The taxman cometh for cloud computing

New efforts to tax cloud computing could make it less cost-effective, and certainly messy for both buyers and providers

You had to see this one coming. As local municipalities and states seek to find additional revenue in this down economy, they now have their sights on the emerging market of cloud computing. As more companies use cloud services, the traditional rules of taxation based on physical presence no longer fit. However, the new set of proposed tax laws could drive more confusion and remove much of the costs savings of transitioning to the cloud.

States recognize the shift in buying patterns from boxed software and hardware to computing services delivered over the Internet. Thus, they want to position or reposition tax laws to make sure they get their traditional share as purchases shift venues.

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Many established interests want to shape this movement. Accountants, lawyers, state tax officials, and companies such as Google, Apple, and NetSuite are looking to develop new guidelines for taxing the use of cloud computing. Amazon.com has exited more than a dozen states that changed their laws to consider such affiliates as equivalent to taxable physical presence for distributors. Instead, Amazon is pulling affiliate arrangements to avoid collecting taxes and trying to get a ballot initiative in front of voters to exempt it from a recent decision to tax online retailers' in-state sales.

Now the federal government is chiming in. This includes Sen. Ron Wyden (D-Ore.) and House Judiciary Committee chairman Lamar Smith (R-Texas), who are backing federal legislation that would limit the states' ability to tax "digital goods and services." As you may recall, this was the same type of law that limited the taxation of the then-emerging Internet-based e-commerce industry in the 1990s, and it's based on an old Supreme Court decision that exempts catalog sales from having to collect sales taxes when the customers are in a different state than the retailer.

At the same time, Amazon and others are supporting a bill from Sen. Dick Durbin (D-Ill.) that would impose a streamlined national sales tax for e-commerce, avoiding the complexity of figuring out hodgepodge of state and local tax rates. As online sales have grown dramatically, states have challenged the catalog sales-based exemption, some imposing sales taxes.

It's that hodgepodge of local rates -- imposed in an era when most goods and services were made and bought locally -- that's the big issue for online retailers. (Chain stores have had to deal with them all along.) But it gets even more complex once you leave catalog-style e-commerce like Amazon and cross into digital services.

For example, a New York-based company may purchase server space and cloud-based software from a Texas-based company. That's relatively straightforward, except that the Texas company may have servers in North Carolina and California, while the New York company may have satellite offices in Illinois, Florida, and Kentucky that use the server space. Who gets the tax bill, and who gets the revenue? Good luck with that one.

My advice is that feds stay out of this issue for now. Let cloud computing grow without having to deal with confusing tax laws and the shadow of a yet-to-be determined tax burden. After all, the legal basis for the taxes remains in dispute. Ending the tax-collection exemption that digital services now enjoy will only create FUD in the emerging cloud market and cause many organizations to avoid cloud services entirely until the tax issues are better understood.

This article, "The taxman cometh for cloud computing," originally appeared at InfoWorld.com. Read more of David Linthicum's Cloud Computing blog and track the latest developments in cloud computing at InfoWorld.com. For the latest business technology news, follow InfoWorld.com on Twitter.

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