Taxation of Digital Goods
Encyclopedia
Digital goods are software programs, music, videos or other electronic files that users download exclusively from the Internet. Some digital goods are free, others are available for a fee. The taxation of digital goods is partially governed by a federal statute and has been the area of significant state legislative and rule-making activity.

Overview of Internet Taxation in the United States of America

In 1997, the federal government decided to limit taxation of Internet activity for a period of time. The Internet Tax Freedom Act
Internet Tax Freedom Act
The 1998 Internet Tax Freedom Act was a United States law authored by Representative Christopher Cox and Senator Ron Wyden, and signed into law on October 21, 1998 by President Bill Clinton in an effort to promote and preserve the commercial, educational, and informational potential of the Internet...

 (ITFA) prohibits taxes on Internet access, which is defined as a service that allows users access to content, information, email or other services offered over the Internet and may include access to proprietary content, information, and other services as part of a package offered to customers. The Act has exceptions for taxes levied before the statute was written and for sales taxes on online purchases of physical goods.

The statute has been amended three times since its enactment to extend this prohibition. The first amendment solely extended the Act's duration. The second extended it again and clarified the definition of Internet access as including certain telecommunication services, as well as reorganizing sections within the Act. The third amendment again extended the prohibition but narrowed the definition of Internet access to “not include voice, audio or video programming, or other products and services . . . that utilize Internet protocol . . . and for which there is a charge” except those related to a homepage, email, instant messaging, video clips, and personal storage capacity.

Currently, Anna Eshoo, Congresswoman from California’s 14th District (which includes most of Silicon Valley), has introduced a bill to make the Act permanent in its most recent permutation.

States levying a tax on digital goods may be violating the ITFA. The states using their original tax code may fall within the grandfather clause of the ITFA, but there has been no litigation to clarify this or other aspects of the Act. One of the few cases brought under the ITFA involved Community Telecable of Seattle suing the city of Seattle in Washington state court, where Telecable claimed it should not have to pay a telephone utility tax because it was an Internet access provider under the ITFA. The Washington State Supreme Court held that Telecable could not be taxed as a telephone provider when it was providing Internet access under the ITFA.

Every digital-specific tax created by a state has been enacted after the ITFA became law. These laws may be preempted because the ITFA bars taxes on Internet access, and multiple or discriminatory taxes on electronic commerce. Courts have yet to clarify whether the existing laws compound taxes or are discriminatory. Although, it is likely that these laws can survive scrutiny under the ITFA because they can be interpreted to only tax services that fit within the exception to Internet access described in the statute and to be the only taxes on these digital products. On the other hand, there may be problems with these taxes because they may cover products and services dealing with homepages, email, personal storage, or video clips.

Without litigation, it may be difficult to distinguish the difference between the definitions of content given by the ITFA, such as between a video clip and video programming. iTunes, for example, could be designated as video programming for the videos it sells based on the definition found in the federal statute regulating cable companies, and as video clips for its previews. These laws may also run into trouble if they tax a download that is already taxed by another state, because multiple taxes are defined as taxing property that has been taxed once before by another state or political subdivision. VIDEO software>

Another possible federal limitation on Internet taxation is the United States Supreme Court case, Quill Corp. v. North Dakota
Quill Corp. v. North Dakota
Quill Corp. v. North Dakota, 504 U.S. 298 is a Supreme Court ruling concerning use tax. Quill Corporation is an office supply retailer...

, 504 U.S. 298 (1992), which held that under the dormant commerce clause
Dormant Commerce Clause
The "Dormant" Commerce Clause, also known as the "Negative" Commerce Clause, is a legal doctrine that courts in the United States have inferred from the Commerce Clause in Article I of the United States Constitution...

, goods purchased through mail order cannot be subject to a state’s sales tax unless the vendor has a substantial nexus with the state levying the tax. The dormant commerce clause could also apply to any efforts to tax digital downloads. Since most digital downloads are from companies that are centralized in a small number of states, it is likely that there will not be many states with a substantial nexus to download providers. At present, no litigation has arisen to determine what will be defined as a proper nexus for a distributor of digital content within a state. It is possible that a state would argue that servers are enough of a nexus to tax the content passing through, although the Supreme Court has already ruled that communication by common carrier is not enough to form a substantial nexus.

States' Taxation of Digital Goods

States initially were slow to enact taxes on digital downloads, but with recent downturns in tax revenue caused by consumers purchasing more digital downloads, many states have sought ways to impose taxes on purely digital transactions. There are multiple ways that downloads are taxed. Some states use their existing franchise, sales, and use taxes to tax purchases/uses/transactions of consumers of Internet goods and services. Other states enacted laws specifically aimed at digital downloads.

States Relying on General Tax Laws to Govern Digital Goods

Some states presume that downloads are automatically covered by their existing tax statutes based on the common law definition of tangible personal property, which is anything that holds value on its own that is not real property.
  • Alabama
  • Arizona – Uses definition of tangible personal property to be anything that can be discerned by human perception, which includes digital goods transmitted electronically.
  • Colorado - Colorado Revenue Code § 39.26.101
  • New Mexico – New Mexico Property Tax Code § 7.35.2
  • Utah – Clarified its tax law to include digital products in 2008, though it claimed sales tax on these products prior to the amendment.
  • West Virginia


In other states, state tax boards have released bulletins to explain what products are subject to sales and use taxes, tax administrative boards have handed down revenue rulings, and statutes have been amended to define “tangible personal property” to include digital goods and therefore subject them to sales tax.
  • Indiana – Interprets tangible personal property as anything that can be perceived by the senses, including electricity, water, gas and steam. Yet, the taxes do not reach as far as purchasing virtual points for an online game because the points themselves cannot be “perceived.”
  • Louisiana – The Supreme Court of Louisiana has interpreted tangible personal property to be equivalent to corporeal movable property. Article 471 of Louisiana’s Civil Code defines corporeal movable property as things that physically exist and normally move or can be moved from one place to another, which is then illustrated by examples, including digital or electronic products such as audio and video downloads.
  • Maine – Taxes all “tangible personal property” that includes any computer software that is not a “custom computer software program.” A custom computer software program is a program made in a single instance for a single customer.
  • Texas – Defines “taxable items” as including tangible personal property in electronic form instead of in physical form. TX Tax Code §151.010. This is in addition to an administrative ruling holding that electronically transmitted music is the same as taxable tangible personal property.

States That Have Enacted Laws Specifically Addressing Digital Goods Taxation

The remaining states that tax downloads have specific statutes that define exactly what is to be taxed and what is not. The similarity in these taxes is that they are based on a sales-type scheme, where each download (or group of downloads) is taxed like a purchase in physical space.
  • Idaho – Includes in its tax code a sales tax on “canned” software, no matter the method of delivery. Other digital products are then defined as canned software.
  • Kentucky – Defines digital property and then taxes it as common tangible personal property.
  • Nebraska – Statute providing for taxes on sales of digital audio works, digital audiovisual works, and digital books. Further, the state taxes digital codes that provide the purchaser with the right to obtain one or more of these products delivered electronically.
  • New Jersey – Statute taxes all digital property delivered through electronic means, such as music, ringtones, movies, books, audio and video works, and similar products.
  • South Dakota – Created a specific statute levying a tax on electronically delivered products, defining the products as analogs of their physical counterparts (CDs, DVDs, etc.).
  • Tennessee – Amended its sales tax to include digital products, which include “specified digital products” sold with either permanent ownership rights or for less than permanent use.
  • Vermont – Created a specific tax on digital audio-visual works, digital audio works, digital books and ringtones that are transferred electronically.
  • Washington State – Has a digital download and digital service specific tax. This tax applies solely to the digital realm, with many exceptions (presumably to avoid preemption by the Internet Tax Freedom Act).
  • Wisconsin – Statute specifies for taxation purposes, digital audio-visual works, digital audio works, and digital books, along with greeting cards, finished artwork, periodicals, video or electronic games, and newspapers or other news or information products that are transferred electronically.

States That Expressly Do Not Tax Digital Goods

  • North Dakota – Defined digital products and then specifically exempted them from taxation.
  • Washington D.C. – Has a sales tax only on data processing and information services which include the distribution of news or current information. However, the tax statute specifically disclaims sales of digital content and certain Internet related services. Title 47 §2001(n)(1)(N) & (n)(2)(G).


Some of these laws specifically address the taxation of software, which may or may not be interpreted by those states’ courts to include downloadable content, i.e. music and video files.

Overview of Internet Taxation in the European Union

The EU operates Value Added Tax (VAT) and electronic goods and services are subject to VAT at the applicable rate. Each member state may set its own rate of VAT.

VAT regulations are very complicated and the intent of this article is not to provide definitive guidance but rather to list some of the relevant factors.

VAT registration threshold

If a business is located within an EU member state and its turnover though internet sales or otherwise exceeds that member state's VAT threshold then the business must register for VAT. It is then obliged to collect VAT on its sales (outputs) and remit it to the tax authorities having deducted the VAT it pays on its purchases (inputs).

Distance selling threshold

If a business makes sales to a member state that exceeds that member states distance selling threshold (typically either EUR 30,000 or EUR 100,000) then it must register to pay VAT in that member state and collect VAT at that member state's VAT rate.

If sales are below the distance selling threshold VAT must be collected at the VAT rate in the business' own member state.

VAT is not collected from foreign EU businesses

A business must alway charge VAT to non-VAT registered entities (i.e. consumers) but should not charge VAT to foreign EU VAT registerered businesses who provide them with a VAT number. These foreign EU businesses are required to declare their purchase and the tax due to their own tax authorities.

See also

  • Internet Tax Freedom Act
    Internet Tax Freedom Act
    The 1998 Internet Tax Freedom Act was a United States law authored by Representative Christopher Cox and Senator Ron Wyden, and signed into law on October 21, 1998 by President Bill Clinton in an effort to promote and preserve the commercial, educational, and informational potential of the Internet...

  • Internet taxes
    Internet taxes
    From the inception of the Internet until the late 1990s, the Internet was free of regulation by government in the United States at all levels, and also free of any specially targeted tax levies, duties, imposts, or license fees. By 1996, however, that began to change, as several U.S...

  • Taxation in the United States
    Taxation in the United States
    The United States is a federal republic with autonomous state and local governments. Taxes are imposed in the United States at each of these levels. These include taxes on income, property, sales, imports, payroll, estates and gifts, as well as various fees.Taxes are imposed on net income of...

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