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January 15, 2013

Virginia Rules Cloud Computing Services Not Taxable

Given the weak economic conditions in the U.S., some states have latched onto the idea that potential revenue can be tapped by taxing cloud-based services.

However, a recent ruling by the Virginia Department of Taxation found that cloud computing services purchased by the taxpayer were not subject to Virginia sales or use tax under certain circumstances.

“The ruling (P.D. 12-215) concludes that the cloud computing services were not subject to Virginia sales or use tax under the following situation: (1) the taxpayer was located in Virginia; (2) the taxpayer purchased a license to use software developed by Company A (located outside of Virginia); (3) the taxpayer contracted separately with Company B, a cloud computing provider located outside of Virginia, to host the software purchased from Company A; (4) Company A shipped the software directly to Company B on a disk rather than by electronic delivery,” according to an article by Michael A. Jacobs and Daniel M. Dixon, attorneys with the international law firm Reed Smith.

Under the Dec. 21, 2012 ruling, cloud services from a location outside of Virginia are not taxable – even when tangible personal property is involved.

“If the customer received the right to use the software (a service), and no tangible personal property is transferred, Va. Code § 58.1-609.5 1 provides an exemption from the retail sales and use tax for: Professional, insurance, or personal service transactions which involve sales as inconsequential elements for which no separate charges are made…,” the ruling states.

According to the authors, the department’s decree implies “that location of delivery of the disk was determinative,” and believe that the focus on the delivery of the disk is a so-called red herring.

“In any purchase of cloud computing services, it is highly unlikely that the ‘true object’ of the transaction would be the receipt of software on a tangible disk,” the authors wrote. “So no matter where your cloud service provider is located, your company should never pay, or have paid, tax on those services, even if the cloud provider is located inside Virginia.”

Based on the ruling, any business that has paid Virginia sales or use tax on cloud computing services based may be entitled to a refund.

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Edited by Rich Steeves
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