Global cloud computing and indirect tax

Cloud computing has burst onto the commercial scene, affecting many industries. Generally defined as the hardware and software that supports transactions over a virtual network (i.e., the internet), cloud computing has a borderless quality that creates complexity for taxing jurisdictions and the tax teams that have to proactively manage tax risks for a product that is rapidly expanding on global scale.

Alongside this, governments are actively investigating and writing tax laws in this area, increasing the risk that taxpayers will be caught unprepared in some countries. In a recent report on base erosion and profit shifting (BEPS), the Organisation for Economic Co-operation and Development (OECD) specifically identified cloud computing transactions as an area in which “international tax standards may not have kept pace with changes in global business practices.”

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 non-resident 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.”

Tax teams need to have visibility and a good understanding of business operations globally to ensure that they can respond to the introduction of new cloud products in new markets without tax risks, which could impact business margins and commercial reputation.

We recently published the Worldwide cloud computing tax guide to help support businesses facing this challenge by giving some insight into the tax treatment of the cloud in more than 100 countries.To accomplish this goal, we surveyed more than 140 countries, 50-plus of which are represented in the initial release.

We explored tax considerations under three operating models that involve a cloud service provider and a user of cloud services:

Commissioned agent: The 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. “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. “Principal” refers to the lead entity that assumes most if not all the risks associated with providing cloud services to customers.

Commissionaire: The model represents an arrangement in which the commissionaire local entity invoices the customer in its own name on behalf of an undisclosed principal. In this model, “commissionaire” refers to the entity that signs customer contracts on behalf of an undisclosed principal.

Buy-sell: The model represents an arrangement in which the local buy-sell/sales and marketing subsidiary performs in country sales and marketing activities 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. In this model, the “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 results

Certain trends emerged from the data. Local tax laws have not evolved sufficiently to specifically address the taxation of cloud computing services, as the laws often predate the technologies entirely. The tax analysis is therefore based on existing laws that seem to have general application to this area and our understanding of and experience with the practice of the countries’ tax authorities.

For each of the operating models, we analyzed the VAT/GST treatment of transactions involving cloud services and assigned a risk rating for each of the 50-plus countries in our initial release of the survey. The following maps summarize the risk rating, from a VAT/GST perspective, for the countries represented.

The risk ratings are represented via a traffic-light system for each of the countries. Those countries illustrated as yellow or red indicate more potential for VAT/GST risks. More attention needs to be paid to the VAT/GST treatment of cloud services in these countries. The potential risks include VAT/GST costs, legislation issues and the possible requirement to register for VAT/GST.

Those countries illustrated as green, while not risk free, indicate that the particular VAT/GST issues may have clearer rules or definitions.

Figure 1. Cloud computing services under the commissioned agent model

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Figure 2. Cloud computing services under the commissionaire model

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Figure 3. Cloud computing services under the buy-sell model

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From an indirect tax perspective, many countries have not defined or have only partially defined the VAT/GST treatment of cloud computing services. In some countries there is a generic definition of services under which cloud computing services would fall, as well as clear and consistent rules in relation to these services. However, certain countries typically have more complex definitions for specific types of services and multiple taxes that apply depending upon the definition.

Therefore, it is important that businesses understand the product being sold, the potential consequences of this definition and the jurisdictions in which they may have VAT/GST reporting obligations. Penalties are often high where errors are made, and the time and cost involved in finalizing tax audits or tax litigation can be significant.

As with any indirect tax analysis, it is important to understand the supply chain and who is obligated to account for local VAT/GST. This is particularly important where the supply chain involves cloud services rather than tangible goods, as the place of taxation can be misinterpreted or misunderstood by suppliers, customers and tax authorities. Often, local VAT/GST rules are based upon a somewhat subjective test regarding the capacity of the supplier or the customer to make or receive the supply.

Businesses should consider where local VAT/GST obligations may arise and look to reduce the risk of exposure to VAT/GST requirements that have not been properly understood or agreed to as part of the commercial relationship, or a challenge by tax authorities when the place of taxation can be uncertain.

On the other hand, the intangible nature of the product provides some flexibility regarding the supply chain and contractual relationships that businesses may want to consider to ensure that any adverse VAT or GST implications are avoided.

Conclusions

Legislation and tax policy dealing with cross-border services (particularly those that are supplied electronically) are constantly evolving, and there are many open issues, such as whether the tax laws will be expanded specifically to capture fees for the use of servers, whether establishment laws will evolve to consider so-called smart servers and whether there will be new rules around intangible property ownership.

The OECD and other stakeholders, policy-makers and lawmakers in numerous jurisdictions have been debating the appropriate taxation of certain industries that perform their business across borders. Businesses must keep apprised of the state of affairs for cloud computing in the countries where they conduct business and assess the impact of tax rules on their specific circumstances to make decisions.

Global cloud computing and indirect tax