Hello Readers,

The Washington Dept. of Revenue, www.dor.wa.gov, has issued new rules on the taxation of computers, computer systems, software, both prepackaged and custom, and digital goods and services.

This rule, known as “Rule 155”, has as its formal citation WAC 458-20-155.   Most of the old rule is repealed and is replaced with familiar language and new language that will have to be understood by taxpayers.  There are many examples of taxable situations in the new rule that may provide guidance in instances where tax liability is not clear.

Most of the concepts around the taxation of manufacturing, retailing, wholesaling and services of computers and software has not changed substantially.  The new rule puts into place the taxation of digital products, digital automated services and remote access software.  For about four years, DOR and taxpayers had a great deal of trouble figuring out the taxation of certain online businesses.  Because there are so many new types of online businesses that do not have a “tangible equivalent” or are very enhanced versions of previously offline services that DOR could not determine if sales tax was owed on a particular transaction.

One of the benefits of the digital goods tax was that for most smaller online businesses based in Washington, they would have to collect sales tax only from Washington consumers, not from out of state consumers.

The problems arose when certain companies selling digital or online services had in-state customers and the company was not clear if they had to collect sales tax or not on a certain transaction.  In some instances, the sales tax dispute was in the thousands of dollars.  For a small company to have a four figure tax liability, it can be enough to put them out of business.

The majority of disputed situations have been sorted out but the complexity of the digital products tax still exists, especially in the area of “digital automated services”.  A number of tax practitioners and tax policy types are rethinking the application of sales tax to digital automated services.

Here is a link to the DOR rules that go into effect March 28, 2013:  http://dor.wa.gov/Docs/Rules/draft/20-155etalcr3Pfrmdraftsfeb2013.pdf

You can find out more about the taxation of digital products here: http://dor.wa.gov/Content/GetAFormOrPublication/PublicationBySubject/TaxTopics/DigitalProducts.aspx

The “online searchable database” special notice is on that page, too.

Another difficult issue has been the definition and exemption of “business inputs”.  The notion here is that items purchased by a business that are integral to or an actual part of the product said business sells to end users should be exempt from sales tax to prevent “pyramiding” of taxes.  When the product is sold to an end user, sales tax is paid.  Deciding which digital products are “business inputs” has been a disputed concept.  Businesses have had to pay sales tax on digital items that they believed were integral to the final product being sold to an end user.

It is strongly suggested that anyone who buys, sells or otherwise trades in digital products or digital services understand these rules.  Please contact us at WTIA if you have questions or comments about these important tax rules.