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To Life's Inevitables, Death And Taxes, Add A Wild Card: The Cloud

Oracle

As anyone who’s recently bought anything from Amazon is painfully aware, the internet is no longer tax-free. Indeed, legislators are exploring, and in many cases hammering out, new tax liabilities related to cloud and other online services.

Legislators are exploring cloud-related tax initiatives in “an attempt to govern the digital economy and capture some of the revenue stream from these activities, as appropriate,” Reid Okimoto, national tax leader for emerging technology at advisory firm KPMG, said in an interview. “We’re going to see new laws,” he added. “It’s inevitable.”

Chief financial officers, in particular, must pay attention—they can’t rely on cloud providers to interpret evolving tax codes for them. But companies have mostly overlooked tax considerations in their rush to the cloud, according to a KPMG survey last year of corporate tax executives.

Planning now for the potential impact of tax legislation on cloud services is not only smart, it’s imperative. For example, Chicago businesses were thrown for a loop (so to speak) when the city passed its “cloud tax” initiative in July.

On a global level, a 34-member-country committee of the Organization for Economic Cooperation and Development (OECD) two years ago drafted the Base Erosion and Profit Shifting (BEPS) tax plan, to address global tax inequalities.

That plan may change the parameters of international taxation, including online services, observers say. In fact, the UK already has introduced tax legislation aimed at e-business, based on the OECD’s BEPS recommendations.

As corporate finance consultant Joe Harpaz wrote in Forbes: “With global acceptance of the BEPS country-by-country reporting mandate firmly in place, regional tax authorities will have the infrastructure in place to enact all sorts of new tax proposals.”

Similar Logic

There are several advantages to transferring IT functions to a cloud service provider over employing on-premises IT resources, particularly in terms of flexibility and scalability.

One advantage is not needing to invest in rapidly aging servers and storage, lump-sum capital expenditures (CapEx) that are projected out over several unpredictable years.

Instead, accessing those resources as online services from a third party, as an operating expenditure (OpEx), can be a more rational and predictable way to spread out and absorb that cost.

A similar logic applies with taxes. Businesses usually apply deductions for operating expenses in the year they occur, which most organizations prefer because they’re more easily associated with the income received from those investments. On the other hand, businesses usually defer deductions for capital expenses, which makes their impact less direct and predictable.

Still, when considering OpEx versus CapEx, finance executives shouldn’t forget to factor in R&D tax credits, KPMG’s Okimoto points out. Tax advantages gained through capital expenditures made for research purposes may be obviated when those R&D functions are moved off on-premises systems and into a third-party vendor’s cloud.

For businesses contemplating cloud services, there are two general categories of taxes that are important: sales tax, including “use” taxes, taxes on services, and value-added taxes (VATs); and income tax, or taxes on corporate profits. Sales tax is probably the most immediate concern when weighing a cloud investment—and the area most in flux.

Too many customers assume that their service provider knows the tax landscape and will incorporate the appropriate charges, if any, at contract time.

That’s a potentially costly mistake, Okimoto said, because the vendor may be either too lax or too aggressive in applying sales tax. Moreover, the provider may not be legally obligated to collect the tax at all.

Another way to miss appropriate tax action in cloud deals is when line-of-business managers make their own decisions about acquiring cloud services. These departmental deals often fall below the corporate radar—until it’s too late, such as at quarterly rollup time. All cloud contracts need the oversight and input of the corporate tax function, now more than ever.

Just as they research technology options, companies need to research tax issues that might relate to a specific cloud implementation.

Considerations should include the geography/jurisdictions of where those services originate, as well as where they’re used. Use tax may apply, for instance. That means tapping knowledgeable sources such as an outside firm, if internal expertise is limited.

An Intricate Formula

The implications related to cloud computing get really complicated where taxes on corporate profits are concerned. Corporate tax liability is an intricate formula incorporating many factors, including assets, business model, employees, and geography. A change in any of those elements may affect tax liabilities significantly.

A move to cloud services may represent just such a change. For instance, it may affect headcount, the location of certain business functions, or even an alteration in business model.

That’s why CFOs must be involved in discussions about cloud plans—not just specific contract negotiations, but also the wider cloud strategy. “If there’s a big investment in cloud or other technology innovation being planned and no tax person is involved in those discussions, that’s a problem,” Okimoto said.

There’s also a technology angle to the intersection of tax structure and cloud strategy. Companies usually build functionality into their ERP systems that calculates tax liability according to factors specific to their organizations.

If a company transfers corporate planning and number crunching to a cloud service, such as a cloud ERP system, it almost certainly won’t incorporate such proprietary tax calculations. Either the provider or the customer will have to build such functionality into the service, at additional cost.

Avoid Costly Mistakes

When choosing a cloud ERP service provider, look for one with experience across multiple jurisdictions, and one that’s used to handling business operations on a global scale.

Its systems should be capable of managing global sales, exemptions, input credits, and multiple access points, as well as changing tax rules. Such capabilities can help reduce the risk of non-compliance and avoid costly mistakes.

The word “tax” has an “undeserved stigma,” Okimoto said, which may be a reason “many companies are not spending enough time around operational tax issues.”

For instance, a few states allow their cities and counties what’s known as “Home Rule,” which lets local entities enact ordinances that may conflict with the state’s policies, including tax policies, Okimoto says. It’s led to an increase in local taxes in those states, and “a bunch of havoc for business,” he said.

At what point do businesses have to be worried about such local taxes being imposed on cloud services? The answer shouldn’t come as a surprise.

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