Sales Tax Situsing for the Digital Economy

Sales Tax Situsing for the Digital Economy

Editor’s Note: The following is an edited extract from: Kranz, Carolyn Iafrate, “Sales Tax Situsing for the Digital Economy,” 2013 NEW YORK UNIVERSITY INSTITUTE ON STATE AND LOCAL TAXATION § 10.01 (Matthew Bender 2013). The entire article may be found in the 2013 NYU SALT volume available for sale LexisNexis® Store.

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OVERVIEW

Identification of the location(s) at which a sale occurs for purposes of sales and use tax is one of the most challenging issues in this tax area; even more so as it relates to emerging technologies, such as digital content and cloud services. This is principally due to a notable lack of clear guidance from states addressing the tax implications associated with situsing the sale of these products and services.

For transactions involving sales of digital content and cloud services, the proper application of situsing rules is largely dependent upon how these product offerings are characterized in a given state. Thus, the threshold issue is to determine how the product or service is characterized for sales and use tax purposes (i.e., tangible personal property, service, etc.) Once that determination is made, each state’s situsing rules may be applied. However … states have proven inconsistent in characterizing the sale of emerging technologies as tangible personal property or services for sales and use tax purposes. As most tax practitioners will attest, these types of state inconsistencies are the rule, rather than the exception, when it comes to addressing the application of sales and use tax to emerging technologies. Nevertheless, once the characterization of a product and its taxability is determined, an understanding of a state’s sourcing rules is essential.

SALES AND USE TAX SOURCING

The Streamlined Sales Tax Governing Board has attempted to lead the charge in establishing clear and predictable rules related to the situsing of transactions for sales and use tax purposes within the uniform provisions of the Streamlined Sales and Use Tax Agreement (“SSUTA”). The SSUTA has created a hierarchy that can be followed to determine how to source all sales. The objective of the hierarchy is to provide clear situsing rules for all transactions, including those in which the more traditional information (i.e., ship to address) is not known. The SSUTA provides as follows:

  1. When the product is received by the purchaser at a business location of the seller, the sale is sourced to that business location.
  2. When the product is not received by the purchaser at a business location of the seller, the sale is sourced to the location where receipt by the purchaser (or the purchaser’s donee, designated as such by the purchaser) occurs, including the location indicated by instructions for delivery to the purchaser (or donee), known to the seller.
  3. When subsections (A)(1) and (A)(2) do not apply, the sale is sourced to the location indicated by an address for the purchaser that is available from the business records of the seller that are maintained in the ordinary course of the seller’s business when use of this address does not constitute bad faith.
  4. When subsections (A)(1), (A)(2), and (A)(3) do not apply, the sale is sourced to the location indicated by an address for the purchaser obtained during the consummation of the sale, including the address of a purchaser’s payment instrument, if no other address is available, when use of this address does not constitute bad faith.
  5. When none of the previous rules of subsections (A)(1), (A)(2), (A)(3), or (A)(4) apply, including the circumstance in which the seller is without sufficient information to apply the previous rules, then the location will be determined by the address from which tangible personal property was shipped, from which the digital good or the computer software delivered electronically was first available for transmission by the seller, or from which the service was provided (disregarding for these purposes any location that merely provided the digital transfer of the product sold).1

The Agreement also further provides as follows:

For the purposes of Section 310, subsection (A), the terms “receive” and “receipt” mean:

A. Taking possession of tangible personal property,
B. Making first use of services, or
C. Taking possession or making first use of digital goods, whichever comes first.

The terms “receive” and “receipt” do not include possession by a shipping company on behalf of the purchaser.2

These rules serve as a benchmark in the 24 states that have adopted the SSUTA throughout the country. In addition, most other states follow similar principles, though their published guidance may be more limited.

While the SSUTA sourcing provisions were intended to address all transactions, it has become increasingly evident that there are still many problems in applying these rules. First and foremost, these rules are not being consistently applied by all SSUTA member states, resulting in two (or more) states attempting to levy tax on the same transaction, based on alternative situsing regimes. This is particularly evident where software sales and purchases are concerned. Most SSUTA member states source software, which is expressly included in the definition of tangible personal property, to the location of the hardware on which the software resides.3 However, a few member states have taken the position that software should be sitused to the location at which it is used.4 Thus, two states could impose tax on the same transaction based on each state’s situsing regime.

In addition, there is a current debate as to the impact of the SSUTA sourcing rules on purchasers for purposes of determining use tax liability. A workgroup established by the Streamlined Sales Tax Governing Board through its State and Local Advisory Council (“SLAC”), has been considering the issue of when a tax is “legally” paid to another state- for purposes of recognizing a credit for taxes paid to another state. The critical issue in this debate is whether a tax is legally imposed in a state when the seller has collected the tax applying the sourcing regime in SSUTA § 310, and more specifically, when the seller has applied a default rule because it lacked the shipping information for the product being sold.

By way of example, consider the sale of electronically delivered software that is ordered and downloaded from the seller’s website. The seller may not know the location of delivery (the location of the hardware to which the software is downloaded). Following the SSUTA hierarchy provided under SSUTA § 310, the seller would likely charge tax based on the bill to location. If the purchaser downloads that software to a server in a state other than the one containing the bill to location; use of that software on the server may constitute taxable use. The question that then arises is whether the tax paid to the state with the bill to location was legally imposed, and therefore entitles the purchaser to a credit for taxes paid to another state. Presumably, in an instance where the states apply different situsing regimes the tax would be legally imposed by both states—thus, the issue for debate is which state had the right of first assessment.

It appears that the work being conducted by the SLAC will not resolve any of these issues in the near future. Based on the recent introduction of federal legislation in Congress intended to mandate collection on remote sellers, the short term efforts of the Streamlined Sales Tax Governing Board will be focused on the implementation issues associated with federal legislation, rather than on these substantive issues.

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1. SSUTA § 310 (2012).
2. SSUTA § 311 (2012).
3.
Wis Stat § 77.522(1)(b).

4. Ind Info Bulletin No 8 (11/2011).

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