Cloud Computing Taxes at Issue in Idaho and Elsewhere

Fast-changing technology has created gray areas in tax laws across the country. Businesses and lawmakers are sparring over whether commercial use of remote computer software and servers should be taxed.

Katy Moeller

The Idaho Tax Commission officials won’t discuss what triggers tax audits on individuals or businesses, or whether a specific industry sector is being targeted on suspicion of non-compliance with the law.

But a flurry of audits on Idaho technology businesses in the past eight months has led to a revolt of sorts by entrepreneurs who say the state is applying outdated tax code to modern Web-based technology.

“It’s something that a lot of people have become passionate about -- it’s been a coalescing force,” said Jay Larsen, president of the 178-member Idaho Technology Council. “We don’t want anybody to move out of state because of this.” Neither Montana nor Oregon have sales taxes.

Since 1965, Idaho has taxed sales of goods. It does not tax services such as those provided by lawyers and accountants. Another way to view it: When you take your car in for a repair, parts are taxed but labor is not.

At issue now is how businesses and tax collectors view “cloud computing” -- commercial use of remote computer software and servers. The Tax Commission sees such use as a taxable transaction. The software users and developers see it as a service that should not be taxed.

Some business owners say the Tax Commission has told them they owe thousands -- even hundreds of thousands of dollars -- in uncollected sales taxes, said Matt Rissell, owner of Eagle-based Tsheets.

His company, which develops Web-based time-tracking software for small- and mid-sized businesses, is currently being audited. “This could be the death knell to the tech community in Idaho -- if the tax commission continues to do this,” he said.

Rissell said he and a small group of fellow tech business owners took their concerns straight to the governor a couple weeks ago. Since then, the Idaho Technology Council has drafted a position paper.

In the paper, the council is asking the Tax Commission and state legislators to work with the group on a “watershed issue that confronts every Idaho technology business that offers services via the Internet.”

The Tax Commission’s Oct. 22 interpretation could “have potentially disastrous economic consequences as Idaho’s cloud-based technology companies seek a more favorable economic climate,” says the paper, drafted by attorneys from the law firm Hawley Troxell.

Tangible, Yet Virtual?

Other states with a sales tax also are hashing these issues out, with varying outcomes.

The Idaho Tech Council points to Kansas, where tax officials have deemed cloud computing services are not taxable because they don’t, by that state’s definitions, involve transfer of tangible personal property. The Idaho Tax Commission’s position is more akin to New York state, where accessing software that is housed remotely is considered a transfer of tangible property.

Everyone agrees that fast-changing technology and business models have created gray areas in tax laws across the country.

Idaho’s 1965 sales tax applied to tangible property you could “feel, touch, lift,” said Saul Cohen, a longtime tax policy specialist at the State Tax Commission.

Since 1986, software reproduced and sold to more than one person was included in the state’s definition of tangible personal property -- regardless of how the software is transferred to the customer.

So if a person buys software on a CD or DVD at the store, or if he or she downloads software electronically from the Web to a home computer, both are considered a taxable transaction.

Evolving Technology

In the 1990s, business models began to change as the Internet developed.

Today, many tech businesses offer customers use of proprietary computing software over the Internet -- cloud-based computing -- without conferring any sort of ownership or physical possession of the software.

Entrepreneurs say cloud-computing is more like a professional selling time and advice than it is a business selling taxable software or hardware.

But analysts at the Idaho Tax Commission view it as merely an evolutionary step in how modern goods are delivered.

A Transfer of Goods, or a Service?

Businesses that serve customers through the cloud-based computing model, like Boise’s Zenware, call themselves “software as a service,” or SaaS, companies.

They insist they are not selling or transferring any tangible goods to customers -- only providing a service.

“They get no rights to do anything but open it (software) and use it,” said Jody Sedrick, Zenware’s CEO. “They are basically renting for a given time period. You can use the software and data that sits on my server.”

Attorney Brad Frazer of Hawley Troxel said the disagreement hinges on whether “software as a service” is a transfer of goods.

“As written, the Idaho Sales Tax Act arguably permits this taxing activity but it’s gray. It’s unclear,” Frazer said. “What the Idaho Technology Council is suggesting is a clarifying amendment to the Sales Tax Act that these are services, not taxable events.”

Cohen of the Tax Commission said he respects those who object to the commission’s interpretation.

“The commission tries to enforce the law fairly and equitably,” he said.

The Tax Commission has 35 income tax auditors, 33 sales tax auditors, 26 tax discovery auditors and 11 financial technicians, but those must oversee all Idaho businesses and taxpayers.

Zenware, which develops business software, has 14 employees. Most of the company’s customers are located outside Idaho, but Sedrick worries about a chilling effect on the tech industry if auditors tax the transactions.

“The ramifications are far-reaching,” Sedrick said.

There Ought to be Clouds

He said cloud-based computing services allow small- to mid-sized businesses use of enterprise software that they couldn’t possibly afford to buy.

For example, Sedrick said, a $30,000 computing program could be accessed by customers at a cost of $65 a month.

If legislators determine that “software as a service” transactions should not be subject to sales tax, the state would lose a growing stream of potential revenue. But Larsen and others say the cost of collecting the sales tax would be even greater.

Growing the tech industry has the best potential to generate Idaho jobs and revenue. “More companies would allow us to have a lot larger tax base,” Larsen said.

©2013 The Idaho Statesman (Boise, Idaho)

Caroline Cournoyer is GOVERNING's senior web editor.