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How Is Your Cloud Taxable? Let Us Count the Ways
In the current economic times, many companies are searching for ways to gain a competitive edge while mitigating costs. As both the number of consumers on the internet and the time they spend connected grow, companies are looking to increase sales and services offered in cyberspace. Internal IT departments are also looking for ways to use "cloud computing" as a cost-effective way to grow their infrastructure on an as-needed basis, while at the same time reducing overhead, capital expenditures and maintenance costs. Many tax professionals are unsure of the impact this could have on their tax footprint and effective tax rate. Taxand US assesses the potential tax impact on decisions of where to locate a server or how to transition from local, hardware-based, company-owned IT resources to working with an outside service provider.
Part 1 of 3: New Tax Impacts of Global Infrastructure Decisions
Transactions that occur in cyberspace raise many tax issues that should be examined prior to deciding on a path forward. Issues can arise over character and source of income, U.S tax deferral on foreign earnings, permanent establishment, withholding tax, VAT, transfer pricing, and state and local tax. In this article, we examine the ability to pursue proactively a tax-efficient location for company-owned infrastructure or a third-party service model that may help to mitigate some of the tax risk associated with operating in cyberspace.
First, we need to understand how a company typically operates in the internet marketplace. Servers and/or other necessary hardware make up the tangible equipment that connects to the internet. Running on that tangible equipment are software applications that facilitate the business activity. Teams of personnel develop and improve those software applications and maintain the server functionality and availability. Together, the hardware, software and personnel create access to a business platform in cyberspace for customers and users from anywhere around the world.
Part 2 of 3: New Tax Planning Considerations for International Profit Growth
The business model is changing rapidly in many industries, especially in the technology sector. Before, customer revenue and operational efficiencies were driven by the sale of on-site hardware and software and by personnel whose job it was to integrate the two with a customer's business model. Now, businesses are increasingly relying on remotely maintained hardware and software, accessed through the internet or intranets in a virtual setting that has been collectively dubbed "The Cloud." Instead of buying or leasing software and investing in the hardware on which the programs would run, businesses are increasingly adopting software as a service (SAAS) models, with new tax rules.
In the SAAS model, capital investment in hardware is reduced because the performance demands on the user's machine are much reduced, as is the need to constantly update software versions on that hardware. This affects virtually every business. A large corporation that sought in the past to manage data and reporting across global geographies no longer needs to maintain its own server farms and enterprise software packages, instead giving its employees access to such functionality from anywhere secure web access is available. Teenagers across the globe no longer need the most expensive laptop and the latest version of their favourite game because they can now simply buy online time at an internet caf?. By reducing up-front capital costs, global customer expansion can increase rapidly to new countries that have an emerging consumer base with rising but still financially constrained disposable income.
Part 3 of 3: New Transfer Pricing Analysis for New Business Paradigms
As businesses increasingly rely on rapidly evolving remote or outsourced information technology (IT) accessed via the internet (colloquially called "The Cloud"), tax planning in general enters into relatively new territory as well. Setting transfer prices for related-party transactions that have the effect of allocating profits among competing taxing jurisdictions is no exception.
Two main challenges have emerged in the transfer pricing arena as a result of this business trend. First, new valuation methods must be meshed with recently reissued regulations that have been less frequently used (and debated) than the methods typically used before The Cloud became prevalent. Second, isolating exactly what drives value -- and therefore profit -- in the services offered through and by The Cloud is not always clear, and this lack of clarity is bound to create confusion and disagreements between taxpayers and taxing authorities when new valuation methods are applied.
...On New Tax Impacts of Global Infrastructure Decisions
If your company is considering adding servers, expanding offerings in cyberspace or outsourcing certain IT functions with options like cloud computing, the income tax answers to these questions may differ depending upon how things are structured. Thus, thinking ahead and structuring properly may get your company a more tax-efficient answer while still meeting the needs of the business.
...On New Tax Planning Considerations for International Profit Growth
If your company is moving into "The Cloud" to capture revenue and lower costs, traditional accepted methods for lowering the tax cost of non-U.S. regional operations may not apply to this new world. New considerations for locating infrastructure, interacting with customers, valuing IP, sharing risk and expenses between the U.S. and foreign operations, and financing expansion may be needed. Thus, thinking ahead and proper structuring may get your company a more tax-efficient answer.
...On New Transfer Pricing Analysis for New Business Paradigms
How can these attenuated, indirect and difficult to distill projections be molded into the related-party transfer pricing methods required by the IRS for electronic services? At least initially, this can only be done with great uncertainty until a body of experience between taxpayers and the government emerges with relatively new rules being applied to extremely new and rapidly evolving business facts. But the chances of success will increase, and the chances of disputes will decrease, to the extent that the economic analysis has been done with rigorous focus on the true value drivers of the electronic service, and rigorous analysis of which pricing methods best approximate those value drivers. In this, the new and evolving Cloud is no different from more traditional business models -- a successful transfer pricing analysis will be critically dependent on an understanding of all aspects of the taxpayer's business and on a careful application of economic and transfer pricing models.
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