What new cloud technology tax changes could mean for Canadian businesses
The growth of cloud computing technologies is challenging tax rule frameworks—and Canadian businesses should be mindful of how new domestic and U.S. guidelines could affect them.
Traditional tax regulation relied on physical location, but this becomes complicated with cloud technologies like software as a service (SaaS), platform as a service (PaaS) and infrastructure as a service (IaaS) where customers and companies can be located in different jurisdictions.
As service providers and customers increasingly span the globe, regulatory bodies had to adapt in order to appropriately tax these entities. Recently, three Canadian provinces—and the U.S. Internal Revenue Service (IRS)—announced new measures for taxing provisions of cloud technologies.
These changes can create immediate tax and pricing obligations, impose new registration and collection requirements and increase the need for allocation methods for cross-jurisdictional customers.
Canadian businesses, in consultation with the appropriate advisors, should evaluate their tax readiness so they can meet their obligations under the updated rules. Critical steps include:
- Confirming where customers are located and how usage will be supported.
- Updating invoicing.
- Implementing tax technology systems that allow for proration.
- Mapping where research and development, key technical personnel and infrastructure are located so cross-border businesses can understand potential U.S. sourcing outcomes under the proposed framework.
Provincial sales tax application on SaaS/PaaS/IaaS
Manitoba, Saskatchewan and British Columbia updated their respective tax regulations to effectively account for provisions of cloud computing services such as SaaS, PaaS, and IaaS.
Cloud technology providers will need to confirm where their clients are located to determine whether they have provincial sales or retail tax obligations.
The taxes are applicable where the services are used in each province. All three sets of regulations allow for proration where the software is used across multiple jurisdictions.
| Province | Tax applicable to: |
|---|---|
| Manitoba |
|
| British Columbia | Software purchased for use on, through or with an electronic device ordinarily situated in B.C.—or is used on, through or with an electronic device ordinarily situated in B.C. |
| Saskatchewan | Sold for consumption or use in or relating to Saskatchewan. |
B.C. and Saskatchewan indicated that a billing address can generally be used to determine where the services will be used. However, B.C.’s new regulations advise using an IP address to determine location as the billing address may differ from where the device is located physically.
Why new U.S. rules matter for Canadian businesses
The IRS released its final regulations on Jan. 10, 2025 regarding the classification of digital content transactions and cloud transactions. It also announced proposed regulations regarding the determination of the source of income from cloud transactions.
These regulatory changes have meaningful implications for companies with cross-border operations. In addition to determining whether income earned by foreign entities in the U.S. is subject to U.S. tax, the changes affect U.S. taxation of:
- Withholdable payments made to non-U.S. recipients.
- Foreign tax credits.
- Income earned by foreign affiliates of U.S. entities.
Canadian businesses with international customers, or with operations like servers in the U.S., should carefully review these revised regulations to understand their potential effects.
Like the aforementioned provincial changes, the U.S. regulations permit taxpayers to use the billing address of the purchaser of digital content to determine where purchasers are located.
Conversely, the proposed rules for cloud transactions would determine U.S.-sourced gross income using a formula that looks at three cost-based factors tied to the provider’s intangibles and R&D, personnel and tangible property such as servers. The income is sourced to the U.S. to the extent those factors are located or performed in the U.S.
The proposed sourcing rules would apply specifically on a taxpayer‑by‑taxpayer basis—focused on the entity’s own employees and assets—and would not use customer or end‑user location or contract‑execution location as a proxy.
However, an anti-abuse rule under the regulations allows the IRS to adjust the source of income if a transaction is structured with a principal purpose of reducing U.S. tax liability in a manner inconsistent with the purpose of the rules.