EU's New VAT "MOSS" - Relevance for MFA?

On January 1, 2015, the EU's new approach for charging and collecting VAT on B2C sales of e-services and digital goods begins. The key to the approach is that all businesses will charge based on the customer's location (destination basis). That makes sense for a consumption tax, but has its challenges.  One key one is knowing where the customer is, which is not always easy to determine for digital goods relative to physical goods.

One administrative simplification is the Mini One Stop Shop or MOSS. This allows a business to register in one country for filing purposes. The business still has to collect the appropriate VAT for the country where the consumer is, but rather than quarterly filing in each country, the business just files in the MOSS country. That country makes sure the funds get to the right country (and handles the currency translation since not all EU countries use the Euro).

As I learned more about the MOSS, I was intrigued as to whether this model might help for collection of sales tax from remote sellers, such as if the Marketplace Fairness Act is enacted.

I have more on this in a recent article on this topic in BloombergBNA's Weekly State Tax Report (11/21/14).  I hope you'll take a look. I provide some background on challenges of taxing digital goods, the old and new EU VAT regimes for these items and how the MOSS (and some other VAT B2C aspects) might be relevant for the MFA.  Yes, I know that few states tax digital items, but I suspect more will start to do so to address eroding sales tax bases and the MOSS is relevant for not only digital goods, but for any consumption tax items (in the EU, it will just be for e-services, digital and broadcast; but that could change later).

What do you think?

Avoiding challenges in taxing digital goods

For years, I have been promoting broadening of state sales tax bases to include 21st century types of consumption, such as iTunes, digital books, and ringtones. The broadening though, should not include items purchased by businesses in order to avoid pyramiding (see my SalesTaxSupport 
blog post of 2/4/13 and my policy paper on the topic).

This year, Minnesota enacted legislation, effective 7/1/13, to broaden its sales tax base to include many types of digital goods. One of the exemptions provided is for textbooks and other instructional materials that students are required to purchase. But to get the exemption, the student has to provide the seller with the Form ST3 exemption certification (see the excerpt above of this 1 page form with 5 pages of instructions, which do not yet cover textbook purchases).

So, imagine a Minnesota college student deciding to be green and save money and buys the digital version of her textbook. If the seller is subject to Minnesota sales tax collection, they need to charge the sales tax unless the student provides the exemption certificate. How is that to be done for this electronic transaction?  Hopefully, e-vendors subject to Minnesota sales tax collection have an online form for the students to use.  Will students appreciate the significance of completing such a form?

If the seller is not subject to sales tax collection in Minnesota because they have not physical presence there (and have not voluntarily registered with SSUTA states since Minnesota is a member), does the student need to let the state know the purchase is exempt from use tax?  If yes, how?

I think this challenge illustrates more the problem of providing exemptions than it does taxing digital goods. It would be better to tax all digital goods purchases of consumers. A broader base can allow for a lower rate. If the state wants to provide some relief to students or schools buying digital goods (or tangible ones too), it should be done in some other way. Perhaps a voucher for college students who also qualify for Pell grants.

What do you think?

State tax challenges of taxing digital items and possible federal assistance

Letter Ruling 2012-06 from the Hawaii Department of Taxation is a reminder of challenges of applying sales tax to software and other digital items (or in Hawaii's case, applying gross receipts tax). Despite ruling that the software was not taxable because used by a customer out of state, the ruling notes the following regarding challenges of taxing digital items.

"Technological innovations and the rapid advances being made have now blurred the lines between product and service. Software as a Service ("SAAS") and electronically delivered content perplex both taxing authorities and sellers on the correct tax treatment to be accorded it, with no uniform consensus. Also known as on-demand hosting or subscription-based software, SAAS has grown exponentially and generally enables customers to pay for the use of Web-based software instead of purchasing or licensing the software outright. The software and other digital media application delivery model has also grown exponentially in the past few years, since one no longer needs to wait for the delivery of a physical disk before being able to use it. Not surprisingly, sellers, buyers, legal counsel and tax auditors are arriving at different conclusions on how a transaction should be taxed, depending on how they answer questions such as:

Ø      Should SAAS be treated like electronically delivered software?

Ø      Is a license agreement imperative, and what happens if there is none?

Ø      Is SAAS simply a “license to use”?

Ø      Is SAAS an information service or database?

Ø      What if tangible backup copies are provided to the licensee?

Ø      What if the agreements provide for periodic updates?

Ø      Is a sale sourced to the customer’s billing/shipping address?

Ø      Is a sale sourced to where the hosting server is located, because the software is "used" in that state?

Ø       Is a sale sourced to where users access it?

Ø      What if it's not known where the users are?

It should be noted that a bill has been introduced in Congress, which may provide uniform guidance. The Digital Goods and Services Tax Fairness Act of 2010 (H.R. 5649) was introduced on June 30, 2010, to promote “neutrality, simplicity and fairness in the taxation of digital goods and digital services.” One of the most significant portions of the bill proposes sourcing the sale of digital goods (including software) to a single location for sales tax and use tax purposes.

Regardless of whether the software is a product, a service, or some combination of the

two, the Company has represented that it is consumed entirely outside the state, and that the Company has no Hawai`i customers. As such, the transaction is exempted under HRS § 237-29.5 and/or HRS § 237-29.53, and no GE tax must be paid."

The reference above to H.R. 5649 is an old bill. The current version is H.R. 1860 (112th Congress) and it was addressed by the House Judiciary Committee at a hearing on May 23, 2011. Among other things, H.R. 1860 provides a sourcing rule for sale of digital items. Under this proposed rule:

"(1) IN GENERAL- Taxes on or with respect to the sale of digital goods or digital services may be imposed only by the State and local jurisdictions whose territorial limits encompass the customer's tax address.

(2) MULTIPLE LOCATIONS- If the sale of digital goods or digital services is made to multiple locations of a customer, whether simultaneously or over a period of time, the seller may determine the customer's tax address or addresses using the address or addresses of use as provided by the customer.

(3) SELLER HELD HARMLESS- A seller that relies in good faith on information provided by a customer to determine the customer's tax address or addresses shall not be held liable for any additional tax based on a different determination of the customer's tax address or addresses."

Digital goods and services are defined fairly broadly except that digital services do not include "telecommunications service, Internet access service, or audio or video programming service."

H.R. 1860 also provides that tax may only be imposed with digital goods or services are sold to a customer other than for resale. While that is good tax policy (to avoid cascading or pyramiding of a sales tax), states will likely not like Congress restricting their taxing powers.

Challenges in state taxation of digital items also exist because businesses and states have not reached agreement on the best sourcing approach. At the May 2011 hearing, testimony presented for the Federation of Tax Administrators noted that group's opposition to the legislation. FTA's objections included that the language was overly broad and hindered legitimate taxing authority of state and local governments and would lead to expensive litigation due to overly broad terms such as "resale" and "discriminatory."

In contrast, the Information Technology and Innovation Foundation, supported H.R. 1860: "The Digital Goods and Services Tax Fairness Act of 2011 would set a national framework to ensure fair and equitable taxation of digital content by creating consistent rules for determining which jurisdiction has taxation authority, disallowing multiple and discriminatory taxes, creating consistent definitions, and ensuring that other taxes, such as those applied to telecommunications services, cannot be inappropriately extended to cover digital goods and services. By creating a fairer and more consistent tax system for digital goods, this legislation will help promote and sustain our growing digital economy."

I don't expect that H.R. 1860 will be enacted in the 112th Congress. More study is needed by state governments and industry to better understand the nature and variety of digital transactions, the tax issues, and possible solutions. A solution that follows principles of good tax policy including simplicity, neutrality, equity and transparency and considers state and local taxing authority is a reality at some point in the near future.

What do you think?

Colorado and Taxing Software - California should do almost the same

On February 24, 2010, Colorado enacted HB 1192 which changes the way sales tax applies to software. Prior to this bill, Special Regulation 7 provided that software transferred electronically or provided by a service provider or obtained via "load and leave" is not subject to sales tax. A similar approach applies in California (Reg 1502) under the assumption that an electronic transfer is not tangible personal property.

HB 1192 repeals Special Regulation 7 effective March 1, 2010. HB 1192 clarifies that it "is not intended to alter, other than the designation of standardized software as tangible personal property, the tax treatment of what is known in the industry as "digital goods", "application service providers", "software as a service", or "cloud computing". Nothing contained in said House Bill 10-1192, including the repeal of Special Regulation 7 or the requirement that tax be apportioned in the case of a business purchase of software for its own users operating both within and outside of the state, shall be read as expressing the general assembly's intent regarding the treatment of such methods of transacting business."

I think California lawmakers should consider a similar change in California. Our current system of only applying sales tax to software obtained on tangible media violates equity and neutrality principles. For example, the tax rules do affect how you'll want to acquire software if one technique is taxable (buy the CD version) and one is not (digital download). Yet, the end result is the same - you have use of the software.

Taxing the electronic download does raise some issues though. When a customer does a digital download and pays with a credit card, the seller has no idea where the person is located UNLESS they ask and the person gives the correct answer. It is not problem to ask - that can be down on the payment webscreen. The legislation should provide that the vendor can rely on the answer given by the customer without liability. If the customer gives wrong information - they should be the ones penalized.

Another modification California should consider is to say that only software obtained by a final consumer (not a business) is subject to sales tax. California needs to start moving its sales tax to only apply to final consumption, not consumption by businesses.

California should go beyond software and tax all digital goods unless purchased by a business. With the provision that the seller may reasonably rely on information from the purchaser as to their location.

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