Cloud computing and tax issues

A recent article (3/28/12) in CIO - "Cloud services face taxing dilemma" by Brandon Butler, points out the continuing challenges in determining if sales tax is owed on any variety of transactions that occur in the cloud. This is an area where state tax laws, based on 20th century ways of living and doing business, are mostly inadequate to address cloud computing. I say that with two perspectives in mind: (1) the law is not clear whether the cloud transaction is subject to the state's sales tax, and (2) the law is clear (such as in California) that because the transaction does not involve tangible personal property it is not taxable, but lawmakers need to update their tax laws to prevent their continued erosion as taxable tangible property transactions convert to intangible transactions. And, I want to stress that I believe good tax policy calls for broadening the sales tax base to only cover purchases by consumers, not by businesses.

In Febraury 2012, the Utah Tax Commission issued Ruling 10-011 on "Sales Tax Treatment of Web-Based Remote Access Services."  Under Utah law, which primarily applies sales tax to sales and transfers of tangible personal property also includes these elements:

• ""Sale" includes: . . . . (v) any transaction under which right to possession, operation, or use of any article of tangible personal property is granted under a lease or contract and the transfer of possession would be taxable if an outright sale were made."
• ""Tangible personal property" includes: . . . . (v) prewritten computer software, regardless of the manner in which the prewritten computer software is transferred."
• ""Tangible personal property" does not include a product that is transferred electronically."
• "Notwithstanding any other provision of this section and except as provided in Subsection (12)(b), if a purchaser uses computer software and there is not a transfer of a copy of that software to the purchaser, the location of the transaction is determined in accordance with Subsections (4) and (5)."

The tax agency concluded that "The Web Services sold for fees to Subscribers located in Utah are subject to Utah sales tax under § 59-12-103(1)-(1)(a), as “retail sales of tangible personal property made within the state.”"  The agency noted that the software is "off-the-shelf" and use of the software is transferred to customers.  The agency found it not to be a non-taxable service because the "Company is not using the proprietary software to sell services."  "Subscribers are paying for the use
of the proprietary software not for services provided by the Company."

And they said: "Our conclusion is not based on your position that the Company does not sell or license software or other tangible personal property to its Subscribers, and that Subscribers cannot access the Company’s internal software for any functional purpose, including modifying code, creating documents, or manipulating files. The Company is still selling the use of the proprietary software even though it is not transferring that software to the Subscribers. Utah Code § 59-12-211 was enacted to address situations such as the one presented for this ruling."

I highlighted the statement above in bold. I think this ruling seems weak, but represents the tax agency doing its best to fit something that appears not to be a transfer of anything.  They call it a transfer of use, but unlike a typical transfer, the customer has nothing that it can transfer to someone else. If I buy a book, I have something I can transfer to someone else.

The sourcing rule above (last bullet) seems to offer support, but that is a sourcing rule. Does the tax base law support that a taxable transfer occurred?

A solution? States should modify their sales tax laws to say that anything - services, use, property (tangible or intangible) acquired by a non-business consumer is subject to sales tax. This would eliminate the need for tax agencies to squeeze modern transactions in and reduce risk of litigation. Lawmakers could carve out any exemptions they think warranted, such as perhaps non-elective medical care.  I would not even suggest they exempt food because it is too big of a benefit to higher income individuals who spend a lot more on food than low income individuals. A refundable income tax credit could be used to provide relief to low-income individuals or to provide the relief on a weekly basis, funds could be deposited into a bank account that has a debit card associated with it, which would also help reduce issues faced by the "unbanked."

What do you think?