McDermott extended its popular Tax in the City® program to Seattle, with a meeting on October 12 at the Amazon headquarters. McDermott established Tax in the City® in 2014 as a discussion and networking group for women in tax aimed to foster collaboration and mentorship, and to facilitate in-person connections and roundtable events around the country. The Seattle program was one of the best attended Tax in the City® events to date, featuring a CLE/CPE presentation about Privilege and the Ethics of Social Media by Cate Battin, Kristen Hazel and Jane May, followed by a roundtable discussion in which Elizabeth Chao and Sandra McGill discussed international issues related to income from digital products. Britt Haxton and Kristen Hazel discussed planning considerations related to federal tax reform, and Diann Smith provided the state and local tax considerations related to both issues. Continue Reading Inaugural Seattle Tax in the City® | Highlights and Takeaways
Yesterday, a legislative conference committee was appointed to approve an already agreed-upon $1.3 billion revenue package, which was immediately approved by both the House (116-75) and Senate (28-22) and sent to Governor Wolf for approval. The governor subsequently issued a press release confirming that he “will sign this revenue package.” A copy of the conference committee report (in full) that passed is available here.
The final revenue package includes (among a host of other revenue raising changes) a new tax on digital content and services, as described in more detail below. Specifically, the expansion captures most (if not all) digital goods within the sales and use tax imposition by defining them as tangible personal property. A number of digital services are also captured in the broadly defined language. Continue Reading Pennsylvania General Assembly Passes Revenue Package with Significant Digital Tax Expansion
Last Friday, the Alabama Court of Civil Appeals handed the Department of Revenue (Department) a significant loss in their continued attempt to tax non-enumerated services and tangible property provided in conjunction with those services under the sales tax. See State Dep’t of Revenue v. Omni Studio, LLC, No. 2140889 (Ala. Civ. App. Apr. 29, 2016). Specifically, the appellate court affirmed the taxpayer’s motion for summary judgment granted by the trial court, which set aside the Department’s assessment on the basis that photographs provided by a photography studio are merely incidental to the nontaxable photography services provided by the studio. While the prospective effect of the holding in the photography context is unclear due to recent amendments to the photography regulation (effective January 4, 2016), the case is significant in that it strengthens the “incidental to service” (or “true object”) precedent in Alabama and should be seen as a rebuke to the Department for ignoring judicial precedent in favor of their own administrative practices and guidance.
This decision is important in analyzing the taxability of mixed/bundled sales to Alabamans (i.e., where services and some degree of tangible personal property are provided as part of the same transaction). As with any decision, taxpayers should consider potential refund claims. Continue Reading Alabama Appellate Court Finds Photos Merely Incidental to Nontaxable Photography Services
Last month, a much-anticipated bill drafted by the Alabama Department of Revenue (Department) was introduced in the Alabama Senate that would have expanded the definition of tangible personal property to include “digital goods.” See Senate Bill 242 (introduced February 16, 2016). Fortunately, the Senate Finance and Taxation Education Committee (Committee) rejected the bill on March 9, 2016, after hearing testimony from Assistant Department Counsel Christy Edwards and extensively questioning her on the bill’s content and motives. Notably, the Department continues to take aggressive positions in an effort to tax digital goods and services, without the requisite statutory or legislative approval to back it up.
On February 28 2015, the Department proposed an amendment to Regulation 810-6-5-.09, which would have amended the rental tax on tangible personal property to include “digital transmissions” (broadly defined to include digital content such as streamed audio and video). After significant opposition from industry representatives, the Joint Legislative Council (composed of leadership from both chambers) wrote a letter to Commissioner Julie Magee in April 2015 requesting that the proposed regulation be withdrawn. It cited to the fact that the proposal was overly expansive and would in effect be the imposition of a new tax, a determination that rests with the legislature. See our prior coverage here. With hesitation and only after continued pushback from the Legislative Council, the Department withdrew the rental tax regulation amendment on July 7, 2015.
In response to the rejection of the proposed regulation, the Department went through its historic revenue rulings and revoked a number of technology rulings in January 2016, noting they will continue attempting to apply the rental tax to streaming services. Commissioner Magee cited the revocations as a mere “clarification” that did not change the law. In her comments to the revocations, Commissioner Magee noted that all taxpayers will be collecting and remitting tax in the future “[e]ither legislatively through a digital goods bill or through audits and assessments.”
Senate Bill 242
The digital goods bill arrived just a few weeks later, sponsored by Senator Trip Pittman. As introduced, the bill would define “tangible personal property” to include “digital goods.” For these purposes, digital goods include “[s]ounds, images, data, facts, or information, or any combination thereof, transferred electronically, including, but not limited to, specified digital products and any other service transferred electronically that uses one or more software applications.” As is readily apparent, this language is extremely broad and arguably includes every service delivered over the internet. The definition also raised concerns because it borrows from Streamlined language (“transferred electronically”; “specified digital products”), but Alabama is not a Streamlined state and does not define those terms elsewhere in the legislation or Code. As drafted, the bill would have become effective immediately upon passage.
After cancelling a scheduled Committee hearing earlier this month, citing the need for revisions, the sponsor and Department entered the March 9 public hearing with a substitute bill. Instead of defining “digital goods” as tangible personal property, the substitute provided that the “digital equivalent of tangible personal property” is now also tangible personal property.
Christy Edwards testified at the hearing in favor of the bill. Consistent with the Department’s position over the past year, she consistently framed the bill as a “clarification” of existing law. Several senators questioned this notion, noting that there would be no need for legislation if digital goods and equivalents are already taxed to the extent suggested in the bill. Many senators also pushed back on the lack of clarity in the bill, asking Ms. Edwards to explain with specificity what is taxable and not taxable based on the bill’s language—which she largely could not do aside from a continued reference to digital photographs. In apparent frustration, one senator specifically requested a chart from the Department listing goods and services that would be taxable (or not) based on this bill to provide to her constituents.
Committee discussion of the bill concluded with a vote on a motion by the sponsor to favorably recommend SB 242 to the Senate as a whole. The Committee emphatically rejected the motion by a two-thirds majority, refusing to advance the bill 8-4.
Companion Exemption Bills
After Senate Bill 242 was introduced, companion exemption bills were introduced in both chambers of the Alabama Legislature that would specifically exempt “products transferred electronically acquired with less than the right of permanent use granted by the seller or use which is conditioned upon continued payment from the purchaser” from the sales, use and rental taxes. See House Bill 349 and Senate Bill 345. This exemption language captures streaming audio, video and games (and any other subscription-based digital good or service to which perpetual use rights are not acquired by the purchaser). While these bills would undercut the efforts of the Department to expand the current statutory imposition to these items, their outlook is unclear. On March 16, 2016, the House bill was passed out of committee and is now being considered by the House as a whole. Last Friday, the exemption bill was endorsed by the Business Council of Alabama after hearing from a number of business groups concerned with the recent efforts of the Department. The exemption legislation is one to closely monitor in the coming weeks.
In a curious decision out of Arizona, an Administrative Law Judge (ALJ) found an out-of-state provider of online research services was properly assessed transaction privilege tax (TPT, Arizona’s substitute for a sales tax) based on the logic that the provider was renting tangible personal property to in-state customers. The Office of Administrative Hearings (OAH) decision, No. 14C-201400197S-REV, available here, should be unsettling for all remote providers of subscription-based services with customers in Arizona. This decision offers an example of the continued push by states to administratively expand the tax base to include nontaxable digital services. Many states, like Arizona, do so by considering remote access to digital goods and services to be tangible personal property, as defined by statutes that are decades old.
The taxpayer was an out-of-state IT research firm offering internally-produced proprietary research and data compilation content remotely. The taxpayer’s headquarters, offices, servers and platform were all located outside Arizona. Customers accessed the research material via usernames and passwords received as part of a subscription. The Arizona Department of Revenue (the Department) determined that the subscription income was subject to the TPT because it was income from the leasing of tangible personal property. The taxpayer filed a protest with the Department, arguing that the online research services provided make it a service provider—not a lessor of tangible personal property. The taxpayer noted “at most, [they are] providing clients with a simultaneous license to use.”
The Department argued that the taxpayer was leasing tangible personal property (research and data content) through the subscriptions they provide to customers. Because they had exclusive access and use to the digital content (via username and password), the customers were able to perceive tangible personal property through their sense of sight. Therefore, the taxpayer’s receipts from subscriptions to its research and data content are taxable rental activities subject to the personal property rental classification.
The ALJ held the taxpayer did not meet its burden of proof of showing the Department misapplied the tax laws. The decision dismissed all of the taxpayer’s arguments that it is not engaged in leasing tangible personal property. At the outset, the ALJ found that the inability to control or modify the digital content was not enough to consider the customers to be lacking “exclusive control.” This is important because the Arizona Supreme Court has made it clear that the scope and application of the personal property rental classification (and its predecessor) hinges on the degree of control over the property in question that is ceded to its putative “lessee” or “renter.” In sum, because the access and use of the proprietary research and data content was offered for a periodic subscription (consideration), such activity is the leasing of tangible personal property, and the assessment by the Department was appropriate.
As a threshold matter, it is unclear whether the Department has authority to consider remote access to digital content to be tangible property merely because the content may be viewed on a computer or mobile device. For purposes of this statute, the definition of tangible personal property was enacted in 1989. See Taxation—Corrections Bill, 1989 Ariz. Legis. Serv. 132. The Internet as we know it today did not exist, with the World Wide Web not even established until 1991. By interpreting the definition as such, the Department is imposing a new tax—something that is the province of the legislature. The proprietary research and data available electronically is more properly characterized as an intangible or service. By purchasing a subscription, customers are really paying for access to the proprietary data and research, the creation of which is unquestionably a service. This information service is the “true object” of the subscription transaction, and any tangible personal property (i.e., the ability to access it via the Internet) is a mere inconsequential element.
Second, even if the classification as tangible personal property is proper, we seriously doubt whether the exclusive use and control requirement is met in this case. In State Tax Commission v. Peck, 106 Ariz. 394, 476 P.2d 849 (1970), the court determined that customers of a coin-operated laundry “have an exclusive use of the equipment for a fixed period of time and for payment of a fixed amount of money . . . [and] exclusively control all manual operations necessary to run the machines.” Id. at 396, 476 P.2d at 851. Over 30 years later, the Arizona Court of Appeals found customers at a tanning salon do not “themselves exclusively control all manual operations necessary to run” the tanning beds in question. The court held that while customers could select within a five-minute window when the tanning session begins and terminate it early, the question of whether a tanning session may be commenced at all, and how long it could last, were exclusively controlled by the taxpayer’s tanning technician. Further, the question of the appropriate tanning device was also significantly within the technician’s control. In sum, the “exclusive use and control by the customer that Peck determined to be the essence of “renting” taxing statute [was] not present” in the tanning salon context. See Energy Squared, Inc. v. Arizona Dep’t of Revenue, 203 Ariz. 507, 510, 56 P.3d 686, 689 (Ct. App. 2002).
Here, like the tanning salon in Energy Squared, the taxpayer’s customers do not have “exclusive use or control” of the research and data. The ability to open and access the content is limited by the subscription level, and customers are only permitted one copy (limitations that someone with exclusive use or control would not receive). Because the information is proprietary in nature, customers are further restricted by the fact that they may not use the research as their own and may only summarize, excerpt or quote it. Further (and perhaps most importantly), the content is at all times housed on the server of the taxpayer, who may add or subtract to the content available to customers at any time. Because the property in question (however it may be classified) is ultimately controlled by the taxpayer, it is not exclusively used or controlled by the customer. This common law requirement is a prerequisite to the application of the TPT personal property rental classification, upon which the Department and ALJ decision relies.
The Arizona Department is not the first revenue department to proffer this logic to tax subscriptions to digital services. Within the past year, the authors are aware of two other state tax agencies that have attempted to tax remote providers—both resulting in legislative action opposing the agency’s actions.
- Alabama: On February 28, 2015, the Alabama Department of Revenue proposed an amended regulation ( Admin. Code r. 810-6-5-.09, available here) that sought to impose rental tax on remote providers of streamed music and video to in-state customers. Similar to Arizona’s tactic here, the proposed regulation would have imposed tax by considering streamed music and movies to be tangible personal property. After significant feedback from industry representatives, the Joint Legislative Council (composed of the state legislative leaders from both chambers) wrote the Commissioner requesting the proposed regulation be withdrawn. The letter cited to the fact that the proposal was overly expansive and would in effect be the imposition of a new tax, a determination that rests with the legislature.
- Idaho: In October 2014, the Idaho State Tax Commission issued a notice of proposed rulemaking for a regulation that would have taxed the sale, lease or rental of digital products (defined as tangible personal property under Idaho law) if the user had the right to stream or download them. See Idaho State Tax Comm’n, Notice of Proposed Rulemaking Dkt. 35-0102-1401 (Oct. 2014). In response, the legislature passed a bill in March 2015 (House Bill 209, available here) that modifies the statute to require digital products be purchased with a permanent right to use to be taxable as tangible personal property, effective April 1, 2015. Notably, the bill states that a permanent right to use does not exist when the right to use is conditioned upon continued payment.
Practice Note: While the OAH decision is appealable, the 30-day period to request review has run. It is unclear whether the taxpayer in this case has requested review, appealed directly to the Board of Tax Appeals or accepted defeat. Taxpayers providing subscriptions to digital goods and services (including streaming audio and video) should be aware of the Arizona decision and be prepared to defend their service offerings from the states apparent position.
In this article, the authors examine a recent Texas administrative law judge’s opinion that says an out-of state company has nexus with Texas through downloaded software that it licenses to Texas customers. They argue that the state comptroller’s adoption of the decision allows sales and use tax liability to be based on economic nexus instead of physical nexus and is therefore unconstitutional.