Massachusetts Tax May Leak Into the Cloud

If a proposal from the governor of Massachusetts is approved by the state legislature, Massachusetts will expand its tax on "canned software" to include some elements of cloud computing.

The proposed 4.5% tax is lower than the state's 6.25% sales tax and it includes exemptions for people storing music or e-books in the cloud.

Members of Gov. Deval Patrick's administration estimated the tax, if approved, would bring in $265 million during 2014, according to story from Boston public-radio station WBUR.org.

"We need our tax code to catch up with the way that technology is affecting everyone in their daily lives," said David Sullivan, legal counsel for the Executive Office for Administration and Finance in WBUR's story.

The tax would cover custom-designed software and services based in the cloud. "Custom" software includes the design of Web sites, so the cost to local businesses of a new Web site would increase by 4.5% on contracts to design the site, write Java, PHP or other custom code. The cost of site hosting and bandwidth would also be taxed.

Most of the tax would be levied against integrators, developers and other companies producing custom software. It's not clear exactly what services would be covered by the tax, but if hosting, bandwidth, storage, security and other services are taxed, presumably the tax would affect any service based away from the premises.

Taxing the Cloud Is Tricky

Taxing cloud-based services poses problems for both the state and the company being taxed, according to a 2012 report from KPMG International. Because many cloud services are available in more than one state, or have physical facilities in more than one state, questions about which state has jurisdiction and what tax might apply become complicated very quickly, according to KPMG.

"Many businesses may share the same 'facilities' [in multi-tenant clouds] and may not know where the data is located," the report went on. "The location could be in a number of places." The report is available for download here as a PDF.

The global market for public-cloud services may grow as much as 18.5% during 2013, to a total of $131 billion, according to Gartner.

In addition to taxing custom software and cloud-based services for the first time, Massachusetts' new tax would consolidate a mesh of regulations covering various aspects of software development, purchase and use, according to press material from the administration.

At least 14 other states tax the cloud explicitly, according to WBUR; another 14 states have taxes that cover some aspects of cloud-based services. For example, Ohio, Texas, New York South Carolina and Washington tax computing services directly, while Utah and the City of Chicago tax the cloud only when deals involve the transfer of control or possession of software as well as computing services, according to national tax-services company WTAS.

At least two states, Vermont and Idaho, have recently passed rules to explicitly exempt cloud-based services from state sales tax.

In Massachusetts the cloud tax is still only a proposal in the governor's budget. That budget, with its $1 billion in new taxes and $1.9 billion in new spending, has generated considerable opposition in the always-contentious Massachusetts State Legislature. Neither the spending nor revenue portion of the budget is likely to get through the Statehouse without significant changes.

Whether the Massachusetts tax is approved or not, taxes on IT services are becoming a routine cost for companies in many parts of the country, according to KPMG. To cope, CIOs and IT contract managers must strip away some of the abstraction in cloud contracts to identify the specific services being offered, their location, and characteristics such as the volume of data to be moved and whether any transfer of software is involved. That is the only way to be prepared for the likelihood of state taxes on the cloud, and to understand which services will be taxed and at what rates, according to KPMG.