TIP on Tax: How cloud computing providers can weather the on-going tax storm

Transcription

1 TIP on Tax: How cloud computing providers can weather the on-going tax storm By Joel Waterfield, Director, State and Local Tax Services and Steve Skiba, Director, State and Local Tax Services As cloud providers expand their service offerings, taxing authorities struggle to keep pace. Though many tax jurisdictions haven t fully addressed legislation related to the cloud, they are looking more closely at providers to see where more revenue might be collected. Recent tax audits have identified areas that could result in significant exposure for companies operating in this space. In this TIP on Tax article, we ll provide tips for providers on navigating the various tax regulations related to the cloud, many of which have not been updated since authorities considered taxing electronic downloads more than a decade ago. We ll also offer some specific business and contracting suggestions to help avoid unpleasant tax surprises. Key takeaways We expect that tax guidance on cloud transactions will increase in the near term, but we are probably still a few years away from seeing the laws codified that will become the norm for these types of transactions. Cloud providers must take a new look at areas of potential risk, such as nexus, points of origin and delivery and transaction details. Contracts and documents must be amended to show details of each agreement and what is being provided. Tax authorities take a new look at cloud computing Though certain types of cloud computing activities have been offered as services for more than a decade, only recently have taxing authorities considered them a source of revenue. As software license revenues have diminished, state and local taxing jurisdictions have been forced to look for new sources of income to offset the reductions. One area they are considering is the cloud. The variety of cloud computing services has expanded tremendously in the past few years. As customers overcame their initial reluctance to receive services virtually, the number of transactions increased, drawing the attention of state and local taxing jurisdictions. Legislation still lags behind cloud industry innovation Though there is more focus on creating new tax laws, developing legislation is a long and difficult process, as evidenced by the recent fiscal cliff and debt ceiling debates. Because of this, most state and local taxing jurisdictions have attempted to use the laws and regulations already in existence; however, these laws were not crafted with cloud transactions in mind. Instead, the laws assumed vendors were dealing with a product they could put their hands on, whether building it or delivering it. As providers in the cloud know, the medium is not so clear-cut. For instance, a cloud provider may host a platform as a service (PaaS) on multiple servers, which are located in different countries and used by customers around the world.

2 That s a big cloud There are many types of activities that fall within the scope of cloud services, including: software as a service (SaaS), infrastructure as a service (IaaS), platform as a service (PaaS), business process as a service (BPaaS ), database as a service (DBaaS), data storage as a service (STaaS), data as a service (DaaS), security as a service (SECaaS), API as a service (APIaaS), and backend as a service (BaaS). The bottom line is that international, federal, state and local tax guidance is finally evolving to capitalize on the increasing number of cloud transactions; however, tax changes are occurring at a much slower pace than the technology is being adopted. We do expect tax guidance on cloud transactions to increase in the near term, but we re still a few years away from laws being codified that will become the norm for taxing these types of transactions. Areas of potential tax exposure for cloud companies Nexus In general, nexus means a connection. In tax law, a nexus describes a situation in which a business has a presence in a state, making it subject to taxes there. For cloud providers, it can be difficult to determine nexus because offices, servers, employees and customers are not all in the same place. For instance, a cloud provider may have employees based in the company s Delaware office who telecommute from homes in Maryland. Are the employees activities in Maryland enough to create nexus there? Another company may use a vendor s network to provide cloud services and the vendor s network is critical in delivering the services. Does this mean nexus has been established in the locale where the vendor is based? These are the types of questions you need to address. Points of origin and delivery Many cloud services have multiple points of origin and destination, which can make it difficult to answer tax audit questions, such as: Does your company designate a point of origin? Does it designate a point of delivery? What is the rationale for these designated points? When companies are unprepared to answer questions like these, auditors may wonder whether revenue and income are properly apportioned and taxed. If it is determined that the apportionment is incorrect, the company could be liable to remit taxes, penalties and interest to the state where they underreported. In addition, the company may not be able to claim a refund in the state where they overpaid because too much time has passed. Transactions Cloud agreements often charge a single fee for a bundle of services, which could include software licenses, hosting, tech support and data analytics. Each service may be taxed differently, however, making it difficult to determine when and where sales tax, use tax and value-added tax (VAT) should be collected. When considering taxes related to transactions, ask yourself if your company charges a single fee for a bundled transaction and if any consideration has been given to invoicing the taxable items separate from the nontaxable items. Otherwise, there is increased risk that a taxing authority will assert that the entire single fee is taxable. Financial statements You will need to assess whether you want to recognize liabilities for uncertain tax positions taken on income tax returns (under ASC 740) and for contingencies associated with exposure related to sales tax, use tax and VAT (ASC 450). In addition, you may need to increase disclosures around the nature of these tax risks and their potential financial implications. 2

3 Contract amendments To mitigate some tax risks, you should amend contracts to provide greater visibility into where cloud services are being provided. In addition, you should put in place ongoing monitoring mechanisms to detect any changes. Negotiating these new provisions in service contracts may be difficult, but it is necessary. Why changing standard contracts is necessary Take the example of a Virginia-based vendor who agrees to provide cloud services to a customer headquartered in California. The vendor s contract spells out the types of services they will provide (e.g., DBaaS and SaaS) and will list the customer s headquarters as the mailing and shipping address. According to the contract, the origin and delivery points seem clear-cut. In reality, the customer has locations throughout the country that are filled with staff and contract employees, some of whom also work from home. The vendor s network equipment is in three separate locations. The vendor s employees are located at the network sites, while management works out of a separate headquarters. There is also a small sales force that doubles as trainers and routinely travels to the offices of customers and prospects. The vendor has a third party that provides additional support; however, the physical location of the third-party support is unknown. While both the vendor and customer understand the complexities of cloud service transactions, there is no documentation to define or confirm how the different points and services are typically bundled and invoiced on a monthly basis, all of it classified as cloud computing services. To auditors, this situation is anything but clear. To better understand the details that could affect taxes, cloud services providers should: map out the type and location of its equipment annually; determine and document the location of its employees and their typical business travel patterns quarterly; and review the customer service offerings to determine what exactly is being sold on an as-needed basis, which is often multiple times per quarter. In addition to completing the above activities, cloud providers must also understand how and where customers are benefiting from the services being received. In other words, you must consider both your own facts and customer-centric information to determine how to properly tax a transaction in various jurisdictions. With this knowledge, you should add new disclosures, representations and warranties to customer contracts. This will give customers the responsibility of identifying where the services will be consumed or where the benefit from services will be received. You should then devise processes to monitor and communicate with clients, identifying any changes that occur related to multiple points of use and multiyear contracts. Price points As governments begin to interpret how to tax cloud transactions and enact new tax legislation to do so, you will need to evaluate whether your costs will increase as a result. If so, you may need to change your pricing. 3

4 Changes to your documentation Because tax authorities have different regulations for the various types of products and services, it is crucial that you have up-to-date documentation that breaks down the monthly fee by the cost of each deliverable. Such documentation does not need to be shared with the customer, but it does need to be put in place when the contract is executed and then updated for modifications, renewals, extensions or other business changes. Without this evidence, it may be difficult to defend tax positions. Contracts and invoices should describe in detail the services being provided to the customer. Services could include hosting, maintenance, data analysis, configuration and testing. Some customers may be exempt from the tax or are self-assessing the tax. Cloud providers should make sure that they have updated exemption certificates and direct-pay documentation from their customers. Without the detailed documentation of what s being provided, tax authorities will generally presume the entire billing is subject to sales tax, use tax or VAT withholding. Keep in mind Software licenses may also be provided on a revocable basis to the customer. Depending on the jurisdiction, certain products, licenses or services may actually be nontaxable, at least from a sales/use tax perspective. 4

5 What you should do now 1. Take time to analyze and document your company s operation to better understand the potential tax consequences of your specific cloud offerings. You will likely discover issues that require your immediate attention. 2. After completing your analysis, you may want to open a dialogue with your customers to identify ways you can work together to ensure tax compliance. You may also need to amend existing agreements to include appropriate customer representations, warranties, disclosures and periodic monitoring procedures. 3. Start to build relationships between your tax team and your customers tax advisers. Allow both to have a voice in negotiations. Including the tax teams will help identify potential issues and solutions early in the process. 4. Stay abreast of developments in this emerging area of taxation. State, local, national and international governing bodies continue to evaluate legislative changes, leading to an increase in audits by tax authorities. Consult a tax professional to make sure current guidance is being applied to your situation. This article provides high-level information on a few of the tax consequences of providing cloud services, but it is far from all-encompassing. Tax issues related to the cloud are everchanging. With careful planning, your company can stay protected. For more information, please contact the authors: Joel Waterfield Director, State and Local Tax Services T E joel.waterfield@us.gt.com Steve Skiba Director, State and Local Tax Services T E steve.skiba@us.gt.com For additional articles in this series, please refer to About Grant Thornton LLP The people in the independent firms of Grant Thornton International Ltd provide personalized attention and the highest quality service to public and private clients in more than 100 countries. Grant Thornton LLP is the U.S. member firm of Grant Thornton International Ltd, one of the six global audit, tax and advisory organizations. Grant Thornton International Ltd and its member firms are not a worldwide partnership, as each member firm is a separate and distinct legal entity. Tax professional standards statement This document supports the marketing of professional services by Grant Thornton LLP. It is not written tax advice directed at the particular facts and circumstances of any person. Persons interested in the subject of this document should contact Grant Thornton or their tax advisor to discuss the potential application of this subject matter to their particular facts and circumstances. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed. To the extent this document may be considered written tax advice, in accordance with applicable professional regulations, unless expressly stated otherwise, any written advice contained in, forwarded with, or attached to this document is not intended or written by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding any penalties that may be imposed under the Internal Revenue Code. The information contained herein is general in nature and based on authorities that are subject to change. It is not intended and should not be construed as legal, accounting or tax advice or opinion provided by Grant Thornton LLP to the reader. This material may not be applicable to or suitable for specific circumstances or needs and may require consideration of nontax and other tax factors. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Grant Thornton LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. No part of this document may be reproduced, retransmitted or otherwise redistributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, re-keying or using any information storage and retrieval system without written permission from Grant Thornton LLP. Grant Thornton LLP All rights reserved U.S. member firm of Grant Thornton International Ltd 5