Chicago may exempt startups from 'cloud tax'

Confusion is driving widespread anger over last week's quiet enactment of a "cloud tax" in Chicago, said Harper Reed ⇒, technologist and CEO of mobile commerce startup Modest.

"We need clarity on what it actually means, what it actually means for all of us," Reed said. "What, as businesses, we can expect?"


The cloud tax is actually an extension of two existing taxes, the city amusement tax and the city personal property lease transaction tax, to cover streaming entertainment as well as cloud-based services.

"That lack of clarity is bad for Chicago, and basically it says that although the mayor or everyone is pro-business, that they're only there when it's fun to take photos," Reed said.

He said the personal property lease transaction tax, which is most likely to affect business, has created more confusion than the amusement tax.

A spokeswoman for the mayor's office responded to concerns Tuesday afternoon in a statement. It said that feedback from the startup community had prompted discussion of the impact on small businesses, and the city would release further guidance later this month.

And tech hub 1871 issued a statement that the city told them it is considering a proposal that "will basically exempt startups (based on revenue) from paying the tax." A city spokeswoman confirmed the statement and said details of that deal are being worked out.

David Hughes, a lawyer specializing in state and local tax at Chicago firm Horwood Marcus & Berk, said the city is likely to be challenged on its new interpretation of the personal property lease transaction tax to include services delivered via the cloud.

He explained how the changes to this decades-old law could affect businesses:

It's all about the "nonpossessory computer lease"

In plain English, this means remotely accessing information or services from a computer you don't own. A 1989 case ruled that the city of Chicago could tax transactions on LexisNexis, which was then used on dedicated terminals connected to a remote mainframe. The tax applied to the time using the database, not the terminal.

The city is now expanding its interpretation of that ruling to include access to remote "computers" — really any device that stores information — regardless of how they're accessed.

"People do feel like this concept of a nonpossessory computer lease, while that might have been valid in the late '80s to tax a LexisNexis-type service as it was delivered in the late '80s, it's really not the same thing today," Hughes said.

Companies present in Chicago must collect

The lease tax remains a tax on consumers, but how the city receives it varies based on certain circumstances. Providers that have a presence in Chicago — as in the form of an office, a store or even salespeople who travel in for meetings — will be responsible for collecting the taxes, Hughes said.

But consumers will be responsible for filing taxes themselves for subscriptions to services from businesses that don't have a presence in Chicago.


Current exemptions are limited

Users will not be taxed for passively accessing information, Hughes said. For example, accessing a stock ticker is not taxable. But logging into a paid service for stock prices and searching its database is subject to the 9 percent tax.

And old exemptions are gone

In the personal property lease transaction tax ordinance, the city included an exemption for leases entered outside Chicago in which more than 50 percent of the usage happened outside Chicago. So if a company based in New York had 10 percent of its employees in Chicago and entered a service agreement outside of Chicago, the city would not have been able to tax any of that company's service use.

In the new ruling, the city says that exception no longer applies, which Hughes said means the city claims it can tax an entire agreement — and use by all of that company's employees — regardless of where the contract was entered and even if the service is mainly used outside of Chicago, as long as that company has operations in Chicago.

Hughes said sourcing and allocation — that is, who should be taxed, based on which factors, and how much of a contract is taxable — will remain major issues for the city and taxpayers to contemplate.

The list goes on

The city listed a number of taxable services in its ruling, including for the first time cloud computing and services. Since this ruling is an interpretation of an existing law and not a statute, Hughes said, it gives the city "wiggle room" to define which services are taxable thanks to the nonpossessory computer lease clause.

"I don't think you can limit yourself to just [what is listed in the ruling] because the city is going to ultimately say that these are just examples," Hughes said. That is to say, any service resembling what's listed in the ruling is likely to be taxed.

You're already on the hook

The city said in its ruling that users or companies would not be held accountable for paying taxes until Sept. 1 but added they could be liable for those payments effective July 1. "It's the city talking out of both sides of its mouth," Hughes said.

And he said those assessments could stretch to before July 1, when the ruling came out, because the ruling was simply a new interpretation of a law that existed for decades. Hughes said the city would not necessarily take advantage of that but that the ruling as written would allow it to.

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