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Sunday, August 18, 2019

Proposed Regulations on Cross-Border Cloud Transactions and other Digital Content Transactions

Determining the source and character of transactions involving the Internet or digital items for U.S. income tax purposes is not always easy, given the paucity of IRS guidance on the subject. Treas. Regs. §1.861-18 is the exception, which addresses how to characterize transactions involving “computer programs,” but that is as far as it goes.

In an effort to bring clarity and guidance to this exploding area of commerce, the IRS has issued proposed regulations under Treas. Regs. §1.861-18 and introduced a new proposed Treas. Regs. §1.861-19.

The proposals under Treas. Regs. §1.861-18 expand the characterization guidance applicable to computer programs to all transfers of “digital content” including digital books, movies and music. The proposals there also undertake to provide a sourcing rule for title passage for digital content. Generally, the income from such transactions will be sourced to where the downloaded items are installed on the end-user’s device that is used to access the content. Thus, it appears the location of the provider’s servers and storage devices or base of operations is not relevant.

Proposed Treas. Regs. §1.801-19 takes on a different subject and provides rules for classifying a “cloud transaction” as either the provision of services or a lease of property, for income tax purposes. A cloud transaction is one through which a person obtains non-de minimis on-demand network access to computer hardware, digital content, or other similar resources. It includes what are commonly known as Saas, PaaS, and LaaS models, and other transactions relating to on-demand network access of technological resources, including access to streaming digital content and information in databases. It does not include a mere download or other electronic transfer of digital content for storage and use on the devices of the acquirer. The regulation provides a list of factors to be used in making the characterization.

Both of the proposed regulations provide useful examples.

While taxpayer’s may quibble with the details, and perhaps question the source rule for downloaded digital content as the location where the content is installed on the acquirer’s device, the Service’s seeking to provide guidance by regulation in this area is to be applauded.


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