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The taxation of cloud based computer services is an evolving area of the law. The same cloud based service may be treated differently depending upon the jurisdiction involved. In this article, McDermott Will & Emery's Mary Kay Martire and Nick Furtwengler discuss how the taxation of cloud based services can be treated differently even within the same state, such as in the City of Chicago, and the State of Illinois.
By Mary Kay Martire and Nick Furtwengler
Mary Kay Martire is a partner, and Nick Furtwengler is an associate, in McDermott Will & Emery LLP's Chicago office.
In two recent General Information Letters (“GILs”), the Illinois Department of Revenue reaffirmed that computer software provided through a cloud-based delivery system is not subject to tax in Illinois. ST 17-0006-GIL (03-02-2017); ST 17-0010-GIL (03-21-2017). The GILs announced that while the Illinois Department of Revenue continues to review cloud-based arrangements and may determine they are taxable at some point, any decision to tax cloud-based services will be applied prospectively only.
In contrast to the State of Illinois, the City of Chicago does tax cloud-based services through its Chicago's Personal Property Lease Transaction Tax (“Chicago Lease Tax” or “Tax”). The Chicago Lease Tax includes cloud-based services in its definition of a “nonpossessory computer lease,” which provides:
[A] nonpossessory lease in which the customer obtains access to the provider's computer and uses the computer and its software to input, modify or retrieve data or information, in each case without the intervention (other than de minimis intervention) of personnel acting on behalf of the provider. The term “nonpossessory computer lease” includes, but is not limited to, time sharing or time or other use of a computer with other users.
Mun. Code of Chicago 3-32-020(I). The Tax Ordinance provides that a computer lease is used in Chicago, and thus potentially subject to the Tax, based on the location of the terminal or other devise by which the user accesses the leased service. (Mun. Code of Chicago 3-32-020(I) (“In the case of a nonpossessory computer lease, the location of the terminal or other device by which a user accesses the computer shall be deemed to be the place of lease or rental and the place of use of the computer for purposes of the [Tax].”) When usage takes place both inside and outside the City, the usage is apportioned using an affidavit provided by the City.
On June 9, 2015, the City issued Personal Property Lease Transaction Tax Ruling #12, which adopted an expansive view of how the Chicago Lease Tax would apply to cloud-based services. ( https://www.cityofchicago.org/city/en/depts/fin/supp_info/revenue/tax_list/personal_propertyleasetransactiontax.html). In particular, the City took the position in the Ruling that “a subscription to an interactive web site will be subject to the lease tax, and will not be exempt, even if most or all of the information available on the web site is fleeting or transitory.” Ruling #12 at ¶ 13. This statement appeared to render almost non-existent the Ordinance's exception for de minimus use of leased computer information. Chic. Mun. Code 3-32-050(11). The Ruling also contained language that created concern amongst taxpayers and practitioners that the City might intend to retroactively apply its expanded interpretation of the taxability of leased cloud-based services. The Department later clarified in an Information Bulletin that Ruling #12 would be applied retroactively only to the extent it restated existing law.
Ruling #12 triggered an outcry in the tech community in Chicago, which was widely reported by the news media. The City responded to complaints in three ways. First, it delayed the effective date of Ruling #12 to January 1, 2016, and entered into settlement agreements with many taxpayers who unexpectedly found themselves subject to the Tax on their cloud-based services. Second, the City lowered the tax rate on nonpossessory computer leases (defined as a lease “of a computer primarily for the purpose of allowing the customer to use the provider's computer and software to input, modify or retrieve data or information that is supplied by the customer…”) (Mun. Code of Chicago 3-32-030(B.1)) to 5.25%. Third, the City added a small new business exception to the Tax. In order to qualify for the exception, a business must have under $25 million in gross receipts or sales during its most recent full calendar year and have been in operation for fewer than 60 months. Mun. Code of Chicago 3-32-050(13).
There are a number of other exceptions to the Chicago Lease Tax, including the following:
Intercompany Leases : The Tax does not apply when the lessor and lessee are members of a “related group,” defined as “a person and all other persons directly or indirectly owned 100 percent by the person.” Mun. Code of Chicago 3-32-050(7).
Re-Leases : An exemption applies to a lease of property where the customer will in turn “act as a lessor of the same property …” Mun. Code of Chicago 3-32-060(A).
Securities Trading : The Tax does not apply when the use is to “effectuate the execution, clearing, processing, matching or recording of a trade …” of securities or commodities. Mun. Code of Chicago 3-32-050(9).
Accessing and Managing Financial Accounts : The Tax does not apply when the use is to “effectuate the deposit, withdrawal, transfer or loan of money or securities, including any related review of accounts or investment options by the account owner …” Mun. Code of Chicago 3-32-050(10).
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