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CBPP: Digital Goods and Services Act Tax Loopholes

  • Jul 3, 2012 | Will Frei

The Digital Goods and Services Tax Fairness Act will eat into state revenue, according to the Center on Budget and Policy Priorities, or CBPP

Michael Mazerov, writing for CBPP before the Act passed, states "The proposed Digital Goods and Services Tax Fairness Act of 2011 would immediately and significantly reduce state and local tax collections, and these revenue losses would accelerate in the future."

CBPP sees four major provisions in the Act that will reduce state revenue.

Repeal of existing taxes

According to the CBPP, the Act repeals existing sales taxes ". . . imposed on computer software sold and delivered online." CBPP indicated that 30 states currently tax software delivered online, and will have to repeal those specific taxes and replace them with new taxes, which software publishers will likely oppose.

Sourcing Loophole

The Act states that if a sale of digital goods or services ". . . is made to multiple locations of  a customer, whether simultaneously or over a period of time, the seller may determine the customer's tax address or addresses using the address or addresses of use as provided by the customer." The seller will then use the tax address to determine the tax jurisdiction for the transaction, so they can apply the correct sales tax rates and rules.

The CBPP argues that this will allow multistate corporations to avoid paying sales tax on digital goods and services. A corporation purchasing digital goods and services for multiple locations could provide the seller with a tax address in a state that does not tax these items. In this way, it avoids sales tax, even though it may redistribute the items to other locations where they are taxed. A corporation might even create locations in exempt states specifically to exploit this loophole.

Repeal of tax for "intermediary services"

Services provided by online intermediaries, such as Amazon or eBay, will no longer be taxable under the Act, which defines them as digital services. These services include customer billing, product listing, brokerage, and payment collections. The CBPP notes that such services are considered taxable when provided by a sales intermediary not operating online, ". . . such as a consignment shop or an auction house."

The CBPP goes on to argue that ". . . companies like Amazon, selling their own inventories of physical goods, could separate their legal structures into a nominal retailing arm and a nominal 'intermediary' arm. This would reduce states' sales tax bases by the amount of compensation received by the online 'intermediary.'"

Sale-for-resale Exemptions

The Act prohibits taxation of digital goods and services used to produce more digital goods and services. The CBPP points out that states such as Ohio, Texas and Washington ". . . impose low-rate taxes on business gross receipts . . . as a general business tax." Thus the Act would require those states to grant sale for resale exemptions for ". . . business purchases of digital goods and services under gross receipts taxes, reducing the revenue yield of these taxes."

A different perspective

Not everyone agrees with the CBPP's assessment of the Digital Goods and Services Tax Fairness Act. Jot Carpenter, vice president of government affairs for CTIA--The Wireless Association, denies that the Act will cause states to lose revenue in the way outlined by the CBPP. He points out that the Act does not prohibit states from taxes digital goods and services.

Stephen Kranz, a partner at Sutherland Asbill & Brennan LLP, Washington, states:

While there are legitimate questions that have been raised regarding the technical language of the [bill] and the need to ensure that unintended consequences do not occur, the CBPP's claim that the bill would 'immediately and significantly reduce state and local tax collections' is based on misinformation about the legislation's purpose and impact. As an example, the argument by CBPP that the bill would repeal existing sales taxes imposed on computer software sold and delivered online is not true." Any state or locality which had statutorily imposed sales tax on computer software would continue to be allowed to do so.

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Avalara Author
Will Frei
Avalara Author Will Frei
Will Frei covers sales tax news including best practices, legislation and sales tax technology. He is the Social Media Manager at Avalara.