Brett D. Maxfield Directed Research Final Paper Prof. Thom Spring 2015 Thinking About How to Properly Tax Internet and Cloud1 Based Businesses “There is nothing more revolting if the grounds upon which it was laid down have vanished long since, and the rule simply persists from blind imitation of the past.”2 Oliver Wendell Holmes, Jr. Introduction This paper is an analysis of how new technology based business models, such as Uber and Airbnb, are disrupting how state and local governments ability to collect taxes from services which were once easy to monitor and tax. It is hoped the reader will gain a better understanding of how different jurisdictions are reacting to the new types of business which have arisen as a result of mobile apps and other new web based business models which take away the traditional methods of monitoring and taxing. Also, I suggest best practices to jurisdictions seeking guidance on how to respond to this new evolution in the area of public finance. According to Governing.com in January 2015:

“. ..cities have seen a surge of app-based driving services, including Uber, Lyft and Sidecar.... many mayors have issued cease-and-desist orders to the new companies, but a handful of tech-friendly localities have revised local regulations to welcome them. So far, states have let cities decide how to deal with this issue, but that could be changing. Last year, Colorado became the second state -- after California -- to establish statewide rules for ridesharing companies, and the first to do so legislatively. Early legislative activity suggests state approaches are likely to vary in the coming years. One model, considered by Illinois and Michigan lawmakers last year, would make

1 The term “Cloud” refers to hosted data storage and processing capabilities made possible via the internet. Thus, all cloud issues are internet issues, but not all internet issues are cloud issues. Therefore, understanding the internet, its history of evolution as well as how it has been taxed is essential to understanding the specific issue of cloud taxation. As Ernst and Young, LLP has recently articulated in a white paper: “Software sold through smartphone app stores actually consists of just the display and user interface components of sophisticated applications that mostly run in cloud data centers. Although there are a number of definitions for cloud computing, cloud computing as borderless commercial transactions conducted over a virtual network (e.g., the internet) in which goods or services are provided to a user (related or unrelated) anywhere in the world with access to such network. More specifically, new technology sector offerings range from software as a service (SaaS) to infrastructure as a service (IaaS) and platform as a service (PaaS). These, in turn, are being joined by hybrid and specialized services, such as business process-, data center-, database- and testing-and-development as a service. Cloud market size projections vary by definition, with the enterprise market for public SaaS and IaaS alone estimated to be growing from $18.3 billion worldwide in 2012 to $31.9 billion in 2017.” Seehttp://www.ey.com/ Publication/vwLUAssets/EY_- _Cloud_taxation_issues_and _impacts/$FILE/EY-Cloud-taxation-issues-and-impacts.pdf, p.7. 2 The Path of the Law, 10 Harv. L. Rev. 457, 469 (1897).

ridesharing a state- regulated enterprise and preempt local oversight of the business. Some states might follow the example of the District of Columbia, where a new law permits ridesharing but also deregulates taxi meter fares when passengers order rides online -- a concession meant to make the taxi industry more competitive.”3

This quote only skims the surface and also draws attention to other administrative issues caused by these types of companies which will not be addressed in depth by my research but also must be examined to some degree to understand the context of the dynamics involved. I am going to focus exclusively on local taxation of these new companies which can be called “Cloud Taxation” due to the fact that these companies are all cloud based technology enabled for their business models to work. I say focus exclusively local government, but I must explain how the federal and state laws and tax systems effect the abilities of local governments to address the issue. This paper will being from a big picture perspective and drill down to the specific nut and bolts of how things work or do not work. Thus, this paper is not just about how a local government can tax a company like Uber, for example, which is really the end goal of this endeavor. Thus, this paper will address three subjects which must be at least superficially looked at to get a proper context from which to form perspectives on the problems presented by Cloud based business which are disrupting traditional tax revenues in local governments. The three are internet laws, state and local taxation law, and relevant federal law and agencies which have played a role in the evolution of the current state of affairs regarding the problems caused and potential solutions to the disruptions of these cloud based businesses. Who has jurisdiction over cyberspace? Who has the right to tax online transactions? These and other questions arise as they relate to tax jurisdiction and are forcing a reexamination of interstate commerce. There is nothing simple about this subject, but on the surface it seems like a simple matter, and it is ironic that the beauty and success of these cloud based businesses is their apparent simplicity. Consumers get them because the services are simple and easy to use and make sense from their point of view economically. New Paradigms of Public Policy Evolving Out of the Digital Economy Some local governments are all about being part of the new digital economy. They have as their top goals building new local digital economies and offering tax incentives to digital economy type businesses to locate in their jurisdictions. The City of Los Angeles is an example of this. However, other governments are under severe pressure to raise public revenues after years of economic downturn. The City of Detroit is an example of this. Also, some governments want to protect the old brick and mortar manufacturing and service based economy from the disruptions of the new digital economy. The City of Boston’s fight, among others, with Uber is an example of this. Furthermore, the ability of governments to keep up with the pace of change in the world of technology is slow at best. Even the cities which pride themselves as being on the cutting edge with the technology world such as New York, San Francisco, and San Jose vary as to their abilities to keep up with the technology and can not help but lag behind the development of new business models, even if they are the first to accommodate or encourage the evolution and change of innovation. They still encounter disruptions and 3 http://www.governing.com/topics/politics/gov-issues-to-watch-2015.html

have to struggle with how to accommodate and incorporate the new with the old as concerns generating tax revenues. The bottom line is even those jurisdictions that wish they can be left behind find that it is in their best interest to understand the new dynamics so that they can get a fair chance to tax these endeavors which may undermine their traditional sources of revenues. The City of Flint, MI, might be an example of this type. Crossing the Chasm from a Public Policy Perspective Regarding Cloud Taxation In 1991, Geoffrey A. Moore published the now famous book entitled Crossing the Chasm: Marketing and Selling High-Tech Products to Mainstream Customers. It is a marketing strategy textbook of sorts for high technology startups that teaches the need to focus on niche customers in the early stage of a company for it to make it beyond the period when the investment capital of the company runs out. In 2006, Tom Byers, Faculty Director of Stanford Technology Ventures Program, stated that the book is "still the bible for entrepreneurial marketing 15 years later”.4 Why you might ask does this book have any relevance to the subject at hand. At the core of the Chasm thesis is the idea of a bell curve which describes the market for new technology, which applies to governments as well as to other consumers.

Note regarding this graphic.5 This curve tells those launching new products how most markets can be predicted to respond. Approximately 5% of all potential customers are innovators/ the very early adaptors of new technology/ pioneers. They are represented in the green part of the curve. These are the people who are very enthusiastic about new technology and are willing to take risks to adopt new ideas. Without these people as customers, there would 4 http://ecorner.stanford.edu/authorMaterialInfo.html?mid=1563 5 This graphic is taken from http://www.eccoid.com/blog/wp-content/uploads/ 2009/06/chasm-dialogue.jpg

never be new technology on a large scale. These are the people waiting days outside to buy the new Apple product the day it comes out. As concerns cities in the US, these are New York, San Francisco, and San Jose. The next market segment is approximately 15% in yellow, called the early adaptors. They do not want to be the first to try something, that is too risky for them, but once they see one or two do something cool and innovative with some success, they want to try it also. This would be Los Angeles, Chicago, and Boston. Of course people may dispute which cities fit where on this curve as to their adaptation of new technology, but I base this on my personal experience of selling a cutting edge technology to city and county governments worldwide as a founding team member of CitySourced. The next sector in orange is called the early majority. These people like new things but are more concerned that there is a well established precedent, some case studies, some publicity from recognized leaders of success with something before they are willing to jump on the wagon. They make up approximately 30% of the market. The next sector is called the late majority. The would rather skip the change altogether but they feel obligated to evolve often several years after the new technology has become part an almost essential component of everyday society. They make up approximately 45% of the market. Then the last 5% are the true laggards, the ones who refuse to change until is an absolute necessity do to so. Again, one may question why I take the time to explain something which seems of little relevance to the subject at hand. My hypothesis is that the way local governments react to taxing the cloud technology will follow similar patterns but with much larger numbers in the front than in the back due to the fact that the above model is based on governments spending money to get a new technology, whereas we are considering ways for governments to increase their tax revenues which they are much more motivated to do. However, this difference, which is large, does not override the parallels when it comes to the attitude toward risk. There is much risk in setting up new tax systems. There are law suits which are almost certainly going to challenge the new tax system. There is much money spent in setting up the new regimes which if ruled illegal by a court or result in net negative economic conditions within a jurisdiction will cause policy makers to loose their careers more likely than not if they are wrong. The Chasm is where a product fails. It does not have enough value to win over the early majority and thus goes out of business once it runs out of venture capital because the revenues brought from the early adopters can not sustain its growth. There are literally millions of these companies, but no one can recall their names. Steve Job’s computer company called Next is a good example. It takes much effort to recall the failures once they have passed because they failed for failure to become popular. Had Proposition 13 failed to pass in California in 1978, whom would know what Prop 13 is? However, today almost everyone knows what Prop 13 is if they live in California. The relevance of this to tax policy on the local level is that there are innovative cities and counties and states which will take the risks of law suits, etc. to establish new tax regimes to capture the revenues which the new technology make possible, either out of brilliant foresight or out of dire necessity or desperation. My suggest in all this is one can substitute new technology for new cloud based tax policies in the bell curve described

and predict how local governments will evolve. This is not an exact science, but it is an interesting and I think useful way to foresee what may take place due to the parallels between the two subjects and the fact that first is the actual cause of the second. Thus, pioneer jurisdictions will be brave and try taxing in ways which may become the basis of the paradigm which will one day be standard for almost all local governments in the US, the iPod of tax regimes, or some will be called out as foul by the courts and be the MicroSoft version of the same, never to be adopted but by a very few and only for a very short time. These failed tax policy will have fallen prey to the chasm between the pioneers and early adaptors and not having been able to persuade the early major it follow suit. Only if the early major follows is there a chance that the late majority will follow, and only when the late majority follows fully is something established as a true success which all the world takes note of as worthy of as a proven method. In this regarding, taking the example of Proposition 13 again, it is a failure as regards setting a standard which all states take as a model in the US. Proposition 13 may stay forever as the law in California, but only few states have adopted the basis concept of Proposition 13. Massachusetts and Oregon for example passed similar but not nearly as radical property tax regimes, but the vast majority of the states do not property tax modes like Proposition 13. Thus, one can say that Proposition 13 has failed in the public market place of public policy ideas as concerns it power to influence or set the standard for other jurisdictions.6 A History of Internet Taxation The history of internet and cloud taxation7 actually began long before the rise of the internet or even computers for that matter. In 1944, the US Supreme Court decided McLeod v. J.E. Dilworth Co.8, which concerned the issue of jurisdiction when sales taxes were all collected in one state even though the goods were delivered to another state. In

6 I think it is worth noting that I write this paper as student at the USC Price School of Public Policy and that as a student here I have observed that the only course on the role of technology in the public sector has failed to obtain even the interest of eight students each time it has been offered and thus had to be taken of the offered class schedule. This is shocking considering that the role of technology in the administration of the public sector is arguably the most important practical aspect of governance in the present day. However, it reveals that even a top leading university such as USC, which arguably has some of the best and brightest minds of the next generation of public policy makers and administrators, has very little interest in taking note of the importance of technology in the role of public policy making or public administration generally. This conservatism of students and the university toward technology is revealing, since the generation in school now is the digital era. If this be the case with those who have been exposed to new technology since inception, one can imagine the attitudes of those who are holding the highest positions of public policy making and public administration to whom smart phones are still strange and suspicious devices and who may still not have personal social media accounts. The danger here is that the technology companies themselves are given the power to create public policy for governments by default, due to the unwillingness, inability, or lack of interest to understand the role of new technology as it relates to governance and public policy issues. If this does not change and those taking the role of public policy makers and government administrators do not start to become somewhat educated on issues of technology as they related to the same, the tail may wage the dog. The technology providers may purposefully or not end up set the agenda of what can and can not be done by their client governments based on the systems they have architected. 7 See FN1. 8 322 U.S. 327 (1944).

this case, a business in Tennessee took orders for goods from an Arkansas company via phone and mail, and collected payment and delivered the goods within the State of Tennessee. Arkansas attempted to collect a sales tax on these transactions because the goods were shipped to Arkansas for use by the company located in Arkansas which had purchased them. The Court ruled that the sale, for the purpose of sales tax, was legally taking place where the goods were paid for and delivered and that for Arkansas to collect a sales tax on this transaction was a tax on interstate commerce and thus beyond its power under the Constitution. However, in McGoldrick v. Berwind-White Coal Mining Co.9, the Court had come to a different opinion in a similar circumstance, similar but different. In McGoldrick, a New York City sales tax was upheld regarding the transactions involving a Pennsylvania corporation, with an office in New York City, making the sales in New York City, and making the delivery of goods within the state. The difference between the two cases was that in McGolrick, the company being forced to collect the sales taxes had an office in the State of New York. In 1967, the Supreme Court revisited the issue of state and local tax jurisdiction beyond its borders in National Bellas Hess, Inc. v. Dep't of Revenue10. In this case, the only contact the out of state business had with Illinois were the catalogues it mailed twice a year and the orders it got via the mail from them. The Court asked if the company being subject to the tax regime was being given any benefit from the state or local government which justified the burden. The Court held that transactions being done purely via the postal service such as this did not justify the imposition of the sales tax regime upon the out of state company. Thus, all three cases revolve around the issue of the degree of contact between the outside party and the state wishing to impose a tax regime upon it. This seems simple. The nexus of contact is still the issue when it comes to the internet and cloud taxation. However, as a recent Ernst and Young white paper put its:

Business users or consumers can encounter potential new tax obligations and reporting burdens that vary from market to market. And if tension has been building between taxpayer and tax authority, the underlying reason is simply that the cloud is borderless and tax jurisdictions are not. But nothing is quite that simple in these early evolutionary days of cloud taxation. There are no familiar, cookie-cutter business models that tax authorities can readily understand. The existing tax law governing technology transactions are often perceived as outdated and inconsistent. The technology and business arrangements are such that even identifying the taxable location of either cloud service providers (CSPs) or their customers can be challenging.11

In 1992, the Supreme Court visited the issue of state sales taxes once again in Quill Corp. v. North Dakota12. In this case, the Court focused on the nexus of contacts between the state seeking to tax and the target to impose the burden upon and if it is reasonable for such an entity to expect such a burden based upon the economic benefit it is deriving from the contact with the state or protection from its laws. In doing this, the Court 9 309 U.S. 33 (1940). 10 386 U.S. 753 (1967). 11 http://www.ey.com/Publication/vwLUAssets/EY_- _Cloud_taxation_issues_and _impacts/$FILE/EY-Cloud-taxation-issues-and-impacts.pdf, p.5. 12 504 U.S. 298 (1992).

applied a similar line of reasoning regarding jurisdiction long arm statutes in light of due process rights which flow out of basic federal civil procedure jurisprudence which any first year law school student is very familiar with. The two most familiar cases to lawyers next to Marbury v. Madison13, are International Shoe Co. v. Washington14 and Burger King Corp. v. Rudzewicz15. The Quill Court asked if the defendant had sufficient contacts with the forum state to expect to defend a suit there, not requiring physical presence to establish jurisdiction as long as the entity derived legal or economic benefits from North Dakota , taking into consideration both due process and the Commerce Clause, and establishing a three part test to determine when jurisdiction over a party would be appropriate for tax purposes in light of due process. The test consists of three questions: 1) Does the party direct its sales to the residents of a state?; 2) Are contacts of the party with the state sufficient for due process purposes?; and 3) Is the tax related to the benefits the corporation receives from the state? The amount of economic activity in a state is a more important factor than a physical presence therein or lack thereof. North Dakota passed the due process test, there were sufficient contacts to justify due process, but due process was not the only factor, there was also a Commerce Clause consideration which must be factored. North Dakota's tax was an unconstitutional burden on interstate commerce, because while the minimum contacts requirements of due process were met, it failed to meet the substantial nexus requirement of the Commerce Clause, upholding the National Bellas Hess rule that jurisdiction should not be imposed over an entity whose only contact with a state was by mail for the purpose of sales tax. The Court also noted that Congress should ultimately decide to what degree states should be allowed to burden interstate commerce as a result of taxation and that Congress had considered legislation more than once which would have overruled the National Bellas Hess presence requirement but did not pass such legislation after due deliberation. Thus, under Quill physical presence is not required by due process for jurisdiction but is required by the Commerce Clause or else a substantial nexus is not established, upholding the rule in National Bellas Hess for the sake of stare decisis but calling out to Congress to decide to what degree states should be able to tax parties only doing business within them by mail under their authority over the Commerce Clause. This idea articulated by the Court that Congress should regulate how state and local governments can tax out of state vendors and buyers is a great idea, but it is one that as of yet Congress has decided to put in to law. However, Congress has passed other laws which do have an effect on this matter, which this paper will address, but it is important to note how much power has been left to the courts generally, not only the federal court but also the state courts to regulate this area. For example, in 2013, the Illinois Supreme Court ruled that the state’s Main Street Fairness Act, which imposed upon out of state retailers the duty to collect sales tax on annual sales of more than $10,000, violated the federal Internet Tax Freedom Act, supra, which prohibits some but not all types of taxes

13 5 U.S. 137 (1803), which establishes the right of the federal courts to review the validity of the government’s actions in light of the Constitution and thus establishes the supremacy of the federal judiciary over the other two branches of government without explicitly stating such. 14 326 U.S. 310 (1945). 15 471 U.S. 462 (1985).

on electronic commerce.16 Thirteen states had similar taxes, unchallenged at the time.17 Illinois was the first state to overturn its own legislature.18 Illinois argued that affiliates in the state, who receive a percentage of any sales generated by customers who clicked to enact a sale through to Amazon or others similar types of online merchants within the state satisfied the nexus required for the collection of a sales tax.19 However, its own Supreme Court did not think it proper. The point of this example for this section of the paper is not to get into the specific legal theories put forth, etc. but to ask should this question be left to such a seemingly random process of policy making, where different results come out of different states with the same facts before them and if these inconsistencies are sufficiently interfering with interstate commerce to get Congress to mandate a structure which all states follow uniformly, as the Court suggests in Quill. Civil Procedure, Personal Jurisdiction, and Sales Taxes Jurisdiction

As has already been mentioned, supra, there are many parallels between the jurisprudence of federal sales taxes case law and federal civil procedure law regarding personal jurisdiction. By this I mean Quill’s abandonment of the need for a physical presence per National Bellas Hess for the sake of due process. In this Quill was following a parallel reasoning articulated in International Shoe Co. and Burger King, supra. In International Shoe Co., the Court established that a person or entity may be subject to the jurisdiction of a state court if it has minimum contacts with that state, outlines the limits on states’ long arm statutes imposed by due process, and outlines the requirements to establish valid service of process, sufficient to establish personal jurisdiction. In other words, who, what, when can be sued by a court, what the geographic boundaries are to jurisdiction and upon what factors such boundaries are established. In Burger King, the Court in which a district court held that Florida had jurisdiction over a dispute between Burger King and a franchisee because of a statute that allowed the state to extend jurisdiction to anyone breaching a contract within the state. The Court of Appeals reversed, ruling that though the defendants had minimum contacts with Florida, it was still a violation of due process under the specific circumstances of the case which did seem unfair. Burger King appealed to the Supreme Court which ruled that defendants purposefully availed themselves of the protection of Florida law and were, therefore, subject to its’ courts’ jurisdiction. Due process was not violated because defendants should have reasonably anticipated being summoned into court in Florida for breach of contract as a result of the long relationship they had with Burger King there. The Burger King reasonableness/ fairness test evolved into a five factor reasonableness test in Asahi v. Superior Court20. Again, all of this is L1 Civil Procedure 101. The five factor test in determining whether the assertion of personal jurisdiction over a defendant violates due process is: 1) What is the burden on the defendant?; 2) What are the interests of the forum state in the litigation?; 3) What is the interest of the plaintiff in litigating the matter in that state?; 4) Does the allowance of jurisdiction serve interstate efficiency?; and 5) Does the allowance of jurisdiction serve interstate policy interests? The Court ruled that the burden on the 16 http://www.mhpbooks.com/illinois-supreme-court-rules-against-amazon-tax/ 17 Id. 18 Id. 19 Id. 20 480 U.S. 102 (1987).

defendant was severe based on both the geographic distance and legal dissimilarities between Japan and the US. Plaintiff was not a California resident, diminishing California's stake in the case, and neither interstate efficiency nor interstate policy interests would be furthered by granting jurisdiction to California over defendant Asahi. The reason I take the time to look at these parallels is that the test in Asahi may prove useful in the area of sales tax legislation as a justification for or against a specific tax, but all this also shows that there is some continuity to the thinking of the Supreme Court over time and that they try to make different but similar issues follow some parallel logic. Whatever policies are made will not be made out of vacuum but out of a long history of parallel lines of reasoning for similar but different issues by analogy. Thus, this history is very important when thinking about how states21 should or should not be able to impose taxes upon cloud based ventures. Cyberjurisdiction The law of civil procedure and personal jurisdiction has also evolved as relates to the internet via cases which involved online businesses and the question of whether or not a court in a particular state has jurisdiction over the case or not. This paper is focused on domestic tax issues which relate to the new cloud based business models. However, cloud companies could be hosted outside the U.S. and this complicates the matter even more. Just analyzing the matter of proper jurisdiction within the U.S. between states is quite an endeavor, but if Europe were to be included, where many new cloud based companies are arising which do business within the U.S. and in which many U.S. based companies are doing business based out of the U.S., then a whole paper could be written addressing the issues of jurisdiction in the U.S. in light of European regimes of the Brussels Regulation, the Rome I Convention, and other laws, never mind trying to address the whole world. At present there is no multilateral convention to resolve disputes over matters of jurisdiction, choice of law, nor conflict of law as regards the internet nor e-commerce. As has already been mention, supra, every state in the U.S. has long arm statutes which attempt to impose jurisdiction over non-residents of the state if they have either engaged in tortuous activity within that state or been engaged in business activities within that state, but some like California leave theirs open-ended, simply saying that they have as much jurisdiction over people outside of California as its Constitution and the U.S. Constitution will allow. California Civil Code of Procedure Section 410.10 reads: “A court of this state may exercise jurisdiction on any basis not inconsistent with the Constitution of this state or of the United States.” However, Massachusetts’ long arm statute is much more narrow, reading in part: “A court may exercise personal jurisdiction over a person, who acts directly or by an agent, as to a cause of action in law or equity arising from the person's (a) transacting any business in this commonwealth; (b) contracting to supply services or things in this commonwealth; (c) causing tortious injury 21 See Hunter v. Pittsburgh, 207 U.S. 161 (1907): “Municipal corporations are political subdivisions of the state, created as convenient agencies for exercising such of the governmental powers of the state as may be entrusted to them....The number, nature, and duration of the powers conferred upon these corporations and the territory over which they shall be exercised rests in the absolute discretion of the state." 207 U.S. 161, 178.

by an act or omission in this commonwealth…”22 The validity of a long arm statute and the way it is being used to justify jurisdiction over a person or entity outside of a state is always first an issue of due process under the 14th Amendment of the Constitution. This due process analysis has already been covered, supra, regarding International Shoe and the minimum contacts that case requires with the forum state for the state to have valid jurisdiction over a party. What has not been discussed yet is the matter of general jurisdiction. General jurisdiction is found when a party’s contacts with a state are so extensive as to be considered “systematic and continuous” as per the1984 Supreme Court holding in Helicoperos Nacionales de Columbia. S.A. v. Hall23, again a 1L law school civil procedure 101 fundamental case. If general jurisdiction is found regarding a party, the state has jurisdiction over that party regardless if the claim arises out of the “systematic and continuous” activities which grant the jurisdiction. Usually a court will look to see if a party has things such as incorporation in the state, bank accounts, offices, etc.24 However, now a website can also qualify for this finding. In 2003, the 9th Circuit found that L.L. Bean, the famous Maine catalog retailer, satisfied a general jurisdiction status in California because of the company’s website which was ruled to be a virtual California store due to its extensive marketing to consumers in California and relationships with California vendors.25 The Supreme Court has not chosen to take up this issue yet. The most famous cyberlaw case is Zippo Manufacturing Co. v. Zippo Dot Com, Inc.26 in the United States District Court for the Western District of Pennsylvania found personal jurisdiction over a California defendant providing services within the State of Pennsylvania via its website, not general jurisdiction, based on a sliding scale test which relates to website function and design. The case is rather antiquated by current day website design activity, but it is still interesting and perhaps useful as to analogy when considering cloud taxation issues. The court in Zippo created a sliding scale with passive websites, which only post information, on one side, and interactive websites on the other, which allow customers to conduct business online or otherwise interact via the website in a significant way, and then established a “gray zone” in between the two. Again, the era of passive websites has gone, so this case is more of a historic relic when it comes to comparing actual business models online. However, one could see a scale like this be used in an analogous manner when it comes to cloud based businesses, with Airbnb and Uber on one side, which have a physical interaction within states via their contractors as service providers, and lets say, Words With Friends and Candy Crush, mobile app games which you download on your phone, on the other side of the scale, all cloud based business models, with a grey zone in between. However, here is where technological advances work in favor of the tax man in an ironic way, it is actually be easier to track where the mobile apps were downloaded because of the GPS features on all smartphones then to know what jurisdiction the renters are in using Airbnb which is web based and thus does not have a GPS feature capability. Nevertheless, one can still get a fairly good 22 Mass. Gen Laws. ch. 223A, § 3, see: http://www.lrcvaw.org/laws/malongarm.pdf 23 466 U.S. 408 (1984). 24 http://definitions.uslegal.com/g/general-jurisdiction/ 25 Gator.com Corp. v. L.L. Bean, Inc., 341 F. 3d 1072 (9th Cir. 2003). 26 952 F. Supp. 1119 (W.D. Pa. 1997).

idea in what jurisdiction a rental is in based on its street address, which then can be digitally and automatically entered into a geospacial matrix to tell Airbnb which jurisdiction’s tax rate should apply. Thus, the technology makes taxing these cloud business relatively easy in theory, but the questions of how many contacts and of what nature they are, with the forum jurisdiction will still be preeminent in line with the tombs of jurisprudence which have framed the ways approach of the subject of jurisdiction. Therefore, it is worthy to understand the way Zippo has influenced courts and how courts have either found or rejected jurisdiction based on its scale when it comes to business conducted in or over cyberspace. Passive Websites In 1996 in Bensusan Restaurant Corp., v. King27, a federal district court in New York ruled that a passive website, one which just posted information like an advertisement in a newspaper or magazine, did not justify establishing jurisdiction over an out of state company. In 1997 in Cybersell Inc. v. Cybersell Inc.28, the 9th Circuit ruled that a family business for computer consulting services in Florida was not subject to jurisdiction in Arizona just because its mostly passive website (the site had contact information for potential customers to call or e-mail) was accessible from Arizona but the Florida company had made no specific efforts to market itself to Arizona residents, nor had any other type of contacts with the state. The court made clear that a party must do something more than just have a website which is accessible from the state signifying that they are seeking to target residents of the state. However, the year previous, in 1996 in Inset Systems, Inc. v. Instruction Set, Inc.29, a federal district court in Connecticut ruled that a website accessible within the state which advertised for a business in Massachusetts and posted a toll free phone number had availed itself of the states’ jurisdiction. This ruling however was seen as too expansive by most observers at the time for this would open up most websites potentially to jurisdiction in all states in which their websites are accessible just for having contact information on the site. However, though the court did not make this distinction, it seems fairly obvious that the fact the state of the party being sought jurisdiction upon was in a neighboring state and could expect to draw customers from Connecticut to Massachusetts was an unmentioned factor in finding jurisdiction whereas had the company with the same type of website been in California, the court would most likely have ruled against jurisdiction. What all these cases have in common is a methodology to analyze proper jurisdiction based upon an internet business model of one variation or another. There are many, many more such cases in this line, but these cases established the basic frameworks which all other cases draw upon in their analysis. One can reason by analogy to see how these cases can help sales tax policy makers reason about what types of internet and cloud based businesses should fall into their sales tax jurisdiction. The one factor not address in any of these cases directly, which makes sense from a purely personal and subject matter jurisdiction perspective, is the volume of business the out of state party is conducting

27 937 F.Supp. 295 (S.D. N.Y. 1996). 28 130 F.3d 414 (9th Cir. 1997). 29 937 F.Supp. 161 (C. Conn. 1996).

within the state. In a long arm sales tax context, the purposeful availment might be based on gross revenues of business done with residents within the state. Thus, if a small family business sells one $10 widget to a resident of a state the business is not located within, there is no violation of the long arm sales tax law (hypothetical law here). However, perhaps if the small business operate via eBay, then all the eBay sales in that state get taxed (however, there are many potential inequities in this which could have a cooling effect on starting and maintaining a small business through a channel like eBay, supra). Another factor which is not made in any of these cases thus far, most likely due to the age of the cases and the change in technology since them, is the difference between using the internet as a channel for selling goods v. services, especially in the form of software. The whole cloud based business model is about SaaS (software as a service). If someone goes to a store in most states an buys a CD with MicroSoft office on it for their PC, they get charged sales tax on that purchase. However, now the same software can be bought online and downloaded, most likely without a sales tax collect (here the software is still just a good for sale but is being delivered by download), but with the SaaS model, there is no software downloaded, the user pays a fee to access a website which allows the user to have the most up to date product always in the cloud which is accessible to the user anywhere in the world where they have an internet connection (except perhaps in China or other countries which have major restrictions on internet access). Thus, there is much SaaS which could be viewed from a tax perspective as a good, even though it is called a service when it comes to cloud based businesses and which more likely than not are not even on the radar of the tax authorities, but which are very easy to track and trace in this era of big data. The Commerce Clause and the Dormant Commerce Clause The Commerce Clause and the Dormant Commerce Clause are very important in understanding the history and context of states ability to tax outsiders. Thus, a brief explanation of the two is useful to the reader of this paper. Article 1, Section 8, Clause 3 of the U.S. Constitution is known as the Commerce Clause and allows Congress the power “to regulate commerce with foreign nations, and among the several states, and with the Indian tribes.”30 The Commerce Clause grants Congress authority to regulate interstate commerce and restricts states’ power to regulate matters which effect interstate commerce. This limitation on states’ power to regulated matters effecting interstate commerce is known as the Dormant Commerce Clause. This prohibition is implied, not explicit. There is much debate about the meaning of the word "commerce" because the Constitution does not define it, thus some argue that is limited to trade or exchange, while others argue a much broader definition. How one views this definition ultimately determines a how one see the dividing line between federal and state police power to a large degree but not exclusively, there are other factors in this balance. The Commerce Clause (“clause”) has been used to uphold federal laws in areas that do not seem to have anything do with interstate “commerce”. In NLRB v. Jones & Laughlin Steel Corp.31, the Court started taking an extremely broad view of the meaning implied 30 US Constitution, Article 1, Section 8, Clause 3. 31 301 U.S. 1 (1937).

by the commerce clause as to its ability to allow the federal government to regulate states’ interests. However, in 1995, the Rehnquist Court put on breaks on this over reaching power creep based on the clause justification in Lopez v. United States, stating that the federal Gun Free School Zones Act of 1990 had gone too far in trying to regulate firearms in local schools, and that true purpose of clause was to regulate the channels of commerce, the instrumentalities of commerce, and actions that substantially affect interstate commerce. Morrison v. United States32, further cut back federal power by stating that the Violence Against Women Act was not justified by the clause. Up to this time many thought that the way the Warren Court had used the clause to help the cause of civil rights was acceptable, but this ruling made clear that the scope was going to be much more narrow moving forward and that Congress could not just invoke the clause in the preamble to a law to secure its legitimacy.33 Two other cases regarding the Commerce Clause are relevant. In Healy v. Beer Institute Inc.34, the Court stated that any attempt by a state to regulate conduct wholly outside of itself violates the clause regardless if the commerce sought to be regulated has an effects within the state seeking to regulate.35 In this case, Connecticut required out of state beer merchants to show that the prices they were selling at to wholesales within the state were the same as those being sold to surrounding New England states. The Court said this law was a violation of clause on its face because it applied only to those engaged in interstate commerce and that it was also an attempt at an illegal protectionism violating the clause. One should easily see how this case might be argued by analogy when it comes to internet commerce and cloud taxation issues, especially those aimed as some form of protectionism. The other case is Granholm v. Heald36, in which Michigan and New York both had laws which allowed wineries within each respective state to sell online to those within those states but not out of state wineries to do the same. Both states laws were ruled to violate the dormant commerce clause by favoring wineries in the states against those outside of them. Unlike, Healy, although somewhat similar, this case actually related specifically to online commerce but do not the taxing of online commerce. Yet, it is a relevant case to keep in mind when thinking about the cloud taxation issue as well. The Internet Tax Freedom Act In1998, Congress passed the Internet Tax Freedom Act to encourage the continue growth of the internet and commerce via the internet.37 This law has evolved over time and changed somewhat since its inception, but it can be best summarized in its initial purpose and effect by the words of a 2003 Congressional Budget Office (“CBO”) report, this law 32 529 U.S. 598 (2000). 33 For a more detailed narration and in depth analysis see https://www.law.cornell.edu/wex/commerce_clause 34 491 U.S. 324 (1989). 35 Id. at 336. 36 544 U.S. 460 (2005). 37 http://www.mhpbooks.com/illinois-supreme-court-rules-against-amazon-tax/ and http://www.cbo.gov/sites/default/files/10-20-internettax.pdf

“posed a three-year moratorium on new federal, state, and local access levies. In addition, it allowed existing taxes on sales over the Internet to remain in effect and permitted governments to impose new taxes on such sales as long as they applied equally to sales made by other means, but it prohibited discriminatory taxes on Internet sales. The law did not give states and local governments the authority to require that remote sellers collect sales taxes.”38

This law still prohibits federal, state and local taxation to the access to the internet and related potential taxes, such as bandwidth taxes and email taxes, for example.39 This law also prohibits some types of online commerce taxes. This act also established an Advisory Commission on Electronic Commerce to make recommendations about Internet taxation, including whether to require retailers to collect sales taxes on Internet purchases.40 The Commission was required to prepare a report: (1) examining how states and other countries tax the Internet; and (2) considering the effect of taxation on the ecommerce.41 Although the law had a cooling effecting on states taxing online commerce, it does not prohibit taxation of online sales, as these may be taxed at the same as mail order sales42. It has was extended several times by Congress, and became the Permanent Internet Freedom Act in 2014.43 The real last impact of this action by Congress from the perspective of this paper however, is not the prohibitions placed upon states by it regarding taxes and the internet, which still leaves room for states to tax the types of cloud based businesses this paper is looking at, but the policy analysis which came out of the report of the Advisory Commission, supra, which was part of the initial action in 1998, but which made no recommendations as per the protocol of the CBO guidelines.44 A similar follow up report worthy of note was published by the COB in 2003 entitled Economic Issues In Taxing Internet and Mail Order Sales45, and the Congressional Research Service (“CRS”) built upon these reports in a report of 2013 entitled State Taxation of Internet Transactions46.

CBO 2003 Report

The CBO report did a great good of setting a framework from which to analysis the subject of states’ desire to tax online transactions. The report consists of three sections. The first section of the report is an overview of the causes and conditions leading up to the need to address the remote sales issue, a summary description of what effects the unforeseen consequences of the internet were having on states budgets, inter alia, at the time, and an explanation of the then current debate over how to best collect on the 38 http://www.cbo.gov/sites/default/files/10-20-internettax.pdf, p. 7. 39 Id. 40 Id. 41 Id. 42 http://www.nationaljournal.com/tech/house-lawmakers-introduce-bill-to-ban-internet-taxes-forever-20150109 43 Id. 44 http://www.cbo.gov/sites/default/files/10-20-internettax.pdf 45 Id. 46 http://www.fas.org/sgp/crs/misc/R41853.pdf

billions of revenues which were being transacted tax free which would otherwise have been collected but for the rise of the internet, via a coordinated effort to get remote sellers to agree to collect these sales taxes for the all the states they were transacting within either by an act of Congress or voluntarily as per a MOU of sorts between coalition of states interested in keeping the power of states in this regard from Congress. The following table taken from the report shows how much the each state which had a sales tax depended upon this source of tax revenue at the time and how different each state was each other in this regard and the complexity of attempting to overlay a system which could equitably address such a synthesis47:

47 Id, p. 4, 5.

Based upon the above table, the CBO noted that the potential loss of revenue from remote purchases had generated the proposed idea that vendors should be required to collect use taxes for the states. The CBO references Quill in this analysis and makes an interpretation of it that “only the Congress can give states the authority to require remote sellers to collect use taxes”48, noting that the federal government’s only stake in the Internet sales tax debate was a as regulator of interstate commerce and that the issue had no federal budgetary effects. The CBO then outlined five issues which it considers the crux of the mater from a policy analysis as to whether Congress should iron out the wrinkles, two arguments for ironing, three for not ironing: 1) There is an inefficiency that results when the differential taxation of commodities causes tax-motivated decisions about consumption and production and also an increase the compliance costs that would be imposed on remote sellers to collect and remit use taxes from multiple jurisdictions (policy argument in favor for Congressional action to fix things); 2) A uniform system requiring remote sellers to collect the taxes imposed by Congress would distribute the burden of sales taxes more equitably and treat people in equal circumstances equally (policy argument in favor for Congressional action to fix things); 3) If Congress acts, it will increase “the size of government and eliminate a tax advantage that is helping the Internet grow to its economically desirable size”49; 4) If Congress acts, it will “impose a tax burden on remote sellers who, unlike local sellers, receive no compensating public service benefits (for example, fire and police protection)”50; and 5) If Congress acts, it will “compromise the fiscal autonomy of states and local governments, which is guaranteed by the Constitution, if standardization of tax bases and rates is required to 48 Id., p. 7. 49 Id. 50 Id.

reduce compliance costs.”51 The result of this analysis and deliberation upon its finds was the evolution of a compromise, not requiring Congress to act, in the form of the Streamline Sales and Use Tax Agreement52.

The Streamline Sales and Use Tax Agreement

The Streamlined Sales and Use Tax evolved out of a series of events in response to the Internet Tax Freedom Act and a fear that Congress might attempt to permanently prohibit states from collecting sales tax on online commerce.53 The Streamlined Sales Tax Project (“SSTP”) was created by the National Governor’s Association and the National Conference of State Legislatures in 1999 to address the sales tax collection issues resulting from internet commerce.54 Leaders from both Associations were members of the Advisory Commission on Electronic Commerce during the time when the Internet Tax Freedom Act was being formulated in 1998.55 The result was that many states’ governors agreed to work together to develop a simpler and efficient sales tax system. The SSTP was dissolved once the Streamlined Sales and Use Tax Agreement (“SSUTA”) became effective in 2005.56 Today, 44 states and the District of Columbia are members to this regime, but only 24 of the 44 states have actually passed legislation to adopt the regime as part of their state’s law.57 This lack of full commitment from member states puts into question how well this act is actually doing in regard to making local governments better able collect sales taxes from retailers and states in a way which creates less burdens on them and makes the administration of such collections much more efficient. The Streamline Sales Tax Governing Board claims:

“The Agreement minimizes costs and administrative burdens on retailers that collect sales tax, particularly retailers operating in multiple states. It encourages "remote sellers" selling over the Internet and by mail order to collect tax on sales to customers living in the Streamlined states. It levels the playing field so that local "brick-and-mortar" stores and remote sellers operate under the same rules. This Agreement ensures that all retailers can conduct their business in a fair, competitive environment.”58

However, as already mentioned, only 24 of the 44 states have passed the conforming legislation. Those states which have passed the legislation have a total population of 92,781,860, representing 33% of the country’s population.59 See map, infra.60

51 Id. 52 http://www.streamlinedsalestax.org/index.php?page=faqs 53 http://www.fas.org/sgp/crs/misc/R41853.pdf 54 Id. 55 Id. 56 Id. 57 http://www.streamlinedsalestax.org/index.php?page=gen_3 58 http://www.streamlinedsalestax.org/index.php?page=gen_1 59 Id. The following states that have passed legislation to conform to the Streamlined Sale and Use Tax Agreement: Arkansas, Georgia, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Vermont, Washington, West Virginia, Wisconsin and Wyoming. 60 Id.

As the map shows, the full member states are not the big economic powerhouse states. All the sunbelt states are merely advisory members. Thus, although this solution makes sense on many levels, the lack of commitment to it by the majority of states, if you include states which have no sales taxes currently, and the fact that the most important states from an economic perspective are only advisory, there is still much uncertainty and need for policy to fill the gap. Not to mention the fact, that this agreement does not even truly address the cloud taxation issue head on, but it does create a framework which could easily be amended to include rules to address the cloud issues. There are many problems with this agreement. First and foremost, it is voluntary on the part of the sellers.61 Thus, those sellers which do not comply are at a competitive advantage over those who do and over the physical stores within the states which they compete against for business. Then, there are wrinkles upon wrinkles. What about resellers?, for example. In 2008, the City of Chicago sued eBay and its subsidary, StubHub for not charging customers city amusement taxes on tickets sold via the websites.62 While eBay did not have any offices in Chicago, StubHub did have a property there.63 The city filed two complaints, one against each company, asking eBay and StubHub to disclose all records of sales in Illinois.64 eBay responded by making a public statement that paying sales taxes would destroy small internet businesses which it helps 61 http://dor.wa.gov/Content/FindTaxesAndRates/RetailSalesTax/DestinationBased/ DepartmentStreamLineFAQ.aspx 62 http://www.tomsguide.com/us/eBay-taxes-chicago,news-1423.html 63 Id. 64 Id.

facilitate because implementing tax collection systems would be cost prohibitive for them.65 This same year, 2008, Amazon and Overstock.com both sued the State of New York separately seeking to overturn a law requiring retailers to pay taxes if they get New York state clients as a result of advertisements through a weblinks.66 Both companies argued that the law was in violation of the Commerce Clause. However, both cases were dismissed in 2009, and a New York appeals court upheld the dismissals in 2010.67 In 2013, New York’s Court of Appeals, the highest state court in New York equivalent to other states’ supreme courts, also upheld the rulings, stating that the companies “established an in-state sales force” via their agreements with affiliates which collected commissions for posting links on their websites.68 Thus, why should states join the Streamline regime fully if they can keep their systems in place and tax as they wish? A state like New York might loose more revenue from having to adjust its practices and does not want to bank on a voluntary system which it can not enforce. Looking at the scoreboard of the map regarding which states have made the Streamline Tax part of their legislature, they have not entered the late majority segment of the market (I speak of the states here as a market place for ideas about tax policy) yet, which according to the Chasm thesis is essential for a venture to last long and thrive. Also, though they have almost full saturation in the early majority segment of states, the states which have adopted the regime are not the states one usually associates with innovative and progressive ideas. Thus, the Streamline Sales and Use Tax Agreement may turn out to be the Betamax, and VHS has not yet been invented. Winkles Upon Winkles Upon Winkles, the FTC, and Local Zoning Laws Much of my historical narrative up to the present time has attempted to simplify a very complicated subject, some may take issue with my calling my narrative simple, but things can get very complicated very quickly as one might easily imagine. There are many laws effecting the operation of the internet and internet based businesses, federal, state, and local, as well as agency regulations, which have nothing to do with taxation and yet which will both be effected by and symbiotically effect any attempts to impose an universal solution to the remote tax issue. For example, the FTC has a program called Consumer Sentinel which has a mission to uncover, inter alia, internet fraud schemes.69 One of the largest problems discovered as concerns online fraud is the sale of fake goods via sites like eBay, where the buyer is told and believes they are purchasing, for sake of illustration, a Coach handbag, which has a high retail price, but which they believe they are getting for a bargain from someone who just needs to cash flow quick. Now imagine the wrinkle a sales tax brings into this if the buyer, not only gets cheated out of the good they thought they were purchasing but pays a state a sales tax on an inflated price for a good which is a fraud. This would add insult to injury if for example eBay collected the

65 Id. 66 http://www.bloomberg.com/news/articles/2013-03-28/amazon-overstock-lose-challenge-to-n-y-web-sales-tax 67 Id. 68 Id. 69 https://www.ftc.gov/enforcement/consumer-sentinel-network

sales tax for the state from the buyer, making it easy for the sellers, here fraudulent, not to have to collect the tax. Now you the buyer have a fake hand bag you paid too much for, you can not get your money back from the seller who was a scam artist, but you may perhaps be able to get the sales tax collected upon this fraudulent transaction if you appeal to the state via eBay? This is all hypothetical, but one can imagine there is no easy fix to this scenario. To be just, every state collecting taxes on these types of transactions will or should have to set up a special department just for these types of problems, and the buyer will be left with a bunch of hoops to jump through before they can get the relatively small sum which the sales tax on such a transaction might engender, meaning most would likely not pursue trying to recapture this loss. Again, this is just an exercise of the imagination of what all the complexities of the web of laws might inflict upon both consumers, states, and sellers or resellers as a result of a poorly planned sales tax regime. Another example much closer to the real issue being focused on in this paper is this: Imagine that the State of California enters into an agreement with Airbnb to have it collect the use tax from those using the service within the state which hotels collect in exchange for a statewide law prohibiting the local governments from prohibiting their residents’ use of their properties for short term rentals within their jurisdictions. This idea may seem farfetched, but this would mean billions of revenues long term, otherwise lost to the state potentially, in exchange for taking away the local right to control land use as regards short term rentals. One can imagine how the residents of Malibu or other small beach cities will like it when their neighbors are gone all summer, and they are forced to live next to party animals which come for three day stays, booked back to back, all summer long, which is illegal under the city’s local zoning law but is now preempted by state law. Again, this is all hypothetical, but one can see how a tax law brokered by the state with a large internet or cloud based business like Airbnb could potentially have ripple effects into areas totally unforeseen or not properly planned for due to the large sums of money at stake in lost revenues. No Cloud dwells in the Clouds

Hopefully this paper has done at least a halfway job of communicating what cloud means, but it better be explained again for the purpose of this section. The term cloud means that the local pc, server, or smarphone is accessing via the internet to a hosted server on which the data and software dwell. There are private clouds which are hosted on a private on premise location owned or leased by the company which owns the cloud and public or shared clouds with redundancy hosted by providers such as MicroSoft and Amazon, inter alia, for example. Thus, no cloud is truly in the clouds. All clouds dwell on a physical geography, which may trigger general jurisdiction issues. These cloud data centers are often called farms. Where you have your farm will almost certainly subject the owner of that farm to general jurisdiction within that state due to the significant contacts physically having a data center trigger as regarding availment of the economic and legal benefits of a state. Public cloud computing is about borderless global networks because the same data and software can be located in redundancy in several countries, for example, the U.S., the E.U., and India. Therefore the location of a public cloud cannot be pinpointed (most small and medium sized and even large companies used public cloud services such as those offered by Amazon or MicroSoft and do not know where the

physical location of their vendor’s hosting infrastructure is located) and furthermore the space upon it is leased not owned (the business of providing cloud bandwidth is a SaaS in itself), which makes the question of which state‘s laws apply in taxing public clouds unanswerable based on the physical location of the cloud or at least less of a factor (there is always the small chance that a SaaS states that it uses MicroSoft or Amazon and the state tax collector happens to know that that specific provider has a data center within its state, but this is an outlier and stretching the boundary of minimum contacts). PriceWaterhouseCoopers (“PWC”) published a white paper in 2012 entitled How Does One Tax The Cloud? which asks a series of rhetorical question along this line of reasoning worthy of consideration:

If a state taxes at the point of use, what if services are free at the point of use? If tax is based on the location of the servers or the office of the cloud computing provider, will providers simply move to the lowest-tax jurisdiction? How does a provider or purchaser avoid being taxed in two locations simultaneously when states apply different sourcing rules for sales and use tax purposes?70

Though most states have not even begun to address the tax issues arising out of the clouds, some do have their heads in the clouds when it comes to thinking about how to tax SaaS. In 2009, the State of Washington State specifically taxed SaaS providers for purposes of both sales and use tax and business and occupancy tax.71 Of course, this is the home state of MicroSoft, so one would expect them to be more advanced than other states. However, this same year, 2009, the Missouri ruled that SaaS hosted on out of the state was not subject to sales tax based on its understanding of minimum contacts72, but New York determined that SaaS hosted out of state are taxable if accessed from a location within the state. New York stated that SaaS is “tangible personal property, the use of which occurs when accessed in New York, and that access constitutes a taxable transfer of possession of the software, because the customers gain constructive possession of the software, and gain the use of the software”, but hosting services are exempt in New York if those services can be purchased as software licenses.73 This gets confusing and very convoluted quick as is already evident. In Massachusetts, where SaaS is taxed, a local SaaS company that provided employment application collection and selection services was deemed tax exempt because the “customer was purchasing the information, not the use of the software.”74 It should also be noted that according to PWC, many states do not tax services, and cloud computing or SaaS is often considered a service, not a good in the form of a software, though as the example of New York, supra, illustrates, this can go either way.75 Again, PWC asks some good questions for tax policy makers to consider:

“A major challenge in the taxation of cloud offerings is in the tax classification of cloud services themselves. Is the offering a taxable or nontaxable service? Is it a data processing or information service? Is it the sale or lease of tangible personal property? While a significant number of states

70 http://www.pwc.com/en_US/us/state-local-tax/assets/pwc-how-does-one-tax-the-cloud.pdf, p. 5. 71 Id. 72 Id. 73 Id. 74 Id. 75 Id.

have addressed cloud services from a SaaS point of view, very few states have addressed tax classification from an IaaS or PaaS standpoint, and very few states have updated their statutes and regulations to address this emerging use of technology.”76

IaaS stands for infrastructure as a service, and PaaS stands for platform as a service, both are types of cloud offerings, and have been described in a simple manner previously, supra, as the SaaS of SaaS, but this is not technically correct. However, I have tried to keep it simple as far as I can in this paper for the non-technical to get their feet wet without losing them altogether in big data terminology and acronyms. Ironically, while company might not wish to have a private cloud due to it triggering jurisdiction within the state where it is physically located, tax benefits are often offered by states to encourage companies to locate their clouds or data farms within their borders. However, this is a matter to negotiate with the state and local jurisdiction prior to committing to a location. According to PWC, some states see private cloud services as ripe for tax purposes, but in other states, service transactions are not.77 However, the lease of tangible personal property is generally subject to tax, and the State of Vermont has suggested that computer memory is tangible personal property even though it has not yet tax it as such. Thus, states may start taxing the hosting or maintenance of a website on a server as a sale or lease of tangible personal property.78 Furthermore:

“Of potentially greater consequence are the possible nexus implications of leasing tangible personal property in a state. Leased property in a state may create nexus for both income tax and sales and use tax in the state where the assets are located. Using a private cloud could create an income tax filing requirement and a sales and use tax collection responsibility for the company. The sales and use tax collection responsibility would apply to all the company‘s transactions in the state, not just those dealing with acquiring private cloud computing services.”

Some states have taken steps which threaten to tax the nexus consequences of a private cloud within their borders.79 The State of Texas for example had a regulation that made any retailer which owned or used tangible personal property within the state, including a computer server or software, considered engaged in business within the state and responsible for sales and use taxes.80 However in 2011, Texas reversed this position, but this example illustrates that states are becoming aware of these issues.81 The State of Washington has made clear to its many software headquartered companies that “ownership of or rights in computer software, including master copies of software, digital goods, or digital codes, stored on servers located in the state” will not be used as factor in determining whether a party has substantial nexus.82 Of course, this is not for the direct benefit of the companies headquartered in the state but for their clients, since any physically located headquartered companies are already subject to the jurisdiction.

76 Id. 77 Id at 6. 78 Id. 79 Id. 80 Id. 81 Id. 82 Id.

States want to attract data farms. Giving tax breaks is often the key to a state attracting big companies to locate a data center in its jurisdiction. The states which are “the frontrunners in a race to attract server farms and data centers through tax incentives include Alabama, Kentucky, New York, North Carolina, Oklahoma, Tennessee, and Virginia.”83 In 2007, the State of Washington decided that data farms would no longer get a tax break.84 Microsoft and Yahoo stopped construction of their centers in Washington, and Microsoft moved its center to Texas.85 As a result Washington temporarily reinstated the tax exemption, but the repeal of the tax incentive has seriously harmed the ability of the state to continue to keep and attract new centers, whereas its neighbor, Oregon, has attracted a Facebook data center via generous tax incentives.86 Back to the Beginning, Uber and Airbnb In January of this year, the State of Virginia reported that it had received $1.7 million in taxes from online travel companies, such as Hotel.com, but nothing from Airbnb which had around 2,500 listings in the state at the time.87 Similarly, Uber and other SaaS companies, not only taxi style concepts, but traditional services made more efficient as a result of GPS enabled smartphones and SaaS business models, “continue to undercut the licensed, regulated and revenue producing” traditional industries.88 State and local governments are faced not only with the declines in traditional tax revenues but issues of equity, economic viability, and creating new regulations to protect consumers, while facing the death or decline of historic industries. This new economy has been called by many names, digital, share, on demand, and the disruptive economy, and it is all these things. The internet, SaaS based businesses leveraging cloud technology, and smartphones have transformed economic patterns worldwide and will continue to change and evolve. How can state and local governments keep up with the changes and address them satisfactorily? What role should the federal government play in this? There is an ever expanding web of interwoven systems of law, policy, and technology which serve as the contextual backdrop of the narrow issue of how can a city properly tax Airbnb, Uber, or other SaaS based businesses. Conclusion In January of this year, Boehner made a statement that Congress would revisit the internet sales tax issue this year. Congress has been studying this issue for years, as has already been discussed in depth in this paper, supra. Several bills have been proposed over the years addressing the issue but have failed to gain enough support to pass. In 2013, the Congressional Research Service published a report entitled State Taxation of Internet Services, supra, which narrates the following summary of one of the bills proposed to address the issue in its basic outlines, later referencing other bills with 83 Id. at 8. 84 Id. 85 Id. 86 Id. 87 http://www.governing.com/columns/public-money/gov-uber-unforeseen-fiscal-challenges.html 88 http://www.theatlantic.com/business/archive/2015/03/santa-monicas-failed-attempt-to-limit-the-taxi-options-of-its-residents/388388/

similar features, both of which are based upon the Streamline Sales and Use Tax Agreement, supra:

“Under S. 1452, Congress would have granted authority to states to compel out-of-state vendors to collect sales taxes, on the condition that 10 states comprising at least 20% of the total population of all states imposing a sales tax have implemented the SSUTA.The legislation also included additional requirements for administering the new sales tax system after the SSUTA adoption threshold has been achieved. The requirements included, but were not limited to a centralized, one-stop multi-state registration system; uniform definitions of products and product-based exemptions; single tax rate per taxing jurisdiction with a single additional rate for food and drugs; single, state-level administration of sales and use taxes; uniform rules for sourcing (i.e., the tax rate imposed is based on the origin or destination of the product); uniform procedures for certification of tax information service providers; uniform rules for filing returns and performing audits; and reasonable compensation for sellers collecting and remitting taxes. The SSUTA generally includes these provisions, though some modifications to the SSUTA or the legislation would have been necessary for enactment.”89

The reason this has not passed in my opinion is that the states do not want to give up more power to the federal government and Congress knows this. Some states have taken a half measure with the SSUTA and got so, so results because it is voluntary and unenforceable primarily. Ultimately, this should be a federal solution, but if a federal law passes what about the local jurisdictions potential conflicts of law, the zoning issues raised by Airbnb, supra, for example. The answer seem to be a federal law which outlines as above who, what, where, and why internet, SaaS/ cloud business get taxed but which specifically gives local police power to the states and local governments as to all other issues effected by such economic activity so that local governance trumps. In other words, the federal law would only preempt state and local laws as to sales and use taxation, but no give a license for disruption upon local customs with the force of a preemptive law. This would be the first step, then a multinational reciprocal sales and use treaty with the E.U., etc.

89 https://www.fas.org/sgp/crs/misc/R41853.pdf, p. 14.