Taxation of digital goods
are software programs, music, videos or other electronic files that users download exclusively from the Internet. Some digital goods are free, others are available for a fee. The taxation of digital goods and/or services, sometimes referred to as digital tax and/or a digital services tax, is gaining popularity across the globe.
The digital economy makes up 15.5% of global GDP in 2021 and has grown two and a half times faster than global GDP over the past 15 years, according to the World Bank. Many of the largest digital goods and services companies are multinational, often headquartered in the United States and operating internationally. There are significant differences in corporate tax rates between countries, and multinational companies can legally use base erosion and profit shifting to report their profits against intellectual property held in low tax jurisdictions to reduce their corporation tax liabilities. This has led to many new legal and regulatory considerations. In the field of international taxation, there has been debate about whether the current rules are appropriate in the modern global economy, especially regarding the allocation of income and profits among countries and the effect of this on taxes paid in each country.
Almost 50 jurisdictions have made changes in their current legislation regarding the taxation to include the digital tax, or presented new laws focused on taxation of digital economy.
Background
Reform to the international tax system
In 2013, the Organization for Economic Cooperation and Development began a project to examine base erosion and profit shifting of multinational companies, with aim to create a single set of consensus-based international tax rules. In 2015, G20 Finance Ministers agreed a series of recommendations for setting minimum standards in national tax systems, revising international standards for the way those systems interlock, and promoting best practices. Under the auspices of the G20, an interim report was made in March 2018. In June 2019, G20 Finance Ministers agreed proposals drawn up by the OECD to find a consensus-based solution by the end of 2020. Later that year, the OECD launched a two-part consultation: first, proposals for determining where tax should be paid and on what basis, as well as what portion of profits could or should be taxed in the jurisdictions where clients or users are located ; and, second, a proposal for a 'global minimum corporate tax level'. In October 2020, the OECD announced that it expects an agreement by mid-2021. The agreement was endorsed by the G7 Finance Ministers in June 2021.National digital services taxes
In the meantime, several countries led first by the European Union have begun to propose and implement digital services taxes which have a number of aims: to raise tax revenues; to put pressure on other countries – in particular the United States – to reach an agreement; and, arguably, to create a level playing field until the OECD/G20 framework reaches an agreement or comes into force. Public debate in many countries has asked whether Big Tech companies are paying too little tax.These national DSTs are mainly aimed at a small number of large digital companies that meet a worldwide revenue threshold and a domestic taxable sales threshold. In practice, most of these companies have their headquarters in the United States. The DSTs that have been proposed or implemented have similar characteristics and almost all were announced to be temporary measures. They are a mix of gross receipts taxes and transaction taxes that apply at rates ranging from 1.5% to 7.5% on receipts from the sale of advertising space, provision of digital intermediary services such as the operation of online marketplaces, and the sale of data collected from users. The attribution of revenue to a jurisdiction is generally based on whether the taxed service is viewed or enjoyed by a consumer on a device located in the jurisdiction based on its IP address or another geolocation method. Some countries have adopted various exemptions to the DST, including for payment services, digital content, and intragroup services.
Criticism
Digital services taxes have been criticized for a number of reasons including: distorting market behavior by discriminating primarily against large U.S. MNCs and therefore providing a relative advantage to other countries' businesses that fall below the revenue threshold; taxing a business input that will likely be passed on to consumers ; and, lack of harmonization in the application of these taxes which may result in double taxation if, for example, two or more countries tax the same revenue stream.North America
United States
In the United States, taxation of digital goods is partially governed by a federal statute and has been the area of significant state legislative and rule-making activity. States initially were slow to enact taxes on downloads, but with recent downturns in tax revenue caused by consumers purchasing more digital downloads, many states have sought ways to impose taxes on purely digital transactions. There are multiple ways that downloads are taxed; some states use their existing franchise, sales, and use taxes to tax purchases/uses/transactions of consumers of Internet goods and services, while other states enacted laws specifically aimed at digital downloads.History
In 1997, the United States federal government decided to limit taxation of Internet activity for a period of time. The Internet Tax Freedom Act prohibits taxes on Internet access, which is defined as a service that allows users access to content, information, email or other services offered over the Internet and may include access to proprietary content, information, and other services as part of a package offered to customers. The Act has exceptions for taxes levied before the statute was written and for sales taxes on online purchases of physical goods.The statute has been amended three times since its enactment to extend this prohibition. The first amendment solely extended the Act's duration. The second extended it again and clarified the definition of Internet access as including certain telecommunication services, as well as reorganizing sections within the Act. The third amendment again extended the prohibition but narrowed the definition of Internet access to "not include voice, audio or video programming, or other products and services... that utilize Internet protocol... and for which there is a charge" except those related to a homepage, email, instant messaging, video clips, and personal storage capacity.
In 2009, Anna Eshoo, Congresswoman from California's 14th District, introduced a bill to make the Act permanent in its most recent permutation. However, this bill died in committee.
States levying a tax on digital goods may be violating the ITFA. The states using their original tax code may fall within the grandfather clause of the ITFA, but there has been no litigation to clarify this or other aspects of the Act. One of the few cases brought under the ITFA involved Community Telecable of Seattle suing the city of Seattle in Washington state court, where Telecable claimed it should not have to pay a telephone utility tax because it was an Internet access provider under the ITFA. The Washington State Supreme Court held that Telecable could not be taxed as a telephone provider when it was providing Internet access under the ITFA.
Every digital-specific tax created by a state has been enacted after the ITFA became law. These laws may be preempted because the ITFA bars taxes on Internet access, and multiple or discriminatory taxes on electronic commerce. Courts have yet to clarify whether the existing laws compound taxes or are discriminatory, although it is likely that these laws can survive scrutiny under the ITFA because they can be interpreted to only tax services that fit within the exception to Internet access described in the statute and to be the only taxes on these digital products. On the other hand, there may be problems with these taxes because they may cover products and services dealing with homepages, email, personal storage, or video clips.
Without litigation, it may be difficult to distinguish the difference between the definitions of content given by the ITFA, such as between a video clip and video programming. iTunes, for example, could be designated as video programming for the videos it sells based on the definition found in the federal statute regulating cable companies, and as video clips for its previews. These laws may also run into trouble if they tax a download that is already taxed by another state, because multiple taxes are defined as taxing property that has been taxed once before by another state or political subdivision.
Another possible federal limitation on Internet taxation is the United States Supreme Court case, Quill Corp. v. North Dakota, 504 U.S. 298, which held that under the dormant commerce clause, goods purchased through mail order cannot be subject to a state's sales tax unless the vendor has a substantial nexus with the state levying the tax. The dormant commerce clause could also apply to any efforts to tax downloads. Since most downloads are from companies that are centralized in a small number of states, it is likely that there will not be many states with a substantial nexus to download providers. At present, no litigation has arisen to determine what will be defined as a proper nexus for a distributor of digital content within a state. It is possible that a state would argue that servers are enough of a nexus to tax the content passing through, although the Supreme Court has already ruled that communication by common carrier is not enough to form a substantial nexus.
States relying on general tax laws to govern digital goods
Some states presume that downloads are automatically covered by their existing tax statutes based on the common law definition of tangible personal property, which is anything that holds value on its own that is not real property.- Alabama
- Arizona – Uses definition of tangible personal property to be anything that can be discerned by human perception, which includes digital goods transmitted electronically.
- New Mexico – New Mexico Property Tax Code § 7.35.2
- Utah – Clarified its tax law to include digital products in 2008, though it claimed sales tax on these products prior to the amendment.
- West Virginia
- Indiana – Interprets tangible personal property as anything that can be perceived by the senses, including electricity, water, gas and steam. Yet, the taxes do not reach as far as purchasing virtual points for an online game because the points themselves cannot be "perceived".
- Louisiana – The Supreme Court of Louisiana has interpreted tangible personal property to be equivalent to corporeal movable property. Article 471 of Louisiana's Civil Code defines corporeal movable property as things that physically exist and normally move or can be moved from one place to another, which is then illustrated by examples, including digital or electronic products such as audio and video downloads.
- Maine – Taxes all "tangible personal property" that includes any computer software that is not a "custom computer software program". A custom computer software program is a program made in a single instance for a single customer.
- Texas – Defines "taxable items" as including tangible personal property in electronic form instead of in physical form. TX Tax Code §151.010. This is in addition to an administrative ruling holding that electronically transmitted music is the same as taxable tangible personal property.