2013-14 Worldwide Cloud Computing Tax Guide
This guide was created in recognition that cloud computing is a technology megatrend that affects all industries, from technology companies as cloud service providers, to brick-and-mortar companies using the cloud to reduce information technology (IT) and infrastructure costs. Although there are a number of definitions for cloud computing, EY generally views cloud computing as borderless commercial transactions conducted over a virtual network (i.e., the internet) in which goods or services are provided to a user (related or unrelated) anywhere in the world with access to such network. Due to its borderless and commercially fluid nature, cloud computing can give rise to a number of tax complexities, especially in the cross-border arena.
Cloud service providers over the past decade have been challenged to effectively manage the tax treatment of cloud-related operations. Moreover, as the market for cloud computing services continues to expand globally across all business sectors, cloud users are now faced with these same questions regarding the appropriate tax treatment and considerations for cloud computing transactions. In addition, many taxing authorities have begun to focus their attention in this area, which is often operated across jurisdictional borders. For example, in a recent report on base erosion and profit shifting (BEPS) released by the Organisation for Economic Co-operation and Development (OECD), cloud computing transactions are specifically identified as an area in which “international tax standards may not have kept pace with changes in global business practices.”1 The report further states, “Today it is possible to be heavily involved in the economic life of another country, e.g., by doing business with customers located in that country via the internet, without having a taxable presence there or in another country that levies tax on profits. In an era where nonresident taxpayers can derive substantial profits from transacting with customers located in another country, questions are being raised on whether the current rules are fit for purpose.”
Although cloud-related operations are evolving and the tax issues around them are uncertain, this guide aims to convey an understanding of how each of the world’s jurisdictions views, under current law, certain cloud-based operating models from a direct and indirect tax perspective. To accomplish this goal, EY surveyed more than 140 countries, 50-plus of which are represented in this initial release, to understand the tax considerations related to cloud computing transactions under three separate operating models that involve a cloud service provider and a user of cloud services:
- Commissioned agent2 model: The commissioned agent operating model represents a disclosed agency arrangement in which the commissioned agent local entity provides services to the principal for an arm’s length agency commission and the customer deals directly with the principal.
- Commissionaire3 model: The commissionaire operating model represents an arrangement in which the commissionaire local entity invoices the customer in its own name on behalf of an undisclosed principal.
- Buy-sell4 model: The buy-sell operating model represents an arrangement in which the local buy-sell/sales and marketing subsidiary performs in-country sales and marketing activities (i.e., promotional activities likely remunerated on a cost-plus basis) for the principal. This entity may also perform buy-sell activities directly with the customer, own the rights to intellectual property and content and assume the risk of loss with respect to the transactions in buy-sell agreements.
Diagrams contained within each chapter contemplate transactions according to the three operating models mentioned above.
Within each operating model, this guide provides high-level tax considerations regarding contractual terms that indicate lease/rent/license, sale or service arrangements. The tax matters considered also include how such payment may be treated from the perspective of:
- Income characterization
- Withholding tax
- Permanent establishment (PE)
- Indirect tax
Assumptions and caveats
Notably, at the time of this release in 2013, the OECD and several other stakeholders, policy-makers and lawmakers in numerous jurisdictions are in the midst of a debate on the appropriate taxation of certain industries that perform their business across borders. This guide is intended only to address the high-level tax considerations of the aforementioned cloud computing operating models under current law and does not discuss proposed legislation, if any. Each taxpayer’s operating model is aligned to the needs of the taxpayer’s particular business, and this guide should not be viewed as an endorsement of the sample operating models used to address the four tax matters identified above.
The three operating models were selected based on their common use in practice and simplicity. The guidance contained herein is meant to be high-level and cannot be relied upon for specific decision-making. Certain assumptions and local terms may be used, and the facts and circumstances surrounding a business’s involvement with cloud computing are likely to be more complex. Therefore, we recommend readers contact their local member firm EY account team to further understand the tax implications with respect to their unique facts and circumstances.
This guide was conducted with certain caveats and assumptions, which are summarized below:
- “Country A” refers to the jurisdiction under review. Conversely, “Country B” refers to a foreign jurisdiction outside Country A.
- No contemplation was given to transactions that might exist between an entity and its parent company.
- “Principal” refers to the lead entity that assumes most if not all the risks associated with providing cloud services to customers.
- “IT infrastructure” refers to the technology hardware used to deliver cloud-based services to customers.
- “Commissioned agent” refers to the entity that works on behalf of a principal to sell cloud-based services to customers in the local market. However, the commissioned agent neither signs contracts with customers nor delivers cloud-based services.
- “Commissionaire” refers to the entity that signs customer contracts on behalf of an undisclosed principal.
- “Buy-sell entity” refers to either a limited risk distributor or a full-fledged distributor. The buy-sell entity may sign customer orders and be contractually responsible, in part or in whole, for the cloud-based services rendered to customers.
General commentary on results
Certain trends emerged from the data upon review, and these are summarized below. In general, the trend reflects that local tax laws have not evolved sufficiently to specifically address the taxation of cloud computing services, as the laws often predate the emergence and rise in popularity of cloud computing technologies. The tax analysis is therefore based on laws that seem to have general application to this area.
- Many countries generally follow OECD principles, which is especially true in the treaty context. Emerging markets tend to provide less certainty and express some opposition to the OECD Model.5
- Many countries surveyed follow the OECD definition of “dependent agent” for taxable nexus.
- Many countries do not attribute a permanent establishment to the principal for storing or providing content via servers leased or rented from third parties.
- Generally, whether a taxable nexus exists is determined by weighing specific facts and circumstances. Certain countries surveyed reported that the mere presence of a server would likely constitute a taxable nexus for equipment, while other countries looked to the server functions.
- Characterization of income is essential to determining whether withholding taxes apply. Some countries may take a formalistic approach to how a payment is characterized while others may look at the substance.
- Characterization also may dictate application of other business taxes.
- It is often unclear how bundled payments are treated. Certain regions of the world (e.g., Latin America) have more burdensome or higher withholding taxes than others (e.g., Europe).
Value-added tax (VAT)
- Many countries have not defined or have only partially defined the VAT treatment of cloud computing services.
- It is important to understand the supply chain and who has the obligation to account for local VAT.
- Place of supply may be deemed to be where the customer is normally resident. In such case, certain jurisdictions may require a foreign supplier to register for VAT or appoint a VAT representative.
- Many countries do not have a VAT regime; however, other indirect taxes may apply.
Although not specifically discussed in this guide, other areas of tax that may affect cloud computing services include:
- State and local tax
- Specific local tax incentives
- Transfer pricing
- The availability of a local ruling or advance pricing agreement (APA)
It should also be noted that this guide is generally focused on inbound taxation. Outbound taxation is generally not discussed.
There are many open issues, such as whether the tax laws will be expanded specifically to capture fees for the use of servers, whether PE laws will evolve to consider so-called smart servers and whether there will be new rules around intangible property ownership. Businesses must keep apprised of the state of affairs for cloud computing in the countries where they conduct business.
1 OECD, Addressing Base Erosion and Profit Shifting, OECD Publishing, 2013 (accessed via http://dx.doi.org/10.1787/9789264192744-en). The OECD works with governments to understand what drives economic, social and environmental change. It sets international standards on a wide range of issues, including tax policy.
2 See the Assumptions and caveats section for the definition of a commissioned agent.
3 See the Assumptions and caveats section for the definition of a commissionaire.
4 See the Assumptions and caveats section for the definition of a buy-sell entity.
5 The OECD Model is a model income tax treaty that provides a uniform template for countries to use in establishing income tax treaties with other countries.