State Tax Snapshot: Do You Know Where Your Web Server Is?

Compliance requirements arising from the location of internet servers are among the most challenging issues to resolve, nearly a third of the tax executives polled by KPMG LLP said in a recent survey. This problem is made worse by another main finding of the survey: most tax professionals are generally not included in discussions with top management of other departments in their organizations to provide tax perspectives on cloud initiatives.

These findings will likely prove alarming to multistate companies given the aggressive stance many states are taking with respect to the income tax nexus implications of renting space on a third-party’s internet server. Officials from tax agencies in 25 states said renting space on a third party’s server that is located within their borders would result in nexus for an out-of-state corporation, according to the Bloomberg BNA 2012 Survey of State Tax Departments.  

A state might argue that having a website hosted on a server located in its jurisdiction takes up physical space and thereby creates a physical presence sufficient to warrant the imposition of income tax. Perhaps many jurisdictions would say that storing data on a server constitutes an “economic presence.”

Also, states could refute arguments that a company lacks control over where its data is stored by pointing out that a corporation can specify the states where its data will be located in its contract with the third party.

 But at least one prominent state tax practitioner believes there is a crucial distinction between a taxpayer that owns a server within a state and a taxpayer that merely leases one. “For the most part when you sign up with a server company, you don't even know where the server is…,” said Ernst & Young LLP's Steven N.J. Wlodychak at Bloomberg BNA’s Advisory Board Roundtable at Georgetown Law Center. “You usually do not have any control over where that [data] is going to be hosted and so the website company could put it on one in Virginia or California,” he said.

“Contrast this result, however, if you own the server. That, to me, is a completely different ball game.  If you have a discreet, identifiable piece of equipment that is located in a state and that is yours, whether leased or owned, you have property in the state, you have a physical presence and so therefore you should be there," he added

The full results of the Bloomberg BNA’s Advisory Board Roundtable will be published later this month.

By Steven Roll

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