Article
Bringing tax regulations into the digital world with changes to income sourcing
Oct. 7, 2019 · Authored by Steven Schechter, Rich Croghan
On Aug. 9, 2019, the IRS published proposed U.S. Department of the Treasury (Treasury) regulations in an attempt to clarify that transactions involving digital content and cloud computing should be treated as a sale, lease, license, or provision of services. This classification is important when applying various international provisions of the Internal Revenue Code.
Digital content and cloud computing have existed for more than 20 years. However, the recent development of popular business models that involve both prompted the IRS to provide much-needed guidance to assist taxpayers with the classification and sourcing of digital and cloud-related income.
The proposed regulations — an update to Regulation Section 1.861-18 and the new Proposed Regulation Section 1.861-19 — would apply to relevant transactions entered into in tax years beginning on or after the date of publication of the Treasury decision to adopt the regulations as final.
Computer software and digital content
The existing Regulation Section 1.861-18 — often referred to as the computer software regulations — were released in 1998. They were intended to help classify transactions related strictly to computer programs and didn’t directly address transactions involving digital format software and media.
The new proposed regulations were drafted in response to subsequent changes in modern computer storage and service technology as well as the increased digitization of today’s economy.
Proposed Regulation Section 1.861-18 builds on the existing regulations by broadening its scope to include digital content, which is defined as any content in digital format that’s either protected by copyright law or unprotected by copyright law solely due to the passage of time. This definition applies whether the medium of transfer is physical, digital, or otherwise.
For example, digital content might include items purchased digitally, such as movies, books, video games, or music.
Cloud transactions
New Proposed Regulation Section 1.861-19 is intended to assist taxpayers with classifying transactions under modern fundamental service models, such as:
- Software as a Service
- Platform as a Service
- Infrastructure as a Service
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