Pennsylvania Making Cloud Use Taxable, Maybe, Sometimes, Depending On Where The Server Is

Just when you thought cloud computing couldn't get any more complicated and fraught with hidden gotchas, the Pennsylvania Department of Revenue has jumped in to sprinkle taxation magic on your cloud business cases. What the Keystone State did—and other states are likely to follow—doesn't make cloud any less profitable, but the specifics of the cloud deployment could now impact tax costs.

A Dallas tax services firm—called simply Ryan—first noted the state's letter from May 31. That letter ruled cloud operations are fully taxable, assuming the end user is in Pennsylvania. "The ruling represents a marked departure from the department's earlier treatment of cloud computing. Prior department guidance advised that access to software solely through the Internet was not a taxable transaction, as long as the server did not reside in Pennsylvania," said a statement issued by Ryan.

For example, let's say Sears buys some SAP suite and installs it in a public or private cloud, and then employees in Pennsylvania Sears stores use the software. Under the new ruling, Sears has to pay sales/use tax on the purchase (including, apparently, purchase of maintenance contracts, which provide additional software) as if it were purchased in Pennsylvania, prorated to the number of employees it has in that state.

Alternatively, let's say Target offers a consumer charge service and happens to handle some of the service on the cloud. If some Target customers in Pennsylvania use this site and pay for the service, even if Target had no stores or other facilities in Pennsylvania, this letter appears to say Target would have to collect sales/use tax on that sale—a ruling that certainly seems to conflict with the nexus element in the Quill decision.

What if only part of the transactions happen on the cloud server? How's this scenario for an accounting nightmare: What if cloud servers—along with physical servers—are in a round-robin? Some of the cloud servers are in Pennsylvania, but many aren't. How can the chain possibly determine which server locations handled particular transactions?

What if employees in Illinois are generating revenue and they happen to use a VPN, which routes through the cloud in Pennsylvania? Does that place all that revenue under Pennsylvania jurisdiction? And just wait until other states try and mimic Pennsylvania's move.

Here's how the state rationalized its decision: "In light of recent case law and technological advances, the department concludes that because computer software is tangible personal property, the charge for electronically accessing taxable software is taxable. In accessing taxable software the user is exercising a license to use the software, as well as control or power over the software, at the user's location."

The state gave some exceptions, for those who found the letter insufficiently confusing: "The sale and use of software that otherwise would be subject to tax is not subject to sales tax if the end user of the software is located outside of the Commonwealth, even if the cloud server that hosts the software is located in Pennsylvania. However, if the end user is located in Pennsylvania, tax is due regardless of the location of the seller or server. Finally, the resale exemption may be claimed on the purchase of software to be located in Pennsylvania when tax will be collected on the use of the software in Pennsylvania."