By: John Pletz, Crain’s Chicago Business
Like shoppers getting a post-holiday credit card bill, tech companies are suffering sticker shock after finding out what the city’s cloud tax will cost them.
Companies such as Amazon Web Services are warning their customers in Chicago that they’ll be collecting the city’s new 5.25 percent tax on their bills in the new year. For some companies, that could mean an annual tax in the six figures that will pinch profits or increase their burn rates, which could cause them to slow their rate of expansion.
“The tax will siphon revenue away, and we’ll be able to hire fewer people this year,” said one CEO who declined to be named for fear of putting a target on his company. “It’s a ton of money that we hadn’t budgeted for.”
Although there’s an exemption for startups that are less than five years old and that have under $25 million in annual revenue, it won’t apply to some of the city’s growth-stage tech companies, which have 100 or more employees and are just beginning to hit their strides.
When word of the tax—technically a clarification that the city’s existing personal property use tax applies to cloud software and services such as hosting—broke, the startup tech community howled.
After months of negotiations between City Hall staff and representatives from the tech community, the tax was reduced from 9 percent to 5.25 percent.
“I can’t help but note the tension between Chicago saying that it wants to support the high-tech job generators on the one hand while imposing this tax that makes us less competitive on the other,” says the CEO of another growth-stage tech company who also declined to be named for fear of being singled out by the city’s tax collectors.
Tech companies have been one of the bright spots for the city’s economy in recent years, providing growth in jobs and demand for office space. But Chicago is one of a few tech cities that are taxing cloud software, including Boston, New York, Seattle and Austin, Texas. Chicago and Austin appear to be the only ones that specifically tax cloud-based infrastructure.
The tax went into effect Jan. 1 and the first monthly payments are expected Feb. 15.
The city contends the tax amounts to applying the existing personal property lease transaction tax to leased software or computer hardware. Revenue officials say some companies already were paying the tax, while competitors were not. The city also notes the 5.25 percent tax on cloud services is lower than Austin’s 6.6 percent rate.
While the tax applies to software accessed via the Internet, such as Microsoft Office or Salesforce, the biggest bite could come on cloud services and infrastructure. A growing number of tech companies run much of their businesses on computers owned by companies such as Amazon, IBM or Microsoft. Some tech companies run their businesses entirely in the cloud.
HOW TO COLLECT?
But confusion abounds about exactly how to pay and collect the tax. There are two issues. One is the tax for tech companies on cloud-based hosting services they purchase themselves from Amazon, Microsoft, IBM or others, as well as the cloud-based software programs used for marketing or sales that they buy from tech companies such as Salesforce. Other cities that tax cloud-delivered software—such as New York, Austin and Seattle—charge rates ranging from 6.25 percent to 9.6 percent, the mayor’s office says.
The other impact comes if the companies also provide their technology to customers via the cloud. They would have to collect the tax from their customers in Chicago. Among the questions is how such a tax would be collected from a large customer that is headquartered in Chicago but has facilities outside the city where much of that software is used.
“A lot of people are trying to figure out the impact and trying to figure out how to properly account for it,” says Michael Gray, a partner at law firm Neal Gerber & Eisenberg in Chicago. He estimates he has dozens of clients who are affected.
“One of the major issues is the city seems to want to get a tax on every piece of the cloud you incorporate into your business, then when you resell it, you or your customers have to pay again,” he said. “It’s multiple layers of tax on the same transaction, which doesn’t seem right.”
The new rules are confusing enough that Amazon Web Services sent a second letter to customers last week saying it won’t immediately be able to start billing and collecting taxes from its customers individually but will calculate the taxes owed on those services and pay the city directly. Amazon did not respond to a request for comment.
A CHILL IN THE AIR
Confusion only adds to the consternation that entrepreneurs—many of whom have been supportive of Mayor Rahm Emanuel, who cultivated a very close relationship with the tech community during his first term in office—say they’re feeling. It’s unclear exactly how much revenue is involved. The city won’t say. So it’s hard to tell if this fight is worth it.
“I’ve been nothing but impressed with how supportive the city, and Mayor Emanuel in particular, have been with the tech community, and to do something that’s pretty detrimental to it seems counter to the spirit in which the city has been acting,” Gray said.
“I think it will have a chilling effect on people starting and keeping tech firms here. My clients who have operations in other parts of the state or world are looking at shifting things away from here. The jobs that tech companies create should generate far more taxes than this cloud tax.”
One sizable, fast-growing tech company said it’s looking at potentially moving some software back to its own local servers, exploring whether the tax on software and purchased or leased hardware, when coupled with capital-expense deductions on the other side of the ledger, could be cheaper than paying 5.25 percent on its entire bill from AWS or another cloud provider. That won’t hurt the city as much as it hurts other technology companies—though it’s hard to see the cloud trend reversing.
Emanuel wooed tech companies as a valuable, if overlooked, constituency that, as he said many times, “just wants City Hall to stay out of its way.” He’s definitely got a constituency that’s not shy about speaking up or looking after its own interests. Be careful what you wish for.