ABA Pushes IRS On Taxation Of Cloud Transactions
The Section of Taxation of the American Bar Association (ABA) has written to the US Internal Revenue Service (IRS) saying that there is a pressing need for guidance from tax authorities due to the rapid growth of the cloud industry.
The ABA noted that, although the Organisation for Economic Co-operation and Development (OECD), as part of its Base Erosion Profit Shifting Action Plan, has sought to address the taxation of the digital services and facilities, further analysis from tax authorities is expected.
“As with other cross-border transactions, tax consequences arising from cloud transactions are rooted in the character and source of the income,” the ABA said. “The relevant tax issue is whether the technological advances enabling electronic products, services, and delivery, are sufficiently removed from traditional business models to warrant diversion – and if so, how much – from traditional tax rules.”
The ABA said that “a lack of clarity as to whether cloud transactions should be characterized as the provision of services (and, consequently, as business profits for treaty purposes) or as a rent or royalty income (taxable at varying withholding tax rates)” means that various approaches are available to member countries.
Those options, the ABA continued, include “redefining the scope of permanent establishment to capture certain digital transactions, creating a withholding tax on digital transactions, and changing consumption taxes to better address the realities of the digital economy.”
The ABA recommended that the IRS should therefore, as a starting point, directly address the characterization of cloud transactions. “While traditional tax principles can be applied to cloud transactions, their current application is unclear,” it wrote. “We suggest that [the IRS] issue additional guidance clarifying the application of such principles to cloud transactions.”
“While it would be possible to modify existing regulations governing the treatment of software transactions,” it suggested that “such regulations not be modified or extended to cover cloud transactions. … [Instead, the IRS should] promulgate new regulations that would generally characterize cloud transactions as services arrangements, with the exception of certain transactions that, based on relevant facts and circumstances, [such as access agreements to servers], would be treated as leasing transactions.”
The ABA therefore concluded with an acknowledgement “that introducing new characterization of income rules to govern cloud transactions may be a viable option to provide guidance in this area of the law. However, given that there are several traditional characterizations that are relevant to cloud transactions, we suggest that the IRS issue regulations clarifying when the existing characterization rules apply rather than create new characterization rules.”
