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Chicago Will Protect Tech Startups from the New ‘Cloud Tax’

The new tax on streaming services came under fire from the local tech community, and the mayor’s office is now responding.

Rahm at 1871   Photo: Michael Tercha/Chicago Tribune

It’s not the coughing up a few extra cents to pay for their “Orange is the New Black” binges that has some Chicagoans up in arms over the new “cloud tax,” which will start taxing city residents who use streaming services such as Netflix and Spotify. The city’s burgeoning startup community, fresh off its most successful year yet, is concerned that the 9 percent tax could put a strain on local businesses.

“Worse than that, it could provide a chilling effect on local tech entrepreneurs that are considering Chicago as a home,” says Brian Fitzpatrick, founder and CTO of Tock, a restaurant-ticketing platform. “I expect they’ll look long and hard at other alternatives, be it the suburbs, New York or even Silicon Valley.”

The “cloud tax” comprises two long-standing levies—the Amusement Tax (est. 1986) and the Personal Property Lease Transaction Tax (est. 1974)—which the Department of Finance amended earlier this month to include “electronically delivered amusements” and “nonpossessory computer leases.” City spokeswoman Elizabeth Langsdorf said in a statement to Chicago magazine that the amendments are nothing new and simply clarify what was already in place.

Streamed data wasn’t previously considered “personal property” under the Lease Transaction Tax, however—at least, the city didn’t enforce it that way—and that’s the big red flag for tech entrepreneurs. Of particular concern are nonpossessory computer leases, which refer to accessing information via the Internet from a computer you don’t own (aka the cloud). Google Docs, Dropbox, and databases such as LexisNexis all count in this.

Digital startups already spend a pretty penny on the cloud, with platforms such as Amazon Web Services making up the second-largest expense for startups after labor, according to Fitzpatrick. And now, after a barrage of complaints from tech entrepreneurs, the mayor is tuning in.

Rahm Emanuel and his office are taking a second look at the nuances of the tax that quietly went into effect without a vote. In a statement to tech incubator 1871, the mayor’s office promised it will “basically exempt start-ups (based on revenue) from paying the tax.” 1871 posted a portion of that statement to its blog last week:

“…we will announce that the administration will be taking measures to provide relief to small businesses so as not to put them at a competitive disadvantage with their peers in other cities. It will take us a month or so to formalize the proposal, but it will basically exempt start-ups (based on revenue) from paying the tax. Obviously a lot of legal issues here as this tax has been on the books for decades, but we are confident we can work through them.”

Under pressure from the local tech community, the administration has decided to enforce the tax differently than it originally planned—we just don’t know how yet.

“Based on feedback we have received from Chicago’s vibrant start-up community, the administration will be taking measures to provide relief to small businesses so as not to put them at a competitive disadvantage,” Langsdorf said. “Proposals are being discussed with stakeholders and will release further guidance later this month.”

2014 was Chicago’s best year ever for digital startups, and we’re halfway through what nearly three out of four entrepreneurs expected to be a better year than the last, according to Silicon Valley Bank’s Annual Innovation Economy Outlook report. Local tech companies raised $4.3 million per day in 2014, compared with $2.9 million in 2013, according to Built in Chicago, an online community for entrepreneurs. There were more exits in Chicago last year than in any previous year, with GrubHub, apartments.com, and Trunk Club among several companies that were bought out. SVB’s report suggests that growth is expected to keep on going.

SVB’s report also indicates that for 41 percent of executives, tax policies affect their strategic decisions. And while Chicago has a low cost of living and job growth on its side—the city says it’s created more than 15,000 tech jobs since 2011—some entrepreneurs are concerned that a tax on something as fiscally significant as cloud services could push new startups out of the city.

Moreover, Michael Wynne, a Chicago-based partner with global law firm Reed Smith, says he’s concerned about the legal ability of the Lease Transaction Tax to cover cloud services in the first place.

“In the Lease Transaction Tax ordinance, one of the things it requires is that the contracts identify the property that is being leased,” he explains. “I don’t know that these cloud service agreements really ever specifically define property, nor are they written as leases. They’re written as service agreements, license agreements.”

In spite of widespread confusion over the new tax—seemingly from both ends—Mayor Emanuel has been historically supportive of Chicago’s growth as a tech hub. Small businesses may be in luck if his exemption comes through.

“After all that the city has done to encourage innovation, I am confident that Mayor Emanuel will do what it takes to prevent small businesses from relocating or discouraging them to start up here in the first place,” says Heidi Brown, founder of Options Away, one of ChicagoInno’s 10 startups to watch this summer.

Businesses should know by the end of the month to what extent the tax will affect them. Until then, anxiety-ridden innovators will have to keep an eye on their monthly bills. 


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