Why taxing digital content is so complicated

It often feels like a trick question: Does this digital good or service require telecom tax, or sales and use tax? The answer typically varies and depends not only on taxing jurisdiction and what other goods or services it might be bundled with, but also on some very specific details concerning the product itself.

When defining a digital good or service, jurisdictions often look very carefully at two details: the specific type of content being delivered and the delivery mechanism for that content.

• Content types might include video, audio, games, or software
• Delivery mechanisms can be streaming (either live or on demand) or downloaded
  

From there, taxation paths can diverge, leaving layers of complexity for digital content providers often selling in thousands of jurisdictions.

Spotlight: streaming services

In many cases, streaming video is considered a communications service and taxed accordingly. This is because, as “pay television,” cable and satellite television were already communication-taxable. In jurisdictions where tax rules on pay TV were generically written, streaming video is typically taxed in the same way as pay TV.

But why is streaming audio different? Considered a common carrier service and generally given away for free, terrestrial radio has not historically been taxed. Since the legacy industry was not typically taxed, there isn’t much precedent for taxing the new technology. This is unlikely to remain the case as jurisdictions realize that consumers are now paying significant sums for what they used to use for free.

However, it’s important to note that neither of these scenarios is absolute. Every jurisdiction has a different point of view, often in complete opposition to a neighboring jurisdiction. For instance, in the city of Chicago, there’s an ongoing battle regarding amusement tax on streaming components like audio, video, and gaming.

And of course, determining taxation is rarely as simple as answering one single question.

Bundles, changes, and complexity

Let’s say you provide both streaming audio and video as a bundled subscription service. In some states, that would potentially make the entire bundle communications-taxable due to the video component. Or, as with the recent precedent-setting case in Iowa, entire Amazon Prime subscriptions for even non-digital goods and services became taxable due to video being a part of the overall subscription fee.

Ensuring you know how each portion of a bundle is taxed and that it’s subsequently reported accurately is critical. The rules, and the interpretation of them, are changing regularly.

It’s critical to keep up in every jurisdiction where your digital goods and services are sold to avoid costly overpayments or audits and fees. As technology changes, jurisdictions are making efforts to keep up — unfortunately, they still tend to lag behind.

Best practices to stay ahead

While digital content taxation will likely continue to undergo change for some time, there are some precautions you can take to minimize your exposure as you sell these products.

1. Keep up with tax and regulatory changes. Outdated rules are being rewritten in jurisdictions, all the way down to the municipal level. If you don’t have the staff to keep up with this level of monitoring, find a way to outsource to a trusted resource/expert in the field.
2. Know the impacts of your product roadmap. Even if everything you’re doing currently only requires sales and use tax, be prepared for potential telecom tax to be imposed at any time. Particularly if you plan to add a video component through either new product development or company acquisition, know that there’s high likelihood you may encounter a much more complex set of tax requirements and technology needs. It’s also critical your marketing team be very specific in product descriptions to ensure appropriate taxes are applied.
   
3. Understand your risks. These rules may often be blurry initially and you may have to choose a path with caution. Understanding what similar companies are doing may be helpful, especially if you enter an audit situation.
   

Want to learn more about taxing digital goods and services? Read Navigating communications taxation for streaming and other digital content.

You can also find out more about how Avalara’s communications tax solutions can help you keep up with these changes.