Not long ago, the talking about clouds was always linked to talking about rain.  With the proliferation of online everything, such as: e-commerce, ‘the cloud’ is something totally different, but can the cloud still rain on your parade?  From a U.S. state and local income tax perspective, the forecast is changing rapidly and the chance of rain is very high.

Cloud Computing – What is it?

The U.S. Department of Commerce has referred to cloud computing as, “a model for enabling convenient, on-demand network access to a shared pool of configurable computing resources that can be rapidly provisioned and released with minimal management effort or service provider interaction”. Whatever the definition, the common consensus is that cloud computing entails a sharing of infrastructure with exceptional accessibility and often at a greatly reduced cost.

Key components of the cloud

Cloud computing has thrived due to the on-demand nature of the products and services offered.  A user can access a program via the internet, store and manipulate data from anywhere as if they were in their office at their desk.  The various programs in the cloud behave exactly as they would if you were in your local network, and often at a similar speed.

Access to the cloud is, by necessity done via network, or internet.  The ability to pool and share resources and data is one of the key features of the cloud.  A stand-alone system, not connected to other systems isn’t able to share or pool resources, so singular systems are not able to benefit from the cloud.

Cost versus Benefits are Compelling

Business use of cloud computing has grown rapidly over the past few years as the ability to increase network speed at very low cost has increased.  By being able to share resources among several departments or locations seamlessly, businesses have used cloud computing to reduce duplication of some infrastructure which greatly reduces cost of investment by business.  Consumers also regularly use cloud computing, often without stopping to consider that they are doing so.  Accessing webmail or on-line banking are examples of cloud computing that have become commonplace in current daily living.

Another benefit of cloud computing is that the services available are easily scalable to meet the needs of the user.  Because of the virtual nature of cloud computing, users can often quickly increase capacity or decrease capacity to meet current requirements.  In traditional IT models, some excess capacity is required to allow for peak usage or permanent growth.  In the cloud, that excess capacity is sold as virtual server capability.  Since users are generally acquiring capability to complete a process, not physical resources, billings are often based on usage.  Therefore, the more you use, the more you pay and vice versa.

So, Where Exactly is This Cloud?

In cloud computing, the sharing that takes place generally uses the most efficient route possible with little consideration of what that route may actually be and where the servers actually reside.  Service providers can offer excess capacity in several locations at once and a user could be accessing computing power in several different parts of the globe simultaneously.  The routing is often designed to maximize data exchange and processing, often with little regard for regulations within the jurisdiction where the data is processed or ultimately resides.

There are four traditional cloud deployment models in current use.  They are;

  • Private – a cloud within a single company
  • Public – a cloud open to the general public (e.g. gmail)
  • Community – a cloud shared by several organizations within a specific community (e.g. a university)
  • Hybrid – two or more clouds that interact without merging into a single cloud

U.S. Federal and State Tax Implications for E-Commerce

This type of technology can create difficult tax issues for businesses.  For example, an order for goods is input in one country, processed in a second country, validated and approved in a third country, drop shipped from a vendor in a fourth country and the data could reside in a fifth country.  Where does the business have a taxable presence and where does the income generated from the transaction get taxed?  These questions are complex when applied between countries, but they are just as complex when applied between the states.  The income tax laws and nexus guidance of the various states are based on twentieth century ideas that often don’t fit well onto twenty-first century technology.  For a more detailed discussion about nexus, please see our article on our website.

US State Income Tax issues

One key aspect of US state income taxes is that the income generated by a business is apportioned among the several states where the taxpayer has sufficient business activity to create nexus.  In the case of cloud computing, two questions arise.  Firstly, does having a customer in a remote state accessing your product in the cloud create nexus?  The second question is where to source the income generated from those customers.

A number of states are adopting an economic nexus standard in respect to income taxes.  These economic nexus standards often incorporate a bright-line test for nexus.  As an example, California’s legislation states that if you have more than $50,000 of property or payroll located in the state, or if more than $500,000 of your gross receipts are from California customers, or if any of your California property, payroll or sales is 25% or more of the total of that factor, then you are considered to be doing business in California and you have nexus.  In Washington, the Business and Occupation tax based on gross receipts has a sales threshold of only $250,000 before nexus is created.  In other states, the threshold may be some different amount, so we recommend that you consult with your US tax advisor before getting too far into e-commerce and cloud based services in the US.

If you have exceeded these minimums and have nexus, the second question poses even greater difficulty for most taxpayers.  Sourcing rules for sale of property are different from those used in the sale of a service.  A taxpayer must first understand if they are selling a license to use software or are they providing software as a service (“SAAS”).  Once you have determined this point, you need to understand where you allocate the gross receipts for apportioning the income.  Some of the options are;

  • the user’s physical location when they accessed the software,
  • the customer’s invoice address,
  • the location of the server accessed by the customer,
  • the location of your servers (which may be different from the server accessed), or
  • your place of commercial domicile.

Since most cloud computing is done by using excess capacity of several servers, and has built in redundancy, your customer could be accessing servers in different locations simultaneously.

As said before, there is often little guidance, although several states are working to deal with emerging issues brought on by internet commerce and cloud computing.  To be certain, the rules are generally different from state to state.  So how do you find your way out of the cloud?

AG TAX LLP Can Help

If you have any other tax-related queries, and/or need assistance with tax planning/filing please contact AG Tax. Our tax professionals are highly-experienced with U.S. and Canadian tax laws and can provide you the right guidance to handle your tax situation.

Aylett Grant Tax LLP is a full service accounting firm with a dedicated team of experts, who are highly-qualified and experienced in handling situations related to U.S., Canada and other international tax laws.

We can assist with:

  • Canadian Personal and corporate tax returns
  • Cross Border Taxation and Business Planning
  • Personal and Corporate Taxation
  • Disclosure of Foreign Assets and other information filings
  • Retirement planning
  • Estate Planning, Inheritance tax advice

To obtain a quote or to arrange for a consultation to discuss your tax related queries, please contact us at:

  • 416-238-5920 (Greater Toronto Area, ON)
  • 604-538-8735 (Greater Vancouver Area, BC)
  • 780-702-2732 (Greater Edmonton Area, AB)

Disclaimer: The information in this publication is accurate as of the time of its publication. AG Tax assumes no responsibility for changes to tax legislation subsequent to the publication of this document. The information provided is for general information purposes only and should not be acted upon without seeking professional advice. If you would like to engage our services, please contact our staff and obtain authorization to send our firm confidential information. A client relationship is not created by the transmission of information. A client relationship is only formed with our firm when a scope and engagement letter signed by the firm and the potential client detailing the terms of engagement is present.