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Tax takes to the Cloud

8th Mar 2012
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Cloud computing doesn’t just pose a challenge to IT managers. Moving an organisation’s technology infrastructure on to the internet also raises interesting tax implications that have attracted the attention of boffins at KPMG.

In a recent paper entitled, ‘Tax in the Cloud’, the Big Four firm grappled with the fundamental principles involved and practical implications for businesses and their advisers.

“Most tax rules were written at a time when physical goods or services were traded, largely in the same country,” said Mike Camburn, indirect tax partner at KPMG in the UK.

“With Cloud transactions, determining what is actually being traded, between whom and where is becoming a real challenge.”

Tax authorities are also taking an interest, he noted, as the geographical fluidity of Cloud services raises the risk of what they would view as tax leakage. With Cloud systems, management and ownership of servers do not have to be in the same location as the servers themselves, so separating ownership and management could generate a tax beneficial outcome.

The report explains: “The global fluidity of Cloud results in tax compliance risks in terms of evaluating the location of the Cloud business and its customers and assessing intra-group Cloud transactions in accordance with the arm’s length principle. However it also provides opportunities for multi-national groups providing Cloud services, either internally or externally, to consider a tax efficient structure/strategy for the provision of such services.”

While these are areas where many fear to tread, the underlying arguments on issues such as classification and jurisdiction are meat and drink for tax experts. For anyone who wants to gain a functional understanding of the issues, a closer reading of the report is recommended. Here are a few brief highlights for everybody else:

  • Classification - Cloud applications, business platforms and infrastructure - or a mixture of all three - demand an analysis of the nature of the transactions undertaken. If a transaction gives rise to sales income, for example through the sale of some item of property, the income would be classed as coming from where the contract is concluded and the benefits and burdens of ownership pass to the buyer. Some Cloud services could well be a mixture of goods and services - for example offsite data storage and management, which might be priced on physical storage and electricity used, along with fees for additional back-up and security services. The client and the tax authorities will both need to have a clear understanding of the exact nature, location and “value drivers” of the underlying supply.
  • Jurisdiction - Pinpointing the location of production activities can be difficult in the Cloud. The OECD Model Tax Convention defined the concept of a permanent establishment (PE) as a fixed place of where the business of an enterprise is wholly or partly conducted. The PE question is a factor both for service providers, who will be affected by where their servers are based, and for customers who make use of services outside their normal home jurisdiction.
  • Transfer pricing - For the multinational companies that KPMG advises, this is where it all comes together. The report advises: “Within a group, you would need to consider how the value (or income) generated by the Cloud should be allocated between the functions performed by the personnel supporting the business and the assets owned by the business, such as IP [intellectual property] and infrastructure. In such an analysis you would also need to consider where the functions and risks are performed and by whom. The identification of which legal entity (or indeed PE) is contributing which aspect of the Cloud service is therefore fundamental for transfer pricing compliance and planning purposes. This can be a highly complex question because multiple entities (both related and third-parties) may combine their efforts to provide Cloud offerings. From a Transfer Pricing perspective each entity’s economic contribution will need to be assessed and each entity will need to be compensated according to the arm’s length principle.”

In other words - this is pretty heavy, complicated stuff for which you would be best advised to call in some hot-rod international tax advisers. It’s a sales pitch, as are most whitepapers of this kind, but a readable and entertaining one that illuminates questions that have previously been neglected by many in the finance and technology professions.


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