International Tax Panorama

The Internal Revenue Service (IRS) has recently issued final regulations that significantly impact resellers of Software-as-a-Service (SaaS) products, especially for U.S.-based companies dealing with foreign vendors. These changes, which build on the foundations set by the 2019 Proposed Regulations, shift the landscape of how cloud transactions are treated under U.S. tax law. Let’s delve into the specifics and implications of these regulations for US based SaaS resellers of foreign entities.

A Shift in Classification: All Cloud Transactions Deemed Services

Previously, cloud transactions could be classified either as a lease of property or the provision of services. The 2025 Final Regulations have streamlined this by classifying all cloud transactions exclusively as services. This uniform classification simplifies the tax approach but necessitates a closer look at how income from these transactions is sourced and taxed.

Impact on SaaS Resellers

For resellers of cloud services, this classification means that their transactions are now consistently treated as service provisions. A practical example provided in the regulations illustrates this shift, showing how a U.S. reseller of a UAE-based SaaS product must approach taxation. Under these new rules, the income generated by reselling SaaS products is considered service income, which can have varying tax implications depending on where the services are deemed to be performed.

New Sourcing Rules for Digital Content

The IRS has adopted a new sourcing rule that bases the location of a digital sale at the customer’s billing address. This change addresses the challenges of applying location-based rules in the digital age, where users might utilize VPNs or reside in multiple jurisdictions. For SaaS resellers, this means the physical location of data download or software installation no longer dictates tax obligations—instead, it’s where the customer pays from that matters.

Determining the Place of Performance

With the transition to all services, determining the place of performance has become crucial for tax purposes. The IRS proposes a three-factor test to pinpoint this:

• Personnel Factor: Where are the employees who manage the cloud infrastructure based?
• Tangible Property Factor: Where is the physical property used in providing the service located?
• Intangible Property Factor: Where are the intangible assets, like software and algorithms, developed and managed?

For foreign companies employing US resellers, these factors will determine if their income is considered U.S. sourced and thus subject to U.S. federal income tax. If services are performed outside the U.S., they might not be taxed domestically, which is a significant consideration for planning and structuring operations.

Tax Consequences and Strategic Moves

The Final Regulations pose several strategic considerations for SaaS resellers:

• Avoiding U.S. Taxable Presence: Companies should consider structuring their operations to ensure that significant parts of their cloud service provisioning, especially R&D and managerial activities, occur outside the U.S. This can minimize the risk of creating a taxable presence.

Conclusion

The IRS’s updated approach to cloud transactions as purely service-based brings both clarity and new challenges to the tax landscape for SaaS resellers. Understanding these new regulations is crucial for U.S. companies engaged in global digital service transactions to navigate tax liabilities effectively and optimize their business structures for international operations. For foreign companies with US SaaS resellers adapting to these changes will be key to maintaining profitability and compliance in an increasingly digital world economy.