1 Taxing the cloud A foggy endeavour The latest in our series on getting the most out of your cloud computing strategies February 2014
2 Taxing the cloud With a name as nebulous as The Cloud, it isn t any wonder that applying multiple complex tax schemes to cloud services can quickly expand into a storm of issues for any business. Huge global opportunities lie in the cloud, as discussed in our earlier publications. But too often the potential tax repercussions of a cloud infrastructure strategy are overlooked or not sufficiently considered until it s too late. A company can be blindsided by unintended tax assessments. The amorphous term cloud is truly appropriate. Electronic services and applications provided on the cloud are drawn from providers everywhere; data is kept on remote servers located in distant locales; and end products can be consumed anywhere one of the fundamental strengths of the entire system. However, it is exactly this strength that creates the complexity around taxing it (see chart on opposite page). So how do we apply tax rules to something that is difficult to define and even locate in today s digital environment? Where do we start? Income tax: permanent establishment Let s begin by looking at the international principle of permanent establishment since tax cloudiness often occurs when electronic transactions cross jurisdictional borders. International treaties generally include articles of permanent establishment that determine whether a taxpayer has a taxable presence in a particular country and the degree of the resulting taxation. The Organisation for Economic Co-operation and Development (OECD) defines permanent establishment as a fixed place of business where an enterprise is wholly or partly conducted. However, it specifically does not include facilities used for storage, collecting information or conducting auxiliary activity. In most cases, under the OECD rules, the location of a server in a particular jurisdiction, by itself, will not give rise to a permanent establishment under a treaty. Under its Model Income Tax Treaty and subsequent commentary, the OECD concludes: (1) a web site cannot, in itself, constitute a permanent establishment; (2) web site hosting arrangements typically do not result in a permanent establishment for the enterprise that carries on business through the hosted web site; (3) except in very unusual circumstances, an internet service provider will not be deemed to constitute a permanent establishment for the enterprises to which it provides services; and (4) a place where computer equipment, such as a server, is located may in certain circumstances constitute a permanent establishment, but requires that the functions performed at that place go beyond what is preparatory or auxiliary. 1 While the model treaty provides some guidance, its usefulness is limited to businesses with complicated cloud models since most determinations have to be done on a case by case basis. For example, whether the use of a server in a particular locale gives rise to a permanent establishment depends upon how core that server is to the taxpayer s business and is specific to the taxpayer s attributes. In recent years, the OECD has worked to address the complexities that arise when applying the principles of permanent establishment to electronic transactions. In October 2012, the OECD released proposed amendments to auxiliary activity within the Model Treaty, potentially allowing for additional activities to create permanent establishment. 1 The OECD commentary may be persuasive to a finder of fact in many instances, but member countries and their courts are not bound to abide by it.
3 An example of how Software as a Service (SaaS) might move around the world IaaS* Provider SaaS hosted in US IaaS* Provider Data center (USA) Desktop Data center (Ireland) Desktop SaaS hosted in Ireland SaaS* Developer (Japan) Desktop Access Access Data center (Brazil) SaaS hosted in Brazil * Infrastructure as a service. Access It is also important to remember that the OECD Model Treaty is not binding, but rather provides a model for bilateral or multilateral treaties. It is these bilateral or multilateral treaties and local tax laws that govern cross border transactions. For example, in the services income context, vigilance is particularly important. Some countries are more aggressive in terms of characterizing services payments as royalties or some other type of income subject to withholding rather than as business profits earned by an enterprise outside the local jurisdiction. Businesses must be aware of these differences in order to avoid tax pitfalls. Treaties and Local Laws When establishing international operations, it is critical that businesses be familiar with treaties and local laws and may want to consult with tax advisors having local country expertise. Many electronic transactions may present novel fact patterns that local tax authorities may have not considered previously, or businesses may simply have to contend with an aggressive jurisdiction thirsty for tax revenues. A certain level of advocacy may be necessary to settle the tax treatment in a local jurisdiction, even in the planning stages. Let s look at the United States as an example. Under the U.S. s effectively connected income ( ECI ) rules, certain types of foreign source income can be taxed in the U.S. if a company has a fixed place of business in the U.S. that is an essential element in producing the income. Among the types of foreign source income that can be taxed are rents and royalties for the use of intangible property such as patents, copyrights and formulas and sales of inventory property making some cloud services potentially taxable depending on how they are characterized. In such circumstances, companies should consider whether a treaty s permanent establishment article can be applied to their situation, providing for a favorable application of U.S. ECI rules. Jurisdictional Tax Issues In addition to country level taxes, businesses providing cloud services must also be concerned about local jurisdictional tax issues. Continuing with the U.S. example, a business may be subject to tax at the U.S. state tax level even if, under U.S. tax treaties with other countries, the business has no federal obligations. Increasingly states are taking the position that companies that derive revenue from within their respective markets have a filing obligation or nexus despite a lack of physical presence in the state. This could be a game changer for companies that attempted to isolate their physical presence in order to limit their taxable nexus with other jurisdictions. Under one argument being used by several states, an economic nexus is created when a business meets certain sales, property or payroll thresholds a concept known as factor presence.
4 Indirect tax As if the complexity around income taxes is not enough, the indirect tax issue can often be even more challenging, with rules varying from country to country. More than 150 countries have a Value Added Tax (VAT) imposed on the sale of goods and services. Businesses generally collect the tax, adding it to the price of their products and passing the cost directly on to the consumer. However, if a business is unaware that a particular transaction is subject to a VAT, or the amount of that VAT, before it has established its pricing structure, it can result in a significant hit to its profit margin. The revenue impact could be as high as 20 percent in countries such as Sweden and Norway, where the standard VAT rate is 25 percent. 2 Global companies doing business in Europe are currently confronting this type of profit threat because of a significant pending change in VAT rules for cloud services in the European Union (EU). Generally speaking, transactions involving the cloud are considered services, as opposed to goods, in most countries, including the EU. While goods are generally only subject to VAT in a country if they are in that country at the time of the sale, the situation for services is much more complicated. A supply of services can be subject to VAT where the supplier is located, where the recipient is located, and/or where the services are performed, depending on the jurisdiction and the type of service performed. Whether the recipient is a taxable business or an individual makes a big difference on who is responsible for collecting the tax and at what rate. The VAT rates and accounting requirements are different for cloud services provided by businesses to private individuals. In addition, these rules are changing significantly in the coming years, sparking concerns about profit margins and Compounding the complexity is the difficulty service providers face in defining their product. Is it a taxable or nontaxable service? It is a data processing or information service? Is it the sale or lease of tangible personal property? pricing structures. Currently, EU-based businesses that sell most cloud services to private individuals are allowed to collect VAT at the rate of the country the supplier business is located. That means that many cloud service providers, including the EU affiliates of global companies, have located in Luxembourg, which has the lowest standard VAT rate in the EU, at 15 percent. Starting January 1, 2015, these companies will instead have to pay the VAT rate of the country where their individual customers are located, which is as high as 25 percent in some countries. It is important to note that the above is true only for services classified by the EU as electronically supplied services (ESS), which include most, but not all, cloud services. Cloud services not defined as ESS are taxed differently still. The coming change puts EU businesses on a level playing field with non-eu businesses providing services to private individuals in the EU. Currently, when non-eu businesses provide ESS to private individuals residing in the EU, the transaction is still subject to the VAT rate in the country where the customer is located. Unlike in business-to-business transactions, the non-eu supplier must account for the VAT by registering and accounting with each EU country it serves, or in a single country through a special process. 2 Example: A U.S.-based company with no presence in the EU sells online games to a Swedish private individual for $10. That sale is subject to 25 percent Swedish VAT, which is presumed to be included in the price. The U.S. company will have to pay the VAT due to the revenue authorities out of the $10 received, leaving revenue of only $8 ($8 x 1.25 = $10), instead of the of the anticipated $10.
5 The above paragraphs describe the complexities of VAT collection on cloud services in just the EU. Each of the more than 100 other countries that have VAT have similarly complicated rules that vary based on the location of the supplier and provider and how the service is defined. All can have a significant impact on the bottom line price of a cloud service for a buyer. Like the VAT in Europe, the taxation of electronic transactions in U.S. states is also changing. The U.S. has no federal sales and use tax. Instead, states and municipalities are allowed to establish their own sales and use taxes. However, under federal law, each state can only require retailers with a physical presence in their particular state to collect and remit sales tax. Financially strapped states looking to increase sales tax revenue are increasingly finding new ways to meet the physical presence requirement. One of the primary ways they have done so is through what is known as click-through nexus. Click-through nexus provisions vary state-to-state, but generally require outof-state and global businesses to collect and remit sales taxes by declaring they have a physical presence in the state since they have an online tie to an in-state business or individual. The argument for physical presence is that the in-state entity helps facilitate the global retailer to sell its goods over the internet, typically by placing on its website a link to the retailer s website, hence the name click-through. The in-state entity then receives commissions from sales generated through the link. In addition to click-through nexus, some states are expanding their definition of physical presence to include anyone in the state deemed to be helping build an out-of-state or global retailer s market in the state. For example, a third-party distribution center could create nexus. And any legal challenges could soon become moot. The U.S. Congress is considering new legislation that would allow states to require global retailers to collect sales tax for sales made in their states, regardless of whether they have a physical presence. Congress has been debating this issue for years, but one bill, the Marketplace Fairness Act of 2013, is finally showing promise. The U.S. Senate passed it in 2013, but it still requires approval from the House of Representatives. Under the legislation, all online retailers that make over $1 million in U.S. sales, regardless of where the retailer is located, would be required to collect and remit sales tax to states that require it. If enacted, the tax would be collected from consumers based on where the item is shipped. The takeaway Almost by definition, cloud services are based on global computing networks that defy borders. This makes determining how they should be taxed a system traditionally based on physical location an enormously complicated task. Is a product still taxed based on the location of its servers if no people actually work where those servers are located? If a jurisdiction taxes a service at the point of use, what happens if the service is free at the point of use or the product is used in various jurisdictions? Compounding the complexity is the difficulty service providers face in defining their product is it a taxable or nontaxable service? It is a data processing or information service? Is it the sale or lease of tangible personal property? Many of these questions can only be answered on a case-by-case basis, through the evaluation of particular circumstances.
6 To have a deeper conversation about how this subject may affect your business, please contact: Pierre-Alain Sur Global Communications and US TICE Leader New York T: Christ Economos Global Communications Tax Leader New York T: John Steveni Partner, UK Communications Tax Leader London T: Thomas Nardozzi Managing Director New York T: Jennifer Jensen Director Washington, DC T: PwC. All rights reserved. PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. Please see for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. PwC helps organisations and individuals create the value they re looking for. We re a network of firms in 158 countries with more than 180,000 people who are committed to delivering quality in assurance, tax and advisory services. Tell us what matters to you and find out more by visiting us at PM
Subcommittee on Base Erosion and Profit Shifting Issues for Developing Countries A. Purpose This note provides information about the project established by the OECD and G20 to address global concerns with
Action Plan on Base Erosion and Profit Shifting Action Plan on Base Erosion and Profit Shifting This work is published on the responsibility of the Secretary-General of the OECD. The opinions expressed
www.pwc.com How does one tax the cloud? January 2012 How does one tax the cloud? Authored by: Jennifer Jensen, reprinted from the December issue of the AICPA Tax Advisor In a world where the sky is the
Global Tax practice Financial Transaction Tax Sending shock waves through global financial services 2 Global Tax practice Financial Transaction Tax Sending shock waves through global financial services
Public Discussion Draft BEPS ACTION 14: MAKE DISPUTE RESOLUTION MECHANISMS MORE EFFECTIVE 18 December 2014 16 January 2015 PROPOSED DISCUSSION DRAFT ON ACTION 14: MAKE DISPUTE RESOLUTION MECHANISMS MORE
OECD BASE EROSION AND PROFIT SHIFTING PROJECT IN AN IRISH CONTEXT Part of the Economic Impact Assessment of Ireland s Corporation Tax Policy OCTOBER 2014 OECD BASE EROSION AND PROFIT SHIFTING PROJECT IN
EUROPEAN COMMISSION DIRECTORATE-GENERAL TAXATION AND CUSTOMS UNION Indirect Taxation and Tax administration Value Added Tax Published 3 April 2014 Explanatory notes on the EU VAT changes to the place of
Trade and Investment Law Clinic Papers, 2013 Tax Base Erosion and Profit Shifting (BEPS) and International Economic Law* 7 January 2014, Geneva Submitted by Isabel Lamers Pauline Mcharo Kei Nakajima To
The post Base Erosion and Profit Shifting world The impact of tax policy and BEPS on life sciences companies kpmg.com/lifesciences KPMG International 2 3 Contents 4 Summary points 5 Executive summary 6
GUIDANCE ON REVENUE OPINIONS ON CLASSIFICATION OF ACTIVITIES AS TRADING. INTRODUCTION The introduction of the general 12½% corporation tax regime for profits from trading activities of companies is focusing
Data Protection Act 1998 Guidance on the use of cloud computing Contents Overview... 2 Introduction... 2 What is cloud computing?... 3 Definitions... 3 Deployment models... 4 Service models... 5 Layered
ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT THE GRANTING OF TREATY BENEFITS WITH RESPECT TO THE INCOME OF COLLECTIVE INVESTMENT VEHICLES (ADOPTED BY THE OECD COMMITTEE ON FISCAL AFFAIRS ON 23
Data protection Personal information online code of practice On 26 May 2011, the rules on using cookies changed. This guidance reflects the law before that date. Our advice on the new cookies Regulations
Ross School of Business at the University of Michigan Independent Study Project Report TERM : Winter 2013 COURSE : LHC 489 PROFESSOR : Dana Muir STUDENT : Blair Hagerman TITLE : E-Commerce and Sales Tax:
Guide to Doing Business in New Jersey Table of Contents Section 1 Starting a New Business 3 Getting Started 3 Elements of a Business Plan 4 Construction of a Business Plan 4 Sample Business Plan Outline
Chapter 2 Fields of Intellectual Property Protection Patents Introduction Conditions of Patentability Drafting and Filing a Patent Application Examination of a Patent Application Infringement Exploitation
Addressing base Erosion and Profit shifting Contents Executive summary Addressing base Erosion and Profit shifting Chapter 1. Introduction Chapter 2. How big a problem is BEPS? An overview of the available
A PRACTICAL GUIDE TO THE CLASSIFICATION OF FINANCIAL INSTRUMENTS UNDER IAS 32 MARCH 2013 Liability or equity? Important Disclaimer: This document has been developed as an information resource. It is intended
IFRS for Investment Funds More Than Just Accounting and Reporting Table of Contents Industry Views on IFRS for Investment Funds... 2 Other Standard Setting Considerations... 2 Challenges and Opportunities
Guide for Canadian Small Businesses RC4070(E) Rev. 08 T he success of small businesses is an essential part of Canada s economic growth. At the Canada Revenue Agency (CRA), our goal is to provide all the
Issues Paper Managing General Agencies Life Insurance Distribution Model Agencies Regulation Committee February 2011 This document reflects the work of regulators who are members of CCIR. The views expressed
Addressing Base Erosion and Profit Shifting Addressing Base Erosion and Profit Shifting This work is published on the responsibility of the Secretary-General of the OECD. The opinions expressed and arguments
Final Report of the Commission Expert Group on European Insurance Contract Law The information and views set out in this report are those of the members of the Expert Group and do not necessarily reflect
A Manager s Guide to Establishing a Hedge Fund Our partner in developing this guidebook: CONTENTS Executive Summary............................................. 3 Legal and Tax Overview for Establishing