Best Practices in Law Firm Business Development and Marketing Click Now! Executive Summary On August 9, 2019, the US Treasury Department published proposed regulations for the classification of “cloud transactions” and “transactions involving digital content” under the source of income rules of the Internal Revenue Code. The proposed regulations would amend existing regulations that were introduced in 1998, at a time when retail digital downloads were virtually non-existent and the commercial use of cloud computer technology was still in its early stages. The proposed regulations largely adapt the principles of income classification that taxpayers have been applying to date to transactions in the cloud. Those principles, which derive from statutory and case tax law, will typically treat cloud computing transactions as a provision of services rather than a lease of property. In addition, the proposed regulations introduce an absolute rule that sources income from digital transactions at the place where the download of the digital content is deemed to occur. This new sourcing rule will of course have implications for cross-border transactions in the cloud, as described in more detail below. A planning and compliance review before the rules become final may have some merit. Definition of Cloud Transactions The proposed regulations include new definitions for classifying cloud computing transactions. The existing 1998 regulations provided rules for classifying transactions involving “computer programs” but did not specifically refer to cloud computing. Cloud technology existed at that time but was still in its infancy and commercially undeveloped. According to the background section accompanying the proposed regulations, cloud computing is characterized by on-demand network access to computing resources, such as networks, servers, storage and software. Cloud computing transactions typically involve what is known in the industry as: Software as a Service (SaaS), Platform as a Service (PaaS) and Infrastructure as a Service (IaaS). Today, these kinds of transactions typically do not involve the transfer of a copyright as was more common when the existing regulations were published. Cloud computing is characterized today by access to technology and not as a transfer of a property right in technology. There are other transactions in the cloud that do not relate to computing but involve on-demand access to technological resources. Examples include streaming video, mobile device applications, and access to data through remotely hosted software. The proposed regulations refer to these transactions and the above cloud computing transactions collectively as “cloud transactions.” A cloud transaction is a transaction through which a person obtains non-de minimis, ondemand network access to computer hardware, digital content, or other similar resources. Classification of Cloud Transactions as Provision of Services or as a Lease The proposed regulations classify a cloud transaction as either a lease of property or a provision of services for US income tax purposes. Factors to consider when classifying a transaction as either a lease of property or a provision of services can be found in case law and in general statutory rules defining services contracts. A non-exclusive list of these factors is added under the proposed […]
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