Recent developments in the sales and use taxation of digital products.

• Author: Duncan, Harley T.

In response to technological developments, states have begun to consider legislation explicitly addressing the taxability of products delivered electronically. Absent specific rules, states have developed inconsistent positions for determining what digital items are subject to sales and use tax. To provide some clarity in this area, a group of states, localities, and business interests have worked through the Streamlined Sales and Use Tax Governing Board to adopt standards that member states must meet if they impose sales tax on certain digital products. This article discusses the Streamlined Sales and Use Tax Agreement's requirements and their potential effect on sales tax laws in both member and nonmember states.

State tax law generally lags technological developments, and the digital revolution is no exception. The iPod and other digital music players have been around for nearly a decade, and electronic book readers such as the Kindle are in their second generation. Yet it is only within the last two years that states have begun to consider legislation explicitly addressing the taxability of various products that are delivered to purchasers electronically, rather than through some tangible storage medium. This recent focus has been spurred considerably by requirements of the Streamlined Sales and Use Tax Agreement (SSUTA), which will become fully effective January 1, 2010. The SSUTA resulted from a coordinated effort by states, local governments, and business interests to simplify the collection and administration of state and local sales taxes. To that end, SSUTA includes model definitions that must be used by member states. Twenty-two states have adopted legislation conforming state statutes to the provisions of the SSUTA. While some states, including both SSUTA members and non-members, have enacted or are considering legislation specifically addressing taxation of digital products, other states have not. For those states that have considered the issue, some of the driving factors for taxation appear to be preserving or expanding the sales tax base and creating parity between digital products and equivalent goods that are delivered in tangible form. Whatever the reason, taxpayers generally agree that transparency in this area is long overdue.

SSUTA Model Definitions

Although state tax laws (at least until recently) generally did not address the taxation of digital products, a number of states took the position that certain digital products were taxable pursuant to their general sales and use tax imposition statutes. Those states determined that digital products were included within the definition of taxable tangible personal property or as specifically enumerated taxable services (e.g., computer or information services) or under some other legal or administrative interpretation of the state's tax law. (1) Often, however, taxpayers were not aware of the state's position regarding the taxability of these products, which resulted in unanticipated tax exposure. To reduce this uncertainty, various affected interests worked to incorporate standards into the SSUTA that member states must meet if they impose sales tax on electronically delivered products.

As amended, the SSUTA provides that, effective January 1, 2008, member states may not tax the sale of "specified digital products" pursuant to their imposition statutes applicable to any of the following items: tangible personal property, "computer software," "telecommunications," or "ancillary services" (a category of telecommunications services). (2) The term "specified digital products" is defined to include "digital audio-visual works," "digital audio works," and "digital books." (3) To tax these defined digital products, a SSUTA member state must enact specific imposition language subjecting these products to taxation and must adopt the SSUTA definition of these terms. (4) Furthermore, effective January 1, 2010, this taxability restriction will be applicable to all other products "transferred electronically," not just the three defined digital products. (5) A product is "transferred electronically" if it is provided to the purchaser by means other than on a tangible storage media. (6) Accordingly, effective January 1, 2010, SSUTA member states generally will no longer be able to tax products delivered via other-than-tangible media unless the state has enacted specific laws taxing electronically delivered or enumerated digital products.

The definitions of the items constituting "specified digital products" were likely developed with a view toward encompassing the most common consumer or personal use digital products such as downloaded music...