Good afternoon Readers,

Part of the government affairs and advocacy services we offer you here at the WTIA is monitoring the activities of state agencies.  Although we are deeply involved with the legislature when it is in session in Olympia, the state agencies are there full time administering and interpreting the laws the legislature passes.  Sometimes, especially with taxes, there are differing views between taxpayers and the government over the meaning and application of laws.  However, most of the state agencies cooperate with their stakeholders and the Dept. of Revenue does reach out to business groups, such as WTIA, when big issues come to the forefront.

Such is the case with the taxation of digital goods, aka "electronically delivered products".  The rise of e-commerce as a mainstay of the global economy has created a number of problems for state tax administrators, especially those with sales taxes, such as Washington.

In the past, tax treatment of physical goods and most services was pretty straighforward, in that it was obvious what was being sold, to whom it was being sold, where it was sold from to where the item or service was being delivered. 

As more and more people and businesses started buying over the Internet and companies like Amazon became major retailers, many of these questions became muddled, in addition to the fact that most consumers were forgoing the paying of sales tax on retail items they were buying over the Internet.  Traditional retailers, along with state and local tax collectors began to complain about how "unfair" this situation was, and to some extent had a point.

The Streamlined Sales Tax Project (SSTP) was formed out of this situation.  This group of state tax administrators came together, along with traditional and electronic retailers, to figure out a way to capture sales tax that was legitimately owed to the states, how to design a "uniform" sales tax system nationwide and to look at how to tax all these new electronic products, some of which had real world equivalents while some do not.

During the 2007 legislative session, state lawmakers created a narrow exemption from sales tax for certain types of financial information.  At the same time, the legislature realized it needed to take a comprehensive look at this issue.  The result is the "Study of Electronically Delivered Products".  A link to the study is here:  http://dor.wa.gov/content/aboutus/statisticsandreports/digitalgoods/default.aspx.

WTIA is closely monitoring this group and weighing in as necessary.  The committee members of the study include a representative of WTIA member Microsoft and Amazon, along with elected officials, Dept. of Revenue, academics and representatives of other industries.  It is quite likely that the study will yield a call for legislative changes that will specifically target the taxation of certain digital goods, such as downloaded music, video games, ringtones and other items.

Another wrinkle to this question is what will be considered a "retail sale" and thereby subject to sales tax versus a "service" that is taxed differently.  The reason this is important is the cost differential to the buyer of such a good or service.  If you buy something that is considered a "retail sale", such as prewritten software, you owe sales tax on that purchase, which is about 9% in King County and slightly less most other places.  The seller then has to collect the sales tax, remit it to the state and pay B&O tax on that sale at the retailing B&O rate.

If, on the other hand, you are buying an electronic item that is not considered a retail sale, the seller is taxed at the "services" B&O rate, which is 1.5% of gross receipts, as opposed to the lower retailing B&O rate.  So, for a buyer of digital goods, it is in their interest to see those classified as something other than retail sales, which helps lower the cost of doing business.  If you are a seller, your B&O tax rate is lower if you have retail sales but you have to collect the sales tax and send it to the state.  Otherwise your B&O tax rate is 1.5%, which can be tough on young, growing companies that are not yet profitable. 

Simple, right?  Now throw in the how electronically delivered products differ materially from physical goods or services.  When you are buying software, web services or certain kinds of music, are you buying the item outright or are you paying a licensing fee to use that item?  Are you paying a royalty for the right to use certain patented or copyrighted inventions or works?  Do you have unlimited rights of use?  In many cases, the answers to these questions are difficult to decipher.  Does the transaction happen where the servers reside or where the purchaser is?  What if the purchaser is a business with multiple locations around the world?

As you can see how to tax digital goods is not easy nor simple.  What is certain is that there will be taxes on some kinds of digital goods; we just do not know which ones yet.  Since this issue hits WTIA members as both sellers and buyers, we sent a letter to the study committee, in conjunction with AeA, laying out some concerns and suggesting that items that businesses buy be exempt from sales tax.  That letter is attached.

Destination Sourcing Starts July 1

Another related development is the implementaiton of legislation generated by the SSTP.  The next phase of sales tax streamlining goes into effect July 1, 2008.  This is "destination sourcing".  This means that the buyer's location determines to which jurisdiction the sales tax ends up.  This was resisted heavily by certain cities that had large warehouse operations such as Auburn, Kent and Fife.  Until now, the sales tax flowed to the city where the purchase was made or to where the item was being delivered from.  The cities that have big warehouses stood to see a big chunk of sales taxes disappear but the legislature budgeted money for "mitigation" for these cities.

This also means changes for retailers who have to be able to source the sales taxes to the buyer's location.  It is likely that there will be a great deal of confusion at first.  Part of the SSTP legislation calls for "certified service providers", which are entities that are licensed to manage the flow of sales taxes and the proper rates by jurisdiction.  One such company is WTIA member, Avalara, http://www.avalara.com/

To learn more about destination sourcing, check out this Dept. of Revenue page:  http://dor.wa.gov/Content/FindTaxesAndRates/RetailSalesTax/DestinationBased/default.aspx

Please contact me by phone or e-mail if you have questions about sales taxes, SSTP or the Study of Electronically Delivered Products.  For WTIA members, we also have a Tax Committee that you are welcome to join where we e-mail you tax related information, meetings, rulemakings, etc.  Contact information is Lmcmurran@washingtontechnology.org or 206-448-3033 x101.