South Carolina's Expansive Treatment of Cloud Computing Services as Taxable Communications

As states continue to wrestle to define tax policy for the services that comprise the expanding world of cloud computing, South Carolina has again asserted its expansive approach for taxing anything that resembles communications services, including charges for Software As a Service (SAaS) or Platform As a Service (PAaS). [Private Letter Ruling #14-4, South Carolina, (Nov. 4, 2014)] In its most recent private ruling on the matter, the Department determined that the Taxpayer’s charges for a cloud-based service for processing and routing calls within a customer's communications system and for other support services constitute “charges for the ways or means for the transmission of the voice or messages”. These charges are taxable communications services pursuant to Code Sections 12-36-910(B)(3) and 12-36-1310(B)(3), and SC Regulation 117-329.4. This most recent ruling makes it evident that the South Carolina Department of Revenue will consider nearly anything that enables the routing of voice, data, information or messages to constitute taxable communications services. You can find the Department’s ruling here...

While the fee is denominated as a “license” fee, the Department noted that the Taxpayer does not in fact license or lease any software or tangible personal property to the customer under the contract.

Specifically, in the Taxpayer’s private ruling request, the Taxpayer noted that under the contract with a customer, Taxpayer will charge the customer a monthly user license fee, calculated based on the number of users. The monthly fee covers the charges for hardware, software, virtual server instance charges, required storage charges, rack space charges, power and cooling charges, as well as monitoring and management charges, most moves-adds-changes and major version upgrades. While the fee is denominated as a “license” fee, the Department noted that the Taxpayer does not in fact license or lease any software or tangible personal property to the customer under the contract. [Private Letter Ruling #14-4, South Carolina, (Nov. 4, 2014)]

In summary, Taxpayer provides customer’s access to a service that communicates with the customer's telecommunications equipment, to provide instructions to the customer's voice gateway device for the processing and routing of incoming and outgoing calls among the customer's phone extensions. Taxpayer’s services enable the routing of voice communications for the customer, and/or support the provision of video communications, messaging, presence (user availability) support, conferencing and mobility services.

With respect to each of the services, a customer utilizes the Taxpayer-owned and hosted software with its own equipment and through its own telecommunication, Internet or other network connection. At no time does the customer download or otherwise possess the software that is hosted by Taxpayer. In addition, Taxpayer does not provide the telecommunication, Internet or network connections necessary for the customer to utilize the services. No calls or communications are ever routed through Taxpayer's servers.

While the Department noted that the service provided by the Taxpayer does not transmit telephone calls through any telecommunication services, “the service does process and route incoming and outgoing telephone calls through the customer's own telephone system .... These services constitute the ways or means for the transmission of the voice or messages.”

While the Department noted that the service provided by the Taxpayer does not transmit telephone calls through any telecommunication services, “the service does process and route incoming and outgoing telephone calls through the customer's own telephone system within its business. The support services route voice, video, and voicemail messages. The support services also support audio conferencing, video conferencing and mobility services. These services constitute the ways or means for the transmission of the voice or messages.” The Department went on to note that while the customer could procure the hardware and software needed to enable these services, the Taxpayer “has created a service through the cloud to provide these same services. [Taxpayer] is providing a service whereby calls are routed within the customer's own communications system and is providing other [taxable communications] services.” As such, the Department concluded that the Taxpayer is providing a “service transaction that is routing (i.e., sending) a voice or message. The service as described in the facts are subject to the tax under Code Sections 12-36-910(B)(3) and 12-36-1310(B)(3) and SC Regulation 117-329.”

Referencing the definition of “tangible personal property” in Code Section 12-36-60 the Department noted that the term tangible personal property includes the sale or use of intangibles, including communications, that are subject to South Carolina sales or use taxes. The Department noted that it “has long held that Code Sections 12-36-910(B)(3) and 12-36-1310(B)(3) impose the sales and use tax on the total amount of money derived, exclusive of deductions, from a commercial venture and accruing or proceeding from charges for the manner, method or instruments for sending a signal of the voice or of messages. See SC Revenue Ruling #89-14, SC Revenue Ruling #04-15 and SC Revenue Ruling #06-8.” In these rulings the Department references, the Department concluded that, among other services, charges for facsimile, voice messaging, electronica mail, credit reporting and database access and transmission services are taxable communications services.

Interestingly, South Carolina Code Section 12-36-910(C) excludes from sales tax charges for “data processing”, which it defines to mean “the manipulation of information furnished by a customer through all or part of a series of operations involving an interaction of procedures, processes, methods, personnel, and computers. It also means the electronic transfer of or access to that information.”

In Revenue Ruling #06-8, relying on the guidance set forth in its previous rulings, the Department concluded that “charges for the ways or means of communication include charges for access to, or use of, a communication system (the manner, method or instruments for sending or receiving a signal of the voice or of messages), whether this charge is based on a fee per a specific time period or per transmission.” This interpretation is broad enough to encompass all cloud computing services provided under a SAaS or PAaS model, by which a service provider charges a fee for remote access to the service provider’s computer network and software (whether applications or operating).

Interestingly, South Carolina Code Section 12-36-910(C) excludes from sales tax charges for “data processing”, which it defines to mean “the manipulation of information furnished by a customer through all or part of a series of operations involving an interaction of procedures, processes, methods, personnel, and computers. It also means the electronic transfer of or access to that information.” Furthermore, earlier this year, the Department ruled that a taxpayer’s charges for computing capacity and data storage did not constitute taxable communications services. [Private Letter Ruling #14-2, South Carolina Department of Revenue, August 26, 2014] This latter ruling would tend to encompass charges by a service provider for Infrastructure As a Service (IAaS), in which the provider charges a fee for data processing, storage, and scalable computing capacity. However, these rulings and the exclusion set forth in South Carolina Code Section 12-36-910(C) will provide an area for potential litigation, as the Department and cloud-based service providers dispute whether services are taxable communications or nontaxable data processing services.

As more consumers and service providers move to a cloud-based model for providing remote access to hosted operating and application software platforms, as well as hosted storage and computing services, these rulings highlight (1) the growing trend among state taxing authorities to expand the scope of taxable services through administrative rulings, as opposed to legislative or administrative rulemaking processes, and (2) the importance of proactively seeking guidance from the taxing authorities regarding the taxability of cloud computing services.