By Sahang-Hee Hahn and Pilar Mata

The Illinois Department of Revenue determined that a taxpayer’s cloud computing receipts should be sourced for sales factor purposes using a market-based approach because the receipts were derived from services. The taxpayer was an information technology hosting services provider engaged in a business that focused on the delivery and support of dedicated and public cloud computing for its customers. The Department relied upon the principles contained in IRC section 7701(e) to characterize the taxpayer’s cloud computing contracts as service contracts. In reaching this conclusion, the Department noted the following: (1) customers do not acquire an ownership interest in, or take physical possession of, the taxpayer’s hardware and software; (2) customers do not control the taxpayer’s hardware or software; (3) customers do not obtain a significant economic or possessory interest in the taxpayer’s hardware or software; (4) the taxpayer bears the risk of substantially diminished receipts or substantially increased expenditures if the taxpayer fails to perform under the contract; (5) the taxpayer uses the hardware and software to provide services concurrently to unrelated customers; and (6) the total contract price substantially exceeds the rental value of the hardware and software for the contract period (noting that the taxpayer provides its customers with remote customer support). Based on the foregoing, the Department determined that because the taxpayer’s cloud computing contracts are services contracts, the receipts should be sourced for sales factor purposes using market sourcing. In Illinois, this methodology first looks to the location where the customer receives the benefit. In this case, because the taxpayer was not able to determine where a customer was physically located when the customer accessed the taxpayer’s servers, the Department indicated that the services will be deemed received at the location of the office from which the customer ordered the services; if that location cannot be determined, the services will be deemed received at the customer’s billing address. The Department further determined that if the taxpayer is not taxable in the state in which services are deemed received, such receipts must be excluded from the numerator and denominator of the taxpayer’s sales factor. This ruling is effective for tax years ending on or after December 31, 2009. Ill. Priv. Ltr. Rul. No. IT 14-0003 (April 24, 2014).