Can They Really Tax SaaS?
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Can They Really Tax SaaS?

The internet of things (IoT) is taking over. Most suspect that by 2020, most aspects of our lives will be connected. We’re talking anything from coffee makers, lamps, ovens or refrigerators to wearable devices. Forbes observed in 2014 that “anything that can be connected, will be connected,” and their point is quickly being proven correct.

Many businesses are switching off of on-premise solutions to one of the three cloud-based options: software-as-a-service (SaaS), Platform-as-a-service (PaaS) and Infrastructure-as-a-service (IaaS).

As the world continues to get smaller due to the growth of interconnectivity, more businesses will turn to the cloud as a way to streamline their workforce. Reports show that over the next five years about $1 trillon in IT spending will go either directly or indirectly to the cloud. According to Gartner, an IT research company, “Cloud-first strategies are the foundation for staying relevant in a fast-paced world.” By 2020, SaaS is expected to grow 37 percent.

The IT world isn’t the only ones who have noticed this cloud overtaking. State and local tax authorities have caught wind and want to reap the benefits. However, since it is such a new industry, many authorities are left scratching their heads on how – or if – they should apply tax to it. Just 3 years ago, many states were still silent on how they would tax cloud services. This is changing, though, and many states are passing laws and issuing rulings around IaaS, PaaS and SaaS, making sales and use tax compliance around cloud computing more complicated.

Businesses are now left struggling to understand the complicated taxing of cloud-based services in different states. Even after they have deciphered the laws, they are struggling to stay compliant and remain compliant among constant changes.

Recent Changes

In 2013, Massachusetts attempted to enact a tax on computer software and services, but it did not last long before it was repealed. Not only was it unpopular among businesses, but the Department of Revenue director, Amy Pitter, stated that the law was a burden due to its complexities and confusion.

In 2014, Michigan enacted a tax on remotely accessed software before the court intervened and it was repealed. This didn’t stop Michigan though and early this year they created two distinct categories of cloud computing for tax purposes: products not including a code, enabling the vendor’s system to operate and products including electronically delivered prewritten computer software.

Even cities are hopping on the bandwagon for taxing cloud computing. Chicago has extended its personal property lease transaction tax to include cloud computing services. The extension took effect on January 1, 2016 and is retroactively including business who have not complied since 4 years ago. Since this has caused a multitude of confusion, Chicago has issued Tax Ruling #12 to explain how to apply the lease tax to technologies such as SaaS, PaaS and IaaS.

Crazy-making Colorado

Colorado makes SaaS tax even more confusing. The state itself does not tax cloud computing services, but it is a home rule state, meaning that counties and cities with a population greater than 2,000 have the power to collect taxes as they see fit. About 70 Colorado municipalities have taken advantage of home rule and have chosen to tax SaaS at the local level.

For example, Denver has fully taken advantage of taxing cloud computing services. It applies to all software, custom or pre-written, whether the product is downloaded, delivered electronically or accessed via the cloud.

The City of Boulder has made things a little more complicated, dancing around the idea of taxing cloud computing services. The city taxes retail sales of computer software unless, “the cost of modification of the software is greater than 25% of the price of the unmodified software.” It also states that a manufacturing company who pays a license fee to a software manufacturer for the right to use the software is taxable. On the other hand, software updates may or may not be taxable. Thanks to these specific specifications, business are advised to contact the city when in doubt.

Since every city and every state is treating tax on cloud computing services differently, it can be hard to keep them straight. Many companies are avoiding the risk of non-compliance fines by using a SaaS solution like Avalara, which automates the sale and use tax process.

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