Guest Blog: Cloud Computing Services: To Tax or Not to Tax?


Twenty years ago, purchasing a software program for your business was direct and straight forward. You bought a CD, possibly paid a sales tax for the tangible property and downloaded the program to your hardware.

Today, it’s not so simple.

No longer is a purchase only made locally but now it can be done out of state, out of country, in the clouds — transactions have no boundaries, especially when the purchase involves a third-party who operates via the Web. Many states, including Michigan, are rushing to keep up with technology and what they deem taxable. It is a necessary evil to provide tax revenue for state operations but no one should have to pay more than their legal obligation.

Although Michigan’s “Main Street Fairness” legislation went into affect Oct. 1, requiring large Internet retailers with a presence in the state, such as Amazon, must collect and remit the sate sales tax of 6 percent on Michigan purchases — many states, including Michigan, have not updated tax laws to include cloud computing as a taxable service — yet.

Michigan is clear on the taxability of the purchase, lease, or use of software and related services, but not on cloud transactions. Based on current law, cloud computing transactions will be taxable if the sale or use includes taxable tangible personal property.

So, the key to taxability is whether there is a transfer of property. Who maintains ownership and where this ownership exists is crucial to determine if tax is due. For example, are you purchasing a service so someone will store your data for you (not taxable) or are you buying a software application that will allow you to store the data on your own server (taxable) — both can use the cloud to perform the function, but where and how is this function being performed? Confusing, right?

So what to do?

First, understand what is being purchased, review purchase agreements to understand what might create tax exposure, know who will manage what and if there is a transfer of tangible personal property. Carefully review invoices — has the vendor charged sales tax? Is it correct? If they didn’t charge tax, should you accrue and pay the use tax? Understand the difference between SaaS (software as a service), PaaS (platform as a service), and IaaS (infrastructure as a service) is important to avoid a tax audit.  SaaS is generally tax-exempt as a service, but the other two can be construed as taxable.

Also, know that the law is still murky. Be prepared to prove what has been purchased and defend your position with statutory authority and case law. If under audit and you are issued an assessment for taxes owing, have the auditor provide the Michigan tax law so you can determine if the purchase is accurately being taxed. If you don’t agree with the tax assessment, disagree, but be ready to support your conclusion. Appeal the assessment if necessary —it’s your right!

Next, expect the law to change — probably in favor of the state. Keep abreast of law changes and current cases. Since Cloud transactions are the future, expect to see more cases go before the courts until changes are made in the tax laws. 

Finally, purchases related to information systems are generally expensive. Don’t forget to include in your purchase order a portion related to sales or use tax, if applicable. When purchases are made and later it is determined that tax is due but was not accounted for be ready for an unexpected cash outlay, and possible audit exposure.

Recent case activity in Michigan concluded that certain cloud computing transactions are not taxable. Today, much of the current law allows for a tax-free exchange on transactions of this type. However, if states recognize the loss of tax revenue, many may pass legislation to tax such activity. Much will depend on whether the federal government will take a stance on this issue.  If not, expect the states to move forward and create new laws, confusing us once again.

Susan Wagner is a state and local tax consultant with UHY Advisors. She spoke recently at the third annual Mark R. Solomon Tax Symposium at Walsh College, discussing the tax issues related to cloud computing.