Iowa and Kansas recently issued rulings regarding the taxability of cloud-based software applications and online training services. While the conclusions reached by both states—that the services are not taxable—are generally the same, the reasoning relied upon by each department of revenue illustrates the ongoing uncertainty of applying state sales and use tax laws to cloud computing services.
The Iowa Department of Revenue (IDOR) looked to the state’s statutory authority and acknowledged that the taxability of “cloud computing has not been expressly addressed by the Iowa Code.” Nonetheless, the IDOR determined that the sale of hosted software is not taxable because the Iowa Code provides that a “taxable ‘sale’ of tangible personal property does not occur if the substance of the transaction is delivered to the purchaser digitally, electronically, or by utilizing cable, radio waves, microwaves, satellites, or fiber optics.” I.C. § 423.3(67). Likewise, the IDOR considered web-based training to be nontaxable because “software training” is not an enumerated service under the Iowa Code.
The Kansas Department of Revenue (KDOR) made a distinction between the treatment of such an arrangement depending on the specific contractual terms agreed upon, for purposes of determining the proper sales and use tax treatment. While the KDOR maintains that the charges for using “someone else’s software” on a remote computer are not subject to tax (commonly referred to as Software as a Service), it has advised that when an in-state or out-of-state business leases space on a remote server located in Kansas and buys prewritten software that is installed on that server, both the software purchase and the charge for leasing space on the Kansas server (commonly referred to as Infrastructure as a Service) are subject to Kansas tax.
The KDOR described a “hosted software” transaction as one that “obligates a service subscriber to pay a fee to gain Internet access to, and the use of, the service provider’s software and servers and to the data the subscriber inputs and stores on those servers.” The ruling further provides that charges for hosted software services are not taxable “because the software that is installed on a remote server isn’t delivered to subscribers or installed on their computers” and “[t]he service provider has title and possession of the software.” But the KDOR further qualifies this position by stating that “[s]uch software is not taxable as a sale of prewritten software so long as the software is not billed to subscriber as a separate line item charge.”
Also important to note is the sourcing implication of this guidance: Kansas considers the location of the server, rather than the customer/user, to be the proper taxing jurisdiction for hosted software applications. Since the majority of states that tax cloud-based software services source the sale to the end user location, the KDOR effort to tax at the server location could lead to multiple taxation.