Rules proposed for classifying cloud and digital content transactions

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Rules proposed for classifying cloud and digital content transactions

The IRS proposed regulations (REG-130700-14) to clarify how to classify transactions involving digital content and cloud computing.

The new rules are designed to help taxpayers decide whether an electronic-commerce transaction is a sale, lease, license, or provision of services when applying various international provisions of the Code, such as sourcing rules and Subpart F. While existing regulations address how to classify transactions involving computer programs, none explicitly cover most transactions involving items such as movies in digital format or cloud computing. The proposed regulations would fill this gap.

Currently, the Code addresses transactions involving computer programs in Regs. Sec. 1.861-18, adopted in 1998. The IRS would revise this regulation and broaden its scope so that it also applies to digital content such as books, movies, and music. “Digital content” would be defined as any content in digital format that is either protected by copyright law or is no longer protected by copyright law solely due to the passage of time, whether or not the content is transferred in a physical medium.

In addition, the IRS would add a new provision, Prop. Regs. Sec. 1.861-19, to deal with cloud transactions. The basic purpose would be to provide guidance about when a taxpayer should classify a cloud transaction as a provision of services and when it should be considered a lease of property. As defined in the proposed regulation, cloud transactions are transactions in which a person obtains non-de minimis on-demand network access to computer hardware, digital content, or other similar resources.

Prop. Regs. Sec. 1.861-19(d) helpfully provides numerous examples showing how the cloud computing classification rules would apply in specific situations to decide whether a transaction is a lease or a provision of services. The transactions illustrated include rented capacity on remote servers; software development platforms and web hosting; downloaded software and software accessed through an application; streamed digital content using third-party servers; and access to online databases.

According to the IRS, it believes the economic impact of the proposed rules will generally be small for businesses of all sizes because the principals underlying them are generally consistent with current industry practice.

The proposed regulations are proposed to be effective for tax years beginning on or after the date they are finalized. The IRS is requesting comments on them by Nov. 12.

Dave Strausfeld, J.D., (David.Strausfeld@aicpa-cima.com) is a JofA senior editor.

Research & References of Rules proposed for classifying cloud and digital content transactions|A&C Accounting And Tax Services
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