Idaho Taxes Software in the Cloud

February 25, 2013

Idaho Cloud TaxIn a surprising and troubling move for the providers and users of “cloud” computing services, state tax authorities in Idaho ruled that software provided through cloud computing networks is subject to the state’s six percent sales tax.  The Idaho ruling characterized all computer software as tangible property subject to tax no mater how it is made accessible to users.

Use of cloud computing networks to make software accessible to consumers is increasingly popular.  The process of providing software through computer networks is commonly referred to as, “software as a service.”

Several states, including Virginia, Nebraska, Tennessee, Kansas, Rhode Island, and Wisconsin determined that software as a service is not subject to sales tax.  They concluded that sales tax should only apply when a copy of software is downloaded to the possession of the end user.  Most cloud computing systems provide access to shared software and do not involve downloading of copies.

Other states are developing some form of sales tax specifically for application to software as a service.  Those states include Washington, Texas, Indiana, New York, and Arizona.

The Idaho ruling is reportedly based on the interpretation that software made accessible through cloud networks is within the “constructive” control of the end user.  Idaho authorities contend that this constructive control is sufficient to make software as a service tangible property under Idaho law.

Idaho is the only state, to date, that treats software in all forms as tangible property.  Providers of cloud computing services fear that the Idaho action will adversely affect the popularity of cloud services by raising the costs of use.

In addition to affecting the cost of software as a service, the Idaho ruling has potentially broader impact, as well.  By characterizing all computer software as tangible property, Idaho has set the foundation for broad and possibly intrusive assertion of its state law against cloud service providers operating out of other jurisdictions.

For example, if software as a service is tangible property, perhaps that property can be attached when there is an unsatisfied Idaho judgment against a cloud computing service provider located in another jurisdiction.

The Idaho tax approach to software as a service seems to be both unnecessary and ill-advised.  Conceptually, it makes no sense to treat shared software as a form of tangible property.  Software made accessible through cloud computing networks does not involve transfer of tangible property.

To the extent that Idaho’s primary goal is capturing greater tax revenue, that objective can be accomplished through application of taxes aimed directly at services, including software as a service provided through cloud networks.  Idaho can pursue greater tax revenue without causing the disruption likely to be associated with a sweeping definition that mischaracterizes software as a service as tangible property.