7.05[1] STATE BUSINESS TAXES 7-8

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Pauline Young
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1 7.05[1] STATE BUSINESS TAXES Specific Digital Products [1] Satellite Radio In order to work in urban areas where tall buildings block a full view of the sky, satellite radio requires ubiquitous repeaters (equipment that receive, amplify and retransmit a signal). Consequently, in many states it is challenging to fashion a no-tax argument based on lack of physical presence. The taxation of satellite radio has been specifically addressed by Tennessee, which generally subjects digital products to its sales and use tax, but exempts subscriptions to satellite radio services from these taxes. 1 [2] Satellite Television The Telecommunications Act of 1996 explicitly states that satellite television providers are exempt from... any tax or fee imposed by any local taxing jurisdiction on direct-to-home service. 2 The key phrase here is local taxing jurisdiction because the statute does permit states to tax such services and distribute the proceeds to local governments. For example, Kentucky taxes satellite broadcast and wireless cable service. 3 Moreover, states are not restricted by federal law from taxing satellite television providers at a different rate than cable television. 4 [3] Music Downloads It is important to distinguish music downloads from pre-paid gift cards that allow a consumer to download music. Pre-paid gift cards represent a $35 billion market. 5 Because of the sheer size of the market and their presence in most retail outlets they are often specifically addressed by statute. For example, in West Virginia, gift cards are exempt from the sales and use tax. 6 Although a large number of states purport to tax music downloads, the words music download itunes or media download do not appear in most state statutes. Many states rely on expansive definition 1 Tenn. Code Ann Pub. L. No , 602(a), codified at 47 U.S.C Ky. Rev. Stat. Ann (19). 4 Congress sought to change this tax disparity in the State Video Tax Fairness Act of 2007 (H.R. 3679). The bill, which did not pass, would have prohibited a discriminatory tax on any means of providing multichannel video programming distribution services. 5 See The U.S. Prepaid and Gift Card Market Report at 6 West Virginia Taxpayer Services Division Publications TSD-427, 06/01/2008.

2 7-9 TAXATION OF DIGITAL PRODUCTS 7.05[4] of software, elastic interpretations of existing statutes, or language that taxes something that is known (music) in any form. In Kentucky the definition of cable service includes digital or other music services, and other similar services. 7 Texas achieves this result through a ruling. 8 New Jersey takes a very broad approach which defines and taxes digital property. Digital property means electronically delivered music, ringtones, movies, books, audio and video works and similar products, where the customer is granted a right or license to use, retain or make a copy of the item. Digital property does not include video programming services, including video on demand television services, and broadcasting services, including content to provide such services. 9 As this provision demonstrates, the carving out of exemptions for certain types of digital services reflects the influence of certain industries who successfully make their case for special treatment. The prominence of digital entertainment and declining tax bases from traditional sources are causing this issue to come to the forefront of tax policy debates. Increasingly, more states are addressing the issue directly and not through interpretation. 10 One notable exception is California. Not surprisingly, the entertainment capital of the world does not tax downloaded entertainment. 11 [4] Movie Downloads The treatment of movie downloads is similar to music downloads with one added component. Many states tax entertainment delivered via telephone, which is a euphemism for 900 adult telephone services. 12 Taxpayers must take care not to get caught in an expansive reading of these statutes. Apple and Google both successfully navigated this with their movie download services. 13 The itunes movie download service is similar to the itunes music model that many are familiar with. It does not allow for the viewing of the movie while it is being downloaded. Apple and Google each used this fact in New 7 Ky. Rev. Stat. Ann (2). 8 Texas Policy Letter Ruling L, 05/30/ N.J. Stat. Ann. 54:32B-2(vv). 10 See The Tax Man Cometh After itunes at -cometh -after-itunes/ _ html (last visited Jan. 27, 2009). 11 Cal. Rev. & Tax. Code 6006, See Massachusetts Technical Information Release 05-8, 07/14/2005. See also, Ohio Rev. Code Ann New York (TSB-A-07(11)S) and (TSB-A-08(22)S).

3 7.05[5] STATE BUSINESS TAXES 7-10 York to avoid the imposition of the tax on live entertainment delivered via telephony. 14 [5] Ringtones Ringtones have not escaped the attention of taxing authorities. They represent a surprisingly large source of revenue for the music industry. Many states specifically address ringtones in their tax statutes. 15 Some states, like Virginia 16 and Indiana, 17 specifically exclude ringtones from their tax on telecommunications. A common exclusion is the language used in Massachusetts 18 and Ohio: 19 Digital products delivered electronically, including music, video, reading materials or ring tones are excluded from the tax on telecommunications services. However, care must be taken to ensure that other parts of a state statute do not cover ringtones. Texas takes the view, through a ruling, that ringtones are taxable tangible property. 20 [6] Bricks and Mortar Stores with Virtual Siblings Some digital products vendors have both an on-line presence and brick and mortar retail locations. For example, Apple has approximately 180 stores in 37 states. Digital products vendors are not the first to employ a dual sales strategy. Many traditional stores have mailorder operations. From a sales tax perspective, this is reminiscent of the failed attempt by a few of states to establish a nexus through actions of affiliates, such as the cases brought against Saks Fifth Avenue (the bricks and mortar chain) and SFA Folio (its mail order affiliate). 21 Another retailer, Barnes and Noble, settled a sales tax collection dispute by agreeing to pay California $9 million. 22 Whether these are separate legal entities with substance (e.g., employees, office space, contracts, etc.) and whether one accepts the other s returns may 14 Id. 15 See, e.g., N.J. Stat. Ann. 54:32B-2(vv). 16 Va. Code Ann (C). 17 Ind. Code Massachusetts Technical Information Release 05-8, 07/14/ See also Ohio Rev. Code Ann (AA). 20 Texas Policy Letter Ruling L, 05/17/ See, for example: Ohio: SFA Folio Collections, Inc. v. Tracy, 73 Ohio St.3d 119, 652 N.E.2d 693 (1995). Tennessee: SFA Folio Collections, Inc. v. Huddleston, Commissioner of Revenue, III (Tenn.. Chancery March 11, 1991). 22 BNA Daily Tax Report, No. 182, Friday, September 19, 2008, p. K-3.

4 7-11 TAXATION OF DIGITAL PRODUCTS 7.05[7] have a bearing on taxability. From an income tax perspective, this is less significant in unitary or combined reporting states. 23 [7] On-Line (Internet) Travel Sites Internet travel sites like Expedia.com, Travelocity.com, Orbitz.com and their competitors have state tax implications. The issue is whether a hotel occupancy tax applies to the amount received by the Internet travel sites, which generally view themselves as reservations agents. These Internet travel sites pay a discounted wholesale price to the hotel, which is lower than the retail price paid by the traveler to the Internet travel sites. The dispute is about the amount of the occupancy tax on the difference between what Internet travel sites receive from the consumers and what they pay the hotels. Understandably, Internet travel sites are taking the position that local occupancy taxes do not apply to reservations made online because the Internet travel sites are not hotel owners. Equally understandably, municipalities take the view that the retail price paid by the traveler should be subject to tax. Hotel companies that run their own online reservation sites are in a somewhat different position in that they or an affiliate typically own the hotels. There have been a large number of cases in this area with inconsistent decisions. The cases often turn on the interpretation of local statutes, rather than federal constitutional issues. In one significant case, a federal court held in favor of the Internet travel sites after finding that the statutes have simply failed to keep up with the times. 24 In another federal court, Internet travel sites were generally held not subject to a hotel tax after the court carefully parsed the enabling statues of various cities finding that the Internet travel sites do not meet the definition of establishments in the sense that hotels typically are. 25 However, the court suggested the Internet travel sites may be liable under an unjust enrichment theory stating: the original plaintiffs did present a viable legal theory to seek an award of taxes collected by Defendants but not remitted to the municipalities. 26 This court s view would require Internet travel sites to collect an occupancy tax on the retail amount but remit only the tax on the wholesale amount. Still another federal case held Internet travel sites liable for the occupancy tax by interpreting the statute as 23 See 2.05[2] and 2.08 supra. 24 Louisville/Jefferson County Metro Government v. Hotel.com, 3:06-CV-480-R (W.D. Ky. Sept. 26, 2008). 25 City of Findlay v. Hotels.com, 561 F. Supp.2d 917, 922 (N.D. Ohio 2008). 26 Id., 561 F. Supp.2d at 919.

5 7.05[7] STATE BUSINESS TAXES 7-12 applying to those who receive consideration for the rental of such hotel or motel room. 27 A number of cases have been dismissed by federal courts because taxing jurisdictions failed to exhaust administrative remedies. 28 This has been a classic trap for taxpayers who seek relief from federal courts before exhausting state administrative remedies and it appears to be a trap that municipalities have fallen into. 27 City of Fairview Heights v. Orbits, Inc., No. 05-CV-840-DRY, 2006 U.S. Dist. LEXIS (S.D. Ill. April 11, 2007). 28 See, e.g.: Second Circuit: County of Nassau v. Hotels.com, No. 2:06-CV-05724, Memorandum of Decision and Order (E.D. N.Y. Aug. 17, 2007). State Courts: Georgia: City of Atlanta v. Hotels.com, 288 Ga. App. 391, 654 S.E.2d 166 (2007).

Digital Goods and Services Tax Fairness Act Section by Section Analysis. Provided by Stacey Sprinkle

Digital Goods and Services Tax Fairness Act Section by Section Analysis Provided by Stacey Sprinkle Section 1 Short Title Section 2 Findings Finds that Congress is exercising its constitutional authority