REPORT 08.07.19 The Current State of Sales on Digital Products

Joyce Beebe, Ph.D., Fellow, Center for Public Finance

Recent technological advancements have of motion. This category includes movies, transformed how people conduct their music videos, news shows, entertainment daily activities. These changes are not programs, and recorded live events. The only affecting how people live and work, SSTGB documents specify that video greeting but they are also redefining how people cards and video games are not included. entertain and learn. Today, it is common Digital audio works are the products resulting to remotely access files stored in Dropbox, from the recording of musical, spoken, or read e-books downloaded on Kindle, watch other kinds of sounds. These include songs, TV shows streamed from or Hulu, music, audiobooks, speeches, ringtones, and and listen to music through . These other sound recordings. Audio greeting cards technological developments are making sent by e-mail are not part of this category. state tax authorities assess the taxability of digital products. This report reviews the Digital books are works that are generally current landscape of state on recognized in the usual sense as “books.” digital products, court cases, administrative This category includes novel-length works of actions, congressional proposals, and fiction and nonfiction, as well as short stories. However, it does not include chat rooms, potential future developments in the There is no universally taxation of digital products. blogs, periodicals, magazines, newspapers, or other news or information products. recognized definition of digital products. The WHAT ARE DIGITAL PRODUCTS? WHAT ABOUT ? most commonly cited Before discussing the taxation of digital definition comes from products, it is first important to understand The SSUTA considers computer software as two publications by the a separate category from digital products,5 what constitutes one. At present, there Streamlined Sales Tax is no universally recognized definition of which is partly why certain states treat digital products. The most commonly cited transactions involving software differently Governing Board. definition comes from two publications by from those involving digital products. In the Streamlined Sales Tax Governing Board addition, the SSUTA specifically designates (SSTGB),1 a multistate effort to simplify sales “prewritten computer software” as a type and collection and administration.2 of “tangible personal property.” Prewritten According to the Streamline Sales and Use Tax computer software, in contrast to custom Agreement (SSUTA)3 and the SSTGB’s rules software, is generally canned or off- and procedures, “specified digital products” the-shelf computer software that is not include digital audiovisual works, digital audio developed for a specific buyer. By identifying works, and digital books. prewritten computer software as tangible personal property, the SSUTA categorizes it Digital audiovisual works are series of related as a type of personal property that “can be images that, when shown in succession with seen, weighed, measured, felt, or touched, accompanying sounds, impart an impression BAKER INSTITUTE REPORT // 08.07.19

or that is in any other manner perceptible capabilities.14 Examples of the SaaS delivery to the senses.”6 This designation has model include web-based email services, significant tax implications. calendars, and digital photo applications. States generally impose sales tax on Taxation of SaaS is the most commonly transactions involving tangible personal addressed service model by individual property, whereas custom software is states due to its popularity and ease of use. viewed as a service and only 10 states tax it.7 However, the tax treatments vary between However, the SSUTA allows member states states. For example, Texas views SaaS as to exempt prewritten computer software taxable data processing service but allows delivered electronically from sales tax.8 As a 20% of revenue to be exempted from tax; result, 45 states and Washington, D.C., tax the New York views SaaS transactions as sales transfer of prewritten software if it is loaded on of prewritten software that are therefore a CD (which makes it “tangible”).9 However, taxable as sales of tangible personal property; 12 states exempt electronically delivered and Wisconsin does not consider SaaS as a software from sales tax, leaving 33 states and taxable data processing service.15 Washington, D.C., that tax prewritten software Infrastructure as a Service (IaaS) providers 10 that is delivered electronically. offer customers computing resources so they Although classifying canned software as can run software applications and operating tangible personal property, or taxing software systems. IaaS providers enable customers to purchases when something tangible changes outsource the equipment needed to support hands, seem like simple rules, the story does the cloud infrastructure. While consumers not stop here. The recent proliferation of Although cloud do not manage or control the underlying cloud computing imposes new challenges on infrastructure, they do have control over the computing services the taxability of software. operating systems, storage, and applications. continue to expand, They may also have limited control of select networking components (e.g., firewalls).16 states have been slow CLOUD COMPUTING AND SALES TAX in addressing how Examples of the IaaS model include web hosting and remote storage services. sales apply to In simple terms, cloud accessibility can roughly be thought of as the .11 As A recent Iowa Department of Revenue the different service long as users have access to a computer ruling provides an example of IaaS. Iowa delivery models. with an internet connection, they can use recently passed rules to impose taxes cloud-based software. A cloud service on digital goods and certain services, 17 provider, such as Web Services, effective January 2019. Amazon requested Cloud, or Azure, essentially clarification regarding whether its Amazon hosts software applications on remote Elastic Compute Cloud Service (EC2) is servers where they store and process data.12 subject to tax under the new rules. The There are three distinct service delivery ruling indicated that Amazon’s EC2 supplies models for cloud computing; however, as storage space and processing power on technology and business models evolve, a network that allows customers to run cloud service providers could integrate software, applications, and operating elements from all three models.13 Although systems. Thus, the EC2 is classified as IaaS 18 cloud computing services continue to and is not taxable. expand, states have been slow in addressing In New York, IaaS is also a nontaxable how sales taxes apply to the different service. However, some practitioners service delivery models, as described below. describe this as counterintuitive because New York classifies SaaS (remotely Software as a Service (SaaS) providers accessed software) as tangible personal offer customers the ability to use property that is taxable, but views software applications running on a cloud IaaS (remotely accessed hardware that infrastructure. Customers generally do not resembles something tangible) as a manage or control the underlying cloud nontaxable service.19 infrastructure, including the network, servers, operating systems, storage, or application 2 THE CURRENT STATE OF SALES TAX ON DIGITAL PRODUCTS

Platform as a Service (PaaS) providers Similar to the lag in taxing cloud offer customers hardware and software to computing, state tax laws are behind launch their own applications on the cloud when it comes to taxing digital products. infrastructure. Consumers do not manage or Furthermore, many digital products do not control the underlying cloud infrastructure, fit into current tax rules because the rules but they do have control over the deployed existed long before the . applications and possibly the configuration States are aware of this issue but have settings for the application-hosting reacted differently, which contributes to the environment.20 For example, developers can lack of uniformity across the U.S. Some states Many digital products use a PaaS platform to create applications have not provided any guidance on taxing do not fit into current and games using programming languages, digital products, others have attempted to tax rules because the tools, and computing power supplied by a root digital product taxability in the existing rules existed long cloud service provider. The taxability of PaaS tax codes or reinterpret current laws to before the digital is less clear than for SaaS or IaaS. apply to digital products, and still others have amended their tax laws to cover these economy. States are products. Among these approaches, states aware of this issue THE CURRENT LANDSCAPE OF STATE that explicitly adopt legislation to tax certain but have reacted TAX ON DIGITAL PRODUCTS products and services have been subject to differently, which less resistance and fewer legal challenges by If the SSUTA were the sole agreement merchants or consumers.28 contributes to the lack adopted nationwide, taxing digital products Despite the complex tax treatment of of uniformity across would be more straightforward. However, digital products, it is undeniable that the the SSUTA currently has only 24 member the U.S. digital economy continues to encompass states, and several large states including a larger share of economic activities. More California, Texas, New York, Florida, and consumers are streaming or downloading Illinois are not members. Although member digital products as opposed to purchasing states have to adhere to the SSUTA’s them through tangible means. From a tax definitions of digital products, the agreement revenue perspective, it is natural to expect does not require them to tax digital products states to expand their taxing power on or align taxability with the definitions digital products. In 2019 alone, more than provided by the SSUTA.21 In other words, 10 states expanded, considered, or proposed member states may include or exclude digital product taxes.29 Even in states that certain products from taxation based on do not impose sales tax on digital products, their own rules, further complicating the tax there may be other assessments. For treatment of digital products.22 example, Florida generally does not levy This decentralization inherently means In 2019 alone, more sales tax on digital products, but it imposes that the taxability of digital products varies a 7.44% Communication Services Tax on than 10 states greatly by state. Among the 45 states video and music streaming services.30 expanded, considered, and Washington, D.C., that have state- or Chicago also imposes the Personal Property or proposed digital district-level sales taxes, 30 states and Lease Transaction Tax on cloud computing Washington, D.C., tax digital products (e.g., product taxes. services at either 5.25% or 9%.31 music, video, books), 22 tax streaming, and 17 states and Washington, D.C., tax cloud computing as of mid-2019.23 For companies NEXUS, CHARACTERIZATION, AND that offer functionally similar digital SOURCING IN THE DIGITAL WORLD products, the location of the transaction (45 states or Washington, D.C.), type of product Besides the complex state rules that (software, information, or services), form determine the taxability of digital goods, of ownership (permanently downloaded or three overarching concepts govern sales tax rental),24 payment frequency (if the right applications: nexus, the characterization of to use a product is based on continued transactions, and sourcing.32 25 payment), and delivery method (CD, Nexus generally refers to the level of 26 cloud-based software, download, or load- connection required between the state and 27 and-leave ) may play a role in taxability. 3 BAKER INSTITUTE REPORT // 08.07.19

taxpayers so that the state can impose as a transfer of intangible goods, which is taxes. In the context of sales tax, this means not taxable. Missouri simply says digital requiring sellers to collect sales taxes for goods are not tangible personal property and the state. As such, a business only needs to are therefore exempt from tax. pay sales tax if it has nexus in that state.33 Elsewhere in the U.S., companies like Historically, nexus referred to the physical Netflix and Automatic Data Processing presence of business operations (such as (ADP) have filed lawsuits against the employees, inventory, or office buildings), Arizona Department of Revenue. Netflix but that standard was overturned after the disagrees with the state’s decision that its U.S. Supreme Court ruling of South Dakota streaming services are taxable as rentals v. Wayfair, Inc., et al. (Wayfair) in 2018.34 of tangible personal property, whereas After Wayfair, nexus can be established ADP challenges the state’s position that without any physical presence in a state. cloud-based software is tangible personal Instead, significant economic presence, such property. The companies generally do not as revenue or the number of transactions, is oppose a properly enacted tax, so they sufficient to establish nexus.35 In addition, to primarily file lawsuits either because the the extent that states view digital products laws are not clear, or because they do not as tangible personal property, the changes believe existing laws characterize their generated by Wayfair also directly affect the services appropriately.38 nexus for sales of digital products.36 In contrast, digital products that are The Wayfair ruling not only changed characterized as taxable services are more the sales tax landscape for online retailers— likely to be defined as data processing Merchants mostly it also ignited state interest in taxing services than information services. For react to the lack of digital products. Digital goods and cloud example, Texas has a broad definition computing service providers have been of taxable tangible personal property; uniformity across able to fly under the state tax authorities’ it also taxes information services and the U.S. by adopting radars because states were focusing on data processing services.39 A 2019 Texas sales tax automation collecting sales taxes from online retailers; comptroller ruling reveals the difference software, referencing or after Wayfair, these providers are now between data processing services and targets for state tax authorities.37 information services.40 At a high level, requesting private letter information services handle data that rulings, or resorting to Characterization: Currently, states characterize digital products as either are more general in nature, whereas litigation. None of these tangible personal property, services, or data processing services deal with more solutions are perfect. intangible property. If a state decides that customer-specific or proprietary information. digital products are taxable, the most One issue for states that characterize common approach is to characterize them digital products as services is that they have as tangible personal property because such to comply with the Internet Tax Freedom association allows states to connect digital Act (ITFA). The ITFA prohibits states from products with existing state tax rules, imposing tax on an online version of a thereby requiring limited administrative or transaction if its similar offline version is not legislative actions. subject to tax; it also prohibits states from On the other hand, some states— imposing different tax rates or collection such as Florida, , Illinois, and obligations for online and offline service Missouri—specifically indicate that digital providers. For example, a state cannot tax products are not tangible personal property. an online tax return preparation service However, the tax treatment of digital without also taxing the fees an accountant products is different across these four would charge for providing similar services states. In Florida, video and music streaming in person. Since most states are not eager to are not subject to sales tax but are subject expand the scope of their sales tax base to to the Communication Services Tax. In include the performance of personal services, Connecticut, digital goods are taxable at 1%, navigating the delicate balance between the same rate as data processing services. characterizing digital products as services and following the ITFA remains a challenge. 4 Illinois considers the sale of digital products THE CURRENT STATE OF SALES TAX ON DIGITAL PRODUCTS

Sourcing: For state sales taxes, sourcing COMPANY RESPONSE refers to the location where a transaction takes place and how the tax rules apply. Merchants mostly react to the lack of Most states and Washington, D.C., apply uniformity across the U.S. by adopting sales sales tax according to destination-based tax automation software, referencing or sourcing, meaning the location of the requesting private letter rulings, or resorting purchaser determines what sales tax rates to litigation. None of these solutions are and rules apply to the transaction. For perfect; tax automation software can be 11 states, origin-based sourcing applies, costly, and the path to obtain a revenue meaning the sales tax rules at the location of or court ruling could take years. In the 41 the seller determines the sales tax. meantime, practitioners reference state When it comes to digital products or private letter rulings to understand each cloud computing, sourcing depends on state revenue department’s perspective in how transactions are characterized. For taxing new technologies. Below are a few instance, if cloud computing is characterized recommendations for coping with the lack Congress recognizes as tangible personal property, it would of clear and consistent state guidance in the complexity of generally be sourced based on its destination taxing digital goods. digital goods taxes or location of use. However, defining use is The most common suggestion is across the U.S., and not without challenges—for remote storage unbundled billing, meaning listing different like IaaS, “use” could arguably be defined services as separate line items for billing it has attempted to as where the data is stored, where the purposes to avoid tax on the entire bundled provide a solution, equipment or server is located, or where the transaction. For instance, California has which designates user retrieves data. In the case of PaaS, it generous unbundle rules in which software the consumer state of can be argued that the location of hardware sold with other taxable items is exempt should be considered. unless it is sold in a tangible form.43 residence as the taxing On the other hand, if cloud computing is Nevertheless, certain states have strict authority for their characterized as a service, it would generally unbundle rules where separate line items digital purchases. be sourced based on where the benefit of on invoices do not necessarily prevent Despite being the service is derived, which could include states from taxing everything on the bill. For introduced multiple more than one state. When a customer example, a ruling indicates that downloads music on their phone and listens although a company provides both cloud- times, this bill has not as they travel, it is difficult to ascertain based employment scheduling software gained much attention. where they derive benefit. To complicate and subsequent programming and support the issue further, there needs to be a profit services, the “true object” is to use the apportionment when a transaction involves software instead of the services. Without multiple states, and companies could the software, the services would have no arguably use the expected usage, actual value to customers.44 The Tennessee ruling usage, or a pro-rata split based on time to states that when a transaction involves apportion profits. taxable and nontaxable components and the The Multistate Tax Commission (MTC) transaction’s true object is subject to tax, recognizes the complexity and uncertainty the entire transaction is taxable. around the various approaches to sourcing Another suggestion is that companies digital goods and services for the purpose should provide appropriate product and of sales taxes. As such, the MTC is currently transactional descriptions consistently studying the issue with the goal of developing across different departments. Contracts a model sourcing statute. The MTC believes drafted by a legal department, software that a statute generated by state-led efforts functionality descriptions prepared by an would be superior to a federal preemption, R&D department, sales brochures designed which typically takes a long time to by a marketing department, and invoices 42 accomplish and even longer to revise. generated by an accounting department should have consistent language delineating the products and services provided.

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Some words such as “platform, solution, Chicago over this tax (Labell v. Chicago). applications, or data processing” may be The plaintiffs believe it violates the ITFA, desirable for marketing purposes; however, the U.S. (which forbids without clear descriptions, these terms may discrimination against interstate commerce), attract the attention of tax authorities.45 and the Illinois Constitution (which requires A recent Texas private letter ruling state and local governments to tax similar reviews the case of a company that sells items at the same rates). A circular court subscriptions of a cloud-based customer ruled in favor of Chicago in May 2018,50 relationship management (CRM) platform arguing that the city only applies the tax to clients, which is SaaS and a taxable data to activities with a substantial nexus in the processing service. Besides the platform, city. The court also stated that Chicago the company also provides advisory does not discriminate against interstate services, which are usually nontaxable commerce. Furthermore, the ruling noted services in Texas. The Texas comptroller that there are substantial differences states that when a nontaxable service between streaming and other forms of is provided with taxable services, it will entertainment; as such, it is justifiable be considered nontaxable only if the two for streaming products to be classified service are unrelated. The ruling cites the differently. The plaintiffs appealed the case There are many parallels company’s executed contracts—which before the First District Appellate Court, and between the ongoing specify that the advisory service ends when a decision is pending.51 development of digital the CRM subscription ends—as evidence Apple also sued Chicago for the goods taxation and that the advisory service is not offered same amusement tax ruling using similar 52 the seemingly settled independently from the sale of the CRM arguments. Because of the similarities platform.46 The comptroller also points out between the two cases, it is pending until the taxation of online sales; that the company’s website stipulates that appellate court decides on Labell v. Chicago. however, for digital an integral part of the advisors’ role is CRM goods, the complexity platform optimization. As a result, the ruling A FEDERAL PROPOSAL FOR A DIGITAL is multiplied by more decided that the company’s services are not provided on a stand-alone basis, and both GOODS AND SERVICES TAX granular variations in transactions are therefore taxable.47 terms of the products, Congress recognizes the complexity of digital goods taxes across the U.S., and it delivery methods, and RECENT COURT CASES has attempted to provide a solution. The the length of ownership. Digital Goods and Services Tax Fairness Act In 2015, Chicago’s Department of Finance (S. 765/H.R. 1725)53 was introduced in March issued a ruling and determined that its 9% 2019. The bill provides a national framework amusement tax applies to internet-based for digital goods taxes and designates the video, music, and game streaming services consumer state of residence as the taxing such as Netflix, Apple, Spotify, Xbox Live, authority for their digital purchases. The bill and Hulu.48 It has become known as the also requires that states tax digital goods and “Netflix Tax,” and Chicago became the first services at the same rate as similar tangible major city in the U.S. to impose such a tax goods and services. on streaming activities. Opponents are concerned that this Critics argue that the tax is unfair framework is overly wide, does not provide because it distinguishes between streaming guidance for individual states, and— entertainment and downloaded movies considering the evolving and amorphous and music. The ruling considers streaming scope of the digital economy—may require services as rental activities involving frequent revisions. However, federal only temporary ownership that are preemptions are usually difficult to revise. therefore subject to the 9% tax, whereas Furthermore, there are disagreements as to downloads are sales involving permanent whether Congress is the appropriate authority ownership that are not taxable.49 A civil to address the issue, or if the taxation of rights organization filed a lawsuit against digital goods falls within states’ rights.54 6 THE CURRENT STATE OF SALES TAX ON DIGITAL PRODUCTS

Considering the bill has been introduced four ENDNOTES times and has not gained much attention, the lack of uniformity in digital goods taxes will 1. SSTGB (Streamlined Sales Tax Governing persist for the near future. Board, Inc.), “About Us,” accessed June 14, 2019, https://www.streamlinedsalestax.org/ about-us/about-sstgb. CONCLUSION 2. When a buyer purchases taxable goods from a seller without paying sales The digital economy has experienced tax, the buyer is required to remit a use tax unprecedented growth that has not gone on taxable goods to the state. Essentially, unnoticed by state and local governments use taxes shift the responsibilities for tax in search of sustainable tax revenue. There remittance from the seller to the buyer are many parallels between the ongoing in cases where the tax is not collected by development of digital goods taxation and the seller. See Joyce Beebe, E-Commerce: the seemingly settled taxation of online Recent Developments in State Taxation of sales, such as how antiquated state laws Federal guidance is Online Sales, Issue Report no. 07.13.17. Rice should evolve to tax the digital economy unlikely, so states University’s Baker Institute for Public Policy, and what the best method is to alleviate the Houston, Texas, https://www.bakerinstitute. should address issues undue burden for small businesses. org/research/state-taxation-online-sales/. related to the taxability However, one issue surrounding digital 3. SSTGB, Streamline Sales and Use goods taxation is more complex than the of digital goods Tax Agreement (SSUTA) (Westby, WI: debate involving online merchants: in through legislative SSTGB, December 14, 2018), Appendix C. Wayfair, the main challenge centers on how actions instead of II, 108, https://www.streamlinedsalestax. different states define nexus. For digital org/docs/default-source/agreement/ simply fitting new goods, the complexity is multiplied by more ssuta/ssuta-as-amended-2018-12-14. granular variations in terms of the products, products and services pdf?sfvrsn=8a83c020_6. delivery methods, or even differences into outdated rules. 4. SSTGB, Rules and Procedures in the length of ownership. In addition, (Westby, WI: SSTGB, May 3, 2018), 70, digital products and services increasingly https://www.streamlinedsalestax.org/ incorporate a wider range of components docs/default-source/agreement/ssuta- that are not easily distinguishable from a rules/rules-as-amended-2018-05-03. taxability perspective, which means that the pdf?sfvrsn=d09623a6_17. complexity will only increase over time. 5. SSTGB, Streamline Sales, Section The future is clear: more states are going 332.A, 57. to tax digital products at a much broader 6. SSTGB, Streamline Sales, Appendix level. The consequences for the lack of C. II, 101, 106. “Tangible personal property” consistency in state tax laws and the absence includes electricity, water, gas, , and of national guidelines are also clear: state prewritten computer software. governments would experience reduced 7. States generally tax canned compliance and decreased revenue. Federal software delivered in a tangible form guidance is unlikely, so states should address unless modifications were made. There are issues related to the taxability of digital differences between states in the taxation of goods through legislative actions instead modified canned software. The 10 states that of simply fitting new products and services tax custom software are Hawaii, Louisiana, into outdated rules. State revenue agencies Mississippi, , New Mexico, South can supplement the process through Carolina, South Dakota, Tennessee, Texas, administrative actions, such as letter rulings, and West Virginia. See Christopher T. Lutz, administrative notices, or audits. States “A Multistate Perspective on Taxation attempting to impose such a digital goods tax of Digital Products,” The National Law without clear legislative support are sure to Review, February 19, 2019, https://www. encounter long legal battles. natlawreview.com/article/multistate- perspective-taxation-digital-products.

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8. SSTGB, Streamline Sales, Appendix C. 15. Texas Comptroller of Public II, 107. Accounts, “Private Letter Ruling No. 9. New Hampshire, Oregon, Montana, 201705045L,” May 30, 2017. https://star. Alaska, and Delaware do not have sales comptroller.texas.gov/view/201705045l. taxes; they are sometimes referred to as Texas defines SaaS as “a software NOMAD states. application delivery model where a vendor 10. Brian Hamer, Sourcing Digital develops a web-native software application Goods and Services, Multistate Tax and hosts and operates the application Commission (MTC) (Denver, CO: Multistate for use by its customers over the internet. Tax Commission, April 25, 2019), Customers do not pay for owning the http://www.mtc.gov/getattachment/ software itself but rather for using it.” Uniformity/Uniformity-Committee/2019/ 16. Mell and Grance, The NIST Definition. Agenda-4-2019/Digital-products-report- 17. State of Iowa, S.F. 2417 (signed May Denver-final.pdf.aspx. 30, 2018), https://www.legis.iowa.gov/ 11. NIST (the National Institute of legislation/BillBook?ga=87&ba=sf2417. Standards and Technology) formally 18. Michael Bologna, “Amazon defines cloud computing as “a model Cloud Services are Taxable, Iowa for enabling ubiquitous, convenient, Revenue Department Says,” Bloomberg on-demand network access to a shared Law, February 7, 2019, https://news. pool of configurable computing resources, bloombergtax.com/daily-tax-report-state/ which could be networks, servers, storage, amazon-cloud-services-are-taxable-iowa- applications and services, that can be rapidly revenue-department-says. provisioned and released with minimal 19. Joseph Endres, “Taxing Cloud management effort or service provider Computing: New York Gets It Half Right,” interaction.” See NIST, Final Version of NIST Hodgson Russ, July 28, 2015, https://www. Cloud Computing Definition Published, NIST, hodgsonruss.com/blogs-Noonans-Notes- October 25, 2011, https://www.nist.gov/ Blog,cloud-computing-tax-iaas. news-events/news/2011/10/final-version- 20. Mell and Grance, The NIST Definition. nist-cloud-computing-definition-published. 21. SSTGB, Streamline Sales, Section 12. In a non-cloud-based system, 332.E, 58. companies must maintain their own servers 22. Gail Cole, “State by State Guide and hardware, and users must physically to the Taxability of Digital Products,” CPA install programs on their personal computers Practice Advisor, February 25, 2019, , via CDs. A cloud-based system therefore https://www.cpapracticeadvisor.com/ relieves companies from the burden of sales-tax-compliance/article/12441611/ operating and owning their own hardware statebystate-guide-to-the-taxability-of- and software systems. Jillian Hufford, digital-products. “Cloud vs. SaaS: What is the Difference?” 23. Brian Hamer, Sourcing Digital Goods. Multichannel Insights (blog), nChannel, 24. Jennifer Dunn, “Sales Tax by February 6, 2018, https://www.nchannel. State: Should You Charge Sales Tax on com/blog/cloud-vs-saas/. Digital Products?” TaxJar, March 12, 2019, 13. Carolynn Iafrate Kranz and Iris https://blog.taxjar.com/sales-tax-digital- Kitamura, “Navigating the Cloud: A Sales & products/. Use Tax Guide,” Avalara, accessed June 14, 25. William Ault and Kendall Phillips, 2019, https://www.avalara.com/us/en/ “Digital Goods and Services: How to Avoid learn/whitepapers/navigating-the-cloud- Tax Related Traps,” Journal of Multistate a-sales-use-tax-guide.html. Taxation and Incentives 28, no. 4 (July 14. Peter Mell and Timothy Grance, 2018): 1-15, https://www.crowe.com/-/ The NIST Definition of Cloud Computing, SP media/Crowe/LLP/folio-pdf/Digital-Goods- 800-145 (Gaithersburg, MD: NIST, September and-Services-Avoid-Tax-Traps-JMTI-TAX- 2011), https://csrc.nist.gov/publications/ 19002-027A_2.ashx?la=en-US&hash=424 detail/sp/800-145/final. 58CB599BE3951B30B81ADC7E09AF2145771 0E. The authors state that Indiana only taxes 8 THE CURRENT STATE OF SALES TAX ON DIGITAL PRODUCTS

specified digital products where consumers no. 01.09.19. Rice University’s Baker Institute have the right of permanent use that is for Public Policy, Houston, Texas, https:// not conditioned on continued payments. www.bakerinstitute.org/research/recent- Other states, such as South Dakota and developments-eus-digital-tax-proposal/. New Jersey, impose sales tax regardless of 33. Joyce Beebe, E-Commerce, payment type. Recent Developments in State Taxation of 26. New Jersey distinguishes between Online Sales, Issue brief no. 07.13.17, Rice the taxability of streamed and downloaded University’s Baker Institute for Public Policy, digital products. Streamed videos are Houston, Texas, https://www.bakerinstitute. exempt when they are only accessed and org/media/files/files/21ea3b88/BI-Brief- not delivered to the purchaser. See Ault and 071317-CPF_Ecommerce.pdf. Phillips, “Digital Goods and Services,” 9. 34. South Dakota v. Wayfair, Inc., 27. “Load-and-leave” means the et al, 585 U.S. (2018). https://www. vendor travels to the customer's location supremecourt.gov/opinions/17pdf/17-494_ and installs the software directly onto the j4el.pdf. customer's computer using tangible storage 35. Joyce Beebe, How Did the Supreme media. Once the installation is complete, the Court Change Online Sales Taxation?, tangible media is returned to the seller. Issue brief no. 06.26.18, Rice University’s 28. John Buhl, “Chicago’s Netflix Tax Baker Institute for Public Policy, Houston, is Wasting Good Policy Bandwidth,” Tax Texas, https://www.bakerinstitute.org/ Foundation, November 21, 2018, https:// files/13072/. taxfoundation.org/chicagos-netflix-tax-is- 36. Ault and Phillips, “Digital Goods and wasting-good-policy-bandwidth/. Services.” 29. These states include Arizona (S.B. 37. Marvin Kirsner and Glenn Newman, 1460), Connecticut (H.B. 7424), Georgia (H.B. “Supreme Court’s Online Tax Decision Will 428), Illinois (H.B. 3359), Kansas (H.B. 2352), Impact Cloud Computing and Software Maryland (H.B. 426), Nevada (A.B. 447), Industries,” GreenbergTraurig, June Oklahoma (H.B. 2531 and S.B. 842), and 27, 2018, https://www.gtlaw.com/ Rhode Island (governor’s FY2020 budget). en/insights/2018/6/supreme-courts- Iowa and Washington D.C.’s digital goods online-tax-decision-will-impact-cloud- taxes became effective in 2019. computing-and-software-industries. 30. Florida Department of Revenue, 38. Brenna Goth and Ryan Prete, “Communication Services Tax,” accessed “Netflix, Others Push States to Decide on July 17, 2019, http://floridarevenue.com/ Taxing Their Services,” Bloomberg Law, May taxes/taxesfees/Pages/cst.aspx. 17, 2019, https://news.bloombergtax.com/ 31. Chicago Department of Finance, daily-tax-report-state/netflix-others- “Personal Property Lease Transaction push-states-to-decide-on-taxing-their- Tax,” accessed June 14, 2019, https:// services. www.chicago.gov/city/en/depts/fin/ 39. Texas Tax Code § 151.0101(a)(10) and supp_info/revenue/tax_list/personal_ (12). propertyleasetransactiontax.html. 40. Texas Comptroller of Public 32. The current discussion of state Accounts, Private Letter Ruling No. sales tax on digital products is parallel to 20180411151546, February 22, 2019. the international effort of taxing digital https://star.comptroller.texas.gov/ activities. The focus of the international view/201902014L?q1=SaaS. Information discussion is to give more taxing rights service means “furnishing general to the jurisdictions where consumers are or specialized news or other current located. However, the effort also focuses information, including financial information on redefining the taxable presence, thereby or electronic data retrieval or research.” allowing companies that do not have a Rule 3.342(a)(1) states that “processing, physical presence to share taxable profits. reformatting, or manipulating data provided See Joyce Beebe, Recent Developments on by the customer is data processing and is the E.U.’s Digital Tax Proposal Issue Report 9 BAKER INSTITUTE REPORT // 08.07.19

not included in the definition of information 52. Apple Inc. v. Chicago, Ill. Cir. Ct., No. services.” Data processing services include 2018-L-050514. (most recently: motion to “word processing, data entry, data retrieval, stay granted February 1, 2019) data search, information compilation . . . and 53. U.S. Congress, S. 765, Digital Goods other computerized data and information and Services Tax Fairness Act of 2019, storage or manipulation.” Section 151.0035. March 13, 2019, https://www.congress.gov/ 41. There are 11 origin-based sourcing bill/116th-congress/senate-bill/765/text. This states: Arizona, California, Illinois, Mississippi, bill was also proposed in 2011, 2015, and 2018. Missouri, New Mexico, Ohio, Pennsylvania, 54. For detailed descriptions of the Tennessee, Texas, Utah, and Virginia. arguments opposing the bill, see (1) Brian 42. Hamer, Sourcing Digital Goods. Hamer, Sourcing Digital Goods; (2) Michael 43. Lutz, “A Multistate Perspective.” Mazerov, “Proposed Digital Goods and 44. Tennessee Department of Revenue, Services Tax Fairness Act Likely to do More “Letter Ruling #17-15,” November 16, 2017, Harm Than Good In Current Form,” Center on https://www.tn.gov/content/dam/tn/ Budget and Policy Priorities, August 11, 2011, revenue/documents/rulings/sales/17-15.pdf. https://www.cbpp.org/research/proposed- 45. Ault and Phillips, “Digital Goods and digital-goods-and-services-tax-fairness- Services.” act-likely-to-do-more-harm-than-good- 46. One issue worth noting is that tax in; and (3) Brenna Goth and Ryan Prete, authorities generally consider the substance “Netflix, Others Push.” of a transaction as more important than the form. Generally, cloud computing contracts are executed through either a service AUTHOR agreement or agreement. Joyce Beebe, Ph.D., is a fellow in public Parties may enter into a contract called finance at the Baker Institute. Her a service agreement, but the underlying See more Baker Institute Reports at: research focuses on tax reforms in the www.bakerinstitute.org/baker-reports terms, conditions, provisions, and rights U.S. and computable general equilibrium conferred are more similar to a license modeling of the effects of tax reforms. Her This publication was written by a agreement. State tax authorities often researcher (or researchers) who other research interests include wealth review the contracts to determine the participated in a Baker Institute project. accumulation over a person’s lifetime and, substance of a transaction. Wherever feasible, this research is generally, how public policies influence 47. Texas Comptroller of Public reviewed by outside experts before it is decision-making. released. However, the views expressed Accounts, “Private Letter Ruling No. herein are those of the individual 2017010120,” September 25, 2017, author(s), and do not necessarily https://star.comptroller.texas.gov/ represent the views of Rice University’s Baker Institute for Public Policy. view/201709026L. 48. Chicago Department of © 2019 Rice University’s Baker Institute Finance, “Amusement Tax Ruling,” for Public Policy June 9, 2015, https://www.chicago. gov/content/dam/city/depts/rev/ This material may be quoted or supp_info/TaxRulingsandRegulations/ reproduced without prior permission, provided appropriate credit is given to AmusementTaxRuling_5_06_09_2015.pdf. the author and Rice University’s Baker 49. Buhl, “Chicago’s Netflix Tax.”. Institute for Public Policy. 50. Circuit Court of Cook County, Illinois, Opinion and Order, Labell v. Chicago, May Cite as: 24, 2018, https://ljc-assets.s3.amazonaws. Beebe, Joyce. 2019. The Current State of Sales Tax on Digital Products. com/2015/09/Labell-v.-Chicago- Baker Institute Report no. 08.07.19. 2018.05.24-Opinion-and-Final-Order.pdf. Rice University’s Baker Institute for 51. Appellate Court of Illinois First Judicial Public Policy, Houston, Texas. District, Appellants’ Brief, Labell v. Chicago, December 5, 2018, https://ljc-assets. https://doi.org/10.25613/fnwn-bp96 s3.amazonaws.com/2015/09/Labell-v.- Chicago-2018.12.05-Appellants-Brief.pdf. 10