[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]


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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.

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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