The Cloud

Wanted: Tax Insight on Cloud Decisions

Tax rules for cloud computing are becoming increasingly complex, but many C-suite executives still aren’t inviting their tax departments into cloud...
Taylor ProvostSeptember 20, 2012

Rackspace, a cloud-hosting firm, is more familiar with tax liabilities than most of its peers. The San Antonio–based company has gone before the Texas House of Representative’s Ways and Means committee twice in the past two years, imploring it to stop charging its customers sales taxes whenever they use a Texas-based Rackspace server. The company also wanted the state to stop charging Rackspace a margin tax — essentially a fee for the privilege of doing business in the state — on business the company conducts with out-of-state customers.

Rackspace’s lobbying was partly successful. Last summer the House passed a bill allowing the company to avoid collecting sales tax from out-of-state users, which made its customers happy. But Rackspace’s margin-tax problem remains. Consequently, the company is now focusing on building data centers in such cloud-friendly states as Virginia and Illinois that forgive property taxes for a period of time and don’t collect sales tax on out-of-state business. As for Texas, Rackspace executives say they are never going to build another data center there . . . at least until the state changes its tax policies.

Although Rackspace executives declined to estimate the total margin tax the company pays Texas, or its impact on its bottom line, from the fact that it is avoiding building new facilities in the state one can assume it’s not trivial.

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The lesson for finance heads and tax officials? It’s time to buddy up.

But that’s a lesson too many companies have yet not learned. A survey of 200 U.S. companies conducted in May and released this month by audit, tax, and advisory firm KPMG found that 52% of senior corporate tax officials are not regularly involved in their companies’ discussions about moving operations to the cloud. And leaving those executives out, respondents said, could hinder the tax department’s ability to face challenges associated with doing business in the cloud. That includes correctly identifying and calculating tax obligations, as well as keeping up with regulations necessary for correctly filing returns across a variety of jurisdictions.

Rackspace found out the hard way how important it was to involve its tax department in its strategic planning. Chris Rosas, the company’s global tax director, says he didn’t become involved in Rackspace’s cloud decision-making until a couple of years ago, when states began becoming more aggressive about taxing cloud operations, especially trying to collect sales taxes whether or not the company had a physical presence (or nexus) in the state. Now Joe Saporito, chief accounting officer at Rackspace, calls the company’s decision-making process “very collaborative.”

“These issues are way too complex,” says Saporito. “So there are financial decisions and accounting decisions where we need [Rosas] to help us understand what the tax climate is. We’re trying to project years in the future, so obviously it requires a lot of expertise.”

Rosas says his department actively monitors the taxability of Rackspace’s cloud services globally, as well as across all 50 states. “It’s only a matter of time,” he says, “before other countries start finding a way to tax payments that have traditionally not been taxed across borders.” He suggests tax departments of any company deploying cloud projects monitor their nexus accordingly.

“Other companies need to understand the implications to them of where the services are provided, how the [services are] viewed by the locality or jurisdiction they have nexus in, and whether or not the cloud provider will have nexus where they don’t have a visible location,” says Rosas.

Rackspace isn’t every company. It’s a provider. The cloud is its lifeblood. But cloud customers also need to be alert when it comes to cloud-tax policy, says Joel Waterfield, a senior manager at Grant Thornton.

For a cloud-service purchaser, a shift from physically owned assets to cloud-based services could be accompanied by a shift in tax structure that might drastically alter the amount of taxes it pays on a recurring basis, says Waterfield. “Senior tax officials, if given the opportunity, could assist management in better recognizing the overall cost associated with [the] purchase of cloud service.”

Further, if the tax department has not made the tax-planning changes required in the company’s migration from a traditional model to a cloud-service model, that could negatively affect the company’s income statement in the form of possible unexpected tax assessments, says Waterfield, which could lead to earnings restatements. And no CFO wants that.

His advice for CFOs?

“Don’t just think of the tax department as a compliance shop,” says Waterfield. “It should also be considered a profit center. If given the proper resources, and access to information, it can provide the company the ability to become competitive in the marketplace either from assistance in calculating the proper price point or reducing overall tax expense on purchases.”

The takeaway? If CFOs listen to their tax guys, they might learn something. Rackspace did.