States have made progress in taxing internet businesses from income tax to sales tax on interstate transactions, but what about the data customers and other internet users leave behind? There is no uniform standard for “taxing the Internet” but every incentive to find ways to generate more tax revenue.
States Losing Tax Revenue
Since the internet became a place to do business and sell products and services, states have fretted over the loss of tax revenue. When fixing this conern, states struggle with:
- jurisdictional limitations on tax authority; and
- how to characterize income generating activities and retail transactions that happen on the internet.
Taxing the Internet
Recently, a company selling email services over the internet to customers in the state of Washington relied on the federal Internet Tax Freedom Act (ITFA) to challenge a sales tax assessment by the state. The federal Internet Tax Freedom Act (ITFA) has prohibited states from taxing independently provided email since 2007.
The Washington Department of Revenue ruled that the company’s services do not fall within the federal ban on Internet tax. The company creates and sends customized digital communications for its customers. The company is not providing standard email accounts. However, another state found that the company’s services were email under IFTA and not taxable by that state.
What is email under IFTA? What can states tax without violating federal law? Is user data collected by internet businesses an item of value that could be taxed?
Federal Guidance for States
Over the last two decades, states have been sorting out how to tax transactions that exist because of the internet. Most recently, the decision in South Dakota vs. Wayfair backtracked on U.S. Supreme Court precedent to address the role that the internet plays in determining nexus between businesses and states. States use the facts of the case as a guide for creating nexus laws.
So far, Congress has not indicated it will address the issues of nexus and internet transactions that involve parties from more than one state. Notably, Congress didn’t make the IFTA moratorium on taxing internet access and imposing multiple or discriminatory taxes on electronic commerce permanent until February of 2016.
State Tax Under ITFA
ITFA does not ban internet taxes that are structured to substitute for or supplement state corporate income taxes, including gross receipts taxes.
For example, income from advertising services would be included in the federal income tax calculation relied on for a state’s income tax return.
Also states may tax internet advertising services under:
- gross receipts tax laws; or
- sales tax laws for services.
Wayfair has made it easier for states to apply sales tax laws to the activities of online marketplaces.
Finally, income from the sales of data collected from internet shoppers is subject to state income tax sourcing rules. Sales factor sourcing rules, for example, vary by state. They may source sales of intangible property to a state if:
- the property is used in the state; or
- the income-producing activity is easily identified with a state based on other factors.
However, what about the value that a company itself receives from the user data it collects on its retail website? The internet customer pays a set price for a good or a service, but the retail business receives more value from doing business on the internet than collecting sales or advertising revenue. It sells data from users other than customers, and itself receives a benefit from the collected data.
A Different Tax Perspective on Digital from Europe
EU countries have, in recent years, addressed this issue by discussing a 3% tax on the revenue of companies that engage in digital transactions. The tax would target revenue derived from digital transactions where internet user participation creates value for the taxpayer.
In early 2018, the European Commission proposed a Digital Services Tax, or DST for countries in the EU. The proposed DST was a 3% tax on a company’s revenues derived from three activities that require participation from internet users:
- selling digital advertising space,
- digital intermediary activities such as services by online marketplaces, and
- sales of user collected data.
The DST would apply to companies that met relatively high revenue thresholds each year.
Ultimately, in November 2018, the EU countries did not agree on the DST. In March 2019, the EU countries also did not agree on a 3% tax that would target only digital advertising revenue. Unable to come to consensus with other countries, EU and other countries are devising their own tax laws for digital companies.
Digital Services Taxes Coming Soon
The UK Government has proposed introducing a digital services tax that will go into effect on April 1, 2020. The 2% tax would apply to income generated from UK users of internet search engines, online marketplaces and social media. The tax would apply to businesses whose annual consolidated income is £500m or more.
Lost State Tax Revenue and the Digital Economy
Arguably, a tax on companies with revenues that make money from digital transactions would violate IFTA as being discriminatory and possibly a double tax. The U.S. government stated it is considering legal action in response to national DSTs in Europe.
Nonetheless, in a digital economy, retailers collect data on internet users that visit their websites from each click of a link to the length of time spent on a page. That data has value to the retailer even when the user doesn’t become an actual customer. Is it market research made easy via software or is it value derived from doing business on the internet that goes beyond sales prices?
States may be continuing to ask whether they are losing tax revenue in the digital economy. The question extends beyond a state’s jurisdiction to tax.
Is there an equivalent to user data in non-ecommerce transactions that would trigger ITFA?
By Lisa Lopata, J.D.