United States: New York Department Determines Cloud Computing Services Are Not Subject To Sales And Use Tax

On April 14, 2015, the New York State Department of Taxation and Finance issued an Advisory Opinion responding to a petitioner's request as to whether the sale of a certain cloud computing product was subject to New York State sales and use tax.1 The Department concluded that the product essentially constituted the provision of computing power to its customers, which was not considered an enumerated service subject to the sales and use tax.

Description of the Cloud Computing Product

The product sold by the petitioner provides customers with Internet infrastructure and computing power. Customers can use this infrastructure for a variety of purposes including running applications for internal purposes and hosting commercial Web sites. The product is a model of computing in which the petitioner provides scalable computing resources as a service. The computing capacity and scalability is utilized by customers to execute applications. Specifically, customers use the petitioner's cloud computing product to run applications, including data analysis software, intranet software, and e-commerce software.

In order for the product to function, customers must use operating system software and/or applications. The customers may choose either the petitioner's open-source operating system ("Open Source Instance") or a designated third-party operating system software ("Third Party Instance"). Open Source Instance software is accessed by customers at no charge from the petitioner. Third Party Instances involve the petitioner licensing the software from a third-party for use in providing the product to its customers. The petitioner does not sublicense the software to its customers or allow any downloading of software.

The pricing model for the product is based on hourly rates for the computing resources consumed by each customer, as well as whether Open Source Instance or Third Party Instance is utilized. There are no fixed fees or separately stated charges for the use of any software or application. The charges are solely for providing computing resources.2

Department Analysis and Conclusion

The Department began its analysis by noting that the New York Tax Law imposes sales and use tax on the retail sale of prewritten computer software, as well as certain enumerated services. The Department explained that the product grants customers access to computing power, enabling those customers to run their own software applications. The Department noted that its regulations consider the granting of the right to use a third-party operating system to be a transfer of the right to use prewritten computer software and, therefore, subject to the sales and use tax.3

The Department determined that while customers are transferred the rights to use an operating system representing prewritten computer software, it is merely used as a portal, and, therefore, incidental to the services provided by the petitioner. Customers use the operating system for the computing power necessary to run applications of their choosing, such as for managing applications, performing searches, and other administrative functions. Customers are seeking the right to use the petitioner's computing power service capabilities, rather than the right to use the petitioner's prewritten software itself.

In support of this claim, the Department noted that the advertising material of the petitioner explained the purpose of the product is to provide customers with computing power to run applications. Additionally, the Department noted that the petitioner's Web site demonstrates an emphasis on the scalability of the computing power offered, the ease of accessing it, and its reliability and security.

The Department determined that the primary purpose of the product was the sale of computing power and, conversely, that the right to use the petitioner's prewritten software is only an incidental part of providing this service. Therefore, the Department concluded that the product was not subject to sales and use tax because providing customers with computing power is not considered a service made taxable by the New York Tax Law.

Commentary

Prior to the issuance of this Advisory Opinion, the Department, along with many other taxing authorities, had been lagging in providing taxpayers with adequate guidance on how sales and use tax should apply to cloud computing or platform as a service (PaaS) applications. With minimal guidance, the taxability of these transactions was largely left up for interpretation by businesses selling these products. This situation has been particularly troubling because uncertain sales and use tax positions can result in deficiencies from a taxing authority or claims for refunds by customers. In practice, New York State auditors used their discretion to make the taxability determinations. This Advisory Opinion is significant because it breaks the silence by providing a piece of guidance in this unknown territory.

Even though Advisory Opinions are not precedential, this Advisory Opinion is instructive because it illustrates the ongoing Department view that transferring the right to use prewritten software that is merely incidental to a service does not create a taxable transaction, provided that the primary purpose of the transaction is for the customer to receive a nontaxable service. Further, this Advisory Opinion provides insight as how the Department makes the determination that the primary purpose of a transaction is not the right to use pre-written computer software. Specifically, the Department explained that it will look to the facts regarding the use of a specific product and the advertising of that product when making a determination as to its taxability.

Further, this Advisory Opinion may be used in concert with prior Advisory Opinions to form a picture of the Department's view of the primary purpose test with respect to online or cloud-based services. While it is unfortunate that neither the Department nor the New York legislature has issued a bright-line test as to taxability, certain common factors for the primary purpose test seem to be emerging, including the following: (1) advertising of the product; (2) whether the product comes in multiple variants; (3) whether customers may use different components of the product without incurring extra charges as a result; (4) whether the different components are highly synergistic; and (5) whether customer invoices have multiple charges.4 In addition, these factors should be considered with respect to the ASC 450 positions taken by taxpayers.

Despite the Department's release of this Advisory Opinion, this is still an area that is continuously evolving in order to keep up with the rapid advancement of technology services, where guidance stems from determinations made only on a case-by-case basis of specific facts and circumstances. Taxpayers should consult with their advisers as to how their specific fact situation is likely to be viewed by the Department.

Footnotes

1.Advisory Opinion, TSB-A-15(2)S (N.Y.S. Dep't of Taxation & Fin., Apr. 14, 2015).

2. The petitioner does charge a data transfer fee which is separately stated on the customer invoice. The taxability of this fee was not addressed in the Advisory Opinion.

3. N.Y. COMP. CODES R. & REGS. tit. 20, § 526.7(e)(4).

4. See Advisory Opinion, TSB-A-13(12)S (N.Y.S. Dep't of Taxation & Fin., Apr. 23, 2013).

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