Massachusetts, or ‘Taxachussetts’ as it’s affectionately known in some circles, has recently released a ruling regarding the imposing of sales tax on Cloud computing services. The Massachusetts Department of Revenue typically applies a sales tax of 6.25% on most goods and property sold within the state. This encompasses pre-written software as well, no matter how the user gets the software.

Cloud services, on the other hand, don’t actually involve the licensing of software to a customer. Instead, users typically either leverage their own applications or log into a web-based portal serviced by the Cloud provider. In other cases, all parties use an open source platform. In these cases, as determined by the Massachusetts Department of Revenue, the Cloud services aren’t taxable.

Because the Cloud services in question use the customer’s own software, or otherwise open source resources and there is no tangible asset changing hands, the Cloud product isn’t taxable in Massachusetts. This represents a crucial distinction regarding how sales tax applies to Cloud computing.

However, if the Cloud service provider requires the customer to purchase licensed software or proprietary applications sold by the Cloud vendor, sales taxes can be assessed on the services when sold to users in the state. This is applicable even if the software incurs separate charges or there is sub-licensing involved. The reasoning lies in the fact that the user actually acquires the software in one form or another, similar to a download of traditional pre-written software.

Many Cloud providers have adopted popular terms for their offerings, such as “Software as a Service” (SaaS) and other similar titles. While descriptive in a sense, these terms have no bearing regarding the taxability of their services according to the Massachusetts Department of Revenue. They further determined that taxability cannot be discerned by examining whether customers download or otherwise install software applications on their own machines.

While these findings only affect vendors and users in the state of Massachusetts, they establish a precedent that could significantly impact deliberations of a similar scope elsewhere across the country.

The take-away for cloud computing services vendors hinges on the sale of pre-written software to customers. If the service requires users to download and install (and pay for) a proprietary software application, sales tax will likely come into play. But again, we’re talking only about Massachusetts at this point.

To better clarify, one source reports that “Massachusetts can impose the obligation on a vendor only if the vendor has sufficient physical presence with Massachusetts.  It is often a challenge to determine whether a vendor has this physical presence, and the determination is based on the ‘facts and circumstances.’  If the vendor does not have sufficient physical presence in Massachusetts, the vendor does not have an obligation to collect the tax, but the customer has an obligation to self-assess the tax and pay the tax to Massachusetts. “

The struggle over how to apply sales tax in these digital realms has been an ongoing battle between the state revenue department and internet-based vendors for quite a while. Ambiguity within the downloadable product space means an uphill battle for Massachusetts lawmakers. The fog on that battlefield has thickened more and more as packaged software drifts away from brick-and-mortar store shelves and further into the Cloud.

For Massachusetts, or any other state for that matter, the loss in revenue from taxes on software could prove significant enough to more closely define taxability on digital services. Most revenue departments will be on the lookout for ways to replace tax revenue losses from the transformation of software into service. Cloud vendors and software developers for Cloud-based services should take note and prepare accordingly for the coming storm.