State Taxation of Cloud Computing
Lusch, Stephen J., Santa Clara Computer & High Technology Law Journal
TABLE OF CONTENTS I. INTRODUCTION II. DEFINING CLOUD COMPUTING III. CHARACTERIZATION A. NORMATIVE CHARACTERIZATION OF THE TRANSACTION B. POSITIVE CHARACTERIZATION FOR SALES TAX IV. NEXUS A. SALES TAX NEXUS B. INCOME TAX NEXUS V. SOURCING A. SALES TAX SOURCING B. INCOME TAX SOURCING VI. DIGITAL GOODS AND SERVICES TAX FAIRNESS ACT OF 2011 VII. RECOMMENDATIONS FOR POLICYMAKERS VIII. CONCLUSION APPENDIX A: TABLE I APPENDIX B: TABLE II
As the digital environment in which we live continues to change at speeds that were unfathomable two decades ago, archaic state tax systems have struggled to keep pace. (1) The advent of the Internet itself raised significant state taxation questions (2) in terms of the potential to tax bandwidth usage, e-mail, etc. As the Internet began to gain popularity the federal government addressed these questions with the Internet Tax Freedom Act of 1998, (3) which greatly limited state and local taxation of the Internet. It should be noted, though, that the Internet Tax Freedom Act did not put restraints on the sales taxation of online sales, (4) which gave rise to the second hurdle that state legislatures are working to address in regard to state taxation of the Internet. Most notable in popular press is the ongoing fight between Amazon and the State of California (5) in regard to whether a nexus (6) is created by their affiliate program. (7) In fact, in 2008 New York was the first state to adopt an "Amazon" tax law,8 and as of July 1, 2011, six other states have enacted similar laws. (9) The next big obstacle for state legislatures to overcome in regard to state taxation of the Internet is how cloud computing transactions, which raise a multitude of difficult questions in regard to nexus, sourcing, and the characterization of the transaction, will ultimately be taxed at the state level.
The purpose of this article is to explore the primary questions facing state courts and legislatures with regard to taxing the cloud. The rest of the article is organized as follows: Part II defines cloud computing, Part III presents arguments on the positive and normative characterization of cloud computing transactions, Part IV discusses the nexus issues of cloud computing, Part V analyzes sourcing of the transactions to tax jurisdictions, Part VI addresses the Digital Goods and Tax Fairness Act of 2011 as it pertains to cloud computing, and finally, Part VII provides recommendations for policymakers.
II. DEFINING CLOUD COMPUTING
Cloud computing is defined by the National Institute of Standards and Technology of the U.S. Department of Commerce as "a model for enabling ubiquitous, convenient, on-demand network access to a shared pool of configurable computing resources (e.g., networks, servers, storage, applications, and services) that can be rapidly provisioned and released with minimal management effort or service provider interaction." (10) In addition, this definition states that cloud computing has five essential characteristics: (1) on-demand self-service, (2) broad network access, (3) resource pooling, (4) rapid elasticity, and (5) measured service. (11) In layman's terms, cloud computing is the ability for a corporation or individual to access data storage space, computing platforms, databases, or software from a cloud computing provider in exchange for a usage fee. Naturally, a question arises as to whether the cloud computing provider must collect sales tax in addition to the usage fee, and this question is not easily answered, since it hinges on a number of other sub-questions. In addition, cloud computing providers also need to consider whether cloud computing transactions will subject them to income taxation within a particular state.
Subsequent to the basic definition of cloud computing, there are three generally agreed upon service models for cloud computing. (12) The first service model is known as Software as a Service (SaaS), in which the customer can access the provider's applications located on the cloud. …