United States: Chicago Department Of Finance Addresses Sales Taxation Of Cloud Computing Transactions

On June 9, the Chicago Department of Finance issued two rulings that expand the city's ability to tax cloud-based products and services. First, an amusement tax ruling extends the tax to electronically delivered entertainment.¹ Also, a personal property lease transaction tax (lease tax) ruling extends the tax to certain specified computer products and services.² Both tax rulings are effective July 1, 2015, but the Department will limit the effect of the rulings to periods on and after September 1, 2015 to allow businesses sufficient time to make required system changes.³ Effective January 1, 2015, the amusement tax and lease tax both are imposed at a rate of 9 percent.⁴

Electronically Delivered Items Subject to Amusement Tax

The City of Chicago imposes an amusement tax "upon the patrons of every amusement within the city."⁵ For purposes of this tax, "amusement" is defined in relevant part as any exhibition, performance, presentation or show for entertainment purposes; any entertainment or recreational activity offered for public participation or on a membership or other basis; and any paid television programming.⁶ Under the Department's ruling, the amusement tax is expanded to include charges paid for the privilege to witness, view or participate in amusements that are delivered electronically to a customer in Chicago. Specifically, the tax applies to charges paid for the privilege of: (i) watching electronically delivered television shows, movies or videos; (ii) listening to electronically delivered music; and (iii) participating in online or other games.⁷

Providers that receive charges for an electronically delivered amusement are considered to be owners or operators that are required to collect the amusement tax from their Chicago customers. The ruling clarifies that the amusement tax does not apply to sales⁸ of shows, movies, videos, music or games, but applies only to rentals.⁹ However, charges that are not subject to the amusement tax may be subject to another tax such as the city's lease tax. The ruling also discusses bundled transaction rules for electronically delivered amusements that include both taxable and non-taxable elements. Bundled transactions are non-taxable so long as the invoice clearly states that at least 50 percent of the price is not subject to the amusement tax.¹⁰ Thus, if a bundled charge is primarily to view, listen or participate in an amusement, the entire charge is taxable.

Cloud Computing Subject to Lease Tax

The Department's lease tax ruling interprets provisions in Chicago's lease tax ordinances. The lease tax is imposed on: (i) the lease or rental in the city of personal property, or (ii) the privilege of using in the city personal property that is leased or rented outside the city.¹¹ The tax generally is imposed on a "nonpossessory computer lease," which is defined as a "nonpossessory lease" in which the customer obtains access to the provider's computer and uses the computer and its software to input, modify or retrieve data or information, in each case without the intervention (other than de minimis intervention) of personnel acting on behalf of the provider.¹² In turn, the term "nonpossessory lease" is defined as a lease or rental where use, but not possession, of personal property is transferred, including but not limited to leased time on or use of computers, computer software, or data processing equipment. However, an exemption from the lease tax is provided if: (i) the customer's use or control of the provider's computer is de minimis and (ii) the related charge is predominantly for information transferred to the customer rather than for the customer's use or control of the computer.¹³ Referenced as "Exemption 11," the ruling clarifies the scope of this exemption.

Transactions Subject to Tax

The ruling provides four examples of taxable instances under the lease tax: (i) performing legal research; (ii) obtaining customer credit reports; (iii) obtaining real estate listings and prices, car prices, stock prices, job listing, marketing data, and other data that has been compiled, entered and stored on the provider's servers; and (iv) word processing, data processing, tax preparation, presentations and other applications available to a customer through access to a provider's computer and its software. The ruling notes that these last examples are sometimes referred to as cloud computing, cloud services, hosted environments, software as a service, platform as a service, or infrastructure as a service.

However, entertainment materials such as copyrighted books, musical and other sound recordings, feature-length and episodic films are not "data information" as this term is used in the definition of a "nonpossessory computer lease."

Charges for Services or Storage of Information Not Subject to Lease Tax

If a customer pays a provider to write a report consisting primarily of the provider's own observations, opinions, ideas or analysis, the charge is for the service of writing the report for that customer and is not subject to the lease tax. Similarly, if a customer pays a provider to create a database, the charge is for the service of creating the database and is not subject to the lease tax. These services are not taxable even if the report or database is accessed electronically. Also, under prior rulings, charges for storing a customer's data on the provider's computer are not subject to the lease tax if the provider's computer is outside the city, provided the charges are solely for storage.¹⁴

Exemption 11

According to the ruling, an exempt use under Exemption 11 may be demonstrated either (i) by access to information or data that is entirely passive (such as streaming data), without interactive use, or, in other cases, (ii) by access to materials that are primarily proprietary, such as copyrighted newspapers, newsletter or magazines. As explained in the ruling, passive access to information is an exempt use of the provider's computer. For example, this exemption applies to a stock market "ticker-tape" that allows the customer to receive a one-way scrolling list of current stock prices for a set group of businesses. Also, access to materials that are primarily proprietary is an exempt use of the provider's computer. Thus, the customer may pay a subscription to download information, and the subscription fee may allow the customer to use a search function to locate the information, but the value of the search function is subordinate to the value of the downloaded information. This exemption will typically apply to a Web site or "app" that allows a subscriber to download or otherwise access materials that are proprietary such as copyrighted newspapers, newsletters or magazines.

In contrast, a legal research database is an example of a product that is not covered by Exemption 11. The customer's use of the provider's computer is extensive and the charge is predominantly for the ability to perform the searches that are necessary to locate documents. A subscription to an interactive Web site is subject to the lease tax even if most or all of the information available on the Web site is fleeting or transitory. For example, a subscription to a Web site that provides financial research, information and analytical tools is subject to the lease tax.

Bundled Transactions

The ruling also discusses bundled transactions rules for leases that include both taxable and non-taxable elements. Bundled transactions are not subject to the lease tax if the invoice clearly states that at least 50 percent of the price is not for the use of any personal property.¹⁵ Thus, if a bundled charge is primarily for the customer's use or control of the provider's computer, the entire charge is taxable.

Sourcing and Nexus Issues

The amusement tax and lease tax follow the sourcing rules set forth in the state's Mobile Telecommunications Sourcing Conformity Act.¹⁶ In general, the taxes apply to any consumers with a personal or primary business address in the City of Chicago, as reflected by their credit card billing address, zip code or other reliable information.

Sourcing determinations are more complex for the lease tax. Under the municipal code, for nonpossessory computer leases, the location of the terminal or other device by which a user accesses the computer is deemed to be the place of lease or rental and the place of use of the computer for lease tax purposes.¹⁷ The ruling clarifies that the exemption for the use in the city of personal property leased or rented outside the city if the property is primarily used outside the city does not apply to nonpossessory computer leases.¹⁸

For purposes of the lease tax, if a customer has some employees who use the provider's computer from terminals located in Chicago, and some employees who access the provider's computer from terminals located outside Chicago, a charge that covers both the Chicago and the non-Chicago use should be apportioned.¹⁹ If a provider has no information to indicate that any of its customer's use will occur in Chicago, the provider will not be required to collect the lease tax. If a provider has information to indicate that some of its customer's use will occur in Chicago but no information of its own that allows it to perform a reasonable apportionment, the provider may rely on the customer's actual data or estimates. In the alternative, a provider will not be required to collect the lease tax from its customers if: (i) the customer has 10 or more employees assigned an access code to use the provider's computer, and (ii) the customer supplies the provider with written confirmation, from the Department, that the customer is required to pay the lease tax.²⁰

Generally, when any of the taxable activities described above occur in Chicago, they will be subject to the amusement tax or lease tax. The rulings acknowledge that the issue of nexus arises with regard to whether a given provider has an obligation to collect the tax from its customer. However, the Department explains that this issue is beyond the scope of the rulings. The rulings advise providers to consult with their attorneys or request a private letter ruling.

Commentary

These rulings have generated considerable attention and interest. They show the growing trend among states and local jurisdictions to broaden their taxation of cloud-based goods and services, but they also raise many questions. The city is expected to release further guidance to clarify the implementation of these rulings. Although the rulings are effective July 1, 2015, the rulings indicate that they will not be enforced until September 1, 2015. Based on the sourcing provisions, even if the use, streaming, or temporary download of amusements or any of the taxable examples for the lease transaction tax are outside the city limits, the taxes will apply if the customer has a Chicago billing address. The issue of nexus is key in sales tax transactions, but the rulings do not address how to determine whether a provider has an obligation to collect the amusement tax or lease tax from its customers. Presumably, providers with a physical presence in Chicago will be required to collect the tax from their customers. However, providers located outside Chicago could not be compelled to collect the tax because they do not have nexus with the city. In this situation, the customers apparently will be responsible for remitting the tax. Also, taxpayers need to be careful when they structure the invoice terms for bundled transactions.

The lease tax provisions concerning "nonpossessory computer leases" and the scope of Exemption 11 are particularly complex. A customer's passive use of a provider's computer is exempt but the interactive use of a database is subject to tax. Also, accessing proprietary items such as newspapers or magazines is exempt from the lease tax. However, taxpayers are likely to have difficulty in drawing these distinctions. Also, the lease tax ruling specifically notes that nonpossessory computer leases are not eligible to claim the exemption for the use of property in the city in situations where the property is leased and predominantly used outside the city. As discussed above, sales need to be apportioned for purposes of the lease tax when the customer has employees who access a provider's computer both within and outside Chicago. This further complicates the application of the lease tax to cloud services.

The City of Chicago is confronted with tremendous budget constraints. The amusement tax and lease tax rates recently were increased from 8 percent to 9 percent, and now the base for both of these taxes has been substantially broadened. The implementation of the tax on cloud computing remains unclear and the legality of these provisions may be challenged. At this point, taxpayers that may be subject to these taxes should carefully consider the legal rulings and watch for the city to release further guidance.

Footnotes

 1 Amusement Tax Ruling #5, City of Chicago Department of Finance, June 9, 2015.

2 Personal Property Lease Transaction Tax Ruling #12, City of Chicago Department of Finance, June 9, 2015.

3 However, this does not release or otherwise affect the liability of any business that failed to comply with existing law prior to July 1, 2015.

4 On November 19, 2014, the City of Chicago raised the rate of the amusement tax and lease tax from 8 percent to 9 percent effective January 1, 2015. Chicago Mun. Code §§ 3-32-030(B); 4-156-020(A).

5 Chicago Mun. Code § 4-156-020(A).

6 Chicago Mun. Code § 4-156-010.

7 The customer will normally receive the provider's electronic communication at a television, radio, computer, tablet, cell phone or other device belonging to the customer.

8 This is normally accomplished by a "permanent" download.

9 This is normally accomplished by streaming or a "temporary" download.

10 The ruling applies the same rules that are set forth in Personal Property Lease Transaction Tax Ruling #3, City of Chicago Department of Finance, June 1, 2004. Also, the ruling cites Chicago Mun. Code § 4-156-020(H).

11 Chicago Mun. Code § 3-32-030(A).

12 The term includes, but is not limited to, time-sharing or time or other use of a computer with other users. For nonpossessory computer leases, the location of the terminal or other device by which a user accesses the computer is deemed to be the place of lease or rental and the place of use of the computer for purposes of the lease tax. Chicago Mun. Code § 3-32-020(I).

13 Chicago Mun. Code § 3-32-050(A)(11). For example, the exemption would apply to a nonpossessory lease of a computer to receive either current price quotations or other information having a fleeting or transitory character.

14 Personal Property Lease Transaction Tax Ruling #5, City of Chicago Department of Finance, June 1, 2004 (as amended, Sept. 1, 2013).

15 The tax ruling applies the same rules that are set forth in Personal Property Lease Transaction Tax Ruling #3, City of Chicago Department of Finance, June 1, 2004. Also, the tax ruling cites Chicago Mun. Code § 3-32-020(K).

16 35 ILL. COMP. STAT. 638.

17 Chicago Mun. Code § 3-32-020(I).

18 Chicago Mun. Code § 3-32-050(A)(1).

19 For an individual assigned an access code, seat, license or other ability to use the provider's computer, all of that individual's use is presumed to take place at the individual's principal office location.

20 In this case, the customer should file a return and pay the tax directly to the Department. See Chicago Mun. Code § 3-32-080(B).

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