Pennsylvania Changes Position on Taxation of "Cloud Computing"

by McNees Wallace & Nurick LLC
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[author: Sharon R. Paxton]

On May 31, 2012, the Pennsylvania Department of Revenue issued a private letter ruling (Ruling No. SUT-12-001), in which it concluded that "[a]ccessing taxable canned software is taxable when the user is located in Pennsylvania."  This ruling, which ties the taxability of software access to the location of the end users, represents a reversal of the Department's long-standing position that the taxability of access to software located on a remote server depended solely on the location of the server.

In earlier letter rulings, the Department had uniformly taken the position that the sale of access to software solely through the Internet was not a taxable transfer of software unless the server was located in Pennsylvania.  See, e.g., Ruling Nos. SUT-10-005 and SUT-08-005, both of which have been removed from the Department's website.  The Department had also applied this rule in situations where a multistate business purchased software for use by its employees.  That is, if a business loaded software on a Pennsylvania server for use by employees located both inside and outside of Pennsylvania, the Department sought to tax the entire purchase price of the software, even if a majority of the employees using the software were located outside the state.  Conversely, if the software was located on a server outside Pennsylvania and accessed by employees in Pennsylvania, no portion of the software charges were subject to sales and use tax in Pennsylvania.

In Ruling No. SUT-12-001, the Department addressed two scenarios in which the taxpayer uses "cloud computing."  First, the taxpayer purchases and installs software on servers for use by its employees to enable them to access their office computers and perform work-related tasks from remote locations, both within and outside of Pennsylvania.  Second, the taxpayer installs software on its servers for access by its customers, who either pay a subscription fee or pay the taxpayer on a per-use basis.  The Department concluded that "in light of recent case law and technological advances," a charge for electronically accessing taxable software in Pennsylvania is subject to sales and use tax because the end user "is exercising a license to use the software, as well as control or power over the software, at the user's location."  Both the taxpayer's employees and its customers were characterized as "end users" of the software licenses under these scenarios.  The same rationale would apply to other types of software purchased by a business and then loaded on a server for use by employee "end users" both within and outside of Pennsylvania at their office computers.

We understand that the Department plans to apply the new policy, which did not result from any change in applicable law, on a prospective basis.  If the billing address for canned software which is accessed remotely is in Pennsylvania, the Department will presume that all users of the software are located in Pennsylvania.  In order to rebut this presumption, a purchaser should provide an exemption certificate to the software vendor, stating the percentage of software users who are located in Pennsylvania on Line 7 of the certificate.The Department's position that the taxable use of software occurs where the software user is located, rather than where the server hosting the software is located, seems more logical than making taxability determinations based solely on the location of the server.  A purchaser of the right to access software over the Internet may not know where the vendor's server(s) are located and has no control over the location of those servers.  Also, the vendor could change the location of the servers from time-to-time without the subscriber's knowledge.

Further guidance from the Department may, however, be needed to clarify the difference between the purchase of a nontaxable service that is provided over the Internet and the purchase of a right to use or "access" canned software.  In Ruling No. SUT-10-005, for example, the Department had addressed the taxability of various "web-based services," but seemed to base its determination that the "services" were not taxable, at least in part, on the fact that "access to software solely through the Internet is not a taxable transfer of software unless the server or data center resides in Pennsylvania."  In the scenario addressed in Ruling No. SUT-10-005, the taxpayer's customers accessed its web-based services (which enabled subscribers to have remote computer access, to attend and participate in meetings online, and to provide technical computer support to employees and external customers) by downloading an applet, for which there was no charge, that allowed them to connect to the taxpayer's system.  No other software was transferred to the taxpayer's customers, and the services did not allow subscribers to access the taxpayer's computer code or manipulate the software in any way.  The taxpayer's proprietary software was maintained in a hosted site, on its equipment, and the equipment and software were at all times under the control of the taxpayer.  While it appears that the web-based services offered by the taxpayer in Ruling No. SUT-10-005 involved "access" by subscribers to the taxpayer's proprietary software in some manner, it is not clear whether the subscribers' access to the taxpayer's system was evidenced by a "license to use" the taxpayer's software.  Ruling No. SUT-12-001 does not directly address the standards that will be applied by the Department to distinguish between nontaxable services and taxable software "access" in these types of situations.

If your company requires assistance in analyzing the impact of Ruling No. SUT-12-001, please contact any member of our State and Local Tax group.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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