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BILL # HB 2479 |
TITLE: TPT; digital goods and services |
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SPONSOR: Ugenti-Rita |
STATUS: House Engrossed |
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PREPARED BY: Hans Olofsson |
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The bill would exclude from the state and municipal Transaction Privilege Tax (TPT), as well as the use tax, the gross proceeds from the sale, lease or licensing of digital services and digital goods that are remotely accessed by customers. The bill provides that prewritten computer software regardless of delivery method and digital goods transferred electronically be taxed under the retail classification of TPT or the use tax.
Examples of digital goods that would be taxed under the bill are movies, music, ringtones, and e-books downloaded by customers onto their computer or other device. Digital services would be excluded from tax, including various cloud-based or remotely accessed computing services. Examples of digital services that would be exempt from tax under the bill are data storage management and movie and music streaming services.
The bill would become effective on the first day of the month following the general effective date.
Estimated Impact
We estimate that the bill would result in a General Fund revenue loss. We are unable, however, to determine the magnitude of the loss. Our forecast ability is limited by 1) a lack of information on the level of currently taxed digital services and 2) a definitive legal interpretation of some of the bill's language.
There are significant challenges in estimating the revenue impact associated with the bill. A quantitative analysis of this bill would require us to estimate the amount of taxes currently collected from the sale of digital goods and services and compare this to the amount that would be collected under the bill. We do not have the data required to do such an analysis.
Based on anecdotal information provided during meetings held in 2017 by the Ad Hoc Joint Committee on the Tax Treatment of Digital Goods and Services, there appears to be uncertainty among businesses as to when they are required to pay TPT on digital goods and services. We are not aware, however, to what extent this lack of clarity has affected TPT collections.
According to the Department of Revenue (DOR), they do not separately track taxes paid on digital goods and services. Businesses report the total amount of gross receipts on the tax form submitted to DOR each month. No detail is provided with respect to the specific items that were sold. The lack of detail included on the form reported to DOR makes it difficult to determine the aggregate statewide amount of taxes collected from the sale of digital goods and services. If a business only engaged in digital services, however, DOR could identify the TPT collections of some well-known firms. Due to confidentiality requirements, our staff would not have access to that information.
We have anecdotal evidence from billing statements, however, that some selected digital streaming services pay TPT. Under the legislation, TPT would no longer be applied to streaming services with no download option. If a streaming service offers the option to download some content (like a movie), the TPT may still be applied. Different stakeholders have different interpretations of the bill's language in this regard. We lack any definitive legal guidance on how to interpret the bill's language on this issue.
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While DOR is not able to release any company-specific information, we have calculated that 2 major streaming services may currently pay a combined $7 million in TPT. In making this calculation, we used a pro-rated share of national sales estimates to determine the Arizona share. If both services offered only remote access (so no downloading), they would no longer be subject to TPT. Both services, however, offer a download option. In that circumstance, depending on the legal interpretation, they may or may not still pay TPT.
Even if these services are still subject to taxation, however, the classification may shift to the use tax depending on DOR's determination as to whether nexus exists or not. (A business that has nexus in Arizona is required to remit TPT to DOR. If a business has no nexus to Arizona, the use tax is applicable). While TPT and use tax have the same rate, the legal responsibility to pay differs. TPT is paid by the seller while use tax is paid by the buyer.
Shifting to the use tax would probably reduce the projected $7 million in collections. The use tax is thought to have lower enforcement rates since the buyer is required to transmit their use tax payment to DOR rather than the seller automatically sending the payments to DOR. Companies can agree to pay the use tax on behalf of the buyer, but we are unaware of the extent of such arrangements.
Our use of two companies is not intended to convey the universe of digital service sales. We are solely attempting to provide some limited quantification of the potential impact of the bill. As noted above, we lack both the broad-based data and legal interpretations necessary to develop any general conclusions about the impact of the legislation.
Our analysis also does not attempt to address any potential legal issues surrounding DOR's current taxation policy of digital transactions.
Digital goods and services are not defined in current statutes. The sales of computer software programs are taxed pursuant to administrative rules. DOR's determination as to whether a specific digital good or service is taxable is largely based on their interpretation of tangible personal property (TPP), as defined in statutes, and existing case law. Under DOR's current practice, TPP is taxed under either the retail or personal property rental classification of TPT.
HB 2479 includes statutory definitions of digital goods and services and specifies under which conditions digital goods are taxable (transferred electronically or downloaded) or tax-exempt (remotely accessed or streamed). As noted above, the bill exempts digital services from TPT and use tax. The tax treatment of computer software is essentially the same under the bill as under current administrative rules.
As noted above, DOR does not have the data required to quantify the fiscal impact estimate of the bill. However, based on our discussions with DOR, we believe that at least some provisions in the bill would result in a revenue loss of some amount, as outlined below.
Software as a Service (SaaS)
SaaS refers to software that is accessed remotely from a server ("in the cloud") as opposed to downloaded onto the user's own computer or other device. SaaS is typically paid for on a subscription-basis. Examples of SaaS are tax-preparation, office productivity and accounting software. If this same software were purchased in a store or downloaded onto the buyer's computer, it would be taxable.
SaaS is purchased by both individuals and businesses. According to DOR, SaaS is currently being taxed under the personal property rental classification of TPT. Since the bill would exempt such sales, the state would incur a revenue loss relative to current practice.
Platform as a Service (PaaS) and Infrastructure as a Service (IaaS)
PaaS and IaaS refer to cloud-based services. PaaS allows the purchasers of such service to deploy their applications on the provider's computer servers, otherwise known as the "cloud." Under IaaS, buyers cannot only deploy their applications
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but also configure an operating system on the provider's cloud infrastructure. These types of digital services are typically purchased by businesses rather than individuals. According to DOR, both PaaS and IaaS are currently taxed under the rental classification of TPT. Under the bill, these types of cloud-based services would be exempt from TPT. Therefore, this provision would result in a revenue loss of some amount.
Streaming Services
The bill would exclude movie, music and other digital-content streaming services that do not include the right to electronic delivery or transfer ("downloading") from TPT. According to DOR, streaming services are currently taxed under the personal property rental classification of TPT. According to proponents of the bill, streaming services that provide customers the option to download digital content for offline viewing on a device would continue to be taxed (albeit under retail rather than rental TPT). Their position is that only streaming services that do not provide such an option ("pure streaming") would be exempt from TPT.
There is a lack of agreement, however, as to which specific streaming providers' services would be taxed or exempted under the bill. As a result, some of the stakeholders are interpreting the bill's language to exempt streaming service providers that are currently taxed in Arizona regardless of whether they provide a download option.
To our knowledge, DOR has not yet opined on their interpretation. Legislative Council is not certain as to how this provision would be implemented and therefore which specific streaming services would be affected. DOR would ultimately have to determine whether the bill would affect only companies providing "pure streaming" services as opposed those offering both streaming and the option to download digital content.
In addition to the digital services discussed above, the bill would exclude several other cloud-based or remotely accessed computing services from TPT, such as data storage management and data processing and information services. We have asked DOR whether they currently collect tax from such services but have not yet received an answer.
Taxing Digital Goods under Retail TPT
As noted previously, tangible personal property (TPP) is either taxed under the retail or personal property rental classification of TPT depending on whether the item is sold or leased/rented. Digital goods and services currently taxed are considered TPP under DOR's interpretation. If the digital good or service is paid for on a subscription-basis or under a license agreement, it is taxed as TPP under rental TPT. However, if the digital good or service is purchased to be owned and used without a time restriction, it is taxed under retail TPT. Under the bill, prewritten software along with downloaded digital goods would be taxed under retail TPT.
Based on a discussion with DOR, it is our understanding that the establishment of nexus for purposes of collecting TPT is different under the retail and rental classifications. To be required to collect and remit TPT to DOR, an out-of-state seller must have "substantial nexus" or connection to the state. If there is no nexus, Arizona buyers become liable for the tax, which they are required to remit directly to DOR as use tax. Under the rental classification, nexus is established when the property that is leased or rented is in the state. Nexus under the retail classification is established if the out-of-state seller has a store, office, warehouse, or sales representative in Arizona. As a result, nexus is more easily achieved under the rental classification.
As suggested above, if an out-of-state seller is not considered to have substantial nexus in the state, the transaction with an in-state buyer will be taxed under the use tax as opposed to TPT.
Based on materials presented by DOR, it is our understanding that most digital goods are currently taxed as TPP under the rental classification of TPT for which nexus is easily established. Therefore, as a general rule, use tax situations do not arise from transactions under the rental classifications. Since the bill provides that digital goods be taxed under the retail classification for which the establishment of nexus is more stringent, it is possible that transactions that otherwise would have been taxed under rental TPT would be taxed as use tax under the bill. Since the state retains all of the use tax, this provision could result in more state revenue under the bill. However, with the use tax, there is also a greater risk of non-compliance, which would reduce state revenue. The net state revenue impact of this provision cannot be determined in advance.
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As suggested above, the magnitude of the bill's revenue loss will depend on how its provisions are legally interpreted. As an example, the revenue loss would depend on whether the bill's language is interpreted to exempt all streaming services or just "pure streaming." In either case, we lack data on the current level of TPT collected from streaming services.
To provide some perspective on the bill's potential revenue loss, we reviewed publicly reported data for a large, well-known company that provides streaming services of movies and television shows with a download option. Based on anecdotal information, this service appears to be paying TPT under current practice. Prorating national streaming revenue reported by this company, we estimate that this streaming service pays $6 million in Arizona TPT.
We also reviewed publicly reported data for a large provider of music streaming services with a download option. This service also appears to pay Arizona TPT. By prorating national data, we estimate that this company pays $1 million in Arizona TPT.
Depending upon the legal interpretation, there are several possible outcomes for these 2 businesses. If streaming services with a download option are ultimately determined to be subject to TPT, the state could still continue to collect the $7 million. If this service is not taxable, the revenue loss would be $(7) million. Our use of two companies is not intended to convey the universe of digital service sales. Therefore, the combined amount of $(7) million should not be interpreted to represent an estimate of the bill's impact.
Even if the streaming services of the two "sample companies" are ultimately determined to be subject to tax, the gross receipts from such services may be taxed as use tax rather than TPT. As discussed above, since the buyer rather than the seller is responsible to remit use tax payments to the state, there is a risk that state revenue losses could arise from a lack of taxpayer compliance.
Therefore, depending on whether nexus exists or the out-of-state seller agrees to collect use tax on behalf of its customers in Arizona, the shift from TPT to use tax liability could by itself result in a revenue loss.
Local Government Impact
Apart from any potential loss of state TPT distributions to cities and counties, the bill's provisions would also affect municipal TPT and county excise taxes. The current tax treatment of digital goods and services by cities is similar (but not identical) to the state. According to the League of Arizona Cities and Towns, the rental classification under the Model City Tax Code is broader than the state's personal property rental classification under statutes. Under this interpretation, more of the digital services included in HB 2479 would be exempted from taxation. For example, the leasing of space on servers in data centers, which is currently taxed by cities (but not the state), would be exempted under the bill, according to the League.
The League surveyed individual cities on the impact of the bill. Based on the survey result from 8 cities in the state, the League reports that estimated municipal taxes for those cities would be reduced by $(23) million annually under the bill. The League further extrapolated the survey result to all the state's municipalities, which reportedly would result in a statewide municipal revenue loss of $(78) million annually. Since we just received this information today, March 1st, we have not been able to analyze the League’s survey results and their methodological approach. Using the same dataset, the League extrapolated the results from the 8 cities to a state level TPT impact. There are differences between the municipal and state tax base, which complicates the process of extrapolating the local level data. As a result, their state level estimate would also require additional review.
Insofar as the bill would result in reduced state TPT, this would adversely affect the counties. The counties are authorized to levy their own excise taxes, which use the same tax base as for state TPT. With the exception for the sale of electricity, counties are not currently allowed to levy a use tax. This means that insofar as bill would result in digital goods being taxed under the use tax rather than retail TPT (see nexus discussion above), counties would experience a loss in revenues. In addition, those cities that do not currently levy a use tax (which is optional for municipalities) could also incur a revenue loss as a result of this provision in the bill.
3/1/18