PA To Tax Cloud Computing

In a private letter ruling issued May 31, 2012 (Letter Ruling SUT-12-001), the Pennsylvania Department of Revenue stated that accessing pre-written software via the Internet is taxable if the purchaser and the user are both located in Pennsylvania.

The ruling represents a departure from the Department's earlier treatment of cloud computing whereby access to software solely through the Internet was not a taxable transaction, as long as the server did not reside in Pennsylvania.

"User" is defined as either an employee or a customer of the software purchaser/owner (according to the Letter Ruling, "In order to access the software, Taxpayer's customers either pay a subscription fee to Taxpayer or pay Taxpayer on a per-use basis. Both Taxpayer's employees and customers may collectively be referred to as 'end users' of the licenses to use the software.")

The reasoning for the new ruling is that computer software is "tangible personal property," and therefore, the charge for electronically accessing such software is taxable if the user is accessing the software from within Pennsylvania. However, if the end user is located outside the Commonwealth, the transaction is not subject to tax, even if the server is located in Pennsylvania.

If the billing address for pre-written software accessed remotely is a Pennsylvania address, all users associated with that billing address are presumed to be located within the state. To show that some users are actually out of state, the purchaser must submit an exemption certificate to the seller stating the percentage of users who are located outside the Commonwealth (this presumably applies only to employees, not customers).

So, in a nutshell, it doesn't matter where the server is located. If the user is in Pennsylvania, the user pays a tax on a subscription or per-usage charge. What the letter does not really address directly is software used only in-house, and not by customers. Presumably, there would be a one-time tax levied at the time of purchase (or on installment payments made by the purchaser).

While this seems like an effort to "rationalize" the taxation process, it may have the effect of discouraging companies from locating facilities with a large head count inside Pennsylvania, or encouraging those (few, these days) who are expanding to look elsewhere (if they use cloud-based solutions on a pay-as-you-go basis to run their business, which businesses increasingly do). And it will certainly discourage companies who offer access to software to their customers on a subscription or per-use basis from locating in the Commonwealth (although only PA residents will be so taxed, but PA is the sixth most populous state). Yes, this can be said of any tax, but unless and until nationwide treatment of situations like this are resolved at the Federal level, states will have to decide between trying to collect additional revenue or encouraging large employers to love Pennsylvania.