Welcome back to our series about how state tax legislation applies to a wide variety of technology industry niches! Today’s focus is digital goods; keep reading to find out what multi-state tax issues this type of merchandise faces when it comes to nexus, state tax legislation, etc.
An Overview of Digital Goods
What are digital goods? Webopedia provides a helpful definition: “Digital goods is a general term used to describe any goods that are stored, delivered and used in an electronic format. Digital goods are shipped electronically to the consumer through e-mail or download from the Internet. Usually when you purchase digital goods online, after payment has been received the merchant will provide you with your digital item as an e-mail attachment or they may provide you with a secure link where you can download the item.
Examples of digital goods include e-books, music files, software, digital images, website templates, manuals in electronic format and any item that can be electronically stored in a file or multiple files.”
State Tax Issues for Digital Goods
As with software and SaaS companies, numerous state tax issues arise when it comes to digital goods.
The Streamlined Sales Tax Project (SSTP) (a group of 20+ states banding together to create uniformity in sales tax definitions, among other things) has tried to create uniform definitions of digital products across the states. Included in their definitions are “specified digital products” such as “digital audio-visual work,” “digital audio works,” and “digital books.” Items such as digital cards, music, movies, pictures and ringtones are specifically identified as meeting the definitions of digital products and are considered taxable. However, not all states are members of the SSTP and, as such, not all states uniformly tax digital goods.
- Nexus: You’ve heard us say this before, but all state tax analysis starts with nexus. Even if you are selling a digital product which would be taxable in a state, the first step is always in determining whether a company has nexus or taxable presence in the state. Nexus issues for digital companies often include sending a traveling salesforce (either their own employees or third party contractors) to customer locations, which can create nexus. Some companies also engage in training or customer support at customer locations. We have a client that uses independent student representatives on various college campuses across the country to sell their digital products. Those third party contractors, even though they are not employees, are creating nexus for the company.
- Sales Tax: Digital goods are definitely products, but are they considered tangible items subject to sales tax? Some states tax downloaded software, but not all digital goods fall into this category. It comes back to the question of, how do you define electronic files? Are they subject to sales tax? Keep reading!
- Sourcing: As we mentioned in our blog post about SaaS companies, even after properly defining a product as digital (and then perhaps taxable), the next step in the process is to correctly source the revenue to the right state – both for income tax and sales tax purposes. The example below provides some of the fodder for the challenges in this area.
Consider the following scenario: A California resident is traveling via plane to New York from her home in San Francisco. She stops in Texas on a layover. While at the airport in Texas, she decides to download some music to her device. She doesn’t listen to it until she’s on the plane again, or when she finally arrives in New York. What are the sales tax ramifications of that sale – to her, or to the company from which she has purchased her downloaded music? California doesn’t tax digital downloads like this and she’s a CA resident. Texas does tax the digital download of music, but she didn’t really use it there – she just purchased it while on the ground. New York also taxes these types of downloads. So, where should the music company charge sales tax? Well, it depends! Where does the music company have nexus? In California, Texas, New York? How does the music company know where the product is used? Likely in this scenario, the taxability decision will be in California, where the the customer’s billing address is. But again, aggressive states like Texas and New York might reach a different conclusion.
How Miles Consulting Assists Digital Products Companies
As with many things in the technology industry, digital products present an interesting challenge because state tax statutes have not kept up with technology. As we assist our clients in navigating these rules, we are often trying to put square pegs into round holes using the existing statutes. Some state revenue agencies have issued their own policies or pronouncements or rulings, which aren’t really law. Often these types of positions are not in favor of taxpayers.
The rise of digital products is another example of the erosion of the tax base. Not long ago, when someone purchased a musical CD, the question in the scenario above would have been much easier. If the customer had bought the CD in California, sales tax would have applied (with a download it doesn’t). If the customer had bought the CD at the airport in Texas she would have paid sales tax on it there. And there would have been no consequence in New York. Today, as more items – music, gaming, software – are digitally downloaded, things have changed!
We help our clients deal with the nexus determinations, taxability analysis and sourcing of revenue for digital products – among others. As with the taxation of SaaS, we assist from beginning to end to find practical answers to navigate this new frontier!
Want to know more about multi-state tax issues surrounding digital goods could affect your company? Please contact us for additional details. Stay tuned for the additional posts in our series surrounding technology industry niches and multi-state tax issues, too!
Miles Consulting Group, Inc. is a professional service firm in San Jose, California specializing in multi-state tax solutions. Our firm addresses state and local tax issues for our clients, including general state tax consulting, nexus reviews, tax credit and tax incentive maximization, income tax and sales/use tax planning and other special projects. We specialize in assisting growing technology companies deal with their state tax issues. To learn more, contact us today at www.MilesConsultingGroup.com.
