The IRS has finally issued its proposed Cloud Regulations to address how taxpayers should treat cloud transactions for taxation purposes. Until this time, no guidance existed to specifically address how the IRS would handle cloud computing transactions for tax. The result of this was taxpayers had to rely on analogous authorities. They had no way of knowing for sure if they were complying with the law. Here, we take a look at the summary of these proposed rules.
Classifying Cloud Transactions as a Service or Lease
The new Cloud Regulations resolve some underlying issues. However, there is still no comprehensive guidance available to clarify certain areas.
In general, the IRS classifies cloud transactions as either a service provision or a property lease. The basis for the classification is on the transaction’s entirety. Unfortunately, the IRS has presented no realistic or concrete examples that it would treat property as a lease. Hopefully, it will adequately address this once it releases the final regulations document.
Also, the IRS does not address the income source rules for this type of transaction. At present, it appears reasonable to assume that:
- if taxpayers treat transactions as services, they should source the generated income within the jurisdiction where they provided the service; and
- if taxpayers treat transactions as leases, they should source the generated income within the jurisdiction where they use the property.
However, because of the various access points, identifying the source is complex.
Computer Program Transaction Regulations
The IRS has modified the regulations regarding how taxpayers treat transactions that involve computer programs for tax. The scope of the rules now applies to all digital content transfers.
The regulations also now clarify the rules surrounding the transfer of rights. The rights to publicly display or perform digital content for advertising the content’s sale does not constitute a transfer of copyright permissions.
The IRS also clarifies more about income when a person sells or transfers a copyrighted article through electronic media. In such cases, it deems the sale to have occurred at the installation or download’s location. Without this information, it will consider the transaction to have occurred at the customer’s site based on his or her recorded sale data.
Determining Income Sources
It remains uncertain whether income source rules that apply to Computer Program Regulations are also applicable to cloud transactions. If the regulations deem a transaction to be a service, the source of income is where that service occurred. There are still questions about where that location should be. Is it the company’s location? The data center’s site? The server’s location? Further clarification will be necessary.
The Practical Implications for Cloud Transactions
The Treasury is trying to stay up to speed with the digital economy’s rapid changes. Yet, taxpayers must learn how these new regulations will affect their transactions. In particular, they need advice regarding the income source rules for cloud transactions involving digital content and computer programs. The rules will require taxpayers to review their existing contracts to evaluate revenue and how to source it differently. There will be more administrative burdens on companies to ensure they are complying with the rules. Business owners will need to decide whether restructuring their operational models is best to align more effectively with the regulations.
For more information about this article, please contact our tax professionals at taxalerts@windes.com or toll free at 844.4WINDES (844.494.6337).