Classification of Cloud Transactions and Transactions Involving Digital Content, 40317-40329 [2019-17425]
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Federal Register / Vol. 84, No. 157 / Wednesday, August 14, 2019 / Proposed Rules
(4) For a client that is a partnership,
corporation, or association, the client’s
trade or fictitious names;
(5) The address of the client’s
physical location (for a client that is a
partnership, corporation, or association,
the physical location would be the
client’s headquarters) and telephone
number;
(6) The client’s email address and
business website;
(7) A copy of the grantor’s unexpired
government-issued photo identification;
(8) The client’s Internal Revenue
Service (IRS) number, employer
identification number (EIN), or importer
of record (IOR) number;
(9) The client’s publicly available
business identification number;
(10) A recent credit report;
(11) A copy of the client’s business
registration and license with state
authorities; and
(12) The grantor’s authorization to
execute power of attorney on behalf of
client.
(d) Verification of information by
customs broker. Before transacting
customs business on behalf of a client,
the customs broker must authenticate
the client’s identity by verifying all the
information collected from the client
pursuant to paragraph (c) of this section.
The customs broker must verify all the
information collected from the client or
the inapplicability of the information to
that client. The customs broker also
must check to determine whether the
client is named as a sanctioned or
restricted person or entity by the U.S.
Government, or if the client is
suspended or debarred from doing
business with the U.S. Government. The
means of verification are at the customs
broker’s discretion; however, the broker
must use as many of the recommended
verification means as necessary to be
reasonably certain as to the client’s
identity. These means include:
(1) A check of the appropriate
websites to determine whether the
client is named as a sanctioned or
restricted person or entity by the U.S.
Government, or if the client is
suspended or debarred from doing
business with the U.S. Government;
(2) An in-person review of the
grantor’s government-issued photo
identification;
(3) An in-person client meeting;
(4) An in-person visit of the client’s
place of business;
(5) A review of the client’s Articles of
Incorporation;
(6) A query of publicly available
information, business information and
credit reporting entities, Federal, state,
and local databases or websites and any
other relevant trade or business sources.
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(e) Establishment of policies,
procedures and internal controls. All
customs brokers must implement
policies, procedures, and internal
controls to identify and verify a client’s
identity before transacting customs
business on behalf of that client. The
policies, procedures, and internal
controls must also fulfill the
recordkeeping requirements in
paragraph (f) of this section, particularly
the requirement for updating
information and records, and reverifying
the client’s identity.
(f) Recordkeeping. All customs
brokers must make, retain, and update
records containing the required
information used to identify and to
verify the client’s identity.
(1) Identification records. At a
minimum, customs brokers must retain
any information collected pursuant to
paragraph (c) of this section, including
any identifying information presented to
the customs broker, as well as any
certifications the client has made.
(2) Verification records. At a
minimum, customs brokers must retain
descriptions of any documents relied
upon, any non-documentary methods
relied upon, any results of measures
undertaken, and any resolution of
discrepancies used to verify the client’s
identity as required by paragraph (d) of
this section. The verification records
must indicate which information
collected pursuant to paragraph (c) was
verified, who performed the
verification, and the date the
verification was performed.
(3) Compliance with other
recordkeeping provisions. All customs
brokers must comply with the
recordkeeping provisions of this part,
part 141 of this chapter, and part 163 of
this chapter. The identification and
verification records must be retained
and made available upon request for
CBP examination in accordance with
parts 111, 141, and 163 of this chapter.
The required retention period for the
identification and verification records is
the same period as is required for a
power of attorney in §§ 111.23 and
163.4 of this chapter.
(4) Updating information. All customs
brokers must implement procedures to
update the records required in this
section and to reverify the information
collected from the client pursuant to the
procedures set forth in paragraph (d)
annually to ensure that the information
is accurate, timely, and complete.
(g) Penalties for noncompliance.
Failure to collect, verify, secure, retain,
update, or make available for inspection
the information required in this section
is grounds for a monetary penalty to be
assessed against the customs broker not
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40317
to exceed $10,000 per client in
accordance with 19 U.S.C.
1641(d)(2)(A), or revocation or
suspension of the customs broker’s
license or permit in accordance with 19
U.S.C. 1641(d)(2)(B).
(h) Timing of verifications. (1)
Prospective clients. For all prospective
clients, customs brokers must verify the
information required in this section
before the customs broker may begin to
transact customs business on behalf of
that client. The customs broker must
comply with all the requirements in this
section for that client including
updating all records and information.
(2) Existing clients. For existing
clients with a power of attorney issued
by a partnership, customs brokers must,
within two years of the final rule being
effective, update and verify the
information required in this section. For
all other existing clients, customs
brokers must, within three years of the
final rule being effective, update and
verify the information required in this
section. By these dates, the customs
broker must have complied with all the
requirements in this section, including
the updating of all records and
information, and must continue to
comply.
(3) Reverification. Reverification must
occur annually after the initial
verification required by this section.
Dated: August 6, 2019.
Kevin K. McAleenan,
Acting Secretary.
[FR Doc. 2019–17179 Filed 8–13–19; 8:45 am]
BILLING CODE 9111–14–P
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG–130700–14]
RIN 1545–BM41
Classification of Cloud Transactions
and Transactions Involving Digital
Content
Internal Revenue Service (IRS),
Treasury.
ACTION: Notice of proposed rulemaking.
AGENCY:
This document contains
proposed regulations regarding the
classification of cloud transactions for
purposes of the international provisions
of the Internal Revenue Code. These
proposed regulations also modify the
rules for classifying transactions
involving computer programs, including
by applying the rules to transfers of
digital content.
SUMMARY:
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Federal Register / Vol. 84, No. 157 / Wednesday, August 14, 2019 / Proposed Rules
Comments and requests for a
public hearing must be received by
November 12, 2019.
ADDRESSES: Send submissions to:
CC:PA:LPD:PR (REG–130700–14), Room
5203, Internal Revenue Service, P.O.
Box 7604, Ben Franklin Station,
Washington, DC 20044. Submissions
may be hand-delivered Monday through
Friday between the hours of 8 a.m. and
4 p.m. to: CC:PA:LPD:PR (REG–130700–
14), Courier’s Desk, Internal Revenue
Service, 1111 Constitution Avenue NW,
Washington, DC. Alternatively,
taxpayers may submit comments
electronically via the Federal
eRulemaking Portal at
www.regulations.gov (REG–130700–14).
FOR FURTHER INFORMATION CONTACT:
Concerning the proposed regulations
Robert Z. Kelley, (202) 317–6939;
concerning submissions of comments
and requests for a public hearing,
Regina L. Johnson, (202) 317–6901 (not
toll free numbers).
SUPPLEMENTARY INFORMATION:
khammond on DSKBBV9HB2PROD with PROPOSALS
DATES:
Background
These regulations (the proposed
regulations) clarify the treatment under
certain provisions of the Internal
Revenue Code (Code) of income from
transactions involving on-demand
network access to computing and other
similar resources. The proposed
regulations also extend the classification
rules in existing § 1.861–18 to transfers
of digital content other than computer
programs and clarify the source of
income for certain transactions
governed by existing § 1.861–18.
Existing § 1.861–18 provides rules for
classifying transactions involving
computer programs. For this purpose,
§ 1.861–18(a)(3) defines a computer
program as ‘‘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 similar
item is incidental to the operation of the
computer program.’’ Under § 1.861–
18(b)(1), a transaction to which the
section applies is categorized as (i) a
transfer of a copyright right in a
computer program; (ii) a transfer of a
copy of a computer program (a
‘‘copyrighted article’’); (iii) the
provision of services for the
development or modification of a
computer program; or (iv) the provision
of know-how relating to computer
programming techniques. Section
1.861–18(c) provides that a transfer of a
computer program is classified as the
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transfer of a copyright right if there is a
non-de minimis grant of any of the
following four rights: (i) The right to
make copies of the computer program
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 computer programs based
upon the copyrighted computer
program; (iii) the right to make a public
performance of the computer program;
or (iv) the right to publicly display the
computer program. Section 1.861–18(f)
further categorizes a transfer of a
copyright right as either the sale or
license of the copyright right and a
transfer of a copyrighted article as either
the sale or lease of the copyrighted
article.
Section 1.861–18 generally does not
provide a comprehensive basis for
categorizing many common transactions
involving what is commonly referred to
as ‘‘cloud computing,’’ which typically
is characterized by on-demand network
access to computing resources, such as
networks, servers, storage, and software.
See, e.g., National Institute of Standards
and Technology, Special Publication
500–322 (February 2018) (‘‘NIST
Report’’). Cloud computing transactions
typically are described for non-tax
purposes as following one or more of
the following three models: Software as
a Service (‘‘SaaS’’); Platform as a Service
(‘‘PaaS’’); and Infrastructure as a Service
(‘‘IaaS’’). SaaS allows customers to
access applications on a provider’s
cloud infrastructure through an
interface such as a web browser. NIST
Report, p. 9–10. PaaS allows customers
to deploy applications created by the
customer onto a provider’s cloud
infrastructure using programming
languages, libraries, services, and tools
supported by the provider. NIST Report,
pp. 10–11. IaaS allows customers to
access processing, storage, networks,
and other infrastructure resources on a
provider’s cloud infrastructure. NIST
Report, p. 11. A cloud computing
transaction typically does not involve
any transfer of a computer program
classified under § 1.861–18 as a transfer
of a copyright right or copyrighted
article or any provision of development
services or know-how relating to
computer programs or programming.
Although certain cloud computing
transactions may provide similar
functionality with respect to computer
programs as transactions subject to
§ 1.861–18 (for example, the transfer of
a computer program via download may
provide similar functionality as the
same program accessed via a web
browser), § 1.861–18 does not address
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the provision of online access to use the
computer program. Accordingly,
§ 1.861–18 would not apply to classify
such a transaction.
In addition to the cloud computing
models described above, other
transactions exist that are not solely
related to computing but still involve
on-demand network access to
technological resources (these
transactions and cloud computing
transactions are collectively referred to
herein as ‘‘cloud transactions’’). These
transactions have increased in
frequency over time and share
similarities with the three cloud
computing models described above.
Examples include streaming music and
video, transactions involving mobile
device applications (‘‘apps’’), and access
to data through remotely hosted
software. These transactions may not
involve, in whole or in part, a transfer
under § 1.861–18 of a copyright right or
copyrighted article, or a provision of
development services or know-how
relating to computer programs or
programming.
In general, a cloud transaction
involves access to property or use of
property, instead of the sale, exchange,
or license of property, and therefore
typically would be classified as either a
lease of property or a provision of
services. Section 7701(e) and case law
provide factors that are relevant for
classifying a transaction as either a lease
of property or a provision of services. In
particular, section 7701(e)(1) provides
that a contract that purports to be a
service contract will be treated instead
as a lease of property if the contract is
properly treated as a lease taking into
account all relevant factors, including
whether (1) the service recipient is in
physical possession of the property, (2)
the service recipient controls the
property, (3) the service recipient has a
significant economic or possessory
interest in the property, (4) the service
provider does not bear any risk of
substantially diminished receipts or
substantially increased expenditures if
there is nonperformance under the
contract, (5) the service provider does
not use the property concurrently to
provide significant services to entities
unrelated to the service recipient, and
(6) the total contract price does not
substantially exceed the rental value of
the property for the contract period.
Section 7701(e)(2) provides that the
factors in section 7701(e)(1) apply to
determine whether any arrangement,
not just contracts which purport to be
service contracts, is properly treated as
a lease. Consistent with the inclusive
statutory language, the legislative
history indicates that this list of factors
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is meant to be non-exclusive and
constitutes a balancing test, such that
the presence or absence of a single
factor may not be dispositive in every
case. S. Prt. No. 169 (Vol. I), 98th Cong.,
2d Sess., at 138 (1984); Joint Committee
on Taxation Staff, General Explanation
of the Revenue Provisions of the Deficit
Reduction Act of 1984, 98th Cong., at 60
(Comm. Print 1984).
In addition, courts have also
considered other factors in determining
whether transactions are leases of
property or the provision of services,
including whether the service provider
had the right to replace the relevant
property with comparable property,
whether the property was a component
of an integrated operation in which the
service provider had other
responsibilities, whether the service
provider operated the equipment, and
whether the service provider’s fee was
based on a measure of work performed
rather than the mere passage of time.
See, e.g., Musco Sports Lighting, Inc. v.
Comm’r, T.C. Memo 1990–331, aff’d,
943 F.2d 906 (8th Cir. 1991); Xerox Corp
v. U.S., 656 F.2d 659 (Ct. Cl. 1981); and
Smith v. Comm’r, T.C. Memo 1989–318.
Explanation of Provisions
I. Proposed § 1.861–19
Proposed § 1.861–19 provides rules
for classifying a cloud transaction as
either a provision of services or a lease
of property. Proposed § 1.861–19(a)
specifies that the rules apply for
purposes of sections 59A, 245A, 250,
267A, 367, 404A, 482, 679, and 1059A;
subchapter N of chapter 1; chapters 3
and 4; and sections 842 and 845 (to the
extent involving a foreign person), as
well as with respect to transfers to
foreign trusts not covered by section
679.
In order to make other sections
consistent with proposed § 1.861–19,
Example 5 in § 1.937–3(e) is proposed to
be removed from the rules for
determining whether income is derived
from sources within a U.S. possession or
territory.
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A. Definition of ‘‘Cloud Transaction’’
Proposed § 1.861–19(b) defines a
cloud transaction as a transaction
through which a person obtains non-de
minimis on-demand network access to
computer hardware, digital content (as
defined in proposed § 1.861–18(a)(3)), or
other similar resources. This definition
is not limited to computer hardware and
software, or to the IaaS, PaaS, and SaaS
models described above, because it is
intended also to apply to other
transactions that share characteristics of
on-demand network access to
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technological resources, including
access to streaming digital content and
access to information in certain
databases. Although this definition is
broad, it does not encompass every
transaction executed or completed
through the internet. For example,
proposed § 1.861–19 clarifies that the
mere download or other electronic
transfer of digital content for storage and
use on a person’s computer hardware or
other electronic device does not
constitute on-demand network access to
the digital content and so would not be
considered a cloud transaction for
purposes of proposed § 1.861–19.
B. Classification of Cloud Transactions
1. Single Classification
Proposed § 1.861–19(c) provides that
a cloud transaction is classified solely as
either a lease of property or the
provision of services. Certain cloud
transactions may have characteristics of
both a lease of property and the
provision of services. Such transactions
are generally classified in their entirety
as either a lease or a service, and not
bifurcated into a lease transaction and a
separate service transaction. For
example, section 7701(e)(1) classifies a
purported service contract as either a
lease or a service contract and does not
contemplate mixed classifications of a
single, integrated transaction. In
Tidewater v. U.S., 565 F.3d 299 (5th Cir.
2009), action on dec., 2010–01 (June 1,
2010) (Tidewater), the Fifth Circuit
applied the factors in section 7701(e)(1)
to determine a single character for a
time charter with respect to an oceangoing vessel, rather than following the
taxpayer’s allocation of consideration
from the transaction into separate
service and lease components.
In some cases, the facts and
circumstances may support the
conclusion that an arrangement involves
multiple cloud transactions to which
proposed § 1.861–19 applies. In such
cases, proposed § 1.861–19 requires a
separate classification of each cloud
transaction except any transaction that
is de minimis.
2. Determination Based on All Relevant
Factors
Proposed § 1.861–19(c)(1) provides
that all relevant factors must be taken
into account in determining whether a
cloud transaction is classified as a lease
of property (specifically, computer
hardware, digital content (as defined in
proposed § 1.861–18(a)(3)), or other
similar resources) or the provision of
services. The relevance of any factor
varies depending on the factual
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situation, and any particular factor may
not be relevant in a given instance.
Proposed § 1.861–19(c)(2) contains a
non-exhaustive list of factors for
determining whether a cloud
transaction is classified as the provision
of services or a lease of property. In
general, application of the relevant
factors to a cloud transaction will result
in the transaction being treated as the
provision of services rather than a lease
of property. In addition to the statutory
factors described in section 7701(e)(1),
the proposed regulations set forth
several factors applied by courts that the
Treasury Department and the IRS have
determined are relevant in
demonstrating that a cloud transaction
is classified as the provision of services:
Whether the provider has the right to
determine the specific property used in
the cloud transaction and replace such
property with comparable property;
whether the property is a component of
an integrated operation in which the
provider has other responsibilities,
including ensuring the property is
maintained and updated; and whether
the 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. The proposed
regulations include several examples
applying the factors in proposed
§ 1.861–19(c)(2) to different types of
cloud transactions.
Certain factors that are relevant under
proposed § 1.861–19(c) may be the same
as or similar to those used to determine
whether transactions other than cloud
transactions are classified as leases or
services under other authorities.
However, cloud transactions, which
involve on-demand network access to
property such as computer hardware
and digital content, may have
significant differences from other lease
and service transactions that involve
direct physical access to property.
Accordingly, the interpretation of
factors and their application to cloud
transactions require an analysis that is
sensitive to the inherent differences
between transactions involving physical
access to property and transactions
involving on-demand network access.
C. Classification of Cloud Transactions
Related to Other Transactions
Certain arrangements may involve
multiple transactions, where one or
more transactions would be classified as
a cloud transaction under proposed
§ 1.861–19(b) and one or more
transactions do not qualify as a cloud
transaction and would be classified
under other sections of the Code and
regulations, or under general tax law
principles. For example, an arrangement
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might involve both a cloud transaction
and a transaction that would be
classified under the rules of § 1.861–18
as a lease of a copyrighted article.
Proposed § 1.861–19(c)(3) provides that,
in such cases, the classification rules
apply only to classify the cloud
transaction, and any non-cloud
transaction will be classified separately
under such other section of the Code or
regulations, or under general tax law
principles. However, for purposes of
administrability, proposed § 1.861–
19(c)(3) provides that no transaction
will be classified separately if it is de
minimis. This rule is illustrated by
examples contained in proposed
§ 1.861–19(d).
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II. Modifications of § 1.861–18
A. Scope of Application
The preamble to the final regulations
under § 1.861–18 governing the
classification of transactions involving
computer programs (T.D. 8785, 63 FR
52971 (October 2, 1998)) indicated that
§ 1.861–18 would apply only to such
transactions because the need for
guidance with respect to transactions
involving computer programs was most
pressing. The preamble noted, however,
that the Treasury Department and the
IRS may consider as part of a separate
guidance project whether to apply the
principles of those regulations to other
transactions. Since § 1.861–18 was
adopted as a final regulation in 1998,
content in digital format and subject to
copyright law, including music, video,
and books, has become a common basis
for commercial transactions.
Consumption of such digital content has
grown in part because of new computer
hardware, including laptops, tablets, ereaders, and smartphones, that allows
users to more easily obtain and use
digital content.
The Treasury Department and the IRS
have determined that the rules and
principles underlying existing § 1.861–
18 have provided useful guidance with
respect to computer programs and that
these rules and principles should apply
to certain other digital content.
Accordingly, proposed § 1.861–18
broadens the scope of existing § 1.861–
18 to apply to all transfers of ‘‘digital
content,’’ defined in proposed § 1.861–
18(a)(3) as any content in digital format
and that is either protected by copyright
law or is no longer protected by
copyright law solely due to the passage
of time, whether or not the content is
transferred in a physical medium.
Digital content includes, for example,
books, movies, and music in digital
format in addition to computer
programs.
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Certain terms have been changed in
proposed § 1.861–18, including
references to computer programs being
replaced with references to digital
content. The application of proposed
§ 1.861–18 to digital content other than
computer programs is illustrated by
proposed § 1.861–18(h)(19) through (21)
(Examples 19 through 21).
B. Rights To Advertise Copyrighted
Articles
Comments received on the proposed
regulations (REG–251520–96; 61 FR
58152; November 13, 1996) (the ‘‘1996
proposed regulations’’) that were
finalized in 1998 as existing § 1.861–18
recommended that the transfer of a right
to publicly perform or display a
computer program should not be
considered the transfer of a copyright
right if the right is limited to the
advertisement of a copyrighted article
and the public performance or display
of the entire copyrighted article is not
permitted. The recommendation of
these comments was not incorporated
into existing § 1.861–18, but the
Treasury Department and the IRS
acknowledged in the preamble to
existing § 1.861–18 that it may be
appropriate to revisit the issue in the
future and observed that the transfer of
such rights to advertise a copyrighted
article in many cases would be de
minimis under existing § 1.861–
18(c)(1)(ii).
In light of experience in administering
existing § 1.861–18, the Treasury
Department and the IRS have
determined that the transfer of the right
to publicly perform or display digital
content for the purpose of advertising
the sale of the digital content should not
constitute the transfer of a copyright
right for purposes of those portions of
the Code enumerated in § 1.861–
18(a)(1). For example, rights provided to
a video game retailer allowing the
retailer to display screenshots of a video
game on television commercials
promoting sales of the game generally
would not, on their own, constitute a
transfer of copyright rights that is
significant in context. Accordingly,
proposed § 1.861–18 modifies existing
§ 1.861–18(c)(2)(iii) and (iv) to provide
that a transfer of the mere right to public
performance or display of digital
content for purposes of advertising the
digital content does not by itself
constitute a transfer of a copyright right.
C. Source of Income for Sales of
Copyrighted Articles in Electronic
Medium
Comments received on the 1996
proposed regulations addressed the
sourcing of income from the sale of
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computer programs through electronic
downloads and noted uncertainty
regarding the application of the title
passage rule of § 1.861–7(c) to these
sales of copyrighted articles. Although
the preamble indicated that the parties
in many cases can agree where title
passes for inventory property, the final
regulations under § 1.861–18 included
only a general reference to the relevant
source rules and did not specifically
address the application of the title
passage rule for sales of copyrighted
articles. Based on experience in
administering existing § 1.861–18 since
1998, the Treasury Department and the
IRS have become more aware of the
uncertainty associated with determining
the source of sales of copyrighted
articles by application of § 1.861–7(c), in
particular in the context of
electronically downloaded software. 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
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.
In light of these considerations,
proposed § 1.861–18(f)(2)(ii) provides
that when copyrighted articles are sold
and transferred through an electronic
medium, the sale is deemed to occur at
the location of download or installation
onto the end-user’s device used to
access the digital content for purposes
of § 1.861–7(c). It is expected that
vendors generally will be able to
identify the location of such download
or installation. Comments are requested
as to the availability, reliability and cost
of this information. In the absence of
information about the location of
download or installation onto the enduser’s device used to access the digital
content, 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. Consistent with existing
§ 1.861–18, proposed § 1.861–18(f)(2)(ii)
provides that income from sales or
exchanges of copyrighted articles is
sourced under sections 861(a)(6),
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862(a)(6), 863, or 865(a), (b), (c), or (e),
as appropriate. The Treasury
Department and the IRS do not expect
proposed § 1.861–18(f)(2)(ii) to impact
the application of income tax treaties to
which the United States is a party given
that the taxation of gains under those
treaties is generally determined by
reference to the residence country of the
seller and not the source of income from
the sale. Income from leases of
copyrighted articles is sourced under
section 861(a)(4) or 862(a)(4), as
appropriate.
In order to make other sections
consistent with proposed § 1.861–
18(f)(2)(ii), a cross-reference has been
added in the rules for sales of inventory
property in § 1.861–7(c), and Example 4
in § 1.937–3(e) has been removed from
the rules for determining whether
income is derived from sources within
a U.S. possession or territory.
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III. Change in Method of Accounting
The application of these new rules for
purposes of the affected Code sections
may require certain taxpayers to change
their methods of accounting under
section 446(e) for affected transactions.
Any change in method of accounting
that a taxpayer makes in order to
comply with these regulations would be
a change initiated by the taxpayer.
Accordingly, the change in method of
accounting must be implemented under
the rules of § 1.446–1(e) and the
applicable administrative procedures
that govern voluntary changes in
method of accounting under section
446(e).
IV. Request for Comments
Comments are requested on all
aspects of these proposed regulations,
including the following topics:
(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;
(2) whether any special
considerations should be taken into
account in applying the rules in existing
§ 1.861–18 to transfers of digital content
other than computer programs;
(3) whether any other aspects of
existing § 1.861–18 need to be modified
if that section is amended as proposed;
(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);
(5) realistic examples of cloud
transactions that would be treated as
leases under proposed § 1.861–19;
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(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;
(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;
(8) administrable rules for sourcing
income from cloud transactions in a
manner consistent with sections 861
through 865; and
(9) application of proposed § 1.861–19
to an arrangement that involves non-de
minimis rights both to access digital
content on-demand over a network and
to download such digital content onto a
user’s electronic device for offline use.
Proposed Effective Date
The regulations are proposed to apply
to taxable years beginning on or after the
date of publication of the Treasury
decision adopting these regulations as
final regulations in the Federal Register.
No inference should be drawn from the
proposed effective date concerning the
treatment of transactions involving
digital content or cloud transactions
entered into before the regulations are
applicable. For transactions involving
transfers of computer programs
occurring pursuant to contracts entered
into before publication of the final
regulations, the rules in former § 1.861–
18, T.D. 8785 and T.D. 9870, will apply.
For proposed dates of applicability, see
§§ 1.861–18(i) and 1.861–19(e).
Special Analyses
Regulatory Planning and Review
Executive Orders 13563 and 12866
direct agencies to assess costs and
benefits of available regulatory
alternatives and, if regulation is
necessary, to select regulatory
approaches that maximize net benefits
(including potential economic,
environmental, public health and safety
effects, distributive impacts, and
equity). Executive Order 13563
emphasizes the importance of
quantifying both costs and benefits, of
reducing costs, of harmonizing rules,
and of promoting flexibility.
These proposed rules have been
designated by the Office of Management
and Budget’s Office of Information and
Regulatory Affairs as subject to review
under Executive Order 12866 pursuant
to the Memorandum of Agreement
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(MOA) (April 11, 2018) between the
Treasury Department and the Office of
Management and Budget regarding
review of tax regulations. The Treasury
Department and the IRS project that
these rules are not economically
significant because current industry
practice is generally consistent with the
principles underlying the proposed
regulations. Comments are requested as
to whether this characterization of
industry practice is inaccurate.
A. Background
When assessing tax on income arising
from international transactions, the
‘‘source’’ of income is important in
determining a taxpayer’s tax liability.
U.S. sourcing rules, generally contained
in code sections 861 to 865, determine
whether income earned is considered
domestic or foreign source. For U.S.
resident taxpayers, the U.S. generally
taxes both domestic and foreign source
income and, for the latter, provides
credits for foreign taxes up to the level
of U.S. tax. Taxpayers with significant
foreign tax credits (FTCs) typically
prefer that income be considered foreign
rather than U.S. source in order to
maximize their use of FTCs and
minimize their U.S. taxes.
Proper assessment of the source of a
particular item of income depends on
the nature and type (or character) of that
income (for example, interest, dividend,
compensation for services, royalties
paid under a license, gains recorded in
a sale). Source rules differ for different
types of income, so it is first necessary
for income tax purposes to classify the
character of an item of income. In the
case of transactions involving digital
content and cloud transactions, the
types of income most relevant are sales,
licenses, and services, but there are
currently no regulations specifically
applicable to the classification of
transactions involving digital content
other than computer programs or the
classification of transactions involving
remote access to digital content through
the cloud. These proposed regulations
provide that guidance.
The character of income also affects
the U.S. taxation of income earned by
U.S. taxpayers through their foreign
subsidiary corporations. Certain U.S.
shareholders of controlled foreign
corporations (as defined in section 957)
must include their share of a controlled
foreign corporation’s subpart F income
in the U.S. shareholder’s gross income
on a current basis. Section 951(a)(1)(A).
The characterization of income can
impact whether it is considered subpart
F income (as defined in section 952).
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B. Need for Proposed Regulations
Transactions involving digital content
and cloud computing have become
common due to the growth of electronic
commerce. Such transactions must be
classified in terms of character in order
to apply various provisions of the Code,
such as sourcing rules and subpart F.
Existing Reg. § 1.861–18, finalized in
1998, provides rules for classifying
transactions involving computer
programs as, for example, a license of a
computer program, a rental of a
computer program, or a sale of a
computer program. These existing
regulations, however, do not explicitly
cover transactions involving other
digital content, such as digital music
and video, or to cloud computing
transactions, and thus taxpayers must
determine how these transactions
should be classified for tax purposes
without clear guidance. The proposed
regulations are needed to reduce this
uncertainty. The proposed regulations
also reduce the opportunities for
taxpayers to take positions on source
and character that inappropriately
minimize their taxes.
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C. Overview of Proposed Regulations
The proposed regulations provide
updated guidance with respect to the
classification of transactions involving
digital content (proposed § 1.861–18)
and new guidance with respect to cloud
transactions (proposed § 1.861–19).
Existing rules, particularly final
regulations under § 1.861–18, which
were adopted in 1998, govern the
classification of transactions involving
computer programs. The Treasury
Department and the IRS have
determined that the rules and principles
underlying existing § 1.861–18 provide
useful guidance for transactions
involving digital content. Proposed
§ 1.861–18 broadens the scope of its
application to include digital content,
which is defined in proposed § 1.861–
18(a)(3) as any content in digital format
that is either protected by copyright law
or is no longer protected solely due to
the passage of time (e.g., books, movies,
and music in digital format, in addition
to computer programs).
Cloud computing transactions, which
are typically characterized by ondemand network access to computing
resources, would not generally be
subject to classification under existing
§ 1.861–18 since such transactions
typically do not include the transfer of
a computer program, nor would such
transactions be subject to proposed
§ 1.861–18 since such transactions
typically do not include the transfer of
a copyright right or copyrighted article,
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or provision of development services
related to computer programming.
Consequently, proposed § 1.861–19
provides rules for classifying a cloud
transaction as either a provision of
service or a lease of property.
D. Economic Analysis
1. Baseline
The Treasury Department and the IRS
have assessed the benefits and costs of
the proposed regulation compared to a
no-action baseline that reflects
anticipated Federal income tax-related
behavior in the absence of these
proposed regulations.
2. Summary of Economic Effects
The proposed regulations provide
certainty and clarity with respect to the
characterization of income from digital
transactions and cloud computing. In
the absence of such guidance, the
chances that different U.S. taxpayers
would interpret the Code differentially,
either from each other or from the
intents and purposes of the underlying
statutes, would be exacerbated. This
divergence in interpretation could cause
U.S. businesses to make economic
decisions based on different
interpretations of, for example, whether
income from making digital music
available to a user would be
characterized as derived from a service
or a lease transaction for purposes of
applying sourcing rules and thus
whether such income is considered
domestic or foreign. If economic
decisions are not guided by uniform
incentives across otherwise similar
investors and across otherwise similar
investments, the resulting pattern of
economic activity is generally
inefficient. Thus, the Treasury
Department and the IRS expect that the
definitions and guidance provided in
the proposed regulation will help
support an efficient allocation of
economic activity among taxpayers,
relative to the baseline.
The characterization of income from
digital transactions and cloud
computing, for example, may impact
taxpayer incentives under section 59A
(the tax on certain base erosion
payments) and section 250 (foreign
derived intangible income and global
intangible low-taxed income). For
example, under section 59A, the
characterization of a cloud transaction
as a service, as opposed to a lease, may
implicate the services cost method
exception under section 59A(d)(5). Such
characterization may also impact the
documentation requirements or
eligibility for treatment as foreignderived intangible income under section
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250(b). However, because current
industry practice is generally consistent
with the principles underlying the
proposed regulations, the Treasury
Department and the IRS expect these
regulations to have only a small effect
on economic activity or compliance
costs relative to the baseline.
The Treasury Department and IRS
solicit comments on the economic
effects of the proposed regulations.
3. Economic Effects of Specific
Provisions
a. Transactions Involving CopyrightProtected Digital Content
Existing § 1.861–18 provides rules for
classifying transfers of computer
programs as, for example, a license of a
computer program, a lease of a
computer program, or a sale of a
computer program. Proposed § 1.861–18
broadens the scope of existing § 1.861–
18 to apply to all transfers of digital
content. In addition, as discussed in
Part II.B of the Explanation of
Provisions section, proposed § 1.861–18
clarifies that a transfer of the mere right
to public performance or display of
digital content for advertising purposes
does not by itself constitute a transfer of
a copyright right. Further, as explained
in Part II.C of the Explanation of
Provisions section, proposed § 1.861–18
provides clarity around the title passage
rule of § 1.861–7(c) by providing that
when copyrighted articles are sold, the
sale is deemed to occur at the location
of the download or installation onto the
end-user’s device, or in the absence of
that information then at the location of
the customer. Proposed 1.861–7(c)
provides that a sale of personal property
is consummated at the place where the
rights, title, and interest of the seller in
the property are transferred to the buyer,
or, when bare legal title is retained by
the seller, where beneficial ownership
passes.
In considering how the place of sale
should be determined for digital
content, the Treasury Department and
the IRS considered, as an alternative,
not issuing specific rules and instead
retaining the existing rules without
further clarification for copyrighted
articles. The Treasury Department and
the IRS elected to provided further
clarity about the sourcing of income
from the sale of copyrighted articles
because (1) in the context of
electronically downloaded software, the
location in which rights, title, and
interest are transferred is often difficult
to determine or not specified, and (2)
the location of transfer could be easily
manipulated (for example, the server
location from which a copyrighted
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article is downloaded). Consequently,
for administrative and clarification
purposes, proposed § 1.861–18(f)(2)(ii)
provides that when a copyrighted article
is sold through an electronic medium,
the sale is deemed to occur at the
location of download or installation
onto the end-user’s device. The
Treasury Department and the IRS are
proposing this location definition
because that is where the sale is
completed, since until the download is
complete, the content is not entirely
transferred.
The Treasury Department and the IRS
solicit comments on these proposed
regulations and particularly solicit
comments that provide data, other
evidence, or models that would enhance
the rigor with which the final
regulations governing digital content
might be developed.
b. Cloud Transactions
Proposed § 1.861–19 provides rules
for classifying a cloud transaction as
either a lease of property (i.e., computer
hardware, digital content, or other
similar resources) or a provision of
services. These rules contain a nonexhaustive list of factors which include
statutory factors described in section
7701(e)(1) and factors applied by courts,
as explained in Part I.B.2. of the
Explanation of Provisions section.
As an alternative, the Treasury
Department and the IRS considered not
providing further specific guidance
regarding how cloud computing
transactions should be classified (for
sourcing and other purposes). The
Treasury Department and the IRS have
developed the proposed regulations
(proposed § 1.861–18 and proposed
§ 1.861–19) because they will provide
clarity to taxpayers and the IRS when
determining the character of income
arising from transactions involving
digital content and cloud computing.
This increased clarity, relative to the
baseline, will reduce the potential for
tax planning strategies that exploit
uncertainty resulting from the lack of
explicit guidance for characterizing
common transactions involving digital
content and cloud computing.
Consistent reporting across taxpayers
also increases the IRS’s ability to
consistently enforce the tax rules, thus
increasing equity and decreasing
opportunities for tax evasion.
The Treasury Department and the IRS
solicit comments on these proposed
regulations and particularly solicit
comments that provide data, other
evidence, or models that would enhance
the rigor with which the final
regulations governing cloud transactions
might be developed.
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E. Regulatory Flexibility Act
The Regulatory Flexibility Act
requires consideration of the regulatory
impact on small businesses. It is hereby
certified that these proposed regulations
will not have a significant economic
impact on a substantial number of small
entities within the meaning of section
601(6) of the Regulatory Flexibility Act
(5 U.S.C. chapter 6).
As discussed elsewhere in the Special
Analyses, transactions involving digital
content and cloud computing have
become common due to the growth of
electronic commerce. Such transactions
must be classified in terms of character
in order to apply various provisions of
the Code, such as sourcing rules and
subpart F. Existing Reg. § 1.861–18,
finalized in 1998, provides rules for
classifying transactions involving
computer programs as, for example, a
license of a computer program, a rental
of a computer program, or a sale of a
computer program. These existing
regulations, however, do not explicitly
cover transactions involving other
digital content, such as digital music
and video, or to cloud computing
transactions and thus taxpayers must
determine how these transactions
should be classified for tax purposes
without clear guidance. The proposed
regulations provide certainty and clarity
to these affected taxpayers.
Although data are not readily
available to estimate the number of
small entities that would be affected by
this proposed rule, the Treasury
Department and the IRS project that any
economic impact of the regulations
would be minimal for businesses
regardless of size. These proposed
regulations generally provide
clarification of definitions regarding
how transactions are classified, they are
not expected to have an impact on
burden for large or small businesses.
The Treasury Department and the IRS
project that any economic impact would
be small because current industry
practice is generally consistent with the
principles underlying the proposed
regulations.
Notwithstanding this certification that
the proposed rule will not have a
significant economic impact on a
substantial number of small entities, the
Treasury Department and the IRS invite
comments on the impact this proposed
rule would have on small entities.
Comments and Requests for a Public
Hearing
Before these proposed regulations are
adopted as final regulations,
consideration will be given to any
comments that are submitted timely to
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40323
the IRS as prescribed in this preamble
under the ADDRESSES section. All
comments will be available at
www.regulations.gov or upon request. A
public hearing will be scheduled if
requested in writing by any person that
timely submits comments. If a public
hearing is scheduled, notice of the date,
time, and place for the public hearing
will be published in the Federal
Register.
Drafting Information
The principal author of these
proposed regulations is Robert Z. Kelley
of the Office of the Associate Chief
Counsel (International). However, other
personnel from the Treasury
Department and the IRS participated in
their development.
List of Subjects in 26 CFR Part 1
Income taxes, reporting, and
recordkeeping requirements.
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is
proposed to be amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 continues to read in part as
follows:
■
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.861–7 is amended by
revising paragraph (c) to read as follows:
■
§ 1.861–7
Sale of personal property.
*
*
*
*
*
(c) Country in which sold. For
purposes of part I (section 861 and
following), subchapter N, chapter 1 of
the Code, and the regulations
thereunder, a sale of personal property
is consummated at the time when, and
the place where, the rights, title, and
interest of the seller in the property are
transferred to the buyer. Where bare
legal title is retained by the seller, the
sale shall be deemed to have occurred
at the time and place of passage to the
buyer of beneficial ownership and the
risk of loss. For determining the place
of sale of copyrighted articles
transferred in electronic medium, see
§ 1.861–18(f)(2)(ii). However, in any
case in which the sales transaction is
arranged in a particular manner for the
primary purpose of tax avoidance, the
foregoing rules will not be applied. In
such cases, 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
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the place where the substance of the
sale occurred.
*
*
*
*
*
Par. 3. Section 1.861–18 is amended
as follows:
■ a. For each paragraph listed in the
following table, removing the language
■
Paragraph
Remove
(a)(1) ..................................................................
(b)(1) introductory text .......................................
(b)(1)(i) ...............................................................
(b)(1)(ii) ..............................................................
(b)(1)(iii) ..............................................................
(b)(1)(iv) .............................................................
(b)(2), first sentence ...........................................
(b)(2), first sentence ...........................................
(b)(2), second sentence .....................................
(c)(1)(i), first sentence ........................................
(c)(1)(i), third sentence ......................................
(c)(1)(i), third sentence ......................................
(c)(1)(ii) ...............................................................
(c)(1)(ii) ...............................................................
(c)(2)(i) ...............................................................
(c)(2)(ii) ...............................................................
(c)(2)(ii) ...............................................................
(c)(3), first sentence ...........................................
(c)(3), second sentence .....................................
(d) .......................................................................
computer programs ..........................................
a computer program .........................................
computer program ............................................
computer program ............................................
computer program ............................................
computer programming techniques .................
Any transaction ................................................
computer programs ..........................................
overall transaction ............................................
a computer program .........................................
a computer program .........................................
that program .....................................................
a computer program .........................................
the computer program ......................................
computer program ............................................
computer programs ..........................................
copyrighted computer program ........................
a computer program .........................................
program ............................................................
a newly developed or modified computer program.
computer program ............................................
a computer program .........................................
computer programming techniques .................
computer programs ..........................................
computer programs ..........................................
a computer program on disk ............................
program ............................................................
a computer program .........................................
a computer program .........................................
the program ......................................................
software ............................................................
a computer program .........................................
the program ......................................................
a computer program .........................................
the program ......................................................
(d) .......................................................................
(e) introductory text ............................................
(e)(1) ..................................................................
(f)(3), subject heading ........................................
(f)(3), first sentence ............................................
(f)(3), second sentence ......................................
(f)(3), third sentence ..........................................
(g)(2) ..................................................................
(g)(3)(i), first sentence .......................................
(g)(3)(i), first sentence .......................................
(g)(3)(i), first sentence .......................................
(g)(3)(ii), first sentence .......................................
(g)(3)(ii), first sentence .......................................
(g)(3)(ii), second sentence .................................
(g)(3)(ii), second sentence .................................
b. Amend paragraph (a)(1) by:
i. Adding before ‘‘367’’ sections ‘‘59A,
245A, 250, 267A,’’;
■ ii. Removing ‘‘551,’’; and
■ iii. Removing ‘‘chapter 3, chapter 5’’
and adding in its place ‘‘chapters 3 and
4,’’.
■ c. Revising paragraphs (a)(3), (c)(2)(iii)
and (iv), and (f)(2).
■ d. Redesignating Examples 1 through
18 of paragraph (h) as paragraphs (h)(1)
through (18), respectively.
■ e. Adding paragraphs (h)(19) through
(21).
■ f. Revising paragraphs (i) and (j).
■ g. Removing paragraph (k).
The revisions and additions read as
follows:
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■
■
§ 1.861–18 Classification of transactions
involving digital content.
*
*
*
*
*
(a) * * *
(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
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Add
by copyright law solely due to the
passage of time, whether or not the
content is transferred in a physical
medium. For example, digital content
includes books in digital format, movies
in digital format, and music in digital
format. 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.
*
*
*
*
*
(c) * * *
(2) * * *
(iii) The right to make a public
performance of digital content, other
than a right to publicly perform digital
content for the purpose of advertising
the sale of the digital content performed;
or
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in the ‘‘Remove’’ column and adding in
its place the language in the ‘‘Add’’
column.
digital content.
digital content.
digital content.
digital content.
digital content.
development of digital content.
Any arrangement.
digital content.
overall arrangement.
digital content.
digital content.
that digital content.
digital content.
the digital content.
digital content.
digital content.
digital content.
digital content.
digital content.
newly developed or modified digital content.
digital content.
digital content.
the development of digital content.
digital content.
digital content.
digital content on a disk.
digital content.
digital content.
digital content.
the digital content.
digital content.
digital content.
the digital content.
digital content.
the digital content.
(iv) The right to publicly display
digital content, other than a right to
publicly display digital content for the
purpose of advertising the sale of the
digital content displayed.
*
*
*
*
*
(f) * * *
(2) Transfers of copyrighted articles—
(i) Classification. The determination of
whether a transfer of a copyrighted
article is a sale or exchange is made on
the basis of whether, taking into account
all facts and circumstances, the benefits
and burdens of ownership have been
transferred. A transaction that does not
constitute a sale or exchange because
insufficient benefits and burdens of
ownership of the copyrighted article
have been transferred, such that a
person other than the transferee is
properly treated as the owner of the
copyrighted article, will be classified as
a lease generating rental income.
(ii) Source. Income from transactions
that are classified as sales or exchanges
of copyrighted articles will be sourced
under section 861(a)(6), 862(a)(6), 863,
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or 865(a), (b), (c), or (e), as appropriate.
When a copyrighted article is sold and
transferred through an electronic
medium, the sale is deemed to have
occurred at the location of download or
installation onto the end-user’s device
used to access the digital content for
purposes of § 1.861–7(c), subject to the
tax avoidance provisions in § 1.861–
7(c). However, in the absence of
information about the location of
download or installation onto the enduser’s device used to access the digital
content, the sale will be deemed to have
occurred at the location of the customer,
which is determined based on the
taxpayer’s recorded sales data for
business or financial reporting
purposes. Income derived from leasing
a copyrighted article will be sourced
under section 861(a)(4) or 862(a)(4), as
appropriate.
*
*
*
*
*
(h) * * *
(19) Example 19—(i) Facts. Corp A
operates a website that offers electronic
books for download onto end-users’
computers or other electronic devices. The
books offered by Corp A are protected by
copyright law. Under the agreements
between content owners and Corp A, Corp A
receives from the content owners a digital
master copy of each book, which Corp A
downloads onto its server, in addition to the
non-exclusive right to distribute for sale to
the public an unlimited number of copies in
return for paying each content owner a
specified amount for each copy sold. Corp A
may not transfer any of the distribution rights
it receives from the content owners. The term
of each agreement Corp A has with a content
owner is shorter than the remaining life of
the copyright. Corp A charges each end-user
a fixed fee for each book purchased. When
purchasing a book on Corp A’s website, the
end-user must acknowledge the terms of a
license agreement with the content owner
that states that the end-user may view the
electronic book but may not reproduce or
distribute copies of it. In addition, the
agreement provides that the end-user may
download the book onto a limited number of
its devices. Once the end-user downloads the
book from Corp A’s server onto a device, the
end-user may access and view the book from
that device, which does not need to be
connected to the internet in order for the
end-user to view the book. The end-user
owes no additional payment to Corp A for
the ability to view the book in the future.
(ii) Analysis. (A) Notwithstanding the
license agreement between each end-user and
content owner granting the end-user rights to
use the book, the relevant transactions are the
transfer of a master copy of the book and
rights to sell copies from the content owner
to Corp A, and the transfers of copies of
books by Corp A to end-users. Although the
content owner is identified as a party to the
license agreement memorializing the enduser’s rights with respect to the book, each
end-user obtains those rights directly from
Corp A, not from the content owner. Because
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the end-user receives only a copy of each
book and does not receive any of the
copyright rights described in paragraph (c)(2)
of this section, the transaction between Corp
A and the end-user is classified as the
transfer of a copyrighted article under
paragraph (c)(1)(ii) of this section. See
paragraphs (h)(1) and (2) of this section
(Example 1 and Example 2). Under the
benefits and burdens test of paragraph (f)(2)
of this section, the transaction is classified as
a sale and not a lease, because the end-user
receives the right to view the book in
perpetuity on its device.
(B) The transaction between each content
owner and Corp A is a transfer of copyright
rights. In obtaining a master copy of the book
along with the right to sell an unlimited
number of copies to customers, Corp A
receives a copyright right described in
paragraph (c)(2)(i) of this section. For
purposes of paragraph (b)(2) of this section,
the digital master copy is de minimis. Under
paragraph (f)(1) of this section, there has not
been a transfer of all substantial rights in the
copyright rights to the content because each
content owner retains the right to further
license or sell the copyrights, subject to Corp
A’s interest; Corp A has acquired no right
itself to transfer the copyright rights to any
of the content; and the grant of distribution
rights is for less than the remaining life of the
copyright to each book. Therefore, the
transaction between each content owner and
Corp A is classified as a license, and not a
sale, of copyright rights.
(20) Example 20—(i) Facts. Corp A offers
end-users memberships that provide them
with unlimited access to Corp A’s catalog of
copyrighted music in exchange for a monthly
fee. In order to access the music, an end-user
must download each song onto a computer
or other electronic device. The end-user may
download songs onto a limited number of its
devices. Under the membership agreement
terms, an end-user may listen to the songs
but may not reproduce or distribute copies of
them. Once the end-user stops paying Corp
A the monthly membership fee, an electronic
lock is activated so that the end-user can no
longer access the music.
(ii) Analysis. The end-users receive none of
the copyright rights described in paragraph
(c)(2) of this section and instead receive only
copies of the digital content. Therefore,
under paragraph (c)(1)(ii) of this section, each
download is classified as the transfer of a
copyrighted article. Although an end-user
will retain a copy of the content at the end
of the payment term, the end-user cannot
access the content after the electronic lock is
activated. Taking into account the special
characteristics of digital content as provided
in paragraph (f)(3) of this section, the
activation of the electronic lock is the
equivalent of having to return the copy.
Therefore, under paragraph (f)(2) of this
section, each transaction is classified as a
lease of a copyrighted article because the
right to access the music is limited.
(21) Example 21—(i) Facts. Corp A offers
a catalog of movies and TV shows, all of
which are subject to copyright protection.
Corp A gives end-users several options for
viewing the content, each of which has a
separate price. A ‘‘streaming’’ option allows
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an end-user to view the video, which is
hosted on Corp A’s servers, while connected
to the internet for as many times as the enduser wants during a limited period. A ‘‘rent’’
option allows an end-user to download the
video to its computer or other electronic
device (which does not need to be connected
to the internet for viewing) and watch the
video as many times as the end-user wants
for a limited period, after which an electronic
lock is activated and the end-user may no
longer view the content. A ‘‘purchase’’ option
allows an end-user to download the video
and view it as many times as the end-user
chooses with no end date. Under all three
options, the end-user may view the video but
may not reproduce or distribute copies of it.
Under the ‘‘rent’’ and ‘‘purchase’’ options,
the end-user may download the video onto
a limited number of its devices.
(ii) Analysis. (A) With respect to the ‘‘rent’’
and ‘‘purchase’’ options, the end-user
receives none of the copyright rights
described in paragraph (c)(2) of this section
but, rather, receives only copies of the digital
content. Therefore, transactions under those
two options are transfers of copyrighted
articles. Transactions for which the end-user
chooses the ‘‘purchase’’ option are classified
as sales of copyrighted articles under the
benefits and burdens test of paragraph (f)(2)
of this section because the end-user receives
the right to view the videos in perpetuity.
Transactions under the ‘‘rent’’ option are
classified as leases of copyrighted articles
under paragraph (f)(2) of this section because
the end-user’s right to view the videos is for
a limited period.
(B) For transactions under the ‘‘streaming’’
option, there is no transfer of any copyright
rights described in paragraph (c)(2) of this
section. There is also no transfer of a
copyrighted article, because the content is
not downloaded by an end-user, but rather is
accessed through an on-demand network.
The transaction also does not constitute the
provision of services for the development of
digital content or the provision of know-how
under paragraph (b)(1) of this section.
Therefore, paragraph (b)(1) of this section
does not apply to such transaction. Instead,
the transaction is a cloud transaction that is
classified under § 1.861–19. See § 1.861–
19(d)(9).
(i) Effective date. This section applies
to transactions involving the transfer of
digital content, or the provision of
services or of know-how in connection
with digital content, pursuant to
contracts entered into in taxable years
beginning on or after the date of
publication of a Treasury decision
adopting these rules as final regulations
in the Federal Register. For transactions
involving computer programs occurring
pursuant to contracts entered into in
taxable years beginning before the date
of publication of a Treasury decision
adopting these rules as final regulations
in the Federal Register, see § 1.861–
18(i) as contained in T.D. 8785 and T.D.
9870.
(j) Change in method of accounting
required by this section. In order to
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comply with this section, a taxpayer
engaging in a transaction involving
digital content pursuant to a contract
entered into in taxable years beginning
on or after the date described in
paragraph (i) of this section may be
required to change its method of
accounting. If so required, the taxpayer
must secure the consent of the
Commissioner in accordance with the
requirements of § 1.446–1(e) and the
applicable administrative procedures for
obtaining the Commissioner’s consent
under section 446(e) for voluntary
changes in methods of accounting.
■ Par. 4. Section 1.861–19 is added to
read as follows:
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§ 1.861–19 Classification of cloud
transactions.
(a) In general. This section provides
rules for classifying a cloud transaction
(as defined in paragraph (b) of this
section) either as a provision of services
or as a lease of property. The rules of
this section apply for purposes of
Internal Revenue Code sections 59A,
245A, 250, 267A, 367, 404A, 482, 679,
and 1059A; subchapter N of chapter 1;
chapters 3 and 4; and sections 842 and
845 (to the extent involving a foreign
person), and apply with respect to
transfers to foreign trusts not covered by
section 679.
(b) Cloud transaction defined. A
cloud transaction is a transaction
through which a person obtains ondemand network access to computer
hardware, digital content (as defined in
§ 1.861–18(a)(3)), or other similar
resources, other than on-demand
network access that is de minimis taking
into account the overall arrangement
and the surrounding facts and
circumstances. A cloud transaction does
not include network access to download
digital content for storage and use on a
person’s computer or other electronic
device.
(c) Classification of transactions—(1)
In general. A cloud transaction is
classified solely as either a lease of
computer hardware, digital content (as
defined in § 1.861–18(a)(3)), or other
similar resources, or the provision of
services, taking into account all relevant
factors, including the factors set forth in
paragraph (c)(2) of this section. The
relevance of any factor varies depending
on the factual situation, and one or more
of the factors set forth in paragraph
(c)(2) of this section may not be relevant
in a given instance. For purposes of this
paragraph (c), computer hardware,
digital content, or other similar
resources are referred to as ‘‘the
property,’’ and the party to the
transaction making such property
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available to customers for use is referred
to as ‘‘the provider.’’
(2) Factors demonstrating
classification as the provision of
services. Factors demonstrating that a
cloud transaction is classified as the
provision of services rather than a lease
of property include the following
factors—
(i) The customer is not in physical
possession of the property;
(ii) The customer does not control the
property, beyond the customer’s
network access and use of the property;
(iii) The provider has the right to
determine the specific property used in
the cloud transaction and replace such
property with comparable property;
(iv) The property is a component of an
integrated operation in which the
provider has other responsibilities,
including ensuring the property is
maintained and updated;
(v) The customer does not have a
significant economic or possessory
interest in the property;
(vi) The provider bears any risk of
substantially diminished receipts or
substantially increased expenditures if
there is nonperformance under the
contract;
(vii) The provider uses the property
concurrently to provide significant
services to entities unrelated to the
customer;
(viii) The 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; and
(ix) The total contract price
substantially exceeds the rental value of
the property for the contract period.
(3) Application to arrangements
comprised of multiple transactions. An
arrangement comprised of multiple
transactions generally requires separate
classification for each transaction. If at
least one of the transactions is a cloud
transaction, but not all of the
transactions are cloud transactions, this
section applies only to classify the
cloud transactions. However, any
transaction that is de minimis, taking
into account the overall arrangement
and the surrounding facts and
circumstances, will not be treated as a
separate transaction, but as part of
another transaction.
(d) Examples. The provisions of this
section may be illustrated by the
examples in this paragraph (d). For
purposes of this paragraph, unless
otherwise indicated, Corp A is a
domestic corporation; Corp B is a
foreign corporation; end-users are
individuals; and no rights described in
§ 1.861–18(c)(2) (copyright rights) are
transferred as part of the transactions
described.
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(1) Example 1: Computing capacity—(i)
Facts. Corp A operates data centers on its
premises in various locations. Corp A
provides Corp B computing capacity on Corp
A’s servers in exchange for a monthly fee
based on the amount of computing power
made available to Corp B. Corp B provides
its own software to run on Corp A’s servers.
Depending on utilization levels, the servers
accessed by Corp B may also be used
simultaneously by other customers. The
computing capacity provided to Corp B can
be sourced from a variety of servers in one
or more of Corp A’s data centers, and Corp
A determines how its computing resources
are allocated among customers. Corp A
agrees to keep the servers operational,
including by performing physical
maintenance and repair, and may replace any
server with another server of comparable
functionality. Corp A agrees to provide Corp
B with a payment credit for server downtime.
Corp B has no ability to physically alter any
server.
(ii) Analysis. (A) The computing capacity
transaction between Corp A and Corp B is a
cloud transaction described in paragraph (b)
of this section because Corp B obtains a nonde minimis right to on-demand network
access to computer hardware of Corp A.
(B) Corp B has neither physical possession
of nor control of the servers, beyond Corp B’s
right to access and use the servers. Corp A
may replace any server with a functionally
comparable server. The servers are a
component of an integrated operation in
which Corp A has other responsibilities,
including maintaining the servers. The
transaction does not provide Corp B with a
significant economic or possessory interest in
the servers. The agreement provides that
Corp A will provide Corp B with a payment
credit for server downtime, such that Corp A
bears risk of substantially diminished
receipts in the event of contract
nonperformance. The servers may,
depending on utilization levels, be used by
Corp A to provide significant computing
capacity to entities unrelated to Corp B. Corp
A is compensated according to the level of
Corp B’s use (that is, the amount of
computing power made available) and not
solely based on the passage of time. Taking
into account all of the relevant factors, the
transaction between Corp A and Corp B is
classified as the provision of services under
paragraph (c) of this section.
(2) Example 2: Computing capacity on
dedicated servers—(i) Facts. The facts are the
same as in paragraph (d)(1)(i) of this section
(the facts in Example 1), except that, in order
to offer more security to Corp B, Corp A
provides Corp B computing capacity
exclusively through designated servers,
which are owned by Corp A and located at
Corp A’s facilities. Corp A agrees not to use
a designated server for any other customer for
the duration of its arrangement with Corp B.
Corp A’s compensation reflects a substantial
return for maintaining the servers in addition
to the rental value of the servers.
(ii) Analysis. (A) As in paragraph (d)(1) of
this section, the transaction between Corp A
and Corp B is a cloud transaction described
in paragraph (b) of this section because Corp
B obtains a non-de minimis right to on-
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demand network access to computer
hardware resources of Corp A.
(B) The fact that Corp A provides
computing capacity to Corp B through
designated servers indicates that such servers
are not used concurrently by other Corp A
customers. However, Corp A retains physical
possession of the servers. In addition, Corp
A’s sole responsibility for maintaining the
servers, and its sole right to replace or
physically alter the servers, indicate that
Corp A controls the servers. Although Corp
B obtains the exclusive right to use certain
servers, Corp B does not have a significant
economic or possessory interest in the
servers because, among other things, Corp A
retains the right to replace the servers, Corp
A bears the risk of damage to the servers, and
Corp B does not share in cost savings
associated with the servers because the fee
paid by Corp B to Corp A does not vary based
on Corp A’s costs. The compensation to Corp
A substantially exceeds the rental value of
the servers. The other relevant factors are
analyzed in the same manner as paragraph
(d)(1) of this section. Taking into account all
of these factors, the transaction between Corp
A and Corp B is classified as a provision of
services under paragraph (c) of this section.
(3) Example 3: Access to software
development platform and website hosting—
(i) Facts. Corp A provides Corp B a software
platform that Corp B uses to develop and
deploy websites with a range of features,
including blogs, message boards, and other
collaborative knowledge bases. The software
development platform consists of an
operating system, web server software,
scripting languages, libraries, tools, and backend relational database software and allows
Corp B to use in its websites certain visual
elements subject to copyrights held by Corp
A. The software development platform is
hosted on servers owned by Corp A and
located at Corp A’s facilities. Corp B’s
finished websites are also hosted on Corp A’s
servers. The software development platform
and servers are also used concurrently to
provide similar functionality to Corp A
customers unrelated to Corp B. Corp B
accesses the software development platform
via a standard web browser. Corp B has no
ability to alter the software code. A small
amount of scripting code is downloaded onto
Corp B’s computers to facilitate secure logins
and access to the software development
platform. All other functions of the software
development platform execute on Corp A’s
servers, and no portion of the core software
code is ever downloaded by Corp B or Corp
B’s customers. Corp A is solely responsible
for maintaining the servers and software
development platform, including ensuring
continued functionality and compatibility
with Corp B’s browser, providing updates
and fixes to the software for the duration of
the contract with Corp B, and replacing or
upgrading the servers or software at any time
with a functionally similar version. Corp B
pays Corp A a monthly fee for the platform
and website hosting that takes into account
the storage requirements of Corp B’s websites
and the amount of website traffic supported,
but there is no stand-alone fee for use of the
software development platform. Corp B
agrees to pay for Corp A’s website hosting
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services for a minimum period, after which
Corp B may continue to pay for Corp A’s
website hosting services or transfer its
developed websites to a different hosting
provider. Corp A agrees to provide Corp B
with a payment credit for server downtime.
(ii) Analysis. (A) Corp A’s provision to
Corp B of access to the software platform is
a cloud transaction described in paragraph
(b) of this section because Corp B obtains a
non-de minimis right to on-demand network
access to computer hardware and software
resources of Corp A. Corp A’s hosting of Corp
B’s finished websites is part of the provision
of access to the software platform and
hardware.
(B) Corp B does not have physical
possession of the software platform or
servers. Although Corp B uses Corp A’s
platform to develop and deploy websites,
Corp B does not maintain the software
platform or the servers on which it is hosted,
and Corp B cannot alter the software
platform. Accordingly, Corp B does not
control the software platform or the servers.
Corp A maintains the right to replace or
upgrade the software platform and servers
with functionally similar versions. The
servers and software platform are
components of an integrated operation in
which Corp A has various responsibilities,
including maintaining the servers and
updating the software. Corp B does not have
a significant economic or possessory interest
in Corp A’s software platform or servers.
Corp B may lose revenue with respect to the
websites that it deploys on Corp A’s servers
when the servers are down; nonetheless,
Corp A bears the risk of substantially
diminished receipts in the event of contract
nonperformance because Corp A will provide
Corp B with a payment credit for server
downtime. Corp A provides access to the
servers and platform to Corp B and other
customers concurrently. Corp A is
compensated based on Corp B’s level of use
(that is, the amount of computing resources
provided) and not solely by the passage of
time. Taking into account all of the factors,
the transaction between Corp A and Corp B
is classified as a provision of services under
paragraph (c) of this section.
(C) Although the download of a small
amount of scripting code to facilitate logins
and access to the software platform would
otherwise constitute a transfer of a computer
program, instead of a cloud transaction under
paragraph (b) of this section, the download
is de minimis in the context of the overall
arrangement, and therefore, under paragraph
(c)(3) of this section, there is no separate
classification of the download. Similarly, the
fact that Corp B receives rights to publicly
display certain copyrighted visual elements
resulting from Corp A’s software
development platform on Corp B’s own
websites, which would otherwise constitute
a transfer of copyright rights under § 1.861–
18, instead of a cloud transaction under
paragraph (b) of this section, does not require
separate classification because the right to
use such elements is also de minimis. Thus,
under paragraph (c) of this section, the entire
arrangement is classified as a service.
(4) Example 4: Access to software—(i)
Facts. The facts are the same as in paragraph
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(d)(3)(i) of this section (the facts in Example
3), except that, instead of providing website
development software, Corp A provides Corp
B access to customer relationship
management software under several options
such as ‘‘entry-level,’’ ‘‘mid-level,’’ and
‘‘advanced-level,’’ via a standard web
browser, which Corp A hosts on its servers
for a monthly subscription fee. Corp B has no
ability to alter the software code, and Corp
A agrees to make available new versions of
the software as they are developed for the
duration of Corp B’s contract, and to ensure
servers’ uptime in accordance with the
service level agreement.
(ii) Analysis. (A) As in paragraph (d)(3) of
this section, the transaction between Corp A
and Corp B is a cloud transaction described
in paragraph (b) of this section because Corp
B obtains a non-de minimis right to ondemand network access to computer
hardware and software resources of Corp A.
(B) The relevant factors are analyzed in the
same manner as in paragraph (d)(3) of this
section, except that compensation due to
Corp A is determined based on the option
chosen and the passage of time rather than
a measure of computing resources utilized.
Although as a general matter compensation
based on the passage of time is more
indicative of a lease than a service
transaction, that factor is outweighed by the
other factors, which support classification as
a service transaction. Taking into account all
of the factors, the transaction between Corp
A and Corp B is classified as a provision of
services under paragraph (c) of this section.
(5) Example 5: Downloaded software
subject to § 1.861–18—(i) Facts. Corp A
provides software for download to Corp B
that enables Corp B to create a scalable,
shared pool of computing resources over
Corp B’s own network for use by Corp B’s
employees. Corp B downloads the software,
which runs solely on Corp B’s servers. Corp
A provides Corp B with free updates for
download as they become available. Corp B
pays Corp A an annual fee, and, upon
termination of the arrangement, an electronic
lock is activated that prevents Corp B from
further using the software.
(ii) Analysis. Under paragraph (b) of this
section, the download of software for use
with Corp B’s computer hardware does not
constitute on-demand network access by
Corp B to Corp A’s software. Accordingly, the
transaction between Corp A and Corp B is
not a cloud transaction described in
paragraph (b) of this section. Because the
transaction involves the transfer of digital
content as defined in § 1.861–18(a)(3), it is
classified under § 1.861–18.
(6) Example 6: Access to online software
via an application—(i) Facts. Corp A
provides Corp B word processing,
spreadsheet, and presentation software and
allows employees of Corp B to access the
software over the internet through a web
browser or an application (‘‘app’’). In order
to access the software from a mobile device,
Corp B’s employees usually download Corp
A’s app onto their devices. To access the full
functionality of the app, the device must be
connected to the internet. Only a limited
number of features on the app are available
without an internet connection. Corp B has
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no ability to alter the software code. The
software is hosted on servers owned by Corp
A and located at Corp A’s facilities and is
used concurrently by other Corp A
customers. Corp A is solely responsible for
maintaining and repairing the servers and
software, and ensuring continued
functionality and compatibility with Corp B’s
employees’ devices and providing updates
and fixes to the software (including the app)
for the duration of the contract with Corp B.
Corp B pays a monthly fee based on the
number of employees with access to the
software. Upon termination of the
arrangement, Corp A activates an electronic
lock preventing Corp B’s employees from
further utilizing the app, and Corp B’s
employees are no longer able to access the
software via a web browser.
(ii) Analysis. (A) Corp A’s provision to
Corp B of a non-de minimis right to ondemand network access to Corp A’s
computer hardware and software resources
for the purpose of fully utilizing Corp A’s
software is a cloud transaction described in
paragraph (b) of this section.
(B) Corp B has neither physical possession
of nor control over Corp A’s word processing,
spreadsheet, and presentation software or
computer hardware. Additionally, the servers
and software are part of an integrated
operation in which Corp A maintains the
servers and updates the software. Corp A
makes available its word processing,
spreadsheet, and presentation software and
servers to Corp B and other customers
concurrently. Corp A’s compensation, though
based in part on the passage of time, is also
determined by reference to Corp B’s level of
use (that is, the number of Corp B employees
with access to the software). Taking into
account all of the factors, the transaction
between Corp A and Corp B is classified as
the provision of services under paragraph (c)
of this section.
(C) The provision of the app to Corp B’s
employees by download onto their devices
would be a transfer of a computer program
rather than a cloud transaction subject to
paragraph (b) of this section. However, under
paragraph (c)(3) of this section, it is necessary
to consider whether that transfer is de
minimis in the context of the overall
arrangement and in light of the surrounding
facts and circumstances. Here, the
significance of the download of the app by
Corp B’s employees is limited by the fact that
the device running the app must be
connected to Corp A’s servers via the internet
to enable most of the app’s core functions.
The software that enables such functionality
remains on Corp A’s servers and is accessed
through an on-demand network by Corp B’s
employees. Therefore, the download of the
app is de minimis, and under paragraph
(c)(3) of this section, the entire arrangement
is classified as a service.
(7) Example 7: Access to offline software
with limited online functions—(i) Facts. Corp
A provides Corp B word processing,
spreadsheet, and presentation software that is
functionally similar to the software in
paragraph (d)(6) of this section (Example 6).
The software is made available for access
over the internet but only to download the
software onto a computer or onto a mobile
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device in the form of an app. The
downloaded software contains all the core
functions of the software. Employees of Corp
B can use the software on their computers or
mobile devices regardless of whether their
computer or mobile device is online. When
online, the software provides a few ancillary
functions that are not available offline, such
as access to document templates and data
collection for diagnosing problems with the
software. Whether working online or offline,
Corp B employees can store their files only
on their own computer or mobile device, and
not on Corp A’s data storage servers. Because
the software provides near full functionality
without access to Corp A’s servers, it requires
more computing resources on employees’
computers and devices than the app in
paragraph (d)(6) of this section. Corp B’s
employees can also download updates to the
software as part of the monthly fee
arrangement. Upon termination of the
arrangement, an electronic lock is activated
so that the software can no longer be
accessed.
(ii) Analysis. The provision of the software
constitutes a lease of a copyrighted article
under § 1.861–18. See § 1.861–18(h)(4). The
access to the online ancillary functions
otherwise would constitute a cloud
transaction under paragraph (b) of this
section, but the access to these functions is
de minimis in the context of the overall
arrangement, considering that the core
functions are available offline through the
downloaded software. Because there is no
cloud transaction described in paragraph (b)
of this section, this section does not apply.
(8) Example 8: Data storage, separate from
access to offline software—(i) Facts. The facts
are the same as in paragraph (d)(7)(i) of this
section (the facts in Example 7), except that
Corp A also provides data storage to Corp B
on Corp A’s server systems in exchange for
a monthly fee based on the amount of data
storage used by Corp B. Under the data
storage terms, Corp B employees may store
files created by Corp B employees using Corp
A’s software or other software. Although
Corp A’s word processing software is
compatible with Corp A’s data storage
systems, the core functionality of Corp A’s
software is not dependent on Corp B’s
purchase of the storage plan. Depending on
utilization levels, the server systems
providing data storage to Corp B may also be
used simultaneously for other customers. The
data storage provided to Corp B can be
sourced from a variety of server systems in
one or more of Corp A’s data centers, and
Corp A determines how its computing
resources are allocated among customers.
Corp A agrees to keep the server systems
operational, including by performing
physical maintenance and repair, and may
replace any server system with another one
of comparable functionality. Corp A agrees to
provide Corp B with a payment credit for
server downtime. Corp B has no ability to
physically alter the server systems.
(ii) Analysis. (A) Corp A’s provision of
software and data storage capacity constitute
separate transactions, and neither is de
minimis. Therefore, under paragraph (c)(3) of
this section, the transactions are classified
separately.
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Sfmt 4702
(B) As in paragraph (d)(7), Corp B’s
download of fully functional software, along
with on-demand network access to certain
limited online features, does not constitute a
cloud transaction, but rather constitutes a
lease of a copyrighted article under § 1.861–
18.
(C) Corp A’s provision of data storage
constitutes a cloud transaction because Corp
B obtains a non-de minimis right to ondemand network access to computer
hardware of Corp A.
(D) Corp B has neither physical possession
of nor control of the server systems, beyond
Corp B’s right to access and use the servers.
Corp A may replace any server with a
functionally comparable server. The server
systems are a component of an integrated
operation in which Corp A has other
responsibilities, including maintaining the
server systems. The transaction does not
provide Corp B with a significant economic
or possessory interest in the servers. The
servers may, depending on utilization levels,
be used by Corp A to provide significant
services to entities unrelated to Corp B. Corp
A is compensated according to the level of
Corp B’s use (that is, the amount of data
storage used by Corp B) and not solely based
on the passage of time. Because Corp A will
provide Corp B with a payment credit for
server downtime, Corp A bears risk of
substantially diminished receipts in the
event of contract nonperformance. Taking
into account all of these factors, the
transaction for data storage is classified as a
provision of services under paragraph (c) of
this section.
(9) Example 9: Streaming digital content
using third-party servers—(i) Facts. Corp A
streams digital content in the form of videos
and music to end-users from servers located
in data centers owned and operated by Data
Center Operator. Data Center Operator’s
content delivery network facility services
multiple customers. Each end-user uses a
computer or other electronic device to access
unlimited streaming video and music in
exchange for payment of a flat monthly fee
to Corp A. The end-user may select from
among the available content the particular
video or song to be streamed. Corp A
continually updates its content catalog,
replacing content with higher quality
versions and adding new content at no
additional charge to the end-user. Content
that is streamed to the end-user is not stored
locally on the end-user’s computer or other
electronic device and therefore can be played
only while the end-user’s computer or other
electronic device is connected to the internet.
Corp A pays Data Center Operator a fee based
on the amount of data storage used and
computing power made available in
connection with Corp A’s content streaming.
The storage and computing power provided
to Corp A can be sourced from a variety of
servers in one or more of Data Center
Operator’s facilities, and Data Center
Operator determines how computing
resources are allocated among its customers.
Data Center Operator covenants to keep the
servers operational, including performing
physical maintenance and repair. Corp A has
no right or ability to physically alter the
servers.
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(ii) Analysis. (A) The relevant factors for
classifying the transaction between Corp A
and Data Center Operator are analyzed in the
same manner as the computing capacity and
data storage transactions in paragraphs (d)(1)
and (8) of this section (Example 1 and
Example 8), respectively, such that the
transaction between Corp A and Data Center
Operator is classified as a provision of
services by Data Center Operator to Corp A
under paragraph (c) of this section.
(B) A transaction between Corp A and an
end-user is a cloud transaction described in
paragraph (b) of this section because the enduser obtains a non-de minimis right to ondemand network access to digital content of
Corp A.
(C) An end-user has neither physical
possession of nor control of the digital
content. Additionally, Corp A has the right
to determine the digital content used in the
cloud transaction and retains the right to
modify its selection of digital content. Digital
content accessed by end-users is a
component of an integrated operation in
which Corp A’s other responsibilities include
maintaining and updating its content catalog.
Corp A’s end-users do not obtain a significant
economic or possessory interest in any of the
digital content in Corp A’s catalog. The
digital content provided by Corp A may be
accessed concurrently by multiple unrelated
end-users. Although, as a general matter,
compensation based on the passage of time
is more indicative of a lease than a service
transaction, that factor is outweighed by the
other factors, which support a services
classification. Taking into account all of the
factors, a transaction between an end-user
and Corp A is classified as a provision of
services under paragraph (c) of this section.
(10) Example 10: Downloaded digital
content subject to § 1.861–18—(i) Facts. Corp
A offers digital content in the form of videos
and music solely for download onto endusers’ computers or other electronic devices
for a fee. Once downloaded, the end-user
accesses the videos and songs from the enduser’s computer or other electronic device,
which does not need to be connected to the
internet in order to play the content. The
end-user owes no additional payment to Corp
A for the ability to play the content in the
future.
(ii) Analysis. Under paragraph (b) of this
section, the download of digital content onto
an end-user’s computer for storage and use
on that computer does not constitute ondemand network access by the end-user to
the digital content of Corp A. Accordingly,
the transaction between the end-user and
Corp A is not a cloud transaction described
in paragraph (b) of this section, and this
section does not apply to the transaction.
Because the transaction involves the transfer
of digital content as defined in § 1.861–
18(a)(3), it will be classified under § 1.861–
18. See § 1.861–18(h)(21).
(11) Example 11: Access to online
database—(i) Facts. Corp A offers an online
database of industry-specific materials. Endusers access the materials through Corp A’s
website, which aggregates and organizes
information topically and hosts a proprietary
search engine. Corp A hosts the website and
database on its own servers and provides
VerDate Sep<11>2014
16:38 Aug 13, 2019
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multiple end-users access to the website and
database concurrently. Corp A is solely
responsible for maintaining and replacing the
servers, website, and database (including
adding or updating materials in the
database). End-users have no ability to alter
the servers, website, or database. Most
materials in Corp A’s database are publicly
available by other means, but Corp A’s
website offers an efficient way to locate and
obtain the information on demand. Certain
materials in Corp A’s database constitute
digital content within the meaning of
§ 1.861–18(a)(3), and Corp A pays the
copyright owners a license fee for using
them. Each end-user may download any of
the materials to its own computer and keep
such materials without further payment. The
end-user pays Corp A a fee based on the
number of searches or the amount of time
spent on the website, and such fee is not
dependent on the amount of materials the
end-user downloads. The fee that the enduser pays is substantially higher than the
stand-alone charge for accessing the same
digital content outside of Corp A’s system.
(ii) Analysis. (A) Corp A’s provision to an
end-user of access to Corp A’s website and
online database is a cloud transaction
described in paragraph (b) of this section
because the end-user obtains a non-de
minimis right to on-demand access to Corp
A’s computer hardware and software
resources.
(B) An end-user’s downloading of the
digital content would be classified as a sale
of copyrighted articles under § 1.861–18.
Nonetheless, taking into account the entire
arrangement, including that the primary
benefit to the end-user is access to Corp A’s
database and its proprietary search engine,
and that the stand-alone charge for accessing
the digital content would be substantially
less than the fee Corp A charges, the
downloads are de minimis. Accordingly,
under paragraph (c)(3) of this section, there
is no separate classification of the
downloads.
(C) The end-user has neither physical
possession of nor control of the database,
software, or the servers that host the database
or software. Corp A retains the right to
replace its servers and update its software
and database. The database, software, and
servers are part of an integrated operation in
which Corp A is responsible for curating the
database, updating the software, and
maintaining the servers. Corp A provides
each end-user on-demand network access to
its software and online database concurrently
with other end-users. Certain end-users pay
Corp A a fee based on time spent on Corp
A’s website, which could be construed as
compensation based on the passage of time
and thus be more indicative of a lease than
a service transaction. However, the fee that
the end-user pays is substantially higher than
the stand-alone charge for accessing the same
digital content outside of Corp A’s system.
Accordingly, on balance, the fee arrangement
supports the classification of the transaction
as a service transaction. Taking into account
all of these factors, the arrangement between
end-users and Corp A is treated as the
provision of services under paragraph (c) of
this section.
PO 00000
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40329
(e) Effective/applicability date. This
section applies to cloud transactions
occurring pursuant to contracts entered
into in taxable years beginning on or
after the date of publication of a
Treasury decision adopting these rules
as final regulations in the Federal
Register.
(f) Change in method of accounting
required by this section. In order to
comply with this section, a taxpayer
engaging in a cloud transaction
pursuant to a contract entered into on or
after the date described in paragraph (e)
of this section may be required to
change its method of accounting. If so
required, the taxpayer must secure the
consent of the Commissioner in
accordance with the requirements of
§ 1.446–1(e) and the applicable
administrative procedures for obtaining
the Commissioner’s consent under
section 446(e) for voluntary changes in
methods of accounting.
§ 1.937–3
[Amended]
Par. 5. Section 1.937–3 is amended by
removing Examples 4 and 5 from
paragraph (e).
■
Kirsten Wielobob,
Deputy Commissioner for Services and
Enforcement.
[FR Doc. 2019–17425 Filed 8–9–19; 4:15 pm]
BILLING CODE 4830–01–P
DEPARTMENT OF HOMELAND
SECURITY
Coast Guard
33 CFR Part 155
[Docket No. USCG–2018–0493]
RIN 1625–AC50
Person in Charge of Fuel Transfers
Coast Guard, DHS.
Notice of proposed rulemaking;
request for comments.
AGENCY:
ACTION:
The Coast Guard is proposing
to amend the requirements regulating
personnel permitted to serve as a person
in charge (PIC) of fuel oil transfers on an
inspected vessel by adding the option of
using a letter of designation (LOD) in
lieu of a Merchant Mariner Credential
(MMC) with a Tankerman-PIC
endorsement. Thousands of towing
vessels are currently transitioning from
being uninspected vessels to becoming
inspected vessels. This proposal would
allow a PIC currently using the LOD
option on one of those uninspected
vessels to continue to use that option to
perform the same fuel oil transfers once
the vessel receives its initial Certificate
SUMMARY:
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Agencies
[Federal Register Volume 84, Number 157 (Wednesday, August 14, 2019)]
[Proposed Rules]
[Pages 40317-40329]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-17425]
=======================================================================
-----------------------------------------------------------------------
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-130700-14]
RIN 1545-BM41
Classification of Cloud Transactions and Transactions Involving
Digital Content
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
-----------------------------------------------------------------------
SUMMARY: This document contains proposed regulations regarding the
classification of cloud transactions for purposes of the international
provisions of the Internal Revenue Code. These proposed regulations
also modify the rules for classifying transactions involving computer
programs, including by applying the rules to transfers of digital
content.
[[Page 40318]]
DATES: Comments and requests for a public hearing must be received by
November 12, 2019.
ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-130700-14), Room
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand-delivered Monday through
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
130700-14), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue NW, Washington, DC. Alternatively, taxpayers may submit comments
electronically via the Federal eRulemaking Portal at
www.regulations.gov (REG-130700-14).
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations
Robert Z. Kelley, (202) 317-6939; concerning submissions of comments
and requests for a public hearing, Regina L. Johnson, (202) 317-6901
(not toll free numbers).
SUPPLEMENTARY INFORMATION:
Background
These regulations (the proposed regulations) clarify the treatment
under certain provisions of the Internal Revenue Code (Code) of income
from transactions involving on-demand network access to computing and
other similar resources. The proposed regulations also extend the
classification rules in existing Sec. 1.861-18 to transfers of digital
content other than computer programs and clarify the source of income
for certain transactions governed by existing Sec. 1.861-18.
Existing Sec. 1.861-18 provides rules for classifying transactions
involving computer programs. For this purpose, Sec. 1.861-18(a)(3)
defines a computer program as ``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 similar item is incidental to the operation of the
computer program.'' Under Sec. 1.861-18(b)(1), a transaction to which
the section applies is categorized as (i) a transfer of a copyright
right in a computer program; (ii) a transfer of a copy of a computer
program (a ``copyrighted article''); (iii) the provision of services
for the development or modification of a computer program; or (iv) the
provision of know-how relating to computer programming techniques.
Section 1.861-18(c) provides that a transfer of a computer program is
classified as the transfer of a copyright right if there is a non-de
minimis grant of any of the following four rights: (i) The right to
make copies of the computer program 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 computer programs based
upon the copyrighted computer program; (iii) the right to make a public
performance of the computer program; or (iv) the right to publicly
display the computer program. Section 1.861-18(f) further categorizes a
transfer of a copyright right as either the sale or license of the
copyright right and a transfer of a copyrighted article as either the
sale or lease of the copyrighted article.
Section 1.861-18 generally does not provide a comprehensive basis
for categorizing many common transactions involving what is commonly
referred to as ``cloud computing,'' which typically is characterized by
on-demand network access to computing resources, such as networks,
servers, storage, and software. See, e.g., National Institute of
Standards and Technology, Special Publication 500-322 (February 2018)
(``NIST Report''). Cloud computing transactions typically are described
for non-tax purposes as following one or more of the following three
models: Software as a Service (``SaaS''); Platform as a Service
(``PaaS''); and Infrastructure as a Service (``IaaS''). SaaS allows
customers to access applications on a provider's cloud infrastructure
through an interface such as a web browser. NIST Report, p. 9-10. PaaS
allows customers to deploy applications created by the customer onto a
provider's cloud infrastructure using programming languages, libraries,
services, and tools supported by the provider. NIST Report, pp. 10-11.
IaaS allows customers to access processing, storage, networks, and
other infrastructure resources on a provider's cloud infrastructure.
NIST Report, p. 11. A cloud computing transaction typically does not
involve any transfer of a computer program classified under Sec.
1.861-18 as a transfer of a copyright right or copyrighted article or
any provision of development services or know-how relating to computer
programs or programming. Although certain cloud computing transactions
may provide similar functionality with respect to computer programs as
transactions subject to Sec. 1.861-18 (for example, the transfer of a
computer program via download may provide similar functionality as the
same program accessed via a web browser), Sec. 1.861-18 does not
address the provision of online access to use the computer program.
Accordingly, Sec. 1.861-18 would not apply to classify such a
transaction.
In addition to the cloud computing models described above, other
transactions exist that are not solely related to computing but still
involve on-demand network access to technological resources (these
transactions and cloud computing transactions are collectively referred
to herein as ``cloud transactions''). These transactions have increased
in frequency over time and share similarities with the three cloud
computing models described above. Examples include streaming music and
video, transactions involving mobile device applications (``apps''),
and access to data through remotely hosted software. These transactions
may not involve, in whole or in part, a transfer under Sec. 1.861-18
of a copyright right or copyrighted article, or a provision of
development services or know-how relating to computer programs or
programming.
In general, a cloud transaction involves access to property or use
of property, instead of the sale, exchange, or license of property, and
therefore typically would be classified as either a lease of property
or a provision of services. Section 7701(e) and case law provide
factors that are relevant for classifying a transaction as either a
lease of property or a provision of services. In particular, section
7701(e)(1) provides that a contract that purports to be a service
contract will be treated instead as a lease of property if the contract
is properly treated as a lease taking into account all relevant
factors, including whether (1) the service recipient is in physical
possession of the property, (2) the service recipient controls the
property, (3) the service recipient has a significant economic or
possessory interest in the property, (4) the service provider does not
bear any risk of substantially diminished receipts or substantially
increased expenditures if there is nonperformance under the contract,
(5) the service provider does not use the property concurrently to
provide significant services to entities unrelated to the service
recipient, and (6) the total contract price does not substantially
exceed the rental value of the property for the contract period.
Section 7701(e)(2) provides that the factors in section 7701(e)(1)
apply to determine whether any arrangement, not just contracts which
purport to be service contracts, is properly treated as a lease.
Consistent with the inclusive statutory language, the legislative
history indicates that this list of factors
[[Page 40319]]
is meant to be non-exclusive and constitutes a balancing test, such
that the presence or absence of a single factor may not be dispositive
in every case. S. Prt. No. 169 (Vol. I), 98th Cong., 2d Sess., at 138
(1984); Joint Committee on Taxation Staff, General Explanation of the
Revenue Provisions of the Deficit Reduction Act of 1984, 98th Cong., at
60 (Comm. Print 1984).
In addition, courts have also considered other factors in
determining whether transactions are leases of property or the
provision of services, including whether the service provider had the
right to replace the relevant property with comparable property,
whether the property was a component of an integrated operation in
which the service provider had other responsibilities, whether the
service provider operated the equipment, and whether the service
provider's fee was based on a measure of work performed rather than the
mere passage of time. See, e.g., Musco Sports Lighting, Inc. v. Comm'r,
T.C. Memo 1990-331, aff'd, 943 F.2d 906 (8th Cir. 1991); Xerox Corp v.
U.S., 656 F.2d 659 (Ct. Cl. 1981); and Smith v. Comm'r, T.C. Memo 1989-
318.
Explanation of Provisions
I. Proposed Sec. 1.861-19
Proposed Sec. 1.861-19 provides rules for classifying a cloud
transaction as either a provision of services or a lease of property.
Proposed Sec. 1.861-19(a) specifies that the rules apply for purposes
of sections 59A, 245A, 250, 267A, 367, 404A, 482, 679, and 1059A;
subchapter N of chapter 1; chapters 3 and 4; and sections 842 and 845
(to the extent involving a foreign person), as well as with respect to
transfers to foreign trusts not covered by section 679.
In order to make other sections consistent with proposed Sec.
1.861-19, Example 5 in Sec. 1.937-3(e) is proposed to be removed from
the rules for determining whether income is derived from sources within
a U.S. possession or territory.
A. Definition of ``Cloud Transaction''
Proposed Sec. 1.861-19(b) defines a cloud transaction as a
transaction through which a person obtains non-de minimis on-demand
network access to computer hardware, digital content (as defined in
proposed Sec. 1.861-18(a)(3)), or other similar resources. This
definition is not limited to computer hardware and software, or to the
IaaS, PaaS, and SaaS models described above, because it is intended
also to apply to other transactions that share characteristics of on-
demand network access to technological resources, including access to
streaming digital content and access to information in certain
databases. Although this definition is broad, it does not encompass
every transaction executed or completed through the internet. For
example, proposed Sec. 1.861-19 clarifies that the mere download or
other electronic transfer of digital content for storage and use on a
person's computer hardware or other electronic device does not
constitute on-demand network access to the digital content and so would
not be considered a cloud transaction for purposes of proposed Sec.
1.861-19.
B. Classification of Cloud Transactions
1. Single Classification
Proposed Sec. 1.861-19(c) provides that a cloud transaction is
classified solely as either a lease of property or the provision of
services. Certain cloud transactions may have characteristics of both a
lease of property and the provision of services. Such transactions are
generally classified in their entirety as either a lease or a service,
and not bifurcated into a lease transaction and a separate service
transaction. For example, section 7701(e)(1) classifies a purported
service contract as either a lease or a service contract and does not
contemplate mixed classifications of a single, integrated transaction.
In Tidewater v. U.S., 565 F.3d 299 (5th Cir. 2009), action on dec.,
2010-01 (June 1, 2010) (Tidewater), the Fifth Circuit applied the
factors in section 7701(e)(1) to determine a single character for a
time charter with respect to an ocean-going vessel, rather than
following the taxpayer's allocation of consideration from the
transaction into separate service and lease components.
In some cases, the facts and circumstances may support the
conclusion that an arrangement involves multiple cloud transactions to
which proposed Sec. 1.861-19 applies. In such cases, proposed Sec.
1.861-19 requires a separate classification of each cloud transaction
except any transaction that is de minimis.
2. Determination Based on All Relevant Factors
Proposed Sec. 1.861-19(c)(1) provides that all relevant factors
must be taken into account in determining whether a cloud transaction
is classified as a lease of property (specifically, computer hardware,
digital content (as defined in proposed Sec. 1.861-18(a)(3)), or other
similar resources) or the provision of services. The relevance of any
factor varies depending on the factual situation, and any particular
factor may not be relevant in a given instance.
Proposed Sec. 1.861-19(c)(2) contains a non-exhaustive list of
factors for determining whether a cloud transaction is classified as
the provision of services or a lease of property. In general,
application of the relevant factors to a cloud transaction will result
in the transaction being treated as the provision of services rather
than a lease of property. In addition to the statutory factors
described in section 7701(e)(1), the proposed regulations set forth
several factors applied by courts that the Treasury Department and the
IRS have determined are relevant in demonstrating that a cloud
transaction is classified as the provision of services: Whether the
provider has the right to determine the specific property used in the
cloud transaction and replace such property with comparable property;
whether the property is a component of an integrated operation in which
the provider has other responsibilities, including ensuring the
property is maintained and updated; and whether the 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. The proposed
regulations include several examples applying the factors in proposed
Sec. 1.861-19(c)(2) to different types of cloud transactions.
Certain factors that are relevant under proposed Sec. 1.861-19(c)
may be the same as or similar to those used to determine whether
transactions other than cloud transactions are classified as leases or
services under other authorities. However, cloud transactions, which
involve on-demand network access to property such as computer hardware
and digital content, may have significant differences from other lease
and service transactions that involve direct physical access to
property. Accordingly, the interpretation of factors and their
application to cloud transactions require an analysis that is sensitive
to the inherent differences between transactions involving physical
access to property and transactions involving on-demand network access.
C. Classification of Cloud Transactions Related to Other Transactions
Certain arrangements may involve multiple transactions, where one
or more transactions would be classified as a cloud transaction under
proposed Sec. 1.861-19(b) and one or more transactions do not qualify
as a cloud transaction and would be classified under other sections of
the Code and regulations, or under general tax law principles. For
example, an arrangement
[[Page 40320]]
might involve both a cloud transaction and a transaction that would be
classified under the rules of Sec. 1.861-18 as a lease of a
copyrighted article. Proposed Sec. 1.861-19(c)(3) provides that, in
such cases, the classification rules apply only to classify the cloud
transaction, and any non-cloud transaction will be classified
separately under such other section of the Code or regulations, or
under general tax law principles. However, for purposes of
administrability, proposed Sec. 1.861-19(c)(3) provides that no
transaction will be classified separately if it is de minimis. This
rule is illustrated by examples contained in proposed Sec. 1.861-
19(d).
II. Modifications of Sec. 1.861-18
A. Scope of Application
The preamble to the final regulations under Sec. 1.861-18
governing the classification of transactions involving computer
programs (T.D. 8785, 63 FR 52971 (October 2, 1998)) indicated that
Sec. 1.861-18 would apply only to such transactions because the need
for guidance with respect to transactions involving computer programs
was most pressing. The preamble noted, however, that the Treasury
Department and the IRS may consider as part of a separate guidance
project whether to apply the principles of those regulations to other
transactions. Since Sec. 1.861-18 was adopted as a final regulation in
1998, content in digital format and subject to copyright law, including
music, video, and books, has become a common basis for commercial
transactions. Consumption of such digital content has grown in part
because of new computer hardware, including laptops, tablets, e-
readers, and smartphones, that allows users to more easily obtain and
use digital content.
The Treasury Department and the IRS have determined that the rules
and principles underlying existing Sec. 1.861-18 have provided useful
guidance with respect to computer programs and that these rules and
principles should apply to certain other digital content. Accordingly,
proposed Sec. 1.861-18 broadens the scope of existing Sec. 1.861-18
to apply to all transfers of ``digital content,'' defined in proposed
Sec. 1.861-18(a)(3) as any content in digital format and that is
either protected by copyright law or is no longer protected by
copyright law solely due to the passage of time, whether or not the
content is transferred in a physical medium. Digital content includes,
for example, books, movies, and music in digital format in addition to
computer programs.
Certain terms have been changed in proposed Sec. 1.861-18,
including references to computer programs being replaced with
references to digital content. The application of proposed Sec. 1.861-
18 to digital content other than computer programs is illustrated by
proposed Sec. 1.861-18(h)(19) through (21) (Examples 19 through 21).
B. Rights To Advertise Copyrighted Articles
Comments received on the proposed regulations (REG-251520-96; 61 FR
58152; November 13, 1996) (the ``1996 proposed regulations'') that were
finalized in 1998 as existing Sec. 1.861-18 recommended that the
transfer of a right to publicly perform or display a computer program
should not be considered the transfer of a copyright right if the right
is limited to the advertisement of a copyrighted article and the public
performance or display of the entire copyrighted article is not
permitted. The recommendation of these comments was not incorporated
into existing Sec. 1.861-18, but the Treasury Department and the IRS
acknowledged in the preamble to existing Sec. 1.861-18 that it may be
appropriate to revisit the issue in the future and observed that the
transfer of such rights to advertise a copyrighted article in many
cases would be de minimis under existing Sec. 1.861-18(c)(1)(ii).
In light of experience in administering existing Sec. 1.861-18,
the Treasury Department and the IRS have determined that the transfer
of the right to publicly perform or display digital content for the
purpose of advertising the sale of the digital content should not
constitute the transfer of a copyright right for purposes of those
portions of the Code enumerated in Sec. 1.861-18(a)(1). For example,
rights provided to a video game retailer allowing the retailer to
display screenshots of a video game on television commercials promoting
sales of the game generally would not, on their own, constitute a
transfer of copyright rights that is significant in context.
Accordingly, proposed Sec. 1.861-18 modifies existing Sec. 1.861-
18(c)(2)(iii) and (iv) to provide that a transfer of the mere right to
public performance or display of digital content for purposes of
advertising the digital content does not by itself constitute a
transfer of a copyright right.
C. Source of Income for Sales of Copyrighted Articles in Electronic
Medium
Comments received on the 1996 proposed regulations addressed the
sourcing of income from the sale of computer programs through
electronic downloads and noted uncertainty regarding the application of
the title passage rule of Sec. 1.861-7(c) to these sales of
copyrighted articles. Although the preamble indicated that the parties
in many cases can agree where title passes for inventory property, the
final regulations under Sec. 1.861-18 included only a general
reference to the relevant source rules and did not specifically address
the application of the title passage rule for sales of copyrighted
articles. Based on experience in administering existing Sec. 1.861-18
since 1998, the Treasury Department and the IRS have become more aware
of the uncertainty associated with determining the source of sales of
copyrighted articles by application of Sec. 1.861-7(c), in particular
in the context of electronically downloaded software. 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 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.
In light of these considerations, proposed Sec. 1.861-18(f)(2)(ii)
provides that when copyrighted articles are sold and transferred
through an electronic medium, the sale is deemed to occur at the
location of download or installation onto the end-user's device used to
access the digital content for purposes of Sec. 1.861-7(c). It is
expected that vendors generally will be able to identify the location
of such download or installation. Comments are requested as to the
availability, reliability and cost of this information. In the absence
of information about the location of download or installation onto the
end-user's device used to access the digital content, 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. Consistent with existing Sec. 1.861-18, proposed Sec.
1.861-18(f)(2)(ii) provides that income from sales or exchanges of
copyrighted articles is sourced under sections 861(a)(6),
[[Page 40321]]
862(a)(6), 863, or 865(a), (b), (c), or (e), as appropriate. The
Treasury Department and the IRS do not expect proposed Sec. 1.861-
18(f)(2)(ii) to impact the application of income tax treaties to which
the United States is a party given that the taxation of gains under
those treaties is generally determined by reference to the residence
country of the seller and not the source of income from the sale.
Income from leases of copyrighted articles is sourced under section
861(a)(4) or 862(a)(4), as appropriate.
In order to make other sections consistent with proposed Sec.
1.861-18(f)(2)(ii), a cross-reference has been added in the rules for
sales of inventory property in Sec. 1.861-7(c), and Example 4 in Sec.
1.937-3(e) has been removed from the rules for determining whether
income is derived from sources within a U.S. possession or territory.
III. Change in Method of Accounting
The application of these new rules for purposes of the affected
Code sections may require certain taxpayers to change their methods of
accounting under section 446(e) for affected transactions. Any change
in method of accounting that a taxpayer makes in order to comply with
these regulations would be a change initiated by the taxpayer.
Accordingly, the change in method of accounting must be implemented
under the rules of Sec. 1.446-1(e) and the applicable administrative
procedures that govern voluntary changes in method of accounting under
section 446(e).
IV. Request for Comments
Comments are requested on all aspects of these proposed
regulations, including the following topics:
(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;
(2) whether any special considerations should be taken into account
in applying the rules in existing Sec. 1.861-18 to transfers of
digital content other than computer programs;
(3) whether any other aspects of existing Sec. 1.861-18 need to be
modified if that section is amended as proposed;
(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);
(5) realistic examples of cloud transactions that would be treated
as leases under proposed Sec. 1.861-19;
(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;
(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;
(8) administrable rules for sourcing income from cloud transactions
in a manner consistent with sections 861 through 865; and
(9) application of proposed Sec. 1.861-19 to an arrangement that
involves non-de minimis rights both to access digital content on-demand
over a network and to download such digital content onto a user's
electronic device for offline use.
Proposed Effective Date
The regulations are proposed to apply to taxable years beginning on
or after the date of publication of the Treasury decision adopting
these regulations as final regulations in the Federal Register. No
inference should be drawn from the proposed effective date concerning
the treatment of transactions involving digital content or cloud
transactions entered into before the regulations are applicable. For
transactions involving transfers of computer programs occurring
pursuant to contracts entered into before publication of the final
regulations, the rules in former Sec. 1.861-18, T.D. 8785 and T.D.
9870, will apply. For proposed dates of applicability, see Sec. Sec.
1.861-18(i) and 1.861-19(e).
Special Analyses
Regulatory Planning and Review
Executive Orders 13563 and 12866 direct agencies to assess costs
and benefits of available regulatory alternatives and, if regulation is
necessary, to select regulatory approaches that maximize net benefits
(including potential economic, environmental, public health and safety
effects, distributive impacts, and equity). Executive Order 13563
emphasizes the importance of quantifying both costs and benefits, of
reducing costs, of harmonizing rules, and of promoting flexibility.
These proposed rules have been designated by the Office of
Management and Budget's Office of Information and Regulatory Affairs as
subject to review under Executive Order 12866 pursuant to the
Memorandum of Agreement (MOA) (April 11, 2018) between the Treasury
Department and the Office of Management and Budget regarding review of
tax regulations. The Treasury Department and the IRS project that these
rules are not economically significant because current industry
practice is generally consistent with the principles underlying the
proposed regulations. Comments are requested as to whether this
characterization of industry practice is inaccurate.
A. Background
When assessing tax on income arising from international
transactions, the ``source'' of income is important in determining a
taxpayer's tax liability. U.S. sourcing rules, generally contained in
code sections 861 to 865, determine whether income earned is considered
domestic or foreign source. For U.S. resident taxpayers, the U.S.
generally taxes both domestic and foreign source income and, for the
latter, provides credits for foreign taxes up to the level of U.S. tax.
Taxpayers with significant foreign tax credits (FTCs) typically prefer
that income be considered foreign rather than U.S. source in order to
maximize their use of FTCs and minimize their U.S. taxes.
Proper assessment of the source of a particular item of income
depends on the nature and type (or character) of that income (for
example, interest, dividend, compensation for services, royalties paid
under a license, gains recorded in a sale). Source rules differ for
different types of income, so it is first necessary for income tax
purposes to classify the character of an item of income. In the case of
transactions involving digital content and cloud transactions, the
types of income most relevant are sales, licenses, and services, but
there are currently no regulations specifically applicable to the
classification of transactions involving digital content other than
computer programs or the classification of transactions involving
remote access to digital content through the cloud. These proposed
regulations provide that guidance.
The character of income also affects the U.S. taxation of income
earned by U.S. taxpayers through their foreign subsidiary corporations.
Certain U.S. shareholders of controlled foreign corporations (as
defined in section 957) must include their share of a controlled
foreign corporation's subpart F income in the U.S. shareholder's gross
income on a current basis. Section 951(a)(1)(A). The characterization
of income can impact whether it is considered subpart F income (as
defined in section 952).
[[Page 40322]]
B. Need for Proposed Regulations
Transactions involving digital content and cloud computing have
become common due to the growth of electronic commerce. Such
transactions must be classified in terms of character in order to apply
various provisions of the Code, such as sourcing rules and subpart F.
Existing Reg. Sec. 1.861-18, finalized in 1998, provides rules for
classifying transactions involving computer programs as, for example, a
license of a computer program, a rental of a computer program, or a
sale of a computer program. These existing regulations, however, do not
explicitly cover transactions involving other digital content, such as
digital music and video, or to cloud computing transactions, and thus
taxpayers must determine how these transactions should be classified
for tax purposes without clear guidance. The proposed regulations are
needed to reduce this uncertainty. The proposed regulations also reduce
the opportunities for taxpayers to take positions on source and
character that inappropriately minimize their taxes.
C. Overview of Proposed Regulations
The proposed regulations provide updated guidance with respect to
the classification of transactions involving digital content (proposed
Sec. 1.861-18) and new guidance with respect to cloud transactions
(proposed Sec. 1.861-19).
Existing rules, particularly final regulations under Sec. 1.861-
18, which were adopted in 1998, govern the classification of
transactions involving computer programs. The Treasury Department and
the IRS have determined that the rules and principles underlying
existing Sec. 1.861-18 provide useful guidance for transactions
involving digital content. Proposed Sec. 1.861-18 broadens the scope
of its application to include digital content, which is defined in
proposed Sec. 1.861-18(a)(3) as any content in digital format that is
either protected by copyright law or is no longer protected solely due
to the passage of time (e.g., books, movies, and music in digital
format, in addition to computer programs).
Cloud computing transactions, which are typically characterized by
on-demand network access to computing resources, would not generally be
subject to classification under existing Sec. 1.861-18 since such
transactions typically do not include the transfer of a computer
program, nor would such transactions be subject to proposed Sec.
1.861-18 since such transactions typically do not include the transfer
of a copyright right or copyrighted article, or provision of
development services related to computer programming. Consequently,
proposed Sec. 1.861-19 provides rules for classifying a cloud
transaction as either a provision of service or a lease of property.
D. Economic Analysis
1. Baseline
The Treasury Department and the IRS have assessed the benefits and
costs of the proposed regulation compared to a no-action baseline that
reflects anticipated Federal income tax-related behavior in the absence
of these proposed regulations.
2. Summary of Economic Effects
The proposed regulations provide certainty and clarity with respect
to the characterization of income from digital transactions and cloud
computing. In the absence of such guidance, the chances that different
U.S. taxpayers would interpret the Code differentially, either from
each other or from the intents and purposes of the underlying statutes,
would be exacerbated. This divergence in interpretation could cause
U.S. businesses to make economic decisions based on different
interpretations of, for example, whether income from making digital
music available to a user would be characterized as derived from a
service or a lease transaction for purposes of applying sourcing rules
and thus whether such income is considered domestic or foreign. If
economic decisions are not guided by uniform incentives across
otherwise similar investors and across otherwise similar investments,
the resulting pattern of economic activity is generally inefficient.
Thus, the Treasury Department and the IRS expect that the definitions
and guidance provided in the proposed regulation will help support an
efficient allocation of economic activity among taxpayers, relative to
the baseline.
The characterization of income from digital transactions and cloud
computing, for example, may impact taxpayer incentives under section
59A (the tax on certain base erosion payments) and section 250 (foreign
derived intangible income and global intangible low-taxed income). For
example, under section 59A, the characterization of a cloud transaction
as a service, as opposed to a lease, may implicate the services cost
method exception under section 59A(d)(5). Such characterization may
also impact the documentation requirements or eligibility for treatment
as foreign-derived intangible income under section 250(b). However,
because current industry practice is generally consistent with the
principles underlying the proposed regulations, the Treasury Department
and the IRS expect these regulations to have only a small effect on
economic activity or compliance costs relative to the baseline.
The Treasury Department and IRS solicit comments on the economic
effects of the proposed regulations.
3. Economic Effects of Specific Provisions
a. Transactions Involving Copyright-Protected Digital Content
Existing Sec. 1.861-18 provides rules for classifying transfers of
computer programs as, for example, a license of a computer program, a
lease of a computer program, or a sale of a computer program. Proposed
Sec. 1.861-18 broadens the scope of existing Sec. 1.861-18 to apply
to all transfers of digital content. In addition, as discussed in Part
II.B of the Explanation of Provisions section, proposed Sec. 1.861-18
clarifies that a transfer of the mere right to public performance or
display of digital content for advertising purposes does not by itself
constitute a transfer of a copyright right. Further, as explained in
Part II.C of the Explanation of Provisions section, proposed Sec.
1.861-18 provides clarity around the title passage rule of Sec. 1.861-
7(c) by providing that when copyrighted articles are sold, the sale is
deemed to occur at the location of the download or installation onto
the end-user's device, or in the absence of that information then at
the location of the customer. Proposed 1.861-7(c) provides that a sale
of personal property is consummated at the place where the rights,
title, and interest of the seller in the property are transferred to
the buyer, or, when bare legal title is retained by the seller, where
beneficial ownership passes.
In considering how the place of sale should be determined for
digital content, the Treasury Department and the IRS considered, as an
alternative, not issuing specific rules and instead retaining the
existing rules without further clarification for copyrighted articles.
The Treasury Department and the IRS elected to provided further clarity
about the sourcing of income from the sale of copyrighted articles
because (1) in the context of electronically downloaded software, the
location in which rights, title, and interest are transferred is often
difficult to determine or not specified, and (2) the location of
transfer could be easily manipulated (for example, the server location
from which a copyrighted
[[Page 40323]]
article is downloaded). Consequently, for administrative and
clarification purposes, proposed Sec. 1.861-18(f)(2)(ii) provides that
when a copyrighted article is sold through an electronic medium, the
sale is deemed to occur at the location of download or installation
onto the end-user's device. The Treasury Department and the IRS are
proposing this location definition because that is where the sale is
completed, since until the download is complete, the content is not
entirely transferred.
The Treasury Department and the IRS solicit comments on these
proposed regulations and particularly solicit comments that provide
data, other evidence, or models that would enhance the rigor with which
the final regulations governing digital content might be developed.
b. Cloud Transactions
Proposed Sec. 1.861-19 provides rules for classifying a cloud
transaction as either a lease of property (i.e., computer hardware,
digital content, or other similar resources) or a provision of
services. These rules contain a non-exhaustive list of factors which
include statutory factors described in section 7701(e)(1) and factors
applied by courts, as explained in Part I.B.2. of the Explanation of
Provisions section.
As an alternative, the Treasury Department and the IRS considered
not providing further specific guidance regarding how cloud computing
transactions should be classified (for sourcing and other purposes).
The Treasury Department and the IRS have developed the proposed
regulations (proposed Sec. 1.861-18 and proposed Sec. 1.861-19)
because they will provide clarity to taxpayers and the IRS when
determining the character of income arising from transactions involving
digital content and cloud computing. This increased clarity, relative
to the baseline, will reduce the potential for tax planning strategies
that exploit uncertainty resulting from the lack of explicit guidance
for characterizing common transactions involving digital content and
cloud computing. Consistent reporting across taxpayers also increases
the IRS's ability to consistently enforce the tax rules, thus
increasing equity and decreasing opportunities for tax evasion.
The Treasury Department and the IRS solicit comments on these
proposed regulations and particularly solicit comments that provide
data, other evidence, or models that would enhance the rigor with which
the final regulations governing cloud transactions might be developed.
E. Regulatory Flexibility Act
The Regulatory Flexibility Act requires consideration of the
regulatory impact on small businesses. It is hereby certified that
these proposed regulations will not have a significant economic impact
on a substantial number of small entities within the meaning of section
601(6) of the Regulatory Flexibility Act (5 U.S.C. chapter 6).
As discussed elsewhere in the Special Analyses, transactions
involving digital content and cloud computing have become common due to
the growth of electronic commerce. Such transactions must be classified
in terms of character in order to apply various provisions of the Code,
such as sourcing rules and subpart F. Existing Reg. Sec. 1.861-18,
finalized in 1998, provides rules for classifying transactions
involving computer programs as, for example, a license of a computer
program, a rental of a computer program, or a sale of a computer
program. These existing regulations, however, do not explicitly cover
transactions involving other digital content, such as digital music and
video, or to cloud computing transactions and thus taxpayers must
determine how these transactions should be classified for tax purposes
without clear guidance. The proposed regulations provide certainty and
clarity to these affected taxpayers.
Although data are not readily available to estimate the number of
small entities that would be affected by this proposed rule, the
Treasury Department and the IRS project that any economic impact of the
regulations would be minimal for businesses regardless of size. These
proposed regulations generally provide clarification of definitions
regarding how transactions are classified, they are not expected to
have an impact on burden for large or small businesses. The Treasury
Department and the IRS project that any economic impact would be small
because current industry practice is generally consistent with the
principles underlying the proposed regulations.
Notwithstanding this certification that the proposed rule will not
have a significant economic impact on a substantial number of small
entities, the Treasury Department and the IRS invite comments on the
impact this proposed rule would have on small entities.
Comments and Requests for a Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any comments that are submitted timely
to the IRS as prescribed in this preamble under the ADDRESSES section.
All comments will be available at www.regulations.gov or upon request.
A public hearing will be scheduled if requested in writing by any
person that timely submits comments. If a public hearing is scheduled,
notice of the date, time, and place for the public hearing will be
published in the Federal Register.
Drafting Information
The principal author of these proposed regulations is Robert Z.
Kelley of the Office of the Associate Chief Counsel (International).
However, other personnel from the Treasury Department and the IRS
participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, reporting, and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
0
Par. 2. Section 1.861-7 is amended by revising paragraph (c) to read as
follows:
Sec. 1.861-7 Sale of personal property.
* * * * *
(c) Country in which sold. For purposes of part I (section 861 and
following), subchapter N, chapter 1 of the Code, and the regulations
thereunder, a sale of personal property is consummated at the time
when, and the place where, the rights, title, and interest of the
seller in the property are transferred to the buyer. Where bare legal
title is retained by the seller, the sale shall be deemed to have
occurred at the time and place of passage to the buyer of beneficial
ownership and the risk of loss. For determining the place of sale of
copyrighted articles transferred in electronic medium, see Sec. 1.861-
18(f)(2)(ii). However, in any case in which the sales transaction is
arranged in a particular manner for the primary purpose of tax
avoidance, the foregoing rules will not be applied. In such cases, 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
[[Page 40324]]
the place where the substance of the sale occurred.
* * * * *
0
Par. 3. Section 1.861-18 is amended as follows:
0
a. For each paragraph listed in the following table, removing the
language in the ``Remove'' column and adding in its place the language
in the ``Add'' column.
------------------------------------------------------------------------
Paragraph Remove Add
------------------------------------------------------------------------
(a)(1).......................... computer programs. digital content.
(b)(1) introductory text........ a computer program digital content.
(b)(1)(i)....................... computer program.. digital content.
(b)(1)(ii)...................... computer program.. digital content.
(b)(1)(iii)..................... computer program.. digital content.
(b)(1)(iv)...................... computer development of
programming digital content.
techniques.
(b)(2), first sentence.......... Any transaction... Any arrangement.
(b)(2), first sentence.......... computer programs. digital content.
(b)(2), second sentence......... overall overall
transaction. arrangement.
(c)(1)(i), first sentence....... a computer program digital content.
(c)(1)(i), third sentence....... a computer program digital content.
(c)(1)(i), third sentence....... that program...... that digital
content.
(c)(1)(ii)...................... a computer program digital content.
(c)(1)(ii)...................... the computer the digital
program. content.
(c)(2)(i)....................... computer program.. digital content.
(c)(2)(ii)...................... computer programs. digital content.
(c)(2)(ii)...................... copyrighted digital content.
computer program.
(c)(3), first sentence.......... a computer program digital content.
(c)(3), second sentence......... program........... digital content.
(d)............................. a newly developed newly developed or
or modified modified digital
computer program. content.
(d)............................. computer program.. digital content.
(e) introductory text........... a computer program digital content.
(e)(1).......................... computer the development of
programming digital content.
techniques.
(f)(3), subject heading......... computer programs. digital content.
(f)(3), first sentence.......... computer programs. digital content.
(f)(3), second sentence......... a computer program digital content on
on disk. a disk.
(f)(3), third sentence.......... program........... digital content.
(g)(2).......................... a computer program digital content.
(g)(3)(i), first sentence....... a computer program digital content.
(g)(3)(i), first sentence....... the program....... the digital
content.
(g)(3)(i), first sentence....... software.......... digital content.
(g)(3)(ii), first sentence...... a computer program digital content.
(g)(3)(ii), first sentence...... the program....... the digital
content.
(g)(3)(ii), second sentence..... a computer program digital content.
(g)(3)(ii), second sentence..... the program....... the digital
content.
------------------------------------------------------------------------
0
b. Amend paragraph (a)(1) by:
0
i. Adding before ``367'' sections ``59A, 245A, 250, 267A,'';
0
ii. Removing ``551,''; and
0
iii. Removing ``chapter 3, chapter 5'' and adding in its place
``chapters 3 and 4,''.
0
c. Revising paragraphs (a)(3), (c)(2)(iii) and (iv), and (f)(2).
0
d. Redesignating Examples 1 through 18 of paragraph (h) as paragraphs
(h)(1) through (18), respectively.
0
e. Adding paragraphs (h)(19) through (21).
0
f. Revising paragraphs (i) and (j).
0
g. Removing paragraph (k).
The revisions and additions read as follows:
Sec. 1.861-18 Classification of transactions involving digital
content.
* * * * *
(a) * * *
(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. For example, digital content includes
books in digital format, movies in digital format, and music in digital
format. 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.
* * * * *
(c) * * *
(2) * * *
(iii) The right to make a public performance of digital content,
other than a right to publicly perform digital content for the purpose
of advertising the sale of the digital content performed; or
(iv) The right to publicly display digital content, other than a
right to publicly display digital content for the purpose of
advertising the sale of the digital content displayed.
* * * * *
(f) * * *
(2) Transfers of copyrighted articles--(i) Classification. The
determination of whether a transfer of a copyrighted article is a sale
or exchange is made on the basis of whether, taking into account all
facts and circumstances, the benefits and burdens of ownership have
been transferred. A transaction that does not constitute a sale or
exchange because insufficient benefits and burdens of ownership of the
copyrighted article have been transferred, such that a person other
than the transferee is properly treated as the owner of the copyrighted
article, will be classified as a lease generating rental income.
(ii) Source. Income from transactions that are classified as sales
or exchanges of copyrighted articles will be sourced under section
861(a)(6), 862(a)(6), 863,
[[Page 40325]]
or 865(a), (b), (c), or (e), as appropriate. When a copyrighted article
is sold and transferred through an electronic medium, the sale is
deemed to have occurred at the location of download or installation
onto the end-user's device used to access the digital content for
purposes of Sec. 1.861-7(c), subject to the tax avoidance provisions
in Sec. 1.861-7(c). However, in the absence of information about the
location of download or installation onto the end-user's device used to
access the digital content, the sale will be deemed to have occurred at
the location of the customer, which is determined based on the
taxpayer's recorded sales data for business or financial reporting
purposes. Income derived from leasing a copyrighted article will be
sourced under section 861(a)(4) or 862(a)(4), as appropriate.
* * * * *
(h) * * *
(19) Example 19--(i) Facts. Corp A operates a website that
offers electronic books for download onto end-users' computers or
other electronic devices. The books offered by Corp A are protected
by copyright law. Under the agreements between content owners and
Corp A, Corp A receives from the content owners a digital master
copy of each book, which Corp A downloads onto its server, in
addition to the non-exclusive right to distribute for sale to the
public an unlimited number of copies in return for paying each
content owner a specified amount for each copy sold. Corp A may not
transfer any of the distribution rights it receives from the content
owners. The term of each agreement Corp A has with a content owner
is shorter than the remaining life of the copyright. Corp A charges
each end-user a fixed fee for each book purchased. When purchasing a
book on Corp A's website, the end-user must acknowledge the terms of
a license agreement with the content owner that states that the end-
user may view the electronic book but may not reproduce or
distribute copies of it. In addition, the agreement provides that
the end-user may download the book onto a limited number of its
devices. Once the end-user downloads the book from Corp A's server
onto a device, the end-user may access and view the book from that
device, which does not need to be connected to the internet in order
for the end-user to view the book. The end-user owes no additional
payment to Corp A for the ability to view the book in the future.
(ii) Analysis. (A) Notwithstanding the license agreement between
each end-user and content owner granting the end-user rights to use
the book, the relevant transactions are the transfer of a master
copy of the book and rights to sell copies from the content owner to
Corp A, and the transfers of copies of books by Corp A to end-users.
Although the content owner is identified as a party to the license
agreement memorializing the end-user's rights with respect to the
book, each end-user obtains those rights directly from Corp A, not
from the content owner. Because the end-user receives only a copy of
each book and does not receive any of the copyright rights described
in paragraph (c)(2) of this section, the transaction between Corp A
and the end-user is classified as the transfer of a copyrighted
article under paragraph (c)(1)(ii) of this section. See paragraphs
(h)(1) and (2) of this section (Example 1 and Example 2). Under the
benefits and burdens test of paragraph (f)(2) of this section, the
transaction is classified as a sale and not a lease, because the
end-user receives the right to view the book in perpetuity on its
device.
(B) The transaction between each content owner and Corp A is a
transfer of copyright rights. In obtaining a master copy of the book
along with the right to sell an unlimited number of copies to
customers, Corp A receives a copyright right described in paragraph
(c)(2)(i) of this section. For purposes of paragraph (b)(2) of this
section, the digital master copy is de minimis. Under paragraph
(f)(1) of this section, there has not been a transfer of all
substantial rights in the copyright rights to the content because
each content owner retains the right to further license or sell the
copyrights, subject to Corp A's interest; Corp A has acquired no
right itself to transfer the copyright rights to any of the content;
and the grant of distribution rights is for less than the remaining
life of the copyright to each book. Therefore, the transaction
between each content owner and Corp A is classified as a license,
and not a sale, of copyright rights.
(20) Example 20--(i) Facts. Corp A offers end-users memberships
that provide them with unlimited access to Corp A's catalog of
copyrighted music in exchange for a monthly fee. In order to access
the music, an end-user must download each song onto a computer or
other electronic device. The end-user may download songs onto a
limited number of its devices. Under the membership agreement terms,
an end-user may listen to the songs but may not reproduce or
distribute copies of them. Once the end-user stops paying Corp A the
monthly membership fee, an electronic lock is activated so that the
end-user can no longer access the music.
(ii) Analysis. The end-users receive none of the copyright
rights described in paragraph (c)(2) of this section and instead
receive only copies of the digital content. Therefore, under
paragraph (c)(1)(ii) of this section, each download is classified as
the transfer of a copyrighted article. Although an end-user will
retain a copy of the content at the end of the payment term, the
end-user cannot access the content after the electronic lock is
activated. Taking into account the special characteristics of
digital content as provided in paragraph (f)(3) of this section, the
activation of the electronic lock is the equivalent of having to
return the copy. Therefore, under paragraph (f)(2) of this section,
each transaction is classified as a lease of a copyrighted article
because the right to access the music is limited.
(21) Example 21--(i) Facts. Corp A offers a catalog of movies
and TV shows, all of which are subject to copyright protection. Corp
A gives end-users several options for viewing the content, each of
which has a separate price. A ``streaming'' option allows an end-
user to view the video, which is hosted on Corp A's servers, while
connected to the internet for as many times as the end-user wants
during a limited period. A ``rent'' option allows an end-user to
download the video to its computer or other electronic device (which
does not need to be connected to the internet for viewing) and watch
the video as many times as the end-user wants for a limited period,
after which an electronic lock is activated and the end-user may no
longer view the content. A ``purchase'' option allows an end-user to
download the video and view it as many times as the end-user chooses
with no end date. Under all three options, the end-user may view the
video but may not reproduce or distribute copies of it. Under the
``rent'' and ``purchase'' options, the end-user may download the
video onto a limited number of its devices.
(ii) Analysis. (A) With respect to the ``rent'' and ``purchase''
options, the end-user receives none of the copyright rights
described in paragraph (c)(2) of this section but, rather, receives
only copies of the digital content. Therefore, transactions under
those two options are transfers of copyrighted articles.
Transactions for which the end-user chooses the ``purchase'' option
are classified as sales of copyrighted articles under the benefits
and burdens test of paragraph (f)(2) of this section because the
end-user receives the right to view the videos in perpetuity.
Transactions under the ``rent'' option are classified as leases of
copyrighted articles under paragraph (f)(2) of this section because
the end-user's right to view the videos is for a limited period.
(B) For transactions under the ``streaming'' option, there is no
transfer of any copyright rights described in paragraph (c)(2) of
this section. There is also no transfer of a copyrighted article,
because the content is not downloaded by an end-user, but rather is
accessed through an on-demand network. The transaction also does not
constitute the provision of services for the development of digital
content or the provision of know-how under paragraph (b)(1) of this
section. Therefore, paragraph (b)(1) of this section does not apply
to such transaction. Instead, the transaction is a cloud transaction
that is classified under Sec. 1.861-19. See Sec. 1.861-19(d)(9).
(i) Effective date. This section applies to transactions involving
the transfer of digital content, or the provision of services or of
know-how in connection with digital content, pursuant to contracts
entered into in taxable years beginning on or after the date of
publication of a Treasury decision adopting these rules as final
regulations in the Federal Register. For transactions involving
computer programs occurring pursuant to contracts entered into in
taxable years beginning before the date of publication of a Treasury
decision adopting these rules as final regulations in the Federal
Register, see Sec. 1.861-18(i) as contained in T.D. 8785 and T.D.
9870.
(j) Change in method of accounting required by this section. In
order to
[[Page 40326]]
comply with this section, a taxpayer engaging in a transaction
involving digital content pursuant to a contract entered into in
taxable years beginning on or after the date described in paragraph (i)
of this section may be required to change its method of accounting. If
so required, the taxpayer must secure the consent of the Commissioner
in accordance with the requirements of Sec. 1.446-1(e) and the
applicable administrative procedures for obtaining the Commissioner's
consent under section 446(e) for voluntary changes in methods of
accounting.
0
Par. 4. Section 1.861-19 is added to read as follows:
Sec. 1.861-19 Classification of cloud transactions.
(a) In general. This section provides rules for classifying a cloud
transaction (as defined in paragraph (b) of this section) either as a
provision of services or as a lease of property. The rules of this
section apply for purposes of Internal Revenue Code sections 59A, 245A,
250, 267A, 367, 404A, 482, 679, and 1059A; subchapter N of chapter 1;
chapters 3 and 4; and sections 842 and 845 (to the extent involving a
foreign person), and apply with respect to transfers to foreign trusts
not covered by section 679.
(b) Cloud transaction defined. A cloud transaction is a transaction
through which a person obtains on-demand network access to computer
hardware, digital content (as defined in Sec. 1.861-18(a)(3)), or
other similar resources, other than on-demand network access that is de
minimis taking into account the overall arrangement and the surrounding
facts and circumstances. A cloud transaction does not include network
access to download digital content for storage and use on a person's
computer or other electronic device.
(c) Classification of transactions--(1) In general. A cloud
transaction is classified solely as either a lease of computer
hardware, digital content (as defined in Sec. 1.861-18(a)(3)), or
other similar resources, or the provision of services, taking into
account all relevant factors, including the factors set forth in
paragraph (c)(2) of this section. The relevance of any factor varies
depending on the factual situation, and one or more of the factors set
forth in paragraph (c)(2) of this section may not be relevant in a
given instance. For purposes of this paragraph (c), computer hardware,
digital content, or other similar resources are referred to as ``the
property,'' and the party to the transaction making such property
available to customers for use is referred to as ``the provider.''
(2) Factors demonstrating classification as the provision of
services. Factors demonstrating that a cloud transaction is classified
as the provision of services rather than a lease of property include
the following factors--
(i) The customer is not in physical possession of the property;
(ii) The customer does not control the property, beyond the
customer's network access and use of the property;
(iii) The provider has the right to determine the specific property
used in the cloud transaction and replace such property with comparable
property;
(iv) The property is a component of an integrated operation in
which the provider has other responsibilities, including ensuring the
property is maintained and updated;
(v) The customer does not have a significant economic or possessory
interest in the property;
(vi) The provider bears any risk of substantially diminished
receipts or substantially increased expenditures if there is
nonperformance under the contract;
(vii) The provider uses the property concurrently to provide
significant services to entities unrelated to the customer;
(viii) The 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; and
(ix) The total contract price substantially exceeds the rental
value of the property for the contract period.
(3) Application to arrangements comprised of multiple transactions.
An arrangement comprised of multiple transactions generally requires
separate classification for each transaction. If at least one of the
transactions is a cloud transaction, but not all of the transactions
are cloud transactions, this section applies only to classify the cloud
transactions. However, any transaction that is de minimis, taking into
account the overall arrangement and the surrounding facts and
circumstances, will not be treated as a separate transaction, but as
part of another transaction.
(d) Examples. The provisions of this section may be illustrated by
the examples in this paragraph (d). For purposes of this paragraph,
unless otherwise indicated, Corp A is a domestic corporation; Corp B is
a foreign corporation; end-users are individuals; and no rights
described in Sec. 1.861-18(c)(2) (copyright rights) are transferred as
part of the transactions described.
(1) Example 1: Computing capacity--(i) Facts. Corp A operates
data centers on its premises in various locations. Corp A provides
Corp B computing capacity on Corp A's servers in exchange for a
monthly fee based on the amount of computing power made available to
Corp B. Corp B provides its own software to run on Corp A's servers.
Depending on utilization levels, the servers accessed by Corp B may
also be used simultaneously by other customers. The computing
capacity provided to Corp B can be sourced from a variety of servers
in one or more of Corp A's data centers, and Corp A determines how
its computing resources are allocated among customers. Corp A agrees
to keep the servers operational, including by performing physical
maintenance and repair, and may replace any server with another
server of comparable functionality. Corp A agrees to provide Corp B
with a payment credit for server downtime. Corp B has no ability to
physically alter any server.
(ii) Analysis. (A) The computing capacity transaction between
Corp A and Corp B is a cloud transaction described in paragraph (b)
of this section because Corp B obtains a non-de minimis right to on-
demand network access to computer hardware of Corp A.
(B) Corp B has neither physical possession of nor control of the
servers, beyond Corp B's right to access and use the servers. Corp A
may replace any server with a functionally comparable server. The
servers are a component of an integrated operation in which Corp A
has other responsibilities, including maintaining the servers. The
transaction does not provide Corp B with a significant economic or
possessory interest in the servers. The agreement provides that Corp
A will provide Corp B with a payment credit for server downtime,
such that Corp A bears risk of substantially diminished receipts in
the event of contract nonperformance. The servers may, depending on
utilization levels, be used by Corp A to provide significant
computing capacity to entities unrelated to Corp B. Corp A is
compensated according to the level of Corp B's use (that is, the
amount of computing power made available) and not solely based on
the passage of time. Taking into account all of the relevant
factors, the transaction between Corp A and Corp B is classified as
the provision of services under paragraph (c) of this section.
(2) Example 2: Computing capacity on dedicated servers--(i)
Facts. The facts are the same as in paragraph (d)(1)(i) of this
section (the facts in Example 1), except that, in order to offer
more security to Corp B, Corp A provides Corp B computing capacity
exclusively through designated servers, which are owned by Corp A
and located at Corp A's facilities. Corp A agrees not to use a
designated server for any other customer for the duration of its
arrangement with Corp B. Corp A's compensation reflects a
substantial return for maintaining the servers in addition to the
rental value of the servers.
(ii) Analysis. (A) As in paragraph (d)(1) of this section, the
transaction between Corp A and Corp B is a cloud transaction
described in paragraph (b) of this section because Corp B obtains a
non-de minimis right to on-
[[Page 40327]]
demand network access to computer hardware resources of Corp A.
(B) The fact that Corp A provides computing capacity to Corp B
through designated servers indicates that such servers are not used
concurrently by other Corp A customers. However, Corp A retains
physical possession of the servers. In addition, Corp A's sole
responsibility for maintaining the servers, and its sole right to
replace or physically alter the servers, indicate that Corp A
controls the servers. Although Corp B obtains the exclusive right to
use certain servers, Corp B does not have a significant economic or
possessory interest in the servers because, among other things, Corp
A retains the right to replace the servers, Corp A bears the risk of
damage to the servers, and Corp B does not share in cost savings
associated with the servers because the fee paid by Corp B to Corp A
does not vary based on Corp A's costs. The compensation to Corp A
substantially exceeds the rental value of the servers. The other
relevant factors are analyzed in the same manner as paragraph (d)(1)
of this section. Taking into account all of these factors, the
transaction between Corp A and Corp B is classified as a provision
of services under paragraph (c) of this section.
(3) Example 3: Access to software development platform and
website hosting--(i) Facts. Corp A provides Corp B a software
platform that Corp B uses to develop and deploy websites with a
range of features, including blogs, message boards, and other
collaborative knowledge bases. The software development platform
consists of an operating system, web server software, scripting
languages, libraries, tools, and back-end relational database
software and allows Corp B to use in its websites certain visual
elements subject to copyrights held by Corp A. The software
development platform is hosted on servers owned by Corp A and
located at Corp A's facilities. Corp B's finished websites are also
hosted on Corp A's servers. The software development platform and
servers are also used concurrently to provide similar functionality
to Corp A customers unrelated to Corp B. Corp B accesses the
software development platform via a standard web browser. Corp B has
no ability to alter the software code. A small amount of scripting
code is downloaded onto Corp B's computers to facilitate secure
logins and access to the software development platform. All other
functions of the software development platform execute on Corp A's
servers, and no portion of the core software code is ever downloaded
by Corp B or Corp B's customers. Corp A is solely responsible for
maintaining the servers and software development platform, including
ensuring continued functionality and compatibility with Corp B's
browser, providing updates and fixes to the software for the
duration of the contract with Corp B, and replacing or upgrading the
servers or software at any time with a functionally similar version.
Corp B pays Corp A a monthly fee for the platform and website
hosting that takes into account the storage requirements of Corp B's
websites and the amount of website traffic supported, but there is
no stand-alone fee for use of the software development platform.
Corp B agrees to pay for Corp A's website hosting services for a
minimum period, after which Corp B may continue to pay for Corp A's
website hosting services or transfer its developed websites to a
different hosting provider. Corp A agrees to provide Corp B with a
payment credit for server downtime.
(ii) Analysis. (A) Corp A's provision to Corp B of access to the
software platform is a cloud transaction described in paragraph (b)
of this section because Corp B obtains a non-de minimis right to on-
demand network access to computer hardware and software resources of
Corp A. Corp A's hosting of Corp B's finished websites is part of
the provision of access to the software platform and hardware.
(B) Corp B does not have physical possession of the software
platform or servers. Although Corp B uses Corp A's platform to
develop and deploy websites, Corp B does not maintain the software
platform or the servers on which it is hosted, and Corp B cannot
alter the software platform. Accordingly, Corp B does not control
the software platform or the servers. Corp A maintains the right to
replace or upgrade the software platform and servers with
functionally similar versions. The servers and software platform are
components of an integrated operation in which Corp A has various
responsibilities, including maintaining the servers and updating the
software. Corp B does not have a significant economic or possessory
interest in Corp A's software platform or servers. Corp B may lose
revenue with respect to the websites that it deploys on Corp A's
servers when the servers are down; nonetheless, Corp A bears the
risk of substantially diminished receipts in the event of contract
nonperformance because Corp A will provide Corp B with a payment
credit for server downtime. Corp A provides access to the servers
and platform to Corp B and other customers concurrently. Corp A is
compensated based on Corp B's level of use (that is, the amount of
computing resources provided) and not solely by the passage of time.
Taking into account all of the factors, the transaction between Corp
A and Corp B is classified as a provision of services under
paragraph (c) of this section.
(C) Although the download of a small amount of scripting code to
facilitate logins and access to the software platform would
otherwise constitute a transfer of a computer program, instead of a
cloud transaction under paragraph (b) of this section, the download
is de minimis in the context of the overall arrangement, and
therefore, under paragraph (c)(3) of this section, there is no
separate classification of the download. Similarly, the fact that
Corp B receives rights to publicly display certain copyrighted
visual elements resulting from Corp A's software development
platform on Corp B's own websites, which would otherwise constitute
a transfer of copyright rights under Sec. 1.861-18, instead of a
cloud transaction under paragraph (b) of this section, does not
require separate classification because the right to use such
elements is also de minimis. Thus, under paragraph (c) of this
section, the entire arrangement is classified as a service.
(4) Example 4: Access to software--(i) Facts. The facts are the
same as in paragraph (d)(3)(i) of this section (the facts in Example
3), except that, instead of providing website development software,
Corp A provides Corp B access to customer relationship management
software under several options such as ``entry-level,'' ``mid-
level,'' and ``advanced-level,'' via a standard web browser, which
Corp A hosts on its servers for a monthly subscription fee. Corp B
has no ability to alter the software code, and Corp A agrees to make
available new versions of the software as they are developed for the
duration of Corp B's contract, and to ensure servers' uptime in
accordance with the service level agreement.
(ii) Analysis. (A) As in paragraph (d)(3) of this section, the
transaction between Corp A and Corp B is a cloud transaction
described in paragraph (b) of this section because Corp B obtains a
non-de minimis right to on-demand network access to computer
hardware and software resources of Corp A.
(B) The relevant factors are analyzed in the same manner as in
paragraph (d)(3) of this section, except that compensation due to
Corp A is determined based on the option chosen and the passage of
time rather than a measure of computing resources utilized. Although
as a general matter compensation based on the passage of time is
more indicative of a lease than a service transaction, that factor
is outweighed by the other factors, which support classification as
a service transaction. Taking into account all of the factors, the
transaction between Corp A and Corp B is classified as a provision
of services under paragraph (c) of this section.
(5) Example 5: Downloaded software subject to Sec. 1.861-18--
(i) Facts. Corp A provides software for download to Corp B that
enables Corp B to create a scalable, shared pool of computing
resources over Corp B's own network for use by Corp B's employees.
Corp B downloads the software, which runs solely on Corp B's
servers. Corp A provides Corp B with free updates for download as
they become available. Corp B pays Corp A an annual fee, and, upon
termination of the arrangement, an electronic lock is activated that
prevents Corp B from further using the software.
(ii) Analysis. Under paragraph (b) of this section, the download
of software for use with Corp B's computer hardware does not
constitute on-demand network access by Corp B to Corp A's software.
Accordingly, the transaction between Corp A and Corp B is not a
cloud transaction described in paragraph (b) of this section.
Because the transaction involves the transfer of digital content as
defined in Sec. 1.861-18(a)(3), it is classified under Sec. 1.861-
18.
(6) Example 6: Access to online software via an application--(i)
Facts. Corp A provides Corp B word processing, spreadsheet, and
presentation software and allows employees of Corp B to access the
software over the internet through a web browser or an application
(``app''). In order to access the software from a mobile device,
Corp B's employees usually download Corp A's app onto their devices.
To access the full functionality of the app, the device must be
connected to the internet. Only a limited number of features on the
app are available without an internet connection. Corp B has
[[Page 40328]]
no ability to alter the software code. The software is hosted on
servers owned by Corp A and located at Corp A's facilities and is
used concurrently by other Corp A customers. Corp A is solely
responsible for maintaining and repairing the servers and software,
and ensuring continued functionality and compatibility with Corp B's
employees' devices and providing updates and fixes to the software
(including the app) for the duration of the contract with Corp B.
Corp B pays a monthly fee based on the number of employees with
access to the software. Upon termination of the arrangement, Corp A
activates an electronic lock preventing Corp B's employees from
further utilizing the app, and Corp B's employees are no longer able
to access the software via a web browser.
(ii) Analysis. (A) Corp A's provision to Corp B of a non-de
minimis right to on-demand network access to Corp A's computer
hardware and software resources for the purpose of fully utilizing
Corp A's software is a cloud transaction described in paragraph (b)
of this section.
(B) Corp B has neither physical possession of nor control over
Corp A's word processing, spreadsheet, and presentation software or
computer hardware. Additionally, the servers and software are part
of an integrated operation in which Corp A maintains the servers and
updates the software. Corp A makes available its word processing,
spreadsheet, and presentation software and servers to Corp B and
other customers concurrently. Corp A's compensation, though based in
part on the passage of time, is also determined by reference to Corp
B's level of use (that is, the number of Corp B employees with
access to the software). Taking into account all of the factors, the
transaction between Corp A and Corp B is classified as the provision
of services under paragraph (c) of this section.
(C) The provision of the app to Corp B's employees by download
onto their devices would be a transfer of a computer program rather
than a cloud transaction subject to paragraph (b) of this section.
However, under paragraph (c)(3) of this section, it is necessary to
consider whether that transfer is de minimis in the context of the
overall arrangement and in light of the surrounding facts and
circumstances. Here, the significance of the download of the app by
Corp B's employees is limited by the fact that the device running
the app must be connected to Corp A's servers via the internet to
enable most of the app's core functions. The software that enables
such functionality remains on Corp A's servers and is accessed
through an on-demand network by Corp B's employees. Therefore, the
download of the app is de minimis, and under paragraph (c)(3) of
this section, the entire arrangement is classified as a service.
(7) Example 7: Access to offline software with limited online
functions--(i) Facts. Corp A provides Corp B word processing,
spreadsheet, and presentation software that is functionally similar
to the software in paragraph (d)(6) of this section (Example 6). The
software is made available for access over the internet but only to
download the software onto a computer or onto a mobile device in the
form of an app. The downloaded software contains all the core
functions of the software. Employees of Corp B can use the software
on their computers or mobile devices regardless of whether their
computer or mobile device is online. When online, the software
provides a few ancillary functions that are not available offline,
such as access to document templates and data collection for
diagnosing problems with the software. Whether working online or
offline, Corp B employees can store their files only on their own
computer or mobile device, and not on Corp A's data storage servers.
Because the software provides near full functionality without access
to Corp A's servers, it requires more computing resources on
employees' computers and devices than the app in paragraph (d)(6) of
this section. Corp B's employees can also download updates to the
software as part of the monthly fee arrangement. Upon termination of
the arrangement, an electronic lock is activated so that the
software can no longer be accessed.
(ii) Analysis. The provision of the software constitutes a lease
of a copyrighted article under Sec. 1.861-18. See Sec. 1.861-
18(h)(4). The access to the online ancillary functions otherwise
would constitute a cloud transaction under paragraph (b) of this
section, but the access to these functions is de minimis in the
context of the overall arrangement, considering that the core
functions are available offline through the downloaded software.
Because there is no cloud transaction described in paragraph (b) of
this section, this section does not apply.
(8) Example 8: Data storage, separate from access to offline
software--(i) Facts. The facts are the same as in paragraph
(d)(7)(i) of this section (the facts in Example 7), except that Corp
A also provides data storage to Corp B on Corp A's server systems in
exchange for a monthly fee based on the amount of data storage used
by Corp B. Under the data storage terms, Corp B employees may store
files created by Corp B employees using Corp A's software or other
software. Although Corp A's word processing software is compatible
with Corp A's data storage systems, the core functionality of Corp
A's software is not dependent on Corp B's purchase of the storage
plan. Depending on utilization levels, the server systems providing
data storage to Corp B may also be used simultaneously for other
customers. The data storage provided to Corp B can be sourced from a
variety of server systems in one or more of Corp A's data centers,
and Corp A determines how its computing resources are allocated
among customers. Corp A agrees to keep the server systems
operational, including by performing physical maintenance and
repair, and may replace any server system with another one of
comparable functionality. Corp A agrees to provide Corp B with a
payment credit for server downtime. Corp B has no ability to
physically alter the server systems.
(ii) Analysis. (A) Corp A's provision of software and data
storage capacity constitute separate transactions, and neither is de
minimis. Therefore, under paragraph (c)(3) of this section, the
transactions are classified separately.
(B) As in paragraph (d)(7), Corp B's download of fully
functional software, along with on-demand network access to certain
limited online features, does not constitute a cloud transaction,
but rather constitutes a lease of a copyrighted article under Sec.
1.861-18.
(C) Corp A's provision of data storage constitutes a cloud
transaction because Corp B obtains a non-de minimis right to on-
demand network access to computer hardware of Corp A.
(D) Corp B has neither physical possession of nor control of the
server systems, beyond Corp B's right to access and use the servers.
Corp A may replace any server with a functionally comparable server.
The server systems are a component of an integrated operation in
which Corp A has other responsibilities, including maintaining the
server systems. The transaction does not provide Corp B with a
significant economic or possessory interest in the servers. The
servers may, depending on utilization levels, be used by Corp A to
provide significant services to entities unrelated to Corp B. Corp A
is compensated according to the level of Corp B's use (that is, the
amount of data storage used by Corp B) and not solely based on the
passage of time. Because Corp A will provide Corp B with a payment
credit for server downtime, Corp A bears risk of substantially
diminished receipts in the event of contract nonperformance. Taking
into account all of these factors, the transaction for data storage
is classified as a provision of services under paragraph (c) of this
section.
(9) Example 9: Streaming digital content using third-party
servers--(i) Facts. Corp A streams digital content in the form of
videos and music to end-users from servers located in data centers
owned and operated by Data Center Operator. Data Center Operator's
content delivery network facility services multiple customers. Each
end-user uses a computer or other electronic device to access
unlimited streaming video and music in exchange for payment of a
flat monthly fee to Corp A. The end-user may select from among the
available content the particular video or song to be streamed. Corp
A continually updates its content catalog, replacing content with
higher quality versions and adding new content at no additional
charge to the end-user. Content that is streamed to the end-user is
not stored locally on the end-user's computer or other electronic
device and therefore can be played only while the end-user's
computer or other electronic device is connected to the internet.
Corp A pays Data Center Operator a fee based on the amount of data
storage used and computing power made available in connection with
Corp A's content streaming. The storage and computing power provided
to Corp A can be sourced from a variety of servers in one or more of
Data Center Operator's facilities, and Data Center Operator
determines how computing resources are allocated among its
customers. Data Center Operator covenants to keep the servers
operational, including performing physical maintenance and repair.
Corp A has no right or ability to physically alter the servers.
[[Page 40329]]
(ii) Analysis. (A) The relevant factors for classifying the
transaction between Corp A and Data Center Operator are analyzed in
the same manner as the computing capacity and data storage
transactions in paragraphs (d)(1) and (8) of this section (Example 1
and Example 8), respectively, such that the transaction between Corp
A and Data Center Operator is classified as a provision of services
by Data Center Operator to Corp A under paragraph (c) of this
section.
(B) A transaction between Corp A and an end-user is a cloud
transaction described in paragraph (b) of this section because the
end-user obtains a non-de minimis right to on-demand network access
to digital content of Corp A.
(C) An end-user has neither physical possession of nor control
of the digital content. Additionally, Corp A has the right to
determine the digital content used in the cloud transaction and
retains the right to modify its selection of digital content.
Digital content accessed by end-users is a component of an
integrated operation in which Corp A's other responsibilities
include maintaining and updating its content catalog. Corp A's end-
users do not obtain a significant economic or possessory interest in
any of the digital content in Corp A's catalog. The digital content
provided by Corp A may be accessed concurrently by multiple
unrelated end-users. Although, as a general matter, compensation
based on the passage of time is more indicative of a lease than a
service transaction, that factor is outweighed by the other factors,
which support a services classification. Taking into account all of
the factors, a transaction between an end-user and Corp A is
classified as a provision of services under paragraph (c) of this
section.
(10) Example 10: Downloaded digital content subject to Sec.
1.861-18--(i) Facts. Corp A offers digital content in the form of
videos and music solely for download onto end-users' computers or
other electronic devices for a fee. Once downloaded, the end-user
accesses the videos and songs from the end-user's computer or other
electronic device, which does not need to be connected to the
internet in order to play the content. The end-user owes no
additional payment to Corp A for the ability to play the content in
the future.
(ii) Analysis. Under paragraph (b) of this section, the download
of digital content onto an end-user's computer for storage and use
on that computer does not constitute on-demand network access by the
end-user to the digital content of Corp A. Accordingly, the
transaction between the end-user and Corp A is not a cloud
transaction described in paragraph (b) of this section, and this
section does not apply to the transaction. Because the transaction
involves the transfer of digital content as defined in Sec. 1.861-
18(a)(3), it will be classified under Sec. 1.861-18. See Sec.
1.861-18(h)(21).
(11) Example 11: Access to online database--(i) Facts. Corp A
offers an online database of industry-specific materials. End-users
access the materials through Corp A's website, which aggregates and
organizes information topically and hosts a proprietary search
engine. Corp A hosts the website and database on its own servers and
provides multiple end-users access to the website and database
concurrently. Corp A is solely responsible for maintaining and
replacing the servers, website, and database (including adding or
updating materials in the database). End-users have no ability to
alter the servers, website, or database. Most materials in Corp A's
database are publicly available by other means, but Corp A's website
offers an efficient way to locate and obtain the information on
demand. Certain materials in Corp A's database constitute digital
content within the meaning of Sec. 1.861-18(a)(3), and Corp A pays
the copyright owners a license fee for using them. Each end-user may
download any of the materials to its own computer and keep such
materials without further payment. The end-user pays Corp A a fee
based on the number of searches or the amount of time spent on the
website, and such fee is not dependent on the amount of materials
the end-user downloads. The fee that the end-user pays is
substantially higher than the stand-alone charge for accessing the
same digital content outside of Corp A's system.
(ii) Analysis. (A) Corp A's provision to an end-user of access
to Corp A's website and online database is a cloud transaction
described in paragraph (b) of this section because the end-user
obtains a non-de minimis right to on-demand access to Corp A's
computer hardware and software resources.
(B) An end-user's downloading of the digital content would be
classified as a sale of copyrighted articles under Sec. 1.861-18.
Nonetheless, taking into account the entire arrangement, including
that the primary benefit to the end-user is access to Corp A's
database and its proprietary search engine, and that the stand-alone
charge for accessing the digital content would be substantially less
than the fee Corp A charges, the downloads are de minimis.
Accordingly, under paragraph (c)(3) of this section, there is no
separate classification of the downloads.
(C) The end-user has neither physical possession of nor control
of the database, software, or the servers that host the database or
software. Corp A retains the right to replace its servers and update
its software and database. The database, software, and servers are
part of an integrated operation in which Corp A is responsible for
curating the database, updating the software, and maintaining the
servers. Corp A provides each end-user on-demand network access to
its software and online database concurrently with other end-users.
Certain end-users pay Corp A a fee based on time spent on Corp A's
website, which could be construed as compensation based on the
passage of time and thus be more indicative of a lease than a
service transaction. However, the fee that the end-user pays is
substantially higher than the stand-alone charge for accessing the
same digital content outside of Corp A's system. Accordingly, on
balance, the fee arrangement supports the classification of the
transaction as a service transaction. Taking into account all of
these factors, the arrangement between end-users and Corp A is
treated as the provision of services under paragraph (c) of this
section.
(e) Effective/applicability date. This section applies to cloud
transactions occurring pursuant to contracts entered into in taxable
years beginning on or after the date of publication of a Treasury
decision adopting these rules as final regulations in the Federal
Register.
(f) Change in method of accounting required by this section. In
order to comply with this section, a taxpayer engaging in a cloud
transaction pursuant to a contract entered into on or after the date
described in paragraph (e) of this section may be required to change
its method of accounting. If so required, the taxpayer must secure the
consent of the Commissioner in accordance with the requirements of
Sec. 1.446-1(e) and the applicable administrative procedures for
obtaining the Commissioner's consent under section 446(e) for voluntary
changes in methods of accounting.
Sec. 1.937-3 [Amended]
0
Par. 5. Section 1.937-3 is amended by removing Examples 4 and 5 from
paragraph (e).
Kirsten Wielobob,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2019-17425 Filed 8-9-19; 4:15 pm]
BILLING CODE 4830-01-P