State and Local Tax Jurisdictions Address Media Streaming and Cloud Services

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Tax-Jurisdictions-Address-Media-Streaming-And-Cloud-Services Netflix and other purely electronic transmission services have become a large part of U.S. entertainment consumption.  Recently, states are beginning to contemplate how these services (or perhaps goods, depending on how you classify them) should fit within their sales tax regimes.  Sales of CDs, DVDs, video games and packaged software have been declining for years as consumers are increasingly streaming comparable services directly from the internet.  The average inflation-adjusted sales tax revenue growth rate nationwide between 2004 and 2014 was about 1.5%.  That figure is down significantly from the 3.1% rate seen a decade earlier.  This disparity can be largely attributed to the revenue lost from declining physical media sales.  National yearly spending on DVD and Blue-ray discs alone has fallen at least 50% from over $20.2 billion less than a decade ago to about $10 billion currently.   This has resulted in a loss of hundreds of millions of tax receipts for state and local governments.   

In order to make up for the lost revenue, state and local governments are looking to a broad array of new digital products that have, for the most part, previously gone untaxed.  Those products include cloud computing, streaming, and other e-commerce transactions.

States have been taxing tangible goods for a long time, however new digital products do not fit seamlessly into the established regulatory framework that provides statutory authority.  Nonetheless, some states have applied electronic transmission taxes through creative interpretation while others have rewritten entirely new tax law.   Some have taken a hybrid approach by extending the definition of services and tangible personal property in statutes, regulations, and administrative guidance to include digital products.
In Tennessee, consumers pay as much as a 7% tax on software and digital games.  In Chicago, city residents pay an extra 9% tax to use services such as Netflix and Spotify. Florida exempts digital goods from taxation, however, has an expansive communication services tax that encompasses a range of telecommunication and audiovisual services transmitted by any medium.

What these states end up with is a patchwork of complex regulation developed over the span of multiple decades or even centuries.  Meanwhile, the technology keeps evolving at a pace that many legal systems are not keeping up with.

Some states have explored the issue in painstaking detail only to decide not to tax electronic transmissions at all.  California applies sales tax only to tangible personal property, excluding digital products.  Alabama recently put its version of the “digital transmissions tax” on hold by writing to the Commissioner of the Department of Revenue stating, “We have [The Alabama Legislature] received concerns from several members of the legislature and other interested parties that the amendments [to the Alabama Administrative Code allowing rental taxes to apply to digital transmissions] may be overly expansive and may also be considered a new tax in which case the Alabama Legislature would be the proper governmental body from which to make such a determination or enactment.”   

Missouri and Virginia thought the courts were the appropriate governing body leaving their ruling in force which held that streaming video content is not subject to sales tax or communications services tax.  Vermont recently abandoned its bid to levy a tax on cloud computing because the legislature concluded it was more akin to a service than a tangible good.  Idaho has taken a somewhat similar position exempting cloud-based software sales and downloadable software.  

These varying positions breed much uncertainty over what the actual law is in any given jurisdiction.  Already, Kentucky and Louisiana are entangled in litigation with Netflix over the issue.  More litigation will inevitably follow. One thing however is clear--digital electronics are here to stay.  How and when each local tax system will respond is anybody’s guess.  

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Charles R Goulding Attorney/CPA, is the President of R&D Tax Savers.

Michael Wilshere is a Tax Analyst with R&D Tax Savers.