A Preview of Treasury's Approach to the Digitalized Economy?
On August 9, 2019, Treasury and the Internal Revenue Service released two sets of regulations -- long-awaited proposed regulations on cloud transactions and proposed regulations on transactions involving digital content. Generally, the cloud transactions proposed regulations classify a cloud transaction as either a provision of services or a lease of property. Prop. Reg. 1.861-19. Treasury provided a non-exhaustive list of factors in making such determination. Although certain cloud transactions may have characteristics of both a lease of property and the provision of services, such transactions are classified as one or the other and not bifurcated into a lease and separate service transaction. If, however, the arrangement involves multiple cloud transactions, then a separate classification is made for each transaction (except any transaction that is de minimis).
The proposed regulations on transactions involving digital content contain a source rule for sales of copyrighted articles through an electronic medium. Prop. Reg. 1.861-18. The final regulations under 1.861-18, issued in 1998, included only a general reference to the title passage rule for the sale of computer programs through electronic downloads. The title passage rule provides that 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." Treas. Reg. 1.861-7(c). Since 1998, Treasury and the IRS have become aware of the uncertainty in applying the title passage rule to sales of copyrighted articles, such as electronically downloaded software. In the preamble to the proposed regulations, Treasury and the IRS wrote:
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.
In addition, Treasury and the IRS noted that the location of the transfer could be easily manipulated. For example, the server location from which the copyrighted article is downloaded could be in almost any jurisdiction in the world.
Treasury and the IRS have proposed an addition to the title passage rule, which provides that when a copyrighted article is 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. If there is an absence of information about the location of the download or installation onto the end-user's device used to access the digital content, then the sale is deemed to occur at the customer's location. The income from sales or exchanges of copyrighted articles is sourced under Code Sections 861(a)(6), 862(a)(6), 863 or 865(a), (b), (c) or (e), whichever is appropriate.