The Down Low on Downloads

Dealing with tricky tax rules on digital goods and services delivery

The Internet has become a convenient way to shop for goods and services; it’s also become a popular way to deliver them. Consumers and businesses can now conduct online transactions for everything from books to movies to software programs and have these delivered digitally or even stored in the Cloud versus physical media. While convenient and cost-effective (no shipping, packaging, etc.) the virtual marketplace can also be confusing when it comes to tax compliance.

The Huffington Post recently ran an article about the difficulties software companies face when applying sales tax to their products and services, particularly those sold online.

The article highlights two recent cases, one in Texas and one in New Mexico, in which nexus (the obligation to collect sales tax based on a presence in a state) was caused simply by the sale of software licenses, most of which were digitally downloaded. In both cases, the states ruled that the sales of the licenses by out-of-state sellers “equated to maintaining property” and “thereby created a physical presence…” in the state under nexus laws.

In the Texas case, the seller was held liable for nine years’ worth of sales tax plus penalties and interest on the software licenses that the company failed to collect or remit to the state.

One of the biggest difficulties companies face around the taxability of digital goods and services is that, like the cases in Texas and New Mexico, they may not easily recognize that what they are providing to customers is a taxable item—in this case, software licenses.

The Streamlined Sales and Use Tax Agreement (SST) has made this somewhat simpler for transactions that take place in member states. However, roughly only half the states in the U.S. participate.

Attempts were made in 2011 and 2013 to introduce federal legislation that would make the process for taxing digital goods and services more consistent through The Digital Goods and Services Tax Fairness Act. The legislation failed to pass, however, so the burden is still on businesses to slog through a myriad state rules and regulations to determine what is and what isn’t taxable.

Avalara’s Identification and Taxability of Digital Products whitepaper provides a high level overview of how states apply taxability to digital goods and services. While it’s important to be informed about tax compliance issues related to your business, putting it into practice is another matter altogether. Assigning this complicated task to your in-house accounting or finance manager will take up a great deal of their time. And, depending on where you have nexus, being familiar with the tax laws of multiples states plus their filing rules and deadlines adds to that burden.

A simpler and safer solution (remember that poor Utah seller) is to have sales tax rates and rules calculated and applied to sales automatically in your billing, ecommerce, or ERP system. You’ll not only be assured that you’re applying sales tax correctly, but you’ll have the reporting and audit trail to back it up.