Aug 8, 2016
Digital sales taxes in the U.S. are becoming increasingly common as States begin to tax digital services such as Netflix, Hulu, Spotify, and games such as Pokémon GO. This taxation evolution is taking place within States as the Federal legislators drag their heels on potential legislation taxing the digital economy in the U.S.
At the start of August Pennsylvania became the latest State to extend its sales tax to include the download of books, music, games, movies, and apps. The tax is expected to raise $47 million for Pennsylvania.
States are adding a sales tax on consumer digital subscriptions and downloads due, in part, to the growing popularity of such services. Forbes recently identified the potential for taxing Pokémon GO as the share price of the game’s creator, Nintendo, rocketed. These taxes are also a means to bolster ailing tax revenue bases. In 2014 alone it has been estimated that States effectively waived $23 billion in potential revenue as a result of not applying a sales tax to online purchases.
For example, this loss of revenue was highlighted in advice given to New York City back in September 2015 by the city’s publicly funded Independent Budgeting Office (IBO). The IBO advised legislators to introduce a new sales tax on digital services and downloads in an attempt to boost New York City’s coffers. In its fiscal brief the IBO stated that New York was foregoing significant revenue from the lack of a tax on digital services:
“Independent Budget Office estimates suggest that New York City would have collected $21 million in additional 2014 sales tax revenue if digital music, video, and books were made taxable, while the State would have collected $38 million more.”
Congressional inertia on remote sales tax issue
To apply a sales tax, or not, on the supply of digital services is an issue that will not fade away. The digital economy is now omnipresent, but legislation has not kept pace with its growth. Congress has held more than 30 hearings on the topic in the past decade, but there has been no direction and no Federal legislation.
One of the central tenets of potential Federal legislation on this topic – according to previous House of Representatives Judiciary Committee hearings – is that “brick-and-mortar, exclusively online, and brick-and-click businesses should all be on equal footing. The sales tax compliance burden on online internet sellers should not be less, but neither should it be greater than that on similarly situated offline businesses.”
Instead of a cogent Federal approach the U.S. is leaving it up for States to make these legislative decisions in isolation.
States going solo on digital sales tax
Pennsylvania’s new 6% sales tax on the supply of digital services and downloads means that everyone purchasing such a digital service via a credit card with a Pennsylvania State billing address is liable for this tax. CBS Pittsburgh added that the State’s sales tax is to be applied to “music, ebooks, apps, online games, and ringtones. However, magazine and newspaper subscriptions, as well as digital versions of the Bible, will be exempt from the digital downloads tax.”
Pennsylvania is the most recent jurisdiction to enact a digital tax law but others, such as the States of Minnesota and South Carolina as well as the City of Chicago (with a 9% cloud tax enacted in July 2015 that was expected to raise $12 million annually), have set precedent. The main problem going forward is this piecemeal, State-by-State, approach to taxing the burgeoning digital economy.
All States in the U.S. can tax digital services, and some – as outlined – have done just that. The taxation conundrum when it comes to remote or intangible services is one of geography with the key question for legislators being: does the seller have nexus within the State (or relevant jurisdiction)? That’s a difficult question to grasp let alone answer in the borderless digital economy where sales can take place at any time and anywhere.
This is a major taxation debate in the U.S. right now as States continue to go it alone, enacting their own versions of digital sales tax legislation, in the face of Congressional inertia. This approach leads to a fragmented and inconsistent application of laws between States, frustrating those online sellers with consumers in multiple States.
The States, frustrated by this Congressional legislative vacuum, are enacting laws as they feel the pinch of a dwindling tax base.
Back in the fall of 1999 there was the aim of a unified approach to digital sales tax legislation with the creation of the Streamlined Sales and Use Tax Association (SSUTA). This organisation was set up by the National Governor’s Association (NGA) and the National Conference of State Legislatures (NCSL) to simplify sales tax collection.
Sales tax administration – according to SSUTA – is improved through tax law simplification, more efficient administrative procedures, and emerging technologies. To date, according to the SSUTA website, 24 States in the U.S. have passed conforming laws. Those States have a total population of over 92 million representing 33% of the country’s population.
Challenges to landmark Supreme Court sales tax decision
SSUTA’s stated goal is to find solutions for the complexity in State sales tax systems that resulted in the U.S. Supreme Court decision (Bellas Hess v.IIlinois and Quill Corp. v. North Dakota) that a State may not require a seller that does not have a physical presence in the state to collect tax on sales into the State.
Given the lack of movement from Federal legislators States are also challenging this landmark 1992 Supreme Court decision.
The simple reasons for these challenges are that the economy has moved on since 1992, but legislation has not kept pace. The nature of the digital economy is that anyone, anywhere can avail of a company’s service. The task for legislators is to “level the playing field” between local and remote sellers: it’s not an easy task but the sellers need certainty not inertia.
Interestingly, back in December 2013 the Supreme Court rejected appeals from Amazon and Overstock over a New York court ruling requiring the eCommerce giants to remit sales tax on their sales to New York consumers just as New York-based companies do.
In response to this decision North Dakota Senator Heidi Heitkamp stated that: “It’s past time that we create a federal system to require online retailers to collect and remit sales tax, just like local shops are required to do.”
This was another illustration how long this digital tax issue has dragged on since the 1992 Supreme Court decision. Heitkamp was actually the North Dakota tax commissioner at the time of that ruling, and now two decades on the battle continues over tech neutrality in the United States.
International context to the U.S. digital sales tax issue
As the digital economy is borderless it is important to understand developments around U.S. digital sales taxes in an international context.
Countries around the world are introducing laws that require U.S. businesses to collect and settle Sales Tax and VAT on digital sales to consumers in their jurisdictions. These jurisdictions have been the architects of digital tax rules that are designed around the location of the consumer. The law in these foreign countries does not take into account whether or not the U.S. business has nexus within these jurisdictions. If we flip this legal approach on its head we get the existing U.S. approach where there is no tax levied on foreign businesses supplying digital services to U.S. consumers where the business does not have a nexus in the US.
It is difficult to see a reasoning behind not levelling the playing field other than inertia. Having a simplified system that is simple and transparent for foreign digital sellers to comply with is in the interest of digital business.
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