UNITED STATES

Indirect Tax News - December 2019

Sales tax and digital goods

There’s no consistent approach to the indirect taxation of digital products in the US.

Introduction

The United States does not have a Value Added Tax (VAT) at either the federal or the state level. Sales and use taxation in the US is operated independently by each of the 50 states and the District of Columbia.

Sales taxes are administered by every state except Alaska, Delaware, Montana, New Hampshire, and Oregon. It should be noted that though there is no state-imposed general transaction tax in these five states, local governments may tax transactions or there may be a state-imposed tax on specific items (for example, on gas, car rentals, alcohol). The sales tax rates vary from 2.9% to over 10%.

Unlike a VAT, a sales tax is imposed only once at the retail or consumer level. In the US, a business can be the consumer. Therefore, in many cases there will not be a pass-thru exemption for purchases by a business. As for what VAT rate to charge, this will depend. There is no universal EU VAT rate for digital goods;  the rates vary from 17-27% depending on the country.

All states impose a sales tax on computer related tangible personal property but only a few states impose a sales tax (and sometimes communications services tax or telecommunications tax) on a computer related or online service. This article will focus on the taxation of digital products or digital goods as defined in the US. We will not address the taxation of other online services, such as data processing, cloud computing, or software as a service.

VAT rules in the European Union

In 2015 VAT rules came into effect in the EU under which telecommunications, broadcasting, and electronic services are now taxable at the place where the customer is resident, not where the supplier is based. This means that the non-EU supplier selling into Europe has to deal with 28 different VAT rates and may have to register for VAT and file VAT returns in 28 different EU Member States. In the US, we have many of the same taxing and sourcing challenges regarding digital goods and services. 

United States: Overview of digital goods

The United States, along with the rest of the world, has embraced the value and convenience of the e-commerce marketplace. We purchase our music, books, movies, apps, and other online products and services and have them seamlessly delivered directly to our phones, tablets, or other storage devices. In the last decade alone, billions of books, movies, and apps have been electronically delivered to consumers around the world.

In the US, many states believe the recent downturn in their tax revenue collections has been caused by consumers increasing their online purchases of digital goods. Therefore, states have been looking for ways to impose taxes on digital products and electronic transactions. The states have arrived at a variety of ways to tax digital goods. Some states have simply used their existing sales and use laws. Other states have enacted new laws specifically aimed at the taxation of digital goods that are either accessed or downloaded over the internet.

What is a digital good?

Digital goods, sometimes referred to as digital products, electronic goods or e-goods, is a generic term used to describe particular goods that are stored, delivered, and used in an electronic format. Digital goods are shipped electronically to the consumer through e-mail or downloaded from the Internet. A digital good is usually received as an e-mail attachment or is downloaded from a secure web-site link. The common examples of digital goods include e-books, music files, software, digital images, and manuals delivered in electronic format. In reality, a digital good could be any item that can be delivered in an electronic format. However, transactions that involve electronic banking are traditionally viewed as outside the definition of a digital good. Also, digital goods generally do not include online web-hosting, software, data processing, or information services.

Taxation of digital goods under the states’ sales tax rules

Approximately 20 of the 45 states currently do not have laws to tax digital goods because they either do not have the ability to tax electronically delivered products or they have specifically identified digital goods as not subject to their sales tax.

The remaining states do not agree on a universal methodology for how to tax a digital good. There are four general classifications states use to categorize taxable digital goods:

  1. Enumerated digital products
  2. Tangible personal property
  3. Tangible functional equivalents
  4. Services

Enumerated taxable digital products

Some states have specifically identified and defined which digital goods are subject to sales tax.  For example, one state has identified digital property to include the following items that are delivered or accessed electronically:

  • Audio works;
  • Audiovisual works;
  • Books, magazines, newspapers, newsletters, reports, or other publications; and
  • Photographs or greeting cards.

So, if the digital good is not one of those specifically identified above, the product is not categorized or taxed as a digital good in the state.

Tangible personal property

Even though many states have not specifically identified digital goods as subject to tax, some of these states impose a sales tax-based provision that applies to the taxation of tangible personal property. For example, all states impose a sales tax on tangible personal property. Many of these states have tax rules that define tangible personal property to include “personal property that may be seen, weighed, measured, felt, touched, or that is in any other manner perceptible to the senses”. In order to tax digital goods, many states classified digital goods under this very broad definition of tangible personal property “anything perceptible to the senses”.

Tangible functional equivalents

Some states will impose sales tax on a digital good if the product has a tangible personal property equivalent. These states have taken the position that the “method of delivery” of the product or good is irrelevant. Therefore, if the product would have been taxable if delivered in a tangible format then the product remains taxable even if delivered through electronic means. 

Services

Some states do not tax digital products as tangible personal property but instead classify them as taxable services. This is a stark contrast to the VAT position in the European Union, which treats digital products as supplies of taxable services in all 28 Member States.

Sourcing of digital goods or services

As difficult as it is to determine whether a digital good is subject to sales tax, it can be equally challenging to determine how to source the sale of the digital good or service. Unfortunately, many states have not directly addressed the sourcing rules for digital goods and are instead relying on the sourcing rules applicable to tangible personal property. Not having a uniform digital good sourcing rule for all states has created an environment that’s encouraging double taxation because it leaves open the possibility that two states could be legally entitled to tax the same digital good transaction.

The Streamline Sales Tax Project

The Streamline Sales Tax Project (SSTP) has tried to create uniform definitions of digital goods and sourcing rules. It has received input from over 40 states, but only about a dozen states have currently adopted the SSTP sourcing rule.

Under SSTP rules, sales of digital goods would be sourced as follows:

  • The source of the sale is the seller’s place of business if the purchaser receives the digital good at the seller’s place of business.
  • The source of the sale is the location where the purchaser receives the item if the purchaser receives the item at a location other than the seller’s place of business.
  • The source the sale is the purchaser’s address as shown in the seller’s business records (though use of this address cannot be done in bad faith).
  • The source of the sale is the purchaser’s address provided at the time of sale (for example, the address on the purchaser’s payment instrument).

Should the sourcing rules above not work, the default is that the digital goods are sourced at the address where the item is first made available for transmission by the seller.

Looking to the future

To resolve the complexity of the taxation and sourcing issues related to digital goods, the US Congress had introduced the Digital Goods and Services Tax Fairness Act of 2019.  This bill was designed to promote neutrality, simplicity, and fairness in the taxation of digital goods and digital services. However, this bill and similar bills submitted in previous years have not been enacted by Congress. It remains to be seen whether Congress will pass the necessary legislation in the near future to help provide uniform rules for the taxpayers to follow.  

In today’s business environment, given that the position on the taxability of digital goods varies in each state, a seller of digital goods must to perform a state-by-state analysis to determine the sales tax treatment of their digital product. Sellers should carefully review the individual statutes, regulations, rulings, and policy statements for each state they are conducting business in to make sure they are compliant with its sales tax laws.

Steve Oldroyd
soldroyd@bdo.com

Ilya Lipin
ilipin@bdo.com