The Wild West of Digital Goods

The taxation of digital goods and services has been called the new frontier. It’s been likened to the American Wild West, a lawless place filled with fiercely independent people, desperate people, outlaws and vigilantes. In other words, no one quite knows how to apply old laws to the new place.

Federal government and tax fairness

Many federal lawmakers are afraid that states will go tax-happy and create new laws as quickly as Wild Bill Hickok could draw his pistol. The Digital Goods and Services Tax Fairness Act of 2013, currently kicking around Capitol Hill, would limit states’ ability to tax digital goods and services. The bill’s sponsors say it would “protect consumers from unfair taxes on digital goods, like those purchased over the internet or on a smartphone.” It would also limit the taxation of a new “driving force” in the national economy.

The Digital Goods and Services Tax Fairness Act would “establish a uniform framework for the taxation of digital goods and services so consumers won’t be double taxed.” Double taxation is a real issue with digital goods and services—much more so than with tangible goods. Today’s cloud computing technology allows a person who lives in Wisconsin to purchase an ebook from Washington-based Amazon while on vacation on Georgia’s Jekyll Island. The server from which the ebook is downloaded could be located anywhere. In this situation, it’s easy to see how Wisconsin, Washington and Georgia could all apply tax to the sale.

States and the level playing field

Many state lawmakers are afraid that the federal government will limit their ability to tax the digital products that are multiplying like outlaws on the western frontier. They argue that to maintain their sales tax base, they must be allowed to tax the ebooks and downloaded music that are rapidly replacing their tangible counterparts. If a bound book is subject to sales tax, they argue, so should be a downloaded book. The same goes for music. Many lawmakers believe that states should also be able to tax strictly digital goods, such as ringtones and virtual sheep.

Already, states have seen sales tax revenue drop from the rise of tax-free online sales. Increasingly, states are finding ways around the physical nexus requirement that has long limited their ability to tax vendors located out of state. In New York for example, remote vendors generating a certain amount of sales through locally owned affiliates must collect sales tax. Although challenged by both Amazon and Overstock, New York's affiliate nexus law has been repeatedly upheld by the courts. And to encourage use tax compliance in Colorado, certain out-of-state sellers are required to provide an account of untaxed purchases to customers and the state Department of Revenue. That use tax notification requirement is temporarily on hold due to legal concerns.

To avoid the confusion and litigation that plagues online sales tax, state lawmakers may indeed embrace a federal digital sales tax law. However, states want to have the right to tax what they want to tax.

What lawmakers are facing 

Wyatt Earp was one of the most famous lawmen of the Wild West. He fearlessly faced down stagecoach robbers, horse thieves and killers from Wichita to Tombstone. Today’s lawmakers face a different reality and need a different set of skills to handle it. They need to be fast with an argument, not fast with a pistol.

In the wild west of digital goods and services, no one is sure what products are. Is a digital good a telecommunications service? An information service? Is it a type of data processing? States define digital goods and services differently (kind of like the way vigilantes had their own twist on how to enforce the law). And how these products are defined matters—it impacts how they’re taxed.

In the wild west of digital goods, no one is quite sure where products are, and therefore which state has the right to tax them. Is it the location of the server? The location of the buyer when he presses “buy now?” The buyer’s billing address? Consider the ebook situation: a buyer from Wisconsin downloads an ebook from Washington-based Amazon while on vacation in Georgia. Should we just let Wisconsin, Washington and Georgia draw their pistols over the right to tax the transition? Which state would have the fastest draw?

In short, figuring out how to tax digital goods is like figuring out where to sit in a Wild West saloon—pick wrong, and you could be in for a heap of trouble.

Automating sales tax helps keeps you on the right side of the law--even in the Wild West of digital goods and services.

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