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Cloud Computing: Massachusetts Sales Tax Consequences
July 31, 2012
"Cloud Computing" is a word that describes when users “rent” or “borrow” online software instead of actually purchasing and installing it on their own computers. Technology solutions that were in the past out of the price range or skill set of many businesses are now available with cloud-based solutions. Due to its increasing popularity, the small businesses utilizing cloud computing should be aware of and learn how they can manage their tax exposure while gaining the benefits afforded by this new technology.
Massachusetts imposes a 6.25% sales tax on sales of tangible personal property and telecommunications services within the state, including sales of prewritten software regardless of the method of delivery. In addition, the price of tangible personal property subject to tax includes services that are part of the sale, whether or not they are separately stated. The Massachusetts Department of Revenue (the “DOR”) recently issued several letter rulings finding that cloud computing services are subject to the state’s sales tax depending on the level of access and control over the software application granted to a customer.
Letter Ruling 12-6 involved the purchase and use by a customer of a hosted service to create newsletters and perform other tasks. The customer used the cloud-based application to control and manipulate data to create a unique product. Based on the high degree of control available to the customer, the DOR held that the purchase is subject to sales tax because it is tantamount to purchasing a license to use taxable software.
Letter Ruling 12-5 involved the purchase by a customer of Internet-based physician services, such as medical records management and access to medical databases. Despite the fact that the customer was able to use the software to perform certain tasks, the DOR concluded that where the services are provided mainly for the purpose of storage and retrieval of information, the services are exempt from state sales tax as “personal and professional” services, information services, and/or database access and management services.
Letter Ruling 12-8 involved the purchase by a customer of (1) cloud computing services that involve the customer’s use of its own software or open-source software (software available free on the Internet), (2) cloud computing services that use software licensed by the seller where there is no separately stated charge for the software and no sublicense of the software to the customer, and (3) remote storage services. The DOR held that, where there is no software provided by the seller, there is no taxable sale of prewritten software. However, where the purchase includes software licensed by the seller, it is subject to sales tax regardless of the fact that there is no separately stated charge, no actual download of the software to the customer’s computer, and no contractual sublicensing of software to the customer. The DOR based this conclusion on its finding that the object of the transaction was acquiring the right to use the software. By contrast, the DOR found that the sale of remote storage services is not subject to sales tax because the object of the transaction is the use of the capacity in the seller’s hardware to safely store or back-up the customer’s information and not the taxable lease of hardware where the customer directs or controls the computer hardware.
Together, these rulings define the approach Massachusetts is taking to taxation of cloud computing services. The key issue appears to be whether the cloud service is characterized as a taxable license or a nontaxable service. The resolution of this issue depends on the level of access and control granted to the customer with respect to the seller’s software and/or hardware. If customers are willing to relinquish more control, the imposition of sales tax might be avoidable. Small businesses offering cloud computing services may have an opportunity to boost business by catering to those customers looking to avoid sales tax if they can tailor their products to offer less access and control to the actual software or hardware.
If you have any questions or need additional information regarding this, please contact any attorneys in our Tax Group.
This Alert is provided for information purposes only, and does not constitute legal advice. According to Mass. SJC Rule 3:07, this material may be considered advertising. ©2012 Posternak Blankstein & Lund LLP. All rights reserved.