On the eve of an election in a year full of rancor over whether taxation belongs at the federal, state or local level, corporate IT buyers are already getting a taste of how regional levies could affect their current costs and future strategies.

The new wrinkle amid growing demand for departmental and line of business technology comes in state taxation of cloud computing, services that move the delivery and maintenance of business tools into the hands of third-party providers.

“There is a lack of uniformity nationwide addressing the taxation of traditional versus cloud services and it’s causing lots of headaches,” says Carolynn Iafrate Kranz, a partner, Kranz & Associates, PLLC, a boutique law firm specializing in state and local tax consulting.

The linchpin in the tax issue is whether cloud products constitutes a transfer of ownership. Advisers say existing laws are vague and vary greatly. States like Oregon or Delaware that don’t levy retail taxes avoid the problem, but only locally. Customers buying consumer goods on the Internet, for example, already see an irregular mix of taxed and non-taxed transactions for items bought across state lines.  

The impact is worse for companies that are moving significant dollars to service spending but don’t foresee a tax bill. Local sales taxation of every subscriber and upgrade to a business's hosted email service, for example, could raise costs an additional 6 to 10 percent, an unwelcome surprise at the scale being addressed. Though popular SaaS products such as salesforce.com,

Workday and Office 365 are more economical than purchasing licenses and have lower carrying costs, across large user bases the subscription model can add a substantial tax burden.

In a July ruling, the Massachusetts Commissioner of Revenue reiterated some very general guidance that didn’t have a lot of case law to begin with, says Shannan Gilmartin Cuddy, senior tax manager at Boston area CPA and consulting firm Moody, Famiglietti & Andronico. “For companies in Massachusetts considering the tax liability, it means determining what’s actually being acquired. It boils down to whether you’re acquiring the right to use software versus acquiring an actual good or service.”

In the case of software as a service, liability can hinge on how the material changes hands. Some states tax software as a service only it if it arrives on a ‘tangible medium’ like a disk drive or CD.

“If it’s delivered electronically or you go to the provider site and download it to your computer, states like Georgia and Florida don’t tax that yet,” says Gilmartin Cuddy, “but New York and Massachusetts do.”

A casual observer might compare this to a surcharge for a pizza that is picked up rather than delivered. But strip cloud computing apart and you’ll find the fundamental issues are primarily “what” and “how,” according to David Tapper, IDC VP of outsourcing and offshore. “The ‘what’ really isn’t changing. My iPad note taker is another way of entering text. Human resources and salespeople have been around a long time.” In other words, what we do is the same; how we do it is what’s different.

Iafrate Kranz says the most detailed guidance thus far comes from the state of Washington. “It’s not the last word, but there is guidance for buyers and sellers in a broad provision for ‘digital automated services’ that puts remotely accessed software in a separate category.”

The category includes several “carve outs” for certain uses and industries like legal services. “Almost all of us deliver services electronically in email, so they created a carve out because they never previously taxed those services,” says Iafrate Kranz. “Part of that carve out is because what is being done principally involves human effort, but it’s so broad that it’s incredibly complex to figure out if you’re in a tax situation or not.”

State jurisdictions, in Washington, Massachusetts and elsewhere, not Amazon or Rackspace, are defining what cloud is, Tapper says. “What they decide is going to have huge implications from a spend perspective,” and companies already have plenty to juggle before they have to worry about taxes. Some observers insist cost savings will be the overall driver of cloud services, but surveys point to flexibility, the ability to do things not possible before and other benefits of offloading formerly in-house duties.

Companies may also find they must adopt cloud technology because they cannot summon internal resources to support their own success or stay compliant with overtaxed or out-of-date internal support.

Fears over privacy and security can pale in the face of regulation. Tapper speaks of one government agency client that audited and found more than 20 Amazon [Web Service] bought on government credit cards. “People talk about runaway cost, I think they’re more scared of compliance and regulation, Tapper says. “Imagine if you had 20 sales force automation systems and all of a sudden you didn’t know it. Then we go public and need our quarterly. The SEC isn’t going to give you an extension just because you have a mess; they will penalize you.”

Other risks extend to insurance and accounting, yet more opportunities for startup specialized cloud services for these purposes. Over time, adoption is likely as businesses have found it as reliable to outsource duties like monitoring of Web logs as it once was to hire groundskeepers.

As for taxes, as more exigencies arrive, they’ll lead to more creative ways to optimize the tax code and call for thicker regulations and dedicated expertise fewer companies will wish to maintain on their own.

As Tapper says, the ‘what’ will remain the same, but the ‘how’ will take a new course.

Jim Ericson is editorial director of Information Management, a SourceMedia publication. You can reach him at Jim.Ericson@sourcemedia.com. Follow him on Twitter at @jimericson. This article originally appeared in Information Management.

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