attributes PaaS is a delivery model that manages the facilities required to support the complete life cycle of building and delivering applications and services from the Web. Application base and support Ability to provide services to support the development life cycle with all the required tools to provide a quality product, including but not limited to, version control, source code control, integration with existing tools, etc. Elasticity and scalability Ability to provide the same level of service for development processes while quickly allowing upward or downward scalability of services as development teams ramp up or down during phases the SDLC Developer affinity, customer service, and enterprise presence Ability for developers to utilize existing skill sets with various tools available to provide the same quality of service throughout application development Sustainable market presence within PaaS 9

11 Platform as a Service (PaaS) is a cost-effective approach for application development and deployment (cont.) Service offering attributes Application base and support Elasticity and scalability Enterprise presence Industry leaders (per Forrester) Google, Mircosoft and Salesforce.com Google, Salesforce.com, Amazon Web Services Google Apps and Salesforce.com 10

12 as a Service (SaaS) offerings are expanding into more enterprise business functions SaaS industry sector will continue to expend resources to address security concerns Service offering attributes SaaS is a delivery model allowing for on-demand licensing of software services providing a costeffective alternative across the web. Accessibility and Reliability Ability to easily, consistently, and frequently access services offerings within SaaS when required due to the critical use of software services for end users of supported business operations Standardized IT-based capability, cost Ability to provide the same quality of service as existing on-site software vendors, such as timely deployment of critical patches, configurability due to multitenancy on the Cloud, etc. service and enterprise presence Sustainable market presence within the SaaS service offering and ability to provide customer service comparable to licensed software products, such as SAP and Oracle. Service offering attributes Accessibility and Reliability Cost Enterprise presence Industry leaders (per Forrester) Salesforce.com Google and Microsoft Salesforce.com 11

13 Vendors offer many different services within the three major categories of Cloud computing Infrastructure-as-a-Service Amazon Web Services Provide on-demand Cloud computing services using variable cost model Amazon Virtual Private Cloud Provide fully private Cloud services model using the Amazon Cloud infrastructure Mozy.com Provides back-up services over the Internet Platform-as-a-Service Google Applications Allows Web applications to be deployed on Google s architecture Microsoft Windows Azure Cloud computing architecture that is offered to host.net applications -as-a-service Relationship Management Salesforce.com myerp.com Oracle On-Demand Business Intelligence SAS Suite of On-Demand Applications Vitria M30 Human Resources Oracle Peoplesoft NetSuite epayroll Production and Collaboration Gmail, Google Apps 12

14 Reasons to move to Cloud Reasons (characteristics) companies are moving towards Cloud computing: Internet based, portable, accessible from anywhere Low up-front cost, no capital outlay Scalable enterprises of all sizes can seamlessly scale their services depending on client demand. A pay as you grow concept No hardware or software upgrades (outsourced business technology platforms and facilitated by massive data centers): Users do not have to administer periodic software updates, plan for hardware upgrades, or add serves to keep pace with capacity 13

15 Reasons to move to Cloud (cont.) Users are able to take advantage of highly specialized professionals that leverage off of a large client pool, and Users can more easily plan annual budgets 14

16 What are the barriers to adoption? Common concerns Security and data ownership Loss of control of information Legal and regulatory concerns of borderless utility of the Cloud Tax implications Risk and compliance issues Long-term stability questions Lack of software support Few big name vendors with mature offerings Too few enterprise references No turning back? 15

17 As interest in Cloud computing grows, vendors are responding with expanded services We can t predict the future, but that hasn t stopped us from trying...deloitte and industry analysts are projecting continued growth and increased enterprise adoption of Cloud Computing in the future Cloud Computing growth will exceed 20% CAGR in the next few years Enterprises will move to Cloud services out of economic necessity Google and Amazon will expand their footholds among start ups and small companies, making inroads at larger enterprises Microsoft Azure services will gain strength among.net users 16

18 As interest in Cloud computing grows, vendors are responding with expanded services (cont.) Major application vendors, such as Oracle, will introduce new Cloud services Cloud computing start ups will continue to be funded and drive innovation As services mature, operational integrity, vendor lock-in, SLAs, and exit strategies for clients will become less of a risk to enterprise adoption Emerging data security standards in the Cloud will increase adoption by larger enterprises Market winners and losers will emerge as vendors gain market share 17

19 Tax Technical Considerations 18

20 Characterization of Income Stream from Computer Programs Issue Transaction Flows What is the federal income tax characterization of a payment received by OpCo from a : Sale, Rent, or Services? (AsiaPac) CloudCo () Foreign OpCos UK Host Payment $$ (EMEA) Payment $$ Payment $$ Relevant Authority Classification of transactions involving computer programs [Treas. Reg ] Analysis Sale The transfer of a computer program constitutes a sale where there has been a transfer of all substantial rights or all benefits and burdens of ownership have been transferred. Conclusion: The transaction should not constitute a sale since the does not possess the following rights: The unrestricted right to use the software in perpetuity (the will have no right to the software upon termination of the subscription or failure to make payment); 19 The right to transfer the software to a third party.

21 Characterization of Income Stream from Computer Programs (Cont.) Issue Transaction Flows What is the federal income tax characterization of a payment received by OpCo from a : Sale, Rent, or Services? (AsiaPac) CloudCo () Foreign OpCos UK Host Payment $$ (EMEA) Payment $$ Payment $$ Relevant Authority Classification of transactions involving computer programs [Treas. Reg ] Analysis Rent The transfer of a computer program may constitute a lease where less than all benefits and burdens of ownership have been transferred. Conclusion: The transaction should not constitute a lease. There is a question whether there is a transfer of the software to the. The does not receive a copy of the software. However, the does have significant control over the software. The does not have a possessory interest in the software. For example, the customer cannot use the software on its own computer. Rather, the may only use the software when connected to the 20

22 Characterization of Income Stream from Computer Programs (Cont.) Issue Transaction Flows What is the federal income tax characterization of a payment received by OpCo from a : Sale, Rent, or Services? (AsiaPac) CloudCo () Foreign OpCos UK Host Payment $$ (EMEA) Payment $$ Payment $$ Relevant Authority Six factor test to determine characterization of certain contracts for providing services [IRC 7701(e)] See e.g., Tidewater Inc. v. Analysis Services: Reg. Sec provides little guidance to identify a service transaction outside contract R&D services. Authorities outside the Sec. 861 regulations are helpful. Sec. 7701(e) provides guidance for determining whether a transaction is a lease or service transaction. The six-factor test: Physical Possession does not take physical possession of the software. Supports services characterization. Control does not control access to the software. Supports services characterization (but see Tidewater case). Economic or Possessory Interest is not responsible for any costs associated with maintaining the software and s risk of loss is limited to its access of the software. Supports services characterization. Substantial Risk of Nonperformance We assume the would have a claim against OpCo for failure to host the software (e.g., the servers go down ). Supports service characterization. 21 Concurrent Use does not have exclusive access to the hosted software which is

23 Characterization of Income Stream from Computer Programs (Cont.) Issue Transaction Flows What is the federal income tax characterization of a payment received by OpCo from a : Sale, Rent, or Services? (AsiaPac) CloudCo () Foreign OpCos UK Host Payment $$ (EMEA) Payment $$ Payment $$ Relevant Authority Six factor test to determine characterization of certain contracts for providing services Analysis Conclusion: payments to Vendors should constitute payments made for services. The majority of the Sec. 7701(e) factors indicate the transaction is a service transaction. The has access to updates and improvements to the software. [IRC 7701(e)] See e.g., 22

24 Source of Income Issue Transaction Flows What is the source, for federal income tax purposes, of the payments received by OpCo from a? (AsiaPac) CloudCo () Foreign OpCos UK Host Payment $$ (EMEA) Payment $$ Payment $$ Relevant Authority Income from sources within the and Income from sources without the [IRC 861(a)(3); 862(a)(3)] Analysis Federal Tax Treatment of Services Income Services income is sourced based on where the services are performed [IRC 861(a)(3)]. Where are services performed in a Cloud Model? Are services performed on the s computer when the accesses the hosted software? Are services performed over the internet? Are services performed on the server which hosts the software? Are services performed where people functions necessary to hosted 23

25 Source of Income (Cont.) Issue Transaction Flows What is the source, for federal income tax purposes, of the payments received by OpCo from a? (AsiaPac) CloudCo () Foreign OpCos UK Host Payment $$ (EMEA) Payment $$ Payment $$ Relevant Authority OECD Commentary to Article 5 Treasury s White Paper, Selected Tax Policy Implications of Global Electronic Commerce Analysis Applicable authorities would look to where the servers are located if there are limited or no people functions in providing the services Conclusion: OpCo should earn foreign source EMEA services income because its services are performed on servers located outside the. OpCos should earn source AsiaPac services income because their services are performed on servers located in the. Observation: The s rules for sourcing electronic services income often differs from similar rules in other countries. For example, many countries source payments for such services to the location of the payer. Additionally, VAT is typically imposed based on customer location. OpCo should be mindful of this 24 fact when structuring future cloud computing arrangements and the impact these

26 Subpart F Considerations Issue Transaction Flows Will the activities of OpCos generate subpart F income? CloudCo () Host Payment $$ UK (AsiaPac) Foreign OpCos (EMEA) Payment $$ Payment $$ Relevant Authority Subpart F [IRC 954(e)(1); Notice ] Analysis Foreign Base Company Services Income Services income earned by a CFC is FBCServI if the services are performed for or on behalf of a related party outside of the CFC s country of incorporation. Substantial Assistance FBCServI may also be generated if a CFC receives substantial assistance (>80%) from a related party in providing the services. Services performed by a CFC will constitute services which are performed for, or on behalf of, a related person in a case where substantial assistance by a related person or persons contributes to the performance of such service. Substantial assistance consists of assistance furnished (directly or indirectly) by a related person or persons to the CFC if the assistance satisfies an objective cost test. The objective cost test will be satisfied if the cost to the CFC of the assistance furnished 25 by the related person or persons equals or exceeds 80 percent of the total cost to the CFC of performing the services. The term "cost" will be determined after taking into account

27 ROW s Subpart F Considerations Issue Transaction Flows Will the activities of OpCos generate subpart F income? Third Party CloudCo () Host Payment $$ UK UK (AsiaPac) Foreign OpCos (EMEA) Payment $$ Payment $$ Relevant Authority Subpart F [IRC 951; 954] Analysis 3P Hosting Conclusion: OpCos contract with the, and in turn with 3rd Party, a third party, to provide the software on 3rd Party servers in the. This fact, coupled with the assumption that OpCos are not doing fulfillment through CloudCo indicates that the OpCos are not providing services for or on behalf of a related party. Additionally, if OpCo s income is effectively connected, it will not be subpart F income. RP Hosting Conclusion: If OpCos pay CloudCo for fulfillment, instead of 3rd Party, OpCos may have FBCServI as a result of the substantial assistance rules. E.g., if CloudCo provides fulfillment services on behalf of OpCos and the cost of such services amounts to more than 80 percent of the total cost to OpCo of performing the services, OpCo would be considered to receive substantial assistance from a related party. Observation: If the contractual arrangements were structured whereby an EMEA 26 were to contract directly with CloudCo (rather than OpCo) for the cloud services, FBCServI would be generated since OpCo would then be performing services

28 AsiaPac s Trade or Business/Effectively Connected Income Issue Transaction Flows Is OpCo engaged in a trade or business? CloudCo () Host Payment $$ Order placement UK (AsiaPac) Foreign OpCos (EMEA) Payment $$ Payment $$ Relevant Authority Trade or Business [IRC 864(b), the Treasury Regulations thereunder, and numerous judicial and administrative rulings related thereto (determination of a trade or business is a facts and circumstances Analysis Trade or Business A foreign person will generally be found to be engaged in a trade or business if such person conducts continuous and regular activity in the either through its own activities or activities conducted through an agent (express or implied). Typically a very low threshold triggers trade or business status. The courts have found that the economic activities necessary to create a trade or business generally involve a geographically relevant asset or activity combined with human intervention. o The mere purchase of services from an independent service provider (that provides such services within the United States) should not constitute a trade or business for the foreign principal. o However, if the service provider constitutes an agent of the foreign principal, the service provider may cause the foreign principal to have a trade or business. Even an 27 independent contractor does not necessarily insulate the foreign principal from being attributed the independent contractor's trade or business, but there is less risk that the

29 AsiaPac s Trade or Business/Effectively Connected Income (Cont.) Issue Transaction Flows Is OpCo engaged in a trade or business? CloudCo () Host Payment $$ Order placement UK (AsiaPac) Foreign OpCos (EMEA) Payment $$ Payment $$ Relevant Authority Trade or Business [IRC 864(b), the Treasury Regulations thereunder, and numerous judicial and administrative rulings related thereto (determination of a trade or business is a facts and circumstances Analysis Conclusion: OpCo should be considered to have a trade or business by virtue of the fact that CloudCo s -based servers are accepting orders from s on behalf of OpCo. Further, even if order acceptance was shifted outside the United States, there would continue to be risk that OpCo would have a trade or business due to servers hosting the software provided by OpCo. Query: Would the Conclusion differ if the software was hosted by a 3rd Party in the? Planning Point: To avoid trade or business status, OpCo should 28 consider (a) moving the order acceptance function outside the, and (b) ensuring that its third-party hosting service provider provides such services

30 AsiaPac s Trade or Business/Effectively Connected Income (Cont.) Issue Transaction Flows If OpCo is engaged in a trade or business, is the source income received by OpCo effectively connected ( ECI ) with the trade or business? (AsiaPac) CloudCo () Foreign OpCos UK Host Payment $$ (EMEA) Order Placement Payment $$ Payment $$ Relevant Authority Effectively Connected Income [IRC 882] Analysis Effectively Connected Income Section 882(a)(1) taxes (at graduated rates including relevant deductions) a foreign corporation on taxable income which is effectively connected with the conduct of a trade or business within the. Specifically, a foreign person s source services income will be effectively connected with a trade or business if one of the following two tests is met: i) an asset use test; or ii) a business activities test. o Under the asset use test, source income is treated as effectively connected if the income is derived from assets used in, or held for use in, the conduct of the foreign person's trade or business. o Under the business activities test, source income is treated as effectively connected if the activities of the trade or business were a material factor in the realization of the income. To the extent that a foreign person s source income is not ECI, such income will be taxed at a gross rate of 30 percent without the ability to offset such income with attributable expenses. Subpart F income and ECI Subpart F income does not include any item which is source income effectively connected with a trade or business. 29 However, if source ECI is exempt from tax, or subject to a reduced rate of tax, pursuant to a treaty, then the characterization of such income would revert back to subpart F income. [IRC 952(b).]

31 AsiaPac s Trade or Business/Effectively Connected Income (continued) Issue Transaction Flows If the income is not ECI, how will it be taxed by the? Third Party UK CloudCo () UK Host Payment $$ Order Placement (AsiaPac) Foreign OpCos (EMEA) Payment $$ Payment $$ Relevant Authority Analysis Taxation of FDAP Income [IRC 881(a)] Conclusion: The based assets and activities that cause OpCo to have a trade or business should be the assets and activities to be analyzed to determine whether OpCo s income is effectively connected. Assuming only 3rd Party hosting and CloudCo s order acceptance activities in the, there is risk that these activities (or assets) would be insufficient to cause OpCo s source services income to be effectively connected. In this case, OpCo s income would be subject to 30 percent gross basis taxation under section 881 (unless treaty applies). In comparison to (a) the marketing, selling, and customer-facing activities of OpCo that are conducted outside the and (b) the activities/assets of 3rd Party (assuming they do not cause OpCo to have a trade or business), the CloudCo order acceptance activities may not be viewed 30 as a material factor in the realization of OpCo s software services income.

32 EMEA s Source of Income Considerations Trade or Business Issue Transaction Flows Will OpCo be engaged in a trade or business by virtue of its activities associated with its EMEA customer software offerings? (AsiaPac) CloudCo () Foreign OpCos UK Host Payment $$ (EMEA) Payment $$ Payment $$ Relevant Authority Trade or Business and/or Source Income Analysis Trade or Business The determination of whether a foreign person is engaged in a trade or business is generally a facts and circumstances analysis. Foreign persons may be engaged in a trade or business through their own activities or activities conducted through an agent (express or implied). As discussed on a prior slide, the location of the servers providing the software offering will generally drive the characterization of the source of the income received. Since the servers are located in the UK, no source income should be generated. Even if OpCo had a trade or business (and a permanent establishment), foreign source services income, by definition, is not effectively connected income. 31 Planning Point: Although not the focus of this analysis, it should be noted that the UK tax

33 AsiaPac s Permanent Establishment Considerations Issue Transaction Flows Does OpCo have a Permanent Establishment in the? Third Party UK (AsiaPac) CloudCo () Foreign OpCos UK Host Payment $$ Order Placement (EMEA) Payment $$ Payment $$ Relevant Authority Analysis Permanent Establishment Provisions of the Respective OpCo Jurisdiction- Treaty E.g., Canada, India, Japan Permanent Establishment A PE is a fixed place of business through which the business of an enterprise is wholly or partly carried on. Activities conducted by a person, whether related or unrelated to an enterprise, may create a PE for an enterprise if such persons are dependent agents. E.g., persons, whether or not employees of the enterprise, who are not independent agents, and have the ability to bind the enterprise. Third Party (3rd Party) should not be considered a dependent agent of OpCo(s) because 3rd Party is legally and economically independent and does not otherwise act for or on behalf of OpCos. o However, CloudCo may be considered an agent of OpCos in the since CloudCo binds OpCos as it accepts orders on behalf of the OpCos on CloudCo s server. Conclusion: As a result of CloudCo acting as a de facto agent of OpCos, OpCos may be considered to have a PE. Under most treaties, a PE will result in the same taxation as results under domestic tax law. If OpCo had a PE, but its source software services income was not attributable to the PE, many Other Income articles under treaties will exempt such income from taxation, including gross basis FDAP income taxation. Planning point: Where there is risk of FDAP taxation, CloudCo may simply wish to structure all contracts with itself and pay the OpCos a marketing fee. This should avoid the potential FDAP problem. Consider impact on tax deferral planning. 32

34 Other Common Cloud Computing Issues Sourcing of Royalties Issue Transaction Flows What is the source of Parent s royalty income? Third Party () Servers UK Royalty CloudCo () Foreign OpCo (Canada) Order placement Relevant Authority IRC 861(a)(4); 862(a)(4) Rev. Rul FAS SNI Netherlands Case Analysis Sourcing of Royalties Royalties for patents, copyrights, and trademarks are sourced based on place of use. Conflicting authorities exist further complicated with difficult cloud computing facts. More clarity for copyright royalties (e.g., Rev Rul ) FSA muddies the water for software royalties Patent authorities are mixed Possible relevant facts include: server location, customer billing address, customer location at time of use, technical support function, sales force, 33etc. Conclusion: For copyright royalties, place of consumption seems quite

35 Cloud Computing Primer Multistate Tax Issues The analytical framework for resolving state tax issues related to Cloud Computing is simple, but applying antiquated state laws to the analysis creates difficulty and uncertainty. The framework is: Is there nexus? Sales Tax Is the transaction taxable? Income Tax How is the income apportioned? Service rules, sale of tpp? 34