As is the case for most contracts, the challenges lie not in the costs but in the terms. Maybe this is even more critical when the contracts being reviewed involve technology where customers tend to focus on costs and NOT terms, and where the terms can be way, way, way more nefarious than any pricing model appears. This is particularly true in agreements that cover communications equipment and services where because of some creative language drafting as well as some (note the word “some”) government mandates, these line items can run anywhere between 10 and 40% above the rates that were quoted by the eager salesperson. That’s right---40% of additional cost beyond what was sold. And that’s today.
As governments require additional funding to support themselves and the services they provide, it’s not a big leap to recognize that the government-mandated charges will rise as expenses do. And that’s before the line items that look like taxes but are actually revenue to the provider jump as well. Further, the rules about taxing at least two of the items that have thus far escaped tax, namely cloud and internet services, are likely to change in a way that’s not beneficial (directly at least) to consumers.
At the risk of going all “Little House on the Prairie,” it’s important to restate the obvious. Sales tax, which is driven from state and municipal governments, was, at one time, easy to calculate before we started shopping online. As such, where a consumer shops now can have a significant impact on his/her ultimate bottom line. This becomes even more complex when the item being purchased can’t be physically touched or located.
Consider “cloud computing,” which Webopedia defines as “a type of computing that relies on sharing computing resources rather than having local servers or personal devices handle applications [read: processing]. What’s happening in the cloud involves not only processes are happening to data somewhere “out there,” but it also includes the method for getting the data to and from wherever that spot is. Ever hear the phrase “vaporware” to refer to something that sounds great but isn’t real? Cloud computing is sort of like that, except it is real. And if it’s real, how can it be taxed when it’s difficult to impossible to know where the processing is actually being done.
“Nexus” is the word that’s used in tax circles to describe the level of business that a company must engage in before taxes can be imposed on its revenue or income. A determination of “nexus” is a highly fact-based process—or series of possible processes—and based upon the model used, the determination can be very, very different, resulting in very different tax liabilities. In 1992, the Supreme Court ruled in the case of Quill Corp. v. North Dakota (112 S.Ct. 1904, 504 U.S. 298, 119 L.Ed.2d 91 (1992) that companies without a “substantial nexus” in the state where the customer resided at the time of purchase were not obligated to pay sales tax.
In the Quill case, nexus determinations consider both the Due Process and Commerce Clauses of the U.S. Constitution. From a due process perspective, a business must have “minimum contacts” with a jurisdiction in order to establish nexus. Under the Commerce Clause a “substantial nexus” involving a physical location, with the taxing jurisdiction.
But the issue is much larger than just physical presence. Under a traditional analysis, web-based hosted software (sometimes known as “software as a service” or “SaaS”) will only reach the substantial nexus threshold if it has physically located devices in a given state, not necessarily where they have customers and no equipment. Interested in minimizing the loss of tax revenue, some states have tried to expand the definition to include what they’ve called “affiliate nexus” or “economic nexus.” Some states have been successful, but nationwide there’s not a great deal of clear guidance.
Bucking that national trend, New York took firm, bright-line action to define economic nexus within its borders. As of January 1, 2015, in New York, a taxpayer is considered to have sufficient nexus within the state based on its receipts from activities provided in New York that meet or exceed a $1,000,000 threshold in a given tax year. Thus, a physical presence in the state is no longer required for an entity to incur corporate income and franchise tax liabilities. Once that tax liability is created, one way or another it’s passed on to the consumer.
From the perspective of cloud computing, pricing that was once incredibly attractive and tax free may be subject to change. It will fall to the terms of the signed provider’s contract to know whether or not the end user’s bill can jump to accommodate what was a previously unimaginable tax hit. But it’s certainly worth paying careful attention. In communications technology, it’s rarely about the quoted price and almost always about the terms.
In a similar vein, in mid-September, the Supreme Court in Oregon threw out a case brought by AT&T (AT&T v. Oregon Department of Revenue, TC-RD 4814; SC S060150,) which claimed that the Department of Revenue owed AT&T a refund for excise taxes paid from 1996 through 1999. The legal question involved what portion of AT&T’s sales of interstate and international telephone and data transmissions was technically performed in the State of Oregon, or whether Oregon was the state with “the greatest share of the ‘cost of performance’ for that activity.” Although this may be too tax-centric for many, the bottom line from the court was that the tax assessment by the Oregon Department of Revenue was correctly based on the transactions between customers located in Oregon and AT&T, and not on the whole of AT&T’s network. In this case, unlike the major federal excise tax cases of a decade ago when customers were eligible for significant credits based on a fresh reading of the tax statute, AT&T would have been better off letting sleeping dogs lie.