Aug 22, 2016
From KPMG TaxWatch
In a recent ruling, the Virginia Tax Commissioner addressed certain questions posed by a taxpayer that provided subscription-based cloud computing services. These questions may provide guidance to other taxpayers that provide similar services or that have similar contacts with the state. Specifically, the taxpayer licensed basic software from a developer and customized the software, which was then resold to clients. All transactions between the taxpayer and the developer and between the taxpayer and its clients were performed through the cloud. The servers that housed the software were owned and operated by the developer. One of the servers was located in Virginia. The taxpayer had no employees in Virginia, but had at least one Virginia client.
The taxpayer requested a ruling as to whether it was liable for Virginia sales tax on its purchases of software subscriptions, or whether its use of the developer’s software housed on a Virginia server was taxable. The taxpayer also questioned whether it established corporate income tax nexus due to having a Virginia client. The Commissioner ruled that the taxpayer was not required to pay sales or use tax on its purchase or use of software or required to collect tax from its clients because all sales and use of the software occurred over the cloud, and no software was delivered in tangible form. It is the Department’s longstanding policy is that the sale of software delivered electronically or downloaded from the cloud does not constitute the sale of tangible personal property.
With respect to corporate income tax nexus, under Virginia law, tax is imposed on income from Virginia sources. It is the Department’s position that a corporation generally has income from Virginia sources if there is sufficient business activity within Virginia to make any one or more of the apportionment factors positive. Virginia, unlike many states, extends the protections of P.L. 86-272 to taxpayers that engage in sales of intangible personal property. The Commissioner, however, was unable to determine whether the taxpayer was protected under P.L. 86-272 because it was not clear whether the software developer was considered “independent” of the taxpayer. If the developer was an independent contractor, then its activities in Virginia – including maintaining a server – would not be attributable to the taxpayer. If the developer was not independent of the taxpayer, but was instead considered a representative of the taxpayer, then its activities could be attributable to the taxpayer.
The Commissioner also addressed the computation of the taxpayer’s potential apportionment factors- presumably if it was, in fact, not protected under P.L. 86-272. Because one of the developer’s servers was located in Virginia, the Commissioner advised the taxpayer to carefully examine its agreements with the developer to determine if the taxpayer was considered to be “renting” any server space in Virginia. The Commissioner also addressed the sales factor, which measures whether a greater proportion of the income-producing activity associated with a sale of other than tangible personal property is performed in Virginia than in any other state, based on costs of performance. In Virginia, a taxpayer can elect to include certain indirect costs in the costs of performance analysis, such as expenses related to activities performed by independent contractors. Thus, if the taxpayer was subject to Virginia corporate income tax, it would likewise need to determine if the developer was an independent contractor for apportionment purposes. If it was, the costs associated with the developer’s services could be included in the taxpayer’s indirect costs. If the developer was not independent, then the developer’s costs would be considered the taxpayer’s direct costs. Please contact Diana Smith at 703-286-8214 with questions on PD 16-135.
For more information about TWIST or to view archived episodes, please visit our TWIST homepage.
To receive TWIST e-mails each Monday morning, make sure that state, local and indirect is checked off as one of your topics of interest on the KPMG TaxWatch registration site.
The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.
The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.