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Tech Tax Directors Suggest Broadening Cloud Transaction Regs

NOV. 12, 2019

Tech Tax Directors Suggest Broadening Cloud Transaction Regs

DATED NOV. 12, 2019
DOCUMENT ATTRIBUTES
  • Authors
    Johnson, Robert F.
  • Institutional Authors
    Silicon Valley Tax Directors Group
  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Tax Analysts Document Number
    2020-4468
  • Tax Analysts Electronic Citation
    2020 TNTF 25-22
    2020 TNTI 25-21
    2020 TNTG 25-26

November 12, 2019

CC:PA:LPD:PR (REG–130700–14)
Room 5203
Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

Re: Comments on proposed §§ 1.861-18 and -19 regulations in REG–130700–14

Dear Sirs or Madams,

The Silicon Valley Tax Directors Group (“SVTDG”) hereby submits these comments on the above-referenced proposed regulations issued under § 861 of the Internal Revenue Code of 1986, as amended, in REG–130700–14, 84 Fed. Reg. 40317 (August 14, 2019) (the “Proposed Regs”). SVTDG members are listed in the Appendix to this letter.

Sincerely,

Robert F. Johnson
Co-Chair, Silicon Valley Tax Directors Group
Silicon Valley Tax Directors Group
Capitola, CA


I. INTRODUCTION AND SUMMARY

A. Background on the Silicon Valley Tax Directors Group

The SVTDG represents U.S. high technology companies with a significant presence in Silicon Valley, that are dependent on R&D and worldwide sales to remain competitive. The SVTDG promotes sound, long-term tax policies that allow the U.S. high tech technology industry to continue to be innovative and successful in the global marketplace.

B. Summary of recommendations — changes that should be made to the Proposed Regs

The Proposed Regs in general are a welcome development. We recommend that Treasury and the IRS make certain specific changes to, and reconsider certain aspects, of the Proposed Regs. Here we summarize our main recommendations.

[A] Scope of the Proposed Regs

We recommend that the scope of Prop. §§ 1.861-18 and 1.861-19 be broadened so that the rules in each section apply for all purposes of the Code. Absent Code-wide applicability of the rules in these two sections, mismatches in the characterization of transactions between different Code sections could lead to troublesome incongruities, and hamper administration of tax laws.

[B] Sourcing rules

We recommend that the proposed modification of § 1.861-7(c) — i.e., that the place of sale of a copyrighted article sold and transferred through an electronic medium is the place of download or installation onto an end-user's device — be removed, and that the existing title-passage rule be retained. We counter the three criticisms of the title-passage rule asserted in the preamble to the Proposed Regs.

When in 1998 Treasury and the IRS promulgated § 1.861-18, they refused to equate transactions in copyrighted articles with transactions in tangible property, or transactions in copyright rights as transactions in intangible property. We recommend that Treasury and the IRS reconsider this and issue guidance, because whether such transfers are of tangible or intangible property is pivotal for applying §§ 250, 367(d), and 482.

[C] Recommendations for cloud transactions

The Proposed Regs endorse the rule in existing § 1.861-18 (1998) that a transfer of software is treated as a transfer of a copyright right if there's a non-de minimis transfer of any one of four specified rights. We believe that if software is transferred to allow the transferee to use the software to conduct a cloud transaction, such a transfer could be of a copyright right. But it's unclear which copyright right could be involved. We recommend final regulations allow taxpayers in this case to elect to characterize such transfer as the transfer of a copyright right. Similar questions arise with respect to transfers of other digital content (e.g., a film) more generally used in connection with a cloud transaction, although the answer should be clearer. It would be helpful if final regulations clarified this point.

We have three alternative recommendations relating to the classification of a cloud transaction as either a service or a lease. We are concerned that the multifactor test in Prop. §1.861-19(c)(2) introduces unnecessary uncertainty to the classification of cloud transactions as services. First, we recommend final regulations include a per se rule that cloud transactions are classified as the provision of services. We believe cloud transactions are fundamentally different than leases. Second, if the per se rule isn't adopted, final regulations should presumptively treat cloud transactions as the provision of services unless unusual circumstances exist. Third, if neither the per se rule nor the presumption is adopted, we recommend Prop. § 1.861-19(c)(2) factor (viii) be eliminated. The basis for fees generally shouldn't have any bearing on whether a transaction is properly classified as a service or a lease.

We recommend that income from cloud transactions that are treated as services be sourced according to the location of assets and activities of the service provider used in providing the service. Such a rule is consistent with §§ 861 through 865, and with the holdings of tax cases addressing source of income in connection with the provision of services. This rule should be administrable — cloud service providers should know the location of assets they own and of employees engaged in providing the service. Income from cloud transactions treated as leases should be sourced according to the location of the leased property, consistent with §§ 861(a)(4) and 862(a)(4).

[D] Coordination with § 250

We recommend Treasury and the IRS introduce a rule under § 1.250(b)-4 stating that intangible property used in providing a service that is a cloud transaction within the meaning of §1.861-19 is used at the location of individuals engaged in, and tangible property (e.g., servers) used in, providing the service. We also suggest a de minimis rule under § 1.250(b)-4 providing that any de minimis use of intangible property is disregarded in a cloud transaction. For example, if in connection with a cloud transaction that is Software-as-a-Service a customer has to download a relatively small piece of client software to engage in the cloud transaction, that should be treated as de minimis and ignored for purposes of § 250.

[E] Other items

Our recommendations in sections [A]–[D] above provide partial responses to the Proposed Regs' request for input on nine specific topics. We also give some supplementary input for some of the topics.

II. SVTDG CONCERNS WITH, AND RECOMMENDATIONS FOR CHANGES TO, THE PROPOSED REGS

A. The scope of the rules in Prop. §§ 1.861-18 and 1.861-19 should be broadened to include the Code, without restriction

The rules in Prop. §§ 1.861-18 and 1.861-19 generally provide helpful clarification for taxpayers engaging in relevant transactions. The scope of the rules in each of Prop. §§ 1.861-18 and 1.861-19 is restricted to certain Code provisions.1 We recommend that the scope of each section be broadened so that the rules apply for all purposes of the Code. Absent Code-wide applicability of the rules in these two sections, mismatches in the characterization of transactions between different Code sections could lead to troublesome incongruities — including uncertainty in the characterization of certain tax aspects of the transactions at issue — and hamper administration of tax laws.

B. The rule in Prop. § 1.861-7(c) for determining source of income from sales of digital content should be clarified and modified

1. Background on treatment of digital content

Existing § 1.861-18(b) treats a transfer of a computer program as either a transfer of a copyright right, a transfer of a copyrighted article, the provision of services, or the provision of know-how. A transfer of a computer program is treated as a transfer of a copyright right if there's a non-de minimis transfer of any of the following rights:

(i) the right to make copies of the computer program for distribution to the public by sale or other transfer of ownership, or by rental, lease, or lending;

(ii) the right to prepare derivative computer programs based on the copyrighted program;

(iii) the right to make a public performance of the computer program; or

(iv) the right to publicly display the program.2

A transfer of a copyright right is further categorized as either a sale or a license, and a transfer of a copyrighted article is further categorized as either a sale or a lease.3

The Proposed Regs update these regulations to apply more broadly to “digital content” rather than solely to computer programs (software). Thus, under the Proposed Regs, a transfer of non-software digital content (e.g., a song or movie) is subject to the characterization rules of § 1.861-18.

The Proposed Regs also modify the location-of-sale rule in § 1.861-7(c) to provide that the location-of-sale of a copyrighted article transferred through an electronic medium is the location of download or installation onto an end user's device.4

2. Sourcing rules

(a) Existing sourcing rules

Subsection 865(a) provides a general rule that gain from the sale of personal property is sourced according to the residence of the seller. There are exceptions to this general rule, including for inventory property, depreciable property, and intangible property. Paragraphs 861(a)(6) and 862(a)(6) source gains from the sale of inventory property according to the place of sale. Existing § 1.861-7(c) says that the place of sale is the place where the rights, title, and interest of the seller in the property are transferred to the buyer (the “title-passage rule”).

(b) Sourcing rules in the Proposed Regs

The Proposed Regs modify the title-passage rule of § 1.861-7(c) by providing that, when copyrighted articles are sold and transferred through an electronic medium, the place of sale is the location the digital content is downloaded or installed onto an end user's device.5 If information about the location of download or installation isn't available, the sale is deemed to have occurred at the location of the customer, based on the taxpayer's recorded sales data for business or financial reporting purposes.6

The preamble explains that the title passage of rule of existing § 1.861-7 is problematic for sales of copyrighted articles:

In many sales of copyrighted articles, the location where rights, title, and interest are transferred is not specified. In some cases, due to intellectual property law concerns, there may be no passage of legal title when the copyrighted article is sold. Moreover, the Treasury Department and the IRS have determined that contractual specification of a location — other than the customer's location — as the location of transfer could be easily manipulated and would bear little connection to the economic reality in the case of a transfer by electronic medium of digital content, given that a sale and transfer of digital content by electronic medium generally would not be considered commercially complete until the customer has successfully downloaded the copy.7

3. Questions and concerns about the Proposed Regs

(a) The revised place of sale rule isn't justified

As noted above, the preamble to the Proposed Regs levels criticisms at the title-passage rule of existing § 1.861-7(c): (1) the location of transfer of rights, title, and interest isn't specified or, for title, doesn't occur at all; (2) the location of such transfer is easily manipulated; and (3) the location of such transfer bears little connection to economic reality because electronic transfer isn't complete until the download has finished. We address these in turn.

First, we believe place of title passage — or the place at which rights and interests pass — can be specified in contracts. This issue was raised during promulgation of existing § 1.861-18. The preamble to existing § 1.861-18, T.D. 8785, notes, “[a]s to the issue of determining the place of sale under the title-passage rule of § 1.861-7(c), the parties in many cases can agree on where title passes for sales of inventory property generally,”8 and states that sales from electronic transfers of inventory property will be sourced under similar rules. It's unclear what in the IRS's experience has caused the change from believing passage of rights, title, and interest can be specified in contracts to believing that such passage can't be specified. Contracts can, and often do, specify the location at which either title or rights and interests pass. While title may not pass in all cases (e.g., in software licenses), rights and interests in the copyrighted article do transfer, and the parties can specify the location at which that occurs.

Second, the concerns noted in the preamble about manipulation of title passage aren't unique to copyrighted articles. Existing § 1.861-7(c) provides —

in any case in which the sales transaction is arranged in a particular manner for the primary purpose of tax avoidance, . . . all factors of the transaction, such as negotiations, the execution of the agreement, the location of the property, and the place of payment, will be considered, and the sale will be treated as having been consummated at the place where the substance of the sale occurred.

This rule “was intended to have limited application in exceptional circumstances where a transaction was arranged in an artificial manner with title passing in a particular place for the primary purpose of the avoidance of taxes.”9 That is, concerns about manipulating title passage are warranted only in “exceptional circumstances” where the transaction itself was artificially arranged.

Several cases have held that delaying title passage to qualify for a tax benefit for foreign source income of Western Hemisphere Trade Corporations didn't trigger this anti-avoidance rule.10 The language in the preamble about title passage being “easily manipulated” in the context of electronic transfers of copyrighted articles suggests that such transactions are unique, deserving of a special rule. But as GCM 34464 and the cases cited above indicate, as long as an agreement to pass title isn't in effect a sham, the parties' intent and agreement should govern.

Third, the proposed rule — place of sale is place of download or installation onto end user's device — could be difficult to administer. A customer's location may be obscured through the use of virtual private networks (“VPNs”) and similar privacy and security applications. Prop. § 1.861-18(f)(2)(ii) provides that, in the absence of information regarding location of download, the sale will deemed to have occurred at the location of the customer, which is determined based on the taxpayer's recorded sales data. The problem, however, isn't a lack of information on location but “false positives” as to location — for example, based on the IP address visible to the taxpayer, the taxpayer might think a customer is in the U.S., but the customer might actually be based in Singapore.

Tax law should arguably be neutral between transactions occurring over the Internet and occurring non-electronically.11 A special sourcing rule for electronic transfers of copyrighted articles violates this principle and is unwarranted.

Recommendation

We recommend that modification of § 1.861-7(c) be removed and that the title-passage rule be retained.

If, contrary to our recommendation, the modification of § 1.861-7(c) is retained, taxpayers should be allowed to use location of the customer, either based on the taxpayers' recorded sales data for business or financial reporting purposes, or based on market data used by the taxpayers for business planning, as safe harbors. Taxpayers shouldn't be required to prove the unavailability of information about location of download or installation.

(b) Coordination of § 1.861-18 and tangible and intangible property

When § 1.861-18 was promulgated in 1998, Treasury and the IRS refused to equate transactions in copyrighted articles with transactions in tangible property, and transactions in copyright rights with transactions in intangible property:

Numerous commentators requested clarification regarding the application of the regulations for purposes of section 482, requesting that transactions in copyright rights be treated as transactions in intangibles and transactions in copyrighted articles be treated as transactions in tangible property, even if delivered electronically.

This suggestion has not been adopted. Treasury and the IRS intend to further consider this issue and may provide additional guidance in the future. See generally, § 1.482-3(f).12

Recommendation

We recommend Treasury and the IRS reconsider this matter and issue guidance. The characterization of a transfer of digital content as tangible or intangible property is important for §§ 250,13 367(d), and 482, among others.

C. Recommendations for cloud transactions

1. Coordination of Prop. §§ 1.861-18 and -19

Application of the list of copyright rights in § 1.861-18(c) to a transfer of rights used to provide cloud transactions can lead to uncertainty. Subsection 1.861-18(c), as modified by the Proposed Regs, provides that a transfer of digital content is the transfer of a copyrighted article unless the transferee gets —

(i) the right to make copies of the digital content for purposes of distribution to the public by sale or other transfer of ownership, or by rental, lease or lending;

(ii) the right to prepare derivative works based upon the copyrighted digital content;

(iii) the right to make a public performance of the digital content, . . .; or

(iv) the right to publicly display the digital content. . . .

It's unclear how these rules would apply in many cases of digital content transferred to provide cloud transactions. For example, assume A, a U.S. corporation, transfers computer software to B, a foreign affiliate. B gets the right to use the software to provide Software-as-a-Service transactions only — that is, B doesn't get the right to sell copies of the software or make derivative works. Is the transfer from A to B a transfer of a copyright right, or is the transfer a transfer of a copyrighted article? It would appear intuitively that a copyright right has been transferred, but it's not clear which of the four rights is implicated. B gets the right to make copies (because each user will be using a copy), but it's unlikely that B is “distributing” the software.14

Does B publicly perform the software by using it to provide Software-as-a-Service? The copyright law definition of “perform” a copyrighted work means “to recite, render, play, dance, or act it, either directly or by means of any device or process or, in the case of a motion picture or other audiovisual work, to show its images in any sequence or to make the sounds accompanying it audible.”15 “Render” means, among other things, “to reproduce or represent by artistic or verbal means,” “execute in an artistic or verbal medium,” “to give an interpretation or performance of,” “to produce a copy or version of,” “to direct the execution of (as justice),” and “to execute the motions of (as a salute).”16 The public performance of online software was discussed in Miller v. Facebook, Inc.17 Miller sued Facebook for failing to prevent a co-defendant (Yeo) from publishing an allegedly infringing video game on Facebook. The court disagreed with Miller that such alleged action infringed on his public display right, and speculated —

At best, defendant Yeo's alleged publication of the ChainRxn video game for play by Facebook users constituted a public performance of plaintiff's copyrighted work under 17 U.S.C. 106(4). Just as Congress considered the “reading a literary work aloud” as a performance rather than display of a literary work, the reading of Boomshine's copyrighted source or machine code by a computer (resulting in the presentation of the video game to the user) could be seen as an analogous performance of the underlying work. See H.R. Rep. No. 94-1476 at 63 (1976). Admittedly, this area of the law is still developing.

If there is a “performance” of software in using it to provide a service, such performance should, under the Supreme Court's holding in American Broadcasting Cos. v. Aereo, Inc.,18 be “to the public.” Aereo operated a service that transmitted copyrighted television broadcasts to individual users over the Internet. The Supreme Court held that this seriatim performance of copyrighted works was “to the public” notwithstanding the fact that each broadcast was captured via an antenna dedicated to each specific user.19 The Court gives the example of transmitting (transmitting constitutes a performance under 17 U.S.C. § 101) a message via separate identical emails or one email to multiple people.20

Recommendation

We believe the rights in § 1.861-18(c) should be revisited, particularly in light of the use of computer software in cloud transactions. We recommend final regulations allow taxpayers — in the case of a transfer of software used to provide cloud transactions — to elect to characterize such transfer as the transfer of a copyright right. An example would be helpful.

Similar questions arise with respect to digital content, although the answer should be clearer. For example, corporation C could transfer rights to a movie to corporation D to both use in streaming to customers and for customers to download. We believe that under Prop. § 1.861-18(c) and existing copyright law, this would be the transfer of a copyright right (likely the right to publicly perform the movie). It would nonetheless be helpful if final regulations clarified this point.

2. Classification of cloud transactions

Prop. § 1.861-19(c)(1) provides that classification of a cloud transaction as a lease or a service is made taking into account all relevant factors, and Prop. § 1.861-19(c)(2) lists nine factors demonstrating a cloud transaction is classified as provision of a service. The preamble to the Proposed Regs asks for any realistic examples of cloud transactions that would be treated as leases.21 We're not aware of any realistic cloud transactions that should be treated as leases. Buying or leasing assets is a fundamentally different transaction — involving different activities, functions, and risks — than entering into a cloud transaction. We are concerned, however, that the modifications and expansions to the § 7701(e) factors introduce unnecessary uncertainty as to the whether cloud transactions are classified as the provision of services or leases. We therefore recommend that final regulations adopt a per se rule classifying cloud transactions as services.

If this suggestion isn't adopted, we recommend that final regulations include a presumption treating cloud transactions as services. This presumption should apply unless there are unusual circumstances. If, contrary to our understanding, Treasury and the IRS believe any realistic cloud transactions should be treated as leases, final regulations should specify these circumstances, and the presumption should otherwise apply.

If neither of these recommendations is adopted and the current multifactor test is retained, we recommend deleting factor (viii). Factor (viii) in Prop. § 1.861-19(c)(2) is that that “[t]he provider's fee is primarily based on a measure of work performed or the level of the customer's use rather than the mere passage of time.” Many arrangements that are properly treated as services have fees that aren't based on the amount of work performed or the level of the customer's use. Annual fees are common. The presence of a fee structure based on the passage of time or on some basis other than work performed or level of customer use shouldn't weigh in favor of lease classification.

Recommendations

Transactions meeting the definition of “cloud transactions” should per se be classified as the provision of services.

If the per se rule isn't adopted, a presumption should exist that cloud transactions are classified as the provision of services unless unusual circumstances demonstrate a lease is more appropriate.

If neither the per se rule nor the presumption is adopted, factor (viii) of Prop. § 1.861-19(c)(2) should be eliminated.

3. Source of income from cloud transactions

The preamble to the Proposed Regs requests comments on “administrable rules for sourcing income from cloud transactions in a manner consistent with [§§ 861 through 865].”22 Cloud transactions are, under the Proposed Regs, treated either as leases or as the provision of services.23 Income from leases (rentals) is sourced according to the location of the property, including the right to use such property within or without the U.S.24 Income from services is sourced according to where the services are performed.25 In Commissioner v. Piedras Negras Broadcasting Co., 127 F.2d 260 (5th Cir. 1942), the taxpayer operated a radio station in Mexico. A majority of the station's listeners was in the U.S., and the taxpayer earned 95 percent of its income from U.S. advertisers. The Fifth Circuit held that the taxpayer's income from the station was all foreign source income, because the broadcasting facilities were outside the U.S. and all the services rendered were performed in Mexico.

Sourcing rules for cloud transactions treated as services should therefore turn on the assets and activities of the service provider used in providing the service. Under existing law, the assets and activities of the service provider (only) are considered. In Miller v. Commissioner, 73 T.C.M. 2319 (1997),26 A-Alpha, a Hong Kong corporation, was hired to provide R&D services to U.S. customers. Payments A-Alpha got from their customers were held to be foreign source for withholding purposes, notwithstanding that A-Alpha subcontracted the performance of R&D services to its Hong Kong and U.S. subsidiaries. A-Alpha and its subsidiaries were separate corporations, and the Tax Court ruled they must be treated separately. Payments from A-Alpha to its U.S. subsidiaries for their services would, however, be U.S. source.

Recommendation

We recommend that income from cloud transactions that are treated as services be sourced according to the location of assets and activities of the service provider used in providing the service. Such a rule is consistent with §§ 861 through 865 and with the holdings in the cases above. Paragraphs 861(a)(3) and 862(a)(3), as well as § 1.861-4, source services according to the location at which they're performed. In the case of a corporation, that is based on the facts and circumstances, which “[i]n many cases . . . will be such that an apportionment on the time basis” is appropriate.27 The time spent by a corporation's employees corresponds to the activities of the corporation, and the location of assets of the corporation, to the extent involved in providing the service, should also be considered.

This rule should be easily administered. The cloud service provider should know the location of the assets it owns and of employees engaged in providing the service. The assets and activities of any subcontracting companies wouldn't be relevant in determining the source of the payment to the cloud service provider (although those assets and activities would be relevant in determining the source of payments from the cloud service provider to the subcontractors). To the extent assets and activities are located partially within and partially without the U.S., arm's length principles could apply to determine an allocation between U.S. and foreign sources.

Income from cloud transactions treated as leases should be sourced according to the location of the leased property, consistent with §§ 861(a)(4) and 862(a)(4).

D. Coordination with § 250's foreign use requirement

1. Location of foreign use

Subsection 250(a) allows a deduction for a portion of a domestic corporation's foreign-derived intangible income (“FDII”) for each taxable year. One of the requirements for income to be FDII for property “sold” (i.e., sold, leased, licensed, etc.) by the taxpayer is that such property must be for a foreign use.28 Subparagraph 250(b)(5)(A) states that “'foreign use' means any use, consumption, or disposition which is not within the United States.'” Proposed § 250 regulations provide that the sale of general property (i.e., tangible property) is for a foreign use if

(A) the property isn't subject to a domestic use within three years of the date of delivery; or (B) the property is subject to manufacture, assembly, or other processing outside the U.S. before the property is subject to a domestic use.29 Under the proposed § 250 regulations, the sale of intangible property is for a foreign use —

only to the extent that the intangible property generates revenue from exploitation outside the United States. A sale of intangible property rights providing for exploitation both within the United States and outside the United States is for a foreign use in proportion to the revenue generated from exploitation of the intangible property outside the United States over the total revenue generated from the exploitation of the intangible property. For intangible property used in the development, manufacture, sale, or distribution of a product, the intangible property is treated as exploited at the location of the end user when the product is sold to the end user.30

We submitted a comment letter on the proposed § 250 regulations, pointing out that the foreign use requirement for intangible property in those regulations is inconsistent with the statutory language (allowing “any use” outside the U.S. to qualify). We recommended changes to the proposed § 250 regulations to counter this inconsistency, and we recommended eliminating the distinction between tangible and intangible property. We reiterate those recommendations here.

Above we gave an example in which A, a domestic corporation, transfers software to B, a foreign corporation, for use in providing Software-as-a-Service via the cloud. To what extent is the software transferred from A “for foreign use”? The proposed § 250 regulations look to revenue from exploitation31 but don't say how to determine the location of revenue from exploitation, except in the case in which the intangible property is used in the development, manufacture, sale, or distribution of a product. In the case of software used in a cloud transaction, we believe that the intangible would generate revenue from exploitation where the service is performed, which, as described above, is where the assets and activities involved in performing the service are located. If the servers and employees used in providing the service are located outside the U.S., the software transferred from A to B would be “used” outside the U.S. The location of the end user isn't relevant because in this case the intangible property isn't used in the development, manufacture, sale, or distribution of a product.

Recommendations

We recommend Treasury and the IRS introduce a rule under § 1.250(b)-4 stating that intangible property used in providing a service that is a cloud transaction (for example, intangible property licensed to a SaaS provider) within the meaning of § 1.861-19 is — for purposes of § 250 — used at the location of the employees engaged in, and tangible property used in, providing the cloud transaction service.

We also suggest a de minimis rule under § 1.250(b)-4 providing that any de minimis use of intangible property is disregarded in a cloud transaction. To return to our example, if A transfers software to B (and such software is treated as intangible property), and B uses that software to provide Software-as-a-Service via the cloud, that intangible property should be treated as “used” where B provides the service, even if end users must download a small piece of client software to access the cloud service. This rule would be consistent with Prop. § 1.861-19(c)(3) and -19(d)(6) Example 6, which disregards any de minimis transaction, including the download of a client application used to access online software.

E. Other areas on which comment was requested

The preamble to the Proposed Regs requests comments on nine areas in particular.

Below we respond to the first eight areas.

[1] Whether the definition of digital content should be defined more broadly than content protected by copyright law and content that is no longer protected by copyright law solely due to the passage of time;

Yes, given the expansion of the diverse types of digital property bought and sold on real marketplaces, in virtual marketplaces and in in-game economies, the definition of “digital content” in Prop. § 1.861-18(a)(3) should be expanded to include any property in digital form in which a person has a right or interest. We recommend the change shown below (added language in bold face):

(3) Digital content. For purposes of this section, digital content means a computer program or any other content in digital format that is either protected by copyright law or no longer protected by copyright law solely due to the passage of time, whether or not the content is transferred in a physical medium, or any property in digital format in which a person has a right or interest. For example, digital content includes books in digital format, movies in digital format, and music in digital format, and property, or an item of value, purchased in a video game or marketplace. For purposes of this section, a computer program is a set of statements or instructions to be used directly or indirectly in a computer in order to bring about a certain result and includes any media, user manuals, documentation, data base, or similar item if the media, user manuals, documentation, data base, or other similar item is incidental to the operation of the computer program.

[2] whether any special considerations should be taken into account in applying the rules in existing § 1.861-18 to transfer of digital content other than computer programs;

Above we describe special considerations that should be taken into account in applying §1.861-18 to transfers of computer programs used to provide cloud services.

[3] whether any other aspects of existing § 1.861-18 need to be modified if that section is amended as proposed;

This item is discussed in our comments above.

[4] whether the classification of cloud transactions as either a service or a lease is correct, or whether cloud transactions are more properly classified in another category (for example, a license or a sale);

This item is discussed in our comments above.

[5] realistic examples of cloud transactions that would be treated as leases under proposed § 1.861-19;

We aren't aware of any cloud transactions that would be characterized as leases.

[6] the existence of arrangements involving both a transaction that would qualify as a cloud transaction and another non-de minimis transaction that would be classified under another provision of the Code or Regulations, or under general tax law principles;

Prop. § 1.861-19(d)(8) Example 8 involves Corp A providing both access to offline software and data storage to Corp B. These are separate, non-de minimis transactions. Similar transactions (provision of data storage and transfer of digital music or movie files) are common.

[7] potential bases for allocating consideration in arrangements involving both a transaction that would qualify as a cloud transaction and another non-de minimis transaction that would be classified under another provision of the Code or Regulations, or under general tax law principles;

In many cases, consideration will be charged separately for the two transactions. In Prop. §1.861-19(d)(8) Example 8, we believe it would be likely that Corp A would charge Corp B separate fees for data storage and offline use of software. To the extent separate consideration isn't charged, taxpayers should be permitted to use any reasonable method for allocating consideration between the two transactions.

[8] administrable rules for sourcing income from cloud transactions in a manner consistent with section 861 through 865;

This item is discussed in our comments above.


Appendix — SVTDG Membership

10x Genomics
Accenture
Activision Blizzard
Adobe
Agilent
Airbnb
Amazon
AMD
Analog Devices
Ancestry.com
Apple
Applied Materials
Aptiv
Arista
Atlassian
Autodesk
Bio-Rad Laboratories
BMC Software
Broadcom Limited
Cadence
CDK Global
Chegg, Inc.
Cirrus Logic
Cisco Systems, Inc.
Coinbase
Confluent
Crowdstrike, Inc.
Cypress Semiconductor
Dell Inc.
Dolby Laboratories, Inc.
Dropbox Inc.
eBay
Electronic Arts
Expedia, Inc.
Facebook
FireEye
Fitbit, Inc.
Flex
Fortinet
Genentech
Genesys
Genomic Health
Getaround
Gigamon, Inc.
Gilead Sciences, Inc.
GitHub GLOBALFOUNDRIES
GlobalLogic
Google Inc.
GoPro
Grail, Inc.
Hewlett-Packard Enterprise HP Inc.
Indeed.com
Informatica
Ingram Micro, Inc.
Intel
Intuit Inc.
Intuitive Surgical
Jazz Pharmaceuticals
Keysight Technologies
KLA-Tencor Corporation
Lam Research
Lime
LiveRamp
Marvell
Maxim Integrated
MaxLinear
Mentor Graphics
Microsoft
Netflix
NVIDIA
Oracle Corporation
Palo Alto Networks
PayPal
Pivotal Software, Inc.
Pure Storage
Qualcomm
Ripple Labs, Inc.
Robinhood salesforce.com
Sanmina-SCI Corporation
Seagate Technology
Snap, Inc.
Snowflake
SurveyMonkey
Symantec Corporation
Synopsys, Inc.
The Cooper Companies
The Walt Disney Company
TiVo Corporation
Trimble, Inc.
Uber Technologies
Velodyne LiDAR Verifone
Veritas
Verizon Media
Visa
VMware Western Digital
Workday, Inc.
Xilinx, Inc.
Yelp

FOOTNOTES

1Prop. §§ 1.861-18(a)(1) (as amended) and 1.861-19(a).

2§ 1.861-18(c).

3§ 1.861-18(f).

4Prop. §§ 1.861-7(c); 1.861-18(f)(2)(ii).

5Prop. § 1.861-18(f)(2)(ii).

6Id.

784 Fed. Reg. at 40320.

8T.D. 8785, 63 Fed. Reg. 52971, 52972 (Oct. 2, 1998).

9GCM 34464 (Mar. 25, 1971).

10See, e.g., Commissioner v. Pfaudler Inter-American Corp. 330 F.2d 471 (2d Cir. 1964); Commissioner v. Hammond Organ Western Export Corp., 327 F.2d 471 (7th Cir. 1964); Barber-Greene Americas, Inc. v. Commissioner, 35 T.C. 365 (1960); Rev. Rul. 64-198 (IRS will follow Pfaudler and Hammond Organ); Rev. Rul. 74-249 (respecting retention of title until foreign delivery).

11Department of the Treasury, Selected Tax Policy Implications of Global Electronic Commerce, 19 (1996) (“Neutrality requires that the tax system treat economically similar income equally, regardless of whether earned through electronic means or through more conventional channels of commerce.”)

12T.D. 8785, 63 Fed. Reg. 52971, 52972 (Oct. 2, 1998).

13Our comment letter on the proposed § 250 regulations recommended eliminating distinctions in the treatment of tangible property and intangible property under § 250. We reiterate those comments here.

14Under copyright law, 17 U.S.C. § 101 (2019), the right to make copies and the right to distribute are distinct rights. Thus, transferring the right to make copies without the right to distribute would be the transfer of a copyright right under copyright law.

1517 U.S.C. § 101 (2019).

16WEBSTER'S THIRD NEW INTERNATIONAL DICTIONARY 1922 (1966).

172010 WL 20198204, 95 U.S.P.Q.2d 1922 (not reported in F.Supp.2d) (N.D.Cal. 2010).

18573 U.S. ___; 134 S.Ct. 2498 (2014).

19Id. at *15; 134 S.Ct. at 2511.

20Id. at *13; 134 S.Ct. at 2509.

2184 Fed. Reg. at 40321.

2284 Fed. Reg. at 40321.

23Prop. § 1.861-19(c)(1).

24§§ 861(a)(4) and 862(a)(4).

25§§ 861(a)(3) and 862(a)(3).

26Aff'd without published decision, 166 F.3d 1218 (9th Cir. 1998).

27§ 1.861-4(b)(1).

29Prop. § 1.250(b)-4(d)(2)(i).

30Prop. § 1.250(b)-4(e)(2)(i).

31Id.

END FOOTNOTES

DOCUMENT ATTRIBUTES
  • Authors
    Johnson, Robert F.
  • Institutional Authors
    Silicon Valley Tax Directors Group
  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Tax Analysts Document Number
    2020-4468
  • Tax Analysts Electronic Citation
    2020 TNTF 25-22
    2020 TNTI 25-21
    2020 TNTG 25-26
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