Most people’s understanding of the Internet extends about as far as their eyes can see. In other words, they know that if they type a few words into the little white box beneath the colorful Google logo, within a fraction of seconds, hundreds of thousands of (hopefully) helpful results will appear on the screen. And that’s awesome. But few people, myself included, fully understand what takes place beyond the keyboards, screens, and cords. In fact, many people are likely willfully blind to the back-end operations of the Internet. 

When it comes to New York State taxes, a similar blind spot may be developing with regard to the tax treatment of cloud-based software applications. Specifically, most tax professionals, whether they agree with the Department of Taxation and Finance’s position or not (we don’t, clearly), can tell you that New York State’s current tax policy is that when a consumer accesses a cloud-based software application, that consumer gains the right to use, control, or direct tangible personal property, making it a taxable sale. But similar to the general public’s limited understanding of the complicated back-end workings of the Internet, many tax professionals (and taxpayers) might not appreciate the unique and potentially favorable sales tax rules that apply to the service providers who support web-based software vendors—specifically the Internet data centers and co-location facilities that house the servers used to host many software products.

If the words “Internet data center” and “co-location facility” are unfamiliar, don’t panic, we’re here to help. For purposes of New York State taxes, an operator of an “Internet data center” is any person who operates a facility specifically designed and constructed to securely hold servers and similar equipment used to continuously host Internet websites. A “co-location facility” is similar to an Internet data center, except that the servers located at the facility are owned by other, third-party customers, and the servers may or may not be used to host websites (the servers could host other information, such as private business records, or Hillary Clinton’s emails). Both of these backend businesses may benefit from the state’s unique sales tax rules for hosting facilities.

First, operators of Internet data centers generally don’t pay sales tax on purchases or uses of machinery, equipment, and certain other tangible personal property (including software) and services used at the data center for website hosting. And hosting is not included among the enumerated services that are subject to New York State sales tax. While not all cloud-based software applications are likely to qualify as a website for purposes of the exemption, others should. This means that vendors who provide 24/7 Internet access to their customers’ web pages may qualify for significant tax savings and be in a much better position than their customers when it comes to owing New York State sales and use taxes.

Second, thanks in part to a recent New York State Advisory Opinion, operators of co-location facilities now know that many of the separate services they provide, including charges for the physical spaces used to house their customers’ servers; various unmetered utility costs; cabling and bandwidth charges; and certain types of technical support are generally exempt from tax. It’s important to note, however, that other co-location charges may be taxable, including hardware maintenance and certain types of telecommunication services. But again, the rules relating to co-location facilities show that a backend facility used to host web-based software products may be entitled to preferential sales tax treatment.

So before sending out another invoice, New York State hosting providers and co-location facility operators should take time to review these rules. There may be some good news for these businesses just beyond the clouds.