Taxation in the cloud

December 10, 2013

In country after country, governments are trying to catch up with multinationals, as they rapidly redefine their business models with the rise of cloud computing. Tax authorities are now engaged in wide-ranging next-version global, regional and local tax rewrites, as they also try to patch up existing electronic services tax rules to make do for now.

By EY´s Channing Flynn, Stephen Bates, Beth Carr and Jon Cisler

Upgrading to cloud computing

As a linchpin of the global digital economy, cloud computing is pervading business across all industries, sending governments around the world scrambling to understand and tax business in the cloud.

The result to date, according to new EY research, is a global tax landscape that is riddled with gaps, inconsistencies and impending change.

Perspective on taxpayers

Both cloud service providers (CSPs) and cloud users who are among their industry’s digital leaders are already achieving unprecedented global operational efficiencies and tapping new revenue streams worldwide.

As taxpayers, however, companies face heightened uncertainty and risk in structuring their global cloud operations and defining their content and service offerings.

Their customers, whether business users or consumers, can also encounter potential new tax obligations and reporting burdens that vary from market to market.

Determining where to locate the assets and people associated with delivering global cloud content and services is a defining tax consideration, in terms of both direct, corporate tax rates and indirect, sales taxes such as value-added tax (VAT).

Among other issues, business customers in any given country can find themselves with added burdens for collecting and reverse charging taxes to their global CSPs.

Similar issues can arise between CSPs and the contractors in their global supply chains. In both cases, the risk increases that tax obligations will go unmet.

Given the sums of money at stake, cloud taxation is not a non-controversial matter, and these controversies are often played out in national news headlines.

From profit margins to partnership arrangements to compliance burdens to brand reputation – all these and more business aspects of global operations today can face significant and rapidly evolving tax implications.

Often, the best a company can do is to ask the right questions – but that is critical in the practice of tax law, because there is no way to get the right answer without the right question.

Perspective on tax authorities

If tension is building between taxpayer and tax authority, the underlying reason is simply that the cloud is borderless and tax jurisdictions are not. But nothing is quite that simple in these early evolutionary days of cloud taxation.

There are no familiar, cookie-cutter business models that tax authorities can readily understand. Technology tax rules are outdated and inconsistent in the context of the new digital economy.

The technology and business arrangements are such that even identifying the taxable location of either CSPs or their customers can be challenging.

Governments have various motivations for increasing their focus on cloud taxation:

  • Some have a long-term interest in building new local digital economies – even offering CSPs tax incentives to locate in their jurisdictions.
  • Others are under severe pressure to quickly raise public revenue after years of economic downturn.

While those are the most common drivers, other governments seek to protect their local markets or to preserve local cultural norms and censor unwanted content.

Change expected at all levels

At a global level, the biggest wave of change is coming from the OECD’s action plan on “base erosion and profit shifting” (BEPS). This plan to review current international tax regimes and coordinate wide-ranging revisions was recently endorsed by leaders of the Group of 20 (G20) nations.

At the regional level, change includes the European Union (EU) rule shifting current VAT obligations. To date, VAT on electronic services has been established by the EU country in which a service provider is situated (with human and technical resources, even if headquartered outside of Europe). In 2015 that same company will instead have to apply VAT based on its customers’ locations.

And at the national level, where EY’s new Worldwide cloud computing tax guide has amassed and compared detailed information on tax rulings across more than 50 countries (with plans to expand to over 100 countries), key international patterns emerge.

Among them:

Taxable nexus: Some countries surveyed report that the mere presence of a cloud server in-country would likely constitute a taxable presence, while other countries base their determination on the server functions.

VAT: Many countries have not defined or have only partially defined the VAT treatment of cloud computing services.

Harmonization: There is widespread (but not universal) adherence to cloud tax models drawn up by the OECD.

Company considerations

Companies need to ask themselves early and often how the cloud tax landscape will change in the coming months and years, and how big of an impact this could have on their risk profile, operational efficiency and profitability.

This text is part of the article “The ‘Beta-fication’ Of Tax Policy In The Digital Economy” which was originally published by Wolters Kluwer CCH in the Global Tax Weekly – a closer look, issue 51, October 31, 2013. The views expressed in this article are those of the authors and do not necessarily reflect the views of EY or its member firms.

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