Up in the air

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Cloud computing is changing the way we work. But when a business model is operated ‘in the cloud’, what are the tax implications for power & utilities (P&U) companies?
J. Andrew Miller and Michael Semes report.

Cloud computing is a technology megatrend affecting all industries. Companies are using the cloud to cut costs, particularly around information technology (IT) and infrastructure, improve collaboration and enhance innovation.

The use of cloud computing is expected to increase at a rate of 19.1% each year to 2016.The International Data Corporation (IDC) reports that annual growth of enterprise cloud application revenues is projected to be 24% over that same period1.

As the market for cloud computing increases, so do questions of how to effectively manage the tax treatment of cloud-related operations.

Utilities state of play

Despite its widespread use in many industries, we are yet to see a large engagement in cloud computing amongst our P&U clients. This is mostly due to the significant security risks faced by regulated businesses and the subsequent difficulty in assuring the safety of data in the cloud.

But while take-up has been slow, it is inevitable that utilities will move towards cloud computing as pressure mounts to be faster, more energy efficient and better at controlling costs.

We envision working with our P&U clients to:

  • Establish smart grid applications
  • Manage software applications
  • Manage data processing and analysis processes in the cloud

While security challenges currently pose problems, we expect that utilities will develop innovative methods to overcome these hurdles and may even use the cloud to improve information security.

Key tax challenges

It is important that P&U companies consider the tax implications of this new way of doing business.

Three key questions to consider are:

  1. What am I buying? Is it a service, such as data storage, or a product, such as software?
  2. Is it subject to tax? If yes, the next question considers location
  3. Where am I using it – and in which jurisdiction will I be taxed? This is a particular issue in the US where some states deem cloud computing to be taxable based on the location of the server, whereas others base tax treatment on the location of the purchaser. Companies should plan carefully and seek advice to ensure they are not taxed twice on the same transaction.

Our recent survey of countries reveals some offer more favorable tax environments for the provision of cloud computing than others (see inset box).

Prepare now

Though cloud computing is a fast-moving trend, the world’s tax laws are less quick to adapt. While some jurisdictions have developed helpful guidance, tax laws in others require further development.

Particular issues include:

  • Whether the tax laws will be expanded to specifically capture fees for the use of servers
  • Whether taxable nexus laws will evolve to consider smart servers

Companies should seek expert advice to keep up with developments and adapt their tax structures and compliance models.

Some best practices for proactively addressing tax issues associated with cloud computing include:

  • Conducting a nexus study that includes a review of cloud computing purchases and contracts
  • Engaging in a dialogue with your company’s IT department to gain a thorough understanding of current and planned cloud computing spend
  • Identifying intercompany cloud computing transactions and evaluating the associated transfer pricing issues
  • Constructing a matrix of state and foreign territory treatment of various types of cloud computing transactions
  • Formulating a policy for strategy for keeping such a matrix current
  • Implementing a strategy for approaching tax agencies to proactively resolve cloud computing tax uncertainties through the use of advance pricing agreements, voluntary disclosure agreements, letter rulings, etc.

Not all clouds are equal

When determining which countries were most favorable for providing cloud computing services, we considered six factors:

  • Risk of creating taxable nexus from the use of equipment located in-country
  • Risks of creating taxable nexus from having people located in-country
  • Existence of transfer pricing rules applicable to cloud computing services
  • Risks of creating withholding tax obligations based upon the character of income
  • Risks of value added taxes being assessed on the income
  • The ability to obtain rulings, APAs, etc

Each country was rated on its tax environment for providing cloud computing services using these criteria:

  • A "Green" rating signifies a low risk of adverse tax consequences based upon the factors considered. Green countries include Ireland, the Netherlands and Switzerland
  • A "Yellow" rating signifies an increased risk that the factors considered could lead to adverse tax consequences; how an existing treaty may mitigate the increased level of risk. Yellow countries include Germany, Japan and the UK
  • A "Red" rating signifies a high risk that the factors considered could cause adverse tax consequences due to the lack of treaties and undeveloped tax laws. Red countries include the US, China and India

For more information

For more information about the tax implications of cloud computing, read our latest global survey report, Tax considerations in cloud computing.

  • 1 “Cloud computing and enterprise software forecast update, 2012,” Forbes online, 11 August 2012.

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