KPMG TaxWatch. State and Local Tax Implications of Cloud Computing

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1 KPMG TaxWatch Webcast State and Local Tax Implications of Cloud Computing June 28, 2012 ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. 2 1

2 Today s Presenters Harley Duncan, Tax Managing Director, State and Local Tax, Washington National Tax Jennifer Petersen, Partner, State and Local Tax Christine Bustamante, Tax Managing Director, Global Relocation and Expansion Services Grady Cunningham, Partner, State and Local Tax Telecommunications 3 Administrative CPE regulations require online participants take part in online questions You must respond to a minimum of four questions per 50 minutes in order to be eligible for CPE credit Polling questions will appear on your media player on top of the slides Results will be reviewed in aggregate and may be published as a pulse survey of the marketplace in the aggregate. Please note that no responses will be tracked back to any individual or organization To ask a question, use the Ask A Question icon on your media player or send an to us-taxwatch@kpmg.com Help Desk: or outside the U.S. at

3 Agenda Introduction State of the states Data center investment incentives Telecommunication and billing issues Q&A 5 State of the States 6 3

4 Essential Characteristics of Cloud Computing Relies on network connectivity - Computing resources -- software, hardware, utilities and data -- commonly accessed remotely rather than being resident on user hardware Metered usage - Charges are on a "pay as you go" basis often as opposed to acquistion, licensing or other forms of ownership Multi-tenancy - Multiple users from multiple customers of cloud provider may be using same resources Broad range of services - Availability of services runs from access to software to access to full range of computing capacity, including servers, storage, network communications and software 7 Characteristics of State-Local Taxes Retail sales tax Sales/leases of tangible personal property and enumerated services taxable Relies on some form of acquisition, transfer, delivery or ownership/possession of property Relies on precise definition of taxable services Relies on known destination of property or place of use of service Corporation Income tax Nature of the income is significant -- sale of TPP, sale of service, sale of intangible or something else Where TPP is destined, where activities are performed or where benefit is received are important 8 4

5 Issues in Taxation of Cloud Services Characterization What is the character or nature of the transaction or income -- sale of TPP, enumerated service? Sourcing Based on character of transaction, which state has the right to tax the transaction or income? 9 Complexities Created by Cloud Services Sales tax characterization Sale/lease of TPP -- no transfer or delivery; no acquisition and (possibly) no license Enumerated service -- May be a continuum -- access to software, data processing, use and manipulation of user or provider data True object -- what is the intent of the user Sales tax sourcing What is the destination? Where does use occur? Where is benefit of service received? Dealing with users in multiple states? Avoiding duplicate taxation 10 5

6 Complexity (cont'd) Income tax characterization Similar characterization issues Is it a sale of property, lease of property, provision of a service or something else Income tax sourcing Dependent on characterization Added complexity of determining income producing activity and costs of performance if characterized as income from services 11 At the End of the Day State laws have not kept up with business model innovations and this is certainly true for cloud computing As businesses and consumers move from buying technology in tangible form to buying technology as a service, they are seeking ways to reduce risk so as to move forward with deployment States are trying to fit the square peg of new services into the round hole of laws last updated in the 1970 s As a result, many states are attempting to tax cloud transactions using tax rules established for sales of tangible personal property Much guidance is necessarily provided with a view toward the impact on the state s tax base State government is reluctant to enact new statutory taxing regimes for cloud computing because this type of change is viewed as a tax increase As a result, much of the cloud computing tax guidance has been developed through rulings and audit positions There is significant uncertainty due to lack of guidance 12 6

7 State of the States - Sales Tax Characterization How are states characterizing cloud-based service transactions? Tangible Personal Property (TPP) e.g., New York, Indiana, Massachusetts, Pennsylvania Information, Data Processing, Digital Automated, or Other Computer Services e.g., Texas, Ohio, Washington, New York, New Jersey Communication Services e.g., South Carolina Personal Service or Intangible Right e.g., Virginia, Tennessee Rental or Lease of TPP e.g., Arizona, City of Chicago 13 State of the States - Sales Tax Characterization (cont d) Factors affecting characterization may include: Terms of agreement Description of service Is there an explicit technology or other license? Level of customer use and control over software Invoice Invoice Description Bundled transactions Are some items provided at no charge (e.g., initial download)? True Object 14 7

8 State of the States Sales Tax Characterization (cont d) Limited guidance available Sales tax on invoice may not be accurate Challenges from different taxability views between vendors and customers Guidance generally in the form of rulings Washington Draft Rule provides guidance on the taxability of digital goods and services New York has issued numerous rulings on the taxability of cloud transactions Massachusetts and Texas have issued a number of rulings Pennsylvania Ruling No. SUT changes the state ss prior position 15 State of the States Sales Tax Sourcing How are states sourcing cloud-based service transactions? Many potential options, but generally look to user location or billing address Streamlined sales tax (SST) provides some guidance in member states Vendor and customer communication is important Sourcing based on multiple points of use may be very beneficial Proper documentation is critical Billing system challenges 16 8

9 State of the States Income Tax Sales of tangible personal property Generally sourced based on destination Sales of other than tangible personal property presumably to include sales of services, intangibles and other non-tpp receipts Generally sourced based on location of the costs of performance (greater or relative/proportional) Are third party costs included? Data centers? Back office? Some states use market sourcing No definitions for TPP provided As a result we see some transporting of sales/use tax definitions In general very limited income tax guidance for cloud transactions Microsoft Corp. V. Franchise Tax Board, CGC Ca. Sup. Ct., 02/17/2011 may provide some guidance on characterization 17 Data Center Data Center Investment Incentives 9

10 Data Center Case Studies Examples of Major Data Center Projects $1 billion, 500,000 sf 25MW data center for a global telecomm provider. Costs evaluated included utility costs, infrastructure, t tax rates, and other criteria in 10 states. Designed cost model to analyze one-time and recurring project costs. Refined the locations to a short list of three. The Company is deciding between two suitable finalist sites in North Carolina and Missouri. Leading communications company with incentives negotiation for a $4 billion data center project in Western New York. Incentives of $500 million, consisting of real property tax abatements and sales tax exemptions for building materials and equipment. Additionally, there was an application and negotiation of hydro-electric power that will provide 15 years of low cost power with an estimated value of approximately $140 million. International site selection for a Fortune I0 IT products and services firm, assisting with call center consolidation, technical support centers, data center projects, logistics centers, and other office facilities. For two recent data center projects, incentives included property tax relief in Texas and bond financing incentives in Georgia. 25MW Data Center $500 million incentives package for $4B data center Fortune 10 Company Data Center Projects 19 Data Center Site Selection Criteria Mitigation of operational risks No seismic, tornado or hurricane risk Reliable electric utility service Cost Availability Incentives/Riders Personal property taxes States that do not levy the tax States/localities that can provide long term abatement 20 10

11 Data Center Site Selection Criteria (cont d) Sales tax on data processing equipment/construction materials Exemptions Refunds Other Incentives Subsidized real estate Cash grants for infrastructure improvements, training Tax Credits Stability of business environment Energy/Sustainability Incentives 21 Previous Data Center Legislation Proved Successful North Carolina Offers three possible sales/privilege tax incentives to data centers: (1)Full exemption for eligible internet data center property and electricity; (2) Virtually full exemption (1%/$80 per article cap) on eligible data center property, but not electricity; and (3) Full exemption on software, however delivered, purchased by data center operator for use in datacenter. Since 2007, when NC enacted this legislation, eight companies, including American Express, Apple, AT&T, Facebook and Google, have spent or announced plans to spend more than $3 billion on data center projects in the state

12 Recent Data Center Legislation Alabama Recently enacted the Alabama Data Processing Center Economic Incentive Enhancement Act of Reduces the employment level required to qualify for tax credits from 50 jobs to 20 and also extends the period of time that granting authorities can abate certain ad valorem taxes and construction-related taxes for data processing centers and warehousing and storage facilities in Alabama Alabama Capital Credit is a credit of 5% of the capital costs of a qualifying project to be applied against income tax generated by the project, each year for 20 years Washington Exempts power infrastructure and server equipment from sales and use tax. Also includes replacement sever equipment and allows qualifying tenants to take same exemption. 23 Recent Data Center Legislation (cont d) Nebraska Offers two different options for data centers through the Nebraska Advantage program Create 30 new jobs and invest $3 million and all sales tax on capital purchases will be refunded Invest $30 million and maintain job levels and all sales tax on all capital purchases will be refunded Minnesota Recently established a statutory sales tax exemption for qualified data centers effective for purchases made after June 30, The exemption applies to information technology equipment, computer software, and electricity purchased for a qualified data center

13 Recent Data Center Legislation (cont d) Ohio In 2011, Ohio enacted a law allowing a discretionary, full or partial sales and use tax exemption on data center equipment. To qualify for exemption, a data center project must apply and receive formal approval from the Ohio Tax Credit Authority prior to constructing the project. The exemption also includes delivery, installation, or repair charges. Requires investment of $100 million and $5 million in payroll Wyoming Wyoming implemented a data center sales tax exemption on the purchase or rental of software, hardware, electrical, and HVAC equipment for data center projects. Iowa Iowa offers an exemption and a refund of sales and use taxes paid by eligible data centers. The exemption applies to purchase or rental of most equipment used in the data center operation, whether directly or indirectly connected to the computers, including cooling and other temperature control systems and electricity or generator fuel. 25 Just In! South Carolina Governor just signed a bill that would exempt data centers from sales taxes on computer equipment, original or replacement computers, software purchases and electricity for centers that invest at least $50 million over a five year period and create at least 25 new jobs within a three year period

14 Telecommunications Tax and Billing Issues Telecommunications and Convergence What is convergence in the telecommunications space? The converging or coming together of the following industries/services: Telecommunications companies wireline, wireless, Internet, video, television, content, applications Cable companies video, Internet, telecom, music, content, applications Software/hardware companies applications, programming, VoIP, Internet, marketplace Bundling of telecommunications services Video/television/Internet access/wireline/wireless/digital downloads/software applications/cloud computing Double, triple and quadruple plays Impact of the cloud/cloud computing? Reduced barriers to entry especially in the telecom (VoIP) space Increased choices for consumers 28 14

15 Taxation of Bundled Charges Bundled charges are those where more than one type of service or product is sold at a single bundled price, and the services are otherwise distinct and identifiable Mobile Telecom Sourcing Act (MTSA) Section 123(b) (b) ADDITIONAL TAXABLE CHARGES. If a taxing jurisdiction does not otherwise subject charges for mobile telecommunications services to taxation and if these charges are aggregated with and not separately stated from charges that are subject to taxation, then the charges for nontaxable mobile Telecommunications services may be subject to taxation unless the home service provider can reasonably identify charges not subject to such tax, charge, or fee from its books and records that are kept in the regular course of business. Internet Tax Freedom Act of 2007 Section 1106 If charges for Internet access are aggregated with and not separately stated from charges for telecommunications services or other charges that are subject to taxation, then the charges for Internet access may be subject to taxation unless the Internet access provider can reasonably identify the charges for Internet access from its books and records kept in the regular course of business. SSTA Bundling Language - WA RCW (5)(a) (a) If the price is attributable to products that are taxable and products that are not taxable, the portion of the price attributable to the nontaxable products are subject to the tax imposed by RCW unless the seller can identify by reasonable and verifiable standards the portion from its books and records that are kept in the regular course of business for other purposes including, but not limited to, nontax purposes; 29 Taxation of Telecommunications Services Multitude of federal, state and local taxes/fees/surcharges can be imposed on telecommunications services including VoIP services Total effective tax/fee rates can exceed 25% of the bill for service Some taxes, fees and surcharges are imposed on the customer and collected by the seller; some are imposed on the seller and are passed on to the customer Failure to bill and collect these taxes does not absolve the seller of liability for paying them over to the taxing jurisdictions. Customer agreement should have language allowing recovery of taxes and surcharges Failure to bill, collect and remit these taxes can take all of the profit (and more) out of the transaction 30 15

16 Taxation of Telecommunications Services Types of taxes, fees and surcharges that apply: Federal Excise Tax Sales Tax E911 TDD/TRS Lifeline Business and Occupation Tax Utility User s Fees Fed & State Regulatory Fees FUSF/SUSF Gross Receipts Right of Way Fees Franchise Fees, License Taxes, Privilege Taxes Excise Tax (e.g., Illinois TET, Florida CST, NY 186e) 31 Billing in the Online Marketplace Billing Issues in the online market when content billed by third party carriers Contract for billing should clearly define the content or application owners Is the carrier reselling the product or services? Is the carrier billing on behalf of the content owner or marketplace provider? Contract should address who is the tax responsible party (TRP) Who will be responsible for collection and remittance of tax? Which system will be the system of record for tax rules, decisions & rates? Other issues to consider How will subscribers be made whole in the event of a billing error? Who is responsible for audits and audit settlements? o Much easier for taxing authority to go after single carrier (billing agent) than multiple content providers (especially with questionable nexus) o Are there any record retention requirements between the parties for audit purposes? 32 16

17 Polling Question Would you like a KPMG professional to contact you regarding the topics discussed today? Yes No 33 Q&A 17

18 Q&A (continued) Today s Presenters Harley Duncan (202) hduncan@kpmg.comcom Jennifer Petersen (415) japetersen@kpmg.com Grady Cunningham (206) gcunnningham@kpmg.com Christine Bustamante (614) cbustamante@kpmg.com 35 Thank you for joining us. Please send any questions to us-taxwatch@kpmg.com Visit for a calendar of upcoming events KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International Cooperative (KPMG International). 18