Proposed “Digital Goods and Services Tax Fairness Act” Likely to do More Harm Than Good In Current Form
[i] See: Michael Mazerov, "Case for Regulating State and Local Taxation of Digital Goods and Services Has Little Merit," Center on Budget and Policy Priorities, August 11, 2011; https://www.cbpp.org/cms/index.cfm?fa=view&id=3561.
[ii] More than one locality taxing digital goods/services — such as a city and a county — could conceivably encompass a given customer tax address. For the sake of readability, this report will refer to a single locality.
[iii] For example, Texas Administrative Code, Subchapter O, Rule 3.330, "Data processing services," provides: "(1) To the extent a data processing service is used to support a separate, identifiable segment of a customer's business (other than general administration or operation of the business) the service is presumed to be used at the location where that part of the business is conducted. (2) If that part of the business is conducted at locations both within and outside the state, the service is not taxable to the extent it is used outside Texas. A multi-state customer may use any reasonable method for allocation which is supported by business records. (3) A multi-state customer purchasing data processing services for the benefit of both in-state and out-of-state locations is responsible for issuing to the data processing service provider an exemption certificate asserting a multi-state benefit, and for reporting and paying the tax on that portion of the data processing charge which will benefit the Texas location." Section 8202 of the Revised Code of Washington [State] provides for similar treatment of digital goods, "digital automated services," computer software, and other services purchased by businesses for "multiple points of use."
[iv] This is the primary sourcing rule for most business purchases of digital goods and services. It is superseded by a slightly different rule covering digital goods and services sold and delivered by mobile phone providers. It is also nominally superseded by a rule covering sales of digital goods and services received by the purchaser at the premises of the seller. It is hard to conceive of realistic circumstances in which that would occur, however, since, by definition, digital goods and services are transferred electronically and not on physical media like DVDs.
[v] If the seller of a digital good/service is in a different state than the purchaser, but has some physical presence (property and/or employees) in the state of the purchaser, then the tax it will be charging the customer technically is a use tax rather than a sales tax. However, there is nothing different about the seller's role in charging one tax versus the other. If the seller does not charge the use tax because it does not have a physical presence in the state of the purchaser, then the purchaser is still legally obligated to self-remit the use tax (if one is imposed).
The Act says that "Taxes on or with respect to the sale of digital goods or digital services may be imposed only by the State and local jurisdictions whose territorial limits encompass the customer's tax address." Because that sentence makes no reference to "use" of a digital good or service, proponents of DGSTFA might argue that the sourcing rules only apply to sales taxes and not use taxes, and therefore don't preclude any state in which a digital good or service is used from trying to collect use taxes directly from the purchaser. But that would mean conceding that the sourcing rules do not apply to use taxes that sellers are required to collect, either — a proposition that proponents of the legislation undoubtedly do not intend. Accordingly, taxes, "with respect to the sale of digital goods or digital services," are undoubtedly intended to encompass use taxes, meaning that the entire sourcing provision applies to such taxes. Accordingly (and as explained in the body of the report), if a purchaser tells a seller that it is using a digital good or service in one state where it clearly has a business location, the Act effectively precludes other states in which the product is also being used from imposing a use tax on even a portion of the purchase price.
[vi] There are no state or local sales taxes in Delaware, Montana, New Hampshire, or Oregon. There is no state sales tax in Alaska, although some local governments there do levy sales taxes.
[vii] See pp. 3-5 of the source cited in Note 1.
[viii] Amazon CEO Jeff Bezos recently disclosed that 30 percent of the items sold on Amazon's site are third-party sales. See: Laura Hazard Owen, "Amazon's Bezos: Mobile Shopping Has Great Room for Improvement," June 7, 2011, http://paidcontent.org/article/419-amazons-bezos-mobile-shopping-has-great-room-for-improvement-/ .
[x] There is considerable circumstantial evidence that sales tax compliance by many of the smaller third-party sellers on Amazon and eBay is poor, even when they are selling taxable items to residents of their home states and are therefore clearly legally obligated to charge the tax. Nonetheless, there is some amount of compliance taking place, if for no other reason than Amazon does charge tax on behalf of some of its third party sellers. Accordingly, some revenue will be lost if the enactment of DGSTFA effectively allows sellers to start collecting and paying tax on the wholesale price rather than the retail price of their merchandise.
[xi] According to its proponents, the Act is only intended to regulate the taxation of digital goods and services. Thus, there is absolutely no justification for the inclusion in the definition of "seller" the terms "tangible personal property" and "other services." The inclusion of those terms is worrisome and could result in much wider unintended consequences from the enactment of DGSTFA than those being discussed in this report. If proponents believe those terms are needed here, then they need to explain in detail what problems they foresee if they are removed.
[xii] In testimony in support of DGSTFA, Robert D. Atkinson of the Information Technology and Innovation Foundation stated that digital music tracks worth $1.5 billion had been sold in 2010, that mobile device "apps" worth $1.6 billion had been sold in the same year, and that sales of digital books surpassed $1.0 billion and are expected to triple by 2015. His testimony is available at judiciary.house.gov/hearings/pdf/Atkinson05232011.pdf.
[xiii] The scenario being described in this section is not far-fetched. Indeed, Amazon has done something very similar to avoid charging sales tax in jurisdictions in which it has located its warehouses. It has formed a separate subsidiary to own those warehouses and claimed that it does not have to charge sales tax in the states in which the warehouses are located because the nominal seller of its merchandise is a different subsidiary that does not have a physical presence in those states. See: Michael Mazerov, "Amazon's Arguments Against Collecting Sales Taxes Do Not Withstand Scrutiny," Center on Budget and Policy Priorities, Revised November 29, 2010, pp. 6-7; www.cbpp.org/11-16-09sfp.pdf.
[xiv] See: Michael Mazerov, "Banning Taxation of Online Hotel Reservations is Unwarranted and Could Cost States and Localities Billions of Dollars," Center on Budget and Policy Priorities, Revised September 18, 2009; https://www.cbpp.org/sites/default/files/atoms/files/9-2-09sfp.pdf . See also: Michael Mazerov, "State and Local Governments Should Close Online Hotel Tax Loophole and Collect Taxes Owed," Center on Budget and Policy Priorities, April 11, 2011; www.cbpp.org/files/4-12-11sfp.pdf.
[xv] Such disputes are all the more likely because the language refers to "charges" rather than "costs." There are no separate "charges" for a bundled digital good or service by definition; the "charge" is whatever the seller says it would hypothetically charge if it were separately charging for the item. The company's cost of providing the digital good or service, in contrast, could be determined with reasonable objectivity, although there would still be disputes about the appropriate profit margin to apply to these costs.
[xvi] Several leading proponents of DGSTFA are mobile telephone companies that have been involved for years in an effort to roll back what they view as excessive and discriminatory tax rates that apply to their services. Some of these companies may be selling, or may be contemplating selling, digital goods and services in a bundle with basic phone service. (For example, they may be selling a package that allows cell phone service subscribers to download a certain number of smartphone apps per month or to include a video streaming service.) Given their position that the tax rate on cell phone service is discriminatory in many jurisdictions, it is understandable that they would want to carve out some amount of the total charge attributable to the bundled digital goods and services that would not be subject to such a "discriminatory" rate. That would especially be true in jurisdictions where the digital goods and services would be completely exempt if sold separately. Nonetheless, if otherwise tax-exempt non-digital goods and services are taxable at the general sales tax rate in the jurisdiction when sold in a bundle with taxable goods, otherwise tax-exempt digital goods and services should be taxable as well when bundled with taxable items.
[xvii] Amazon's "Participation Agreement" for its "Marketplace" sellers states: "You agree that it is the Seller's responsibility to determine whether Seller Taxes apply to the transactions and to collect, report, and remit the correct seller taxes to the appropriate tax authority. You also agree that Amazon is not obligated to determine whether Seller Taxes apply and is not responsible to collect, report, or remit any sales, use, or similar taxes arising from any transaction." Available at http://www.amazon.com/gp/help/customer/display.html?nodeId=1161302 .
[xviii] In response to objections about DGSTFA's exception to the Tax Injunction Act, proponents have argued that the Act does not require that challenges based upon it be brought in federal court but merely authorizes concurrent federal court jurisdiction. This is a disingenuous argument. Leaving aside the fact that corporations routinely complain that their tax challenges do not get a fair hearing in state courts whose personnel are paid with state tax revenues, most states require the payment of challenged taxes while litigation is proceeding. An injunction against payment is usually only available when the case is brought in federal court, which is why DGSTFA challenges will inevitably be brought there if the Act is enacted in its current form.
[xix] The Streamlined Sales and Use Tax Agreement is available at http://www.streamlinedsalestax.org/uploads/downloads/Archive/SSUTA/SSUTA%20As%20Amended%2005-19-11.pdf
[xx] See Section 332A of the Agreement and its definition of "tangible personal property."
[xxi] See, for example, Section 310.A.5. and Section 311.C. of the Agreement.
[xxii] See Section 332D of the Agreement.
[xxiii] See: Michael Mazerov, "The '4-R' Act: A Cautionary Tale for the Proposed 'Internet Tax Freedom Act'," Center on Budget and Policy Priorities, April 24, 1998. Available from the author.
[xxv] The author of this report is a long-time Rhapsody subscriber, which is why it is used as an example several times.
[xxvi] See the answer to the first question on the "Tax Facts" document on the Download Fairness Coalition's website at www.downloadfairness.com/tax-facts/. "Streaming of a movie or video game" is provided as an example of both a digital good and a digital service.
[xxvii] Letter from Martin Morris, Federation of Tax Administrators, to Representative Howard Coble, dated Mary 31, 2011. Copy available from the author of this report.
[xxviii] The "Terms and Conditions" document for Apple's iTunes Store states "Your total price will include the price of the product plus any applicable sales tax; such sales tax is based on the bill-to address and the sales tax rate in effect at the time you download the product. We will charge tax only in states where digital goods are taxable." See: www.apple.com/legal/itunes/us/terms.html.
[xxix] For example, as discussed above, the Act authorizes businesses that sell, for one price, a package of taxable goods/services and tax-exempt digital goods/services to "unbundle" them if they can "reasonably" separate the two charges and charge tax only on the taxable item. This provision could conceivably open the door to consumer class action lawsuits against a company on the grounds that it assigned too little of the combined charge to the tax-exempt items and therefore overcharged tax. This is not a hypothetical. AT&T was just forced to pay almost $1 billion to its customers to settle a class-action suit alleging that it had improperly charged tax on data services that were tax exempt under the Internet Tax Freedom Act. AT&T was a major supporter of the enactment of ITFA. Had the law never been enacted, the company would not have had to pay this money out of its own pocket while trying to collect refunds from state and local governments.