Is It Time to Tax Digital Goods?

It’s often unclear to ecommerce merchants whether to charge sales tax on Internet sales, especially on digital goods like music, movies, and books. Until a few years ago, taxable products were typically tangible. As consumers move their entertainment online, that’s starting to change. And like all things sales tax, the variable treatment of digital goods can be confusing even for the savviest ecommerce merchant. The bottom line is more states are attempting to require sellers to charge sales tax on digital goods.

Here are three questions to ask when selling into new markets or new states:

1. How do I know whether to charge sales tax on digital goods?

Generally speaking, digital goods are taxed when:

·       A product is delivered digitally to a buyer within the same state.

·       A product is delivered digitally to a buyer at the seller’s location.

·       An in-state address is used as a billing address.

·       A billing address in the state is indicated in the seller’s business records.

As with all things sales tax compliance-related, it’s crucial to review the individual statutes in each state into which you sell.

2. Do I have digital goods-related nexus?

Nexus is the legal connection a state has with a vendor giving a state the right to collect sales tax.  Determining nexus requires reviewing customer location, location of actual transaction, ownership of products, and the vendor’s location. In the case of digital goods, the location of the vendor can also include servers or other technology. Determining nexus for sales of digital goods can be tricky given their nature, making compliance even more challenging.

3. How does “sourcing” affect digital goods taxation? 

“Sourcing” is the location that determines the applicable sales tax rules. Destination-based means taxability is based on the location of the buyer. Origin-based means taxability is based on the location of the seller. Digital goods sourcing is even more complicated. Is the source of a music download the location of the server? The seller? The buyer’s location at time of download?

Digital goods sourcing also raises the question of whether or not the location of the buyer on a smartphone is the true “source” of the sales tax rules. Given the diversity of related digital goods definitions and statutes, it’s easy to see why there is confusion among vendors.

What’s next?

While it’s unclear whether or not federal lawmakers will weigh in on the digital goods confusion, a bill was introduced in recent years that attempted to address the issue.

The Digital Goods and Services Tax Fairness Act attempted to require states to only charge sales tax on digital goods, only if same applied to tangible products. Though the bill ultimately failed, it did indicate one of the puzzles of digital goods taxability: inconsistent tax policy between states and potential unfairness resulting from it.

Whatever happens, it’s clear that states are turning to digital goods taxation to shore up revenue.