Sales tax compliance for Digital Services simplified (for the US)

For a business, selling overseas is a huge milestone. And selling to the United States of America is a massive stamp of credibility.

However, before your business wades into transactions with vendors in the United States, you should remember that tax and compliance in the country are not easy to deal with.

The United States believes that one of the reasons for a downturn in tax revenue is that more people are now purchasing products online. Therefore States are looking to impose tax and compliance liabilities on digital transactions. However, this is not easy because such products are relatively new.

So how do the 50 states deal with such an issue? More importantly, how do non-US businesses deal with the USA's lack of clarity on sales tax?  

From different tax jurisdictions to varying definitions of what might or might not be taxable - the United States sales tax system is a difficult path to navigate. This article attempts to simplify sales tax compliance requirements for digital services when your business transacts with vendors in the USA. 

Let's begin by defining digital goods and services.

Digital goods are also called digital products, electronic goods, or e-goods. This is a very generic term and is usually used to describe goods stored and delivered in an electronic format. These goods are delivered to the customer through email or downloading products off the internet. Common examples of digital goods include ebooks, music files, software systems, digital images, and manuals delivered in electronic format. 

It is also crucial to understand the definition your products fall under.

Now, individual states in the USA wrote and developed their sales tax laws before any such products came into existence. There is no formal definition for digital services under USA sales tax policies. Currently, most states have sales tax liabilities that apply to "tangible personal property." However, an ebook is not a physical book, and a movie being streamed on Netflix can't be held like a DVD.

So technically, some digital services do not fall under individual states' existing sales tax definitions.

At this point, there are four categories of digital products and services in the United States. Some states agree with these categories, while some don't. Namely - 

  • Enumerated digital products
  • Concrete personal property
  • Tangible, functional equivalents
  • Services

Several US states have tried to make the existing definitions work for digital products as a workaround. For example, some states like California don't tax digital products because they are considered intangible. Some other states like Indiana consider digital products and services as tangible because they can be seen even though they can be not held. Some States even use existing laws as a guideline and have declared that if a product is taxable in its tangible form, it will be taxable in its intangible form.

If you plan to transact within a specific jurisdiction, have your team figure out what defines your products. This will help you adhere to mandatory tax compliances and make the most of exemptions.

Bonus tip - check if the state you transact within is a member of the Streamlined Sales and Use Tax Agreement (SSUTA). Such states will adhere to uniform definitions of digital products and services. 

Next, know the jurisdiction you are transacting within.

Unlike other countries, where tax jurisdictions might change between federal or state levels or federal or city levels, the United States levies sales tax as per individual States, cities, counties, and even municipalities. This brings the total number of sales tax jurisdictions in the USA to over 13,000.

This implies that when you conduct a transaction for digital services, the sales tax liabilities, including tax rates, what is considered liable, tax deadlines, etc., could be different. It also means that your business will be required to keep track of the various jurisdictions and file sales tax accordingly and within the given timeline.

As a non-US seller, your business might have to consider the thousands of local sales tax jurisdictions and track your American customer's exact location to know what additional Sales Tax rates calculations, collections, and filings will be required.

Now, let's focus specifically on digital services. In the United States, around 30 individual states tax some digital services. Some states even exempt digital services from sales tax. For instance, California exempts taxes on selling electronic products such as data, digital images, ebooks, mobile applications, and software. This is because California State law believes that such a transaction does not involve the transfer of tangible personal property. 

The United States doesn't adhere to universal sales tax definitions. That means individual states each develop their definitions. So your business can use the opportunity to seek out vendors to transact within tax-free jurisdictions, for starters. You can also determine which individual states offer the most lucrative tax rates to make better profits. Finally, you can use automation tax technology that will zero in on your customer's location and tell you the exact tax and compliance requirements in that jurisdiction. 

Knowing your product's definition and tax jurisdiction is the first step to getting sales tax right when conducting business in the USA. However, this task can be overwhelming, and if your company works manual operations to manage such a complicated task, there will be enormous scope for human error.

In today's competitive business environment, sellers need to concentrate on getting ahead of the curve. But that's not possible if your team focuses on running pillar to post to figure out the United States' complicated sales tax system.

Automating sales tax calculation, remittance, and returns, zeroing in on the proper jurisdiction and consequent applicable liabilities will help your business focus on what really matters - making money and keeping it.

Recent posts
Four must-know pitfalls of US sales tax
7 things to avoid while selling online- tips for running a successful omnichannel retail store
Five Cross-border compliance challenges for Manufacturers

Prepare your business for e-invoicing under GST

Discover how to meet all compliance requirements while integrating e-invoicing into your tax function.

Prepare your business for e-invoicing under GST

Stay up to date

Sign up for our free newsletter and stay up to date with the latest tax news.