Articles

Written by: Matthew Walsh, director of tax research, ADP, Inc.

In the past, items that we purchase on a regular basis were delivered in tangible form. However, as technology has advanced, more and more items are being delivered digitally. Software, music, movies and books are now all widely available via online download. When books, movies, and music are purchased in a brick and mortar store, sales tax is generally charged. However the same cannot always be said when otherwise identical items are purchased in a digital format. History has shown that the tax treatment of presumably identical items can vary. So, how will today's dynamic digital environment affect the future of sales tax?

Brief History Of Sales Tax
Sales tax as we know it first developed in the United States in the early 1930's and over time, 45 of the 50 states have enacted a sales tax. As these taxes were implemented, the scope generally covered sales of tangible personal property (TPP). This made sense, since at the time our economy was primarily goods-based. Through the years, as our economy changed, some states expanded the scope of their sales tax to keep pace with the changing marketplace. To this day, however, sales tax remains primarily a tax on the sale of TPP in most states.

TPP is generally defined as: an item that can be seen, weighed, touched or is somehow otherwise perceptible to the senses. Given the technology of the early 20th century, this definition was easy to interpret and made sense as a foundation upon which to base a sales tax. However, in today's digital economy, this definition often restricts the application of tax on these new digital products.

The Slow Movement To Tax Digital Items
There has been a movement among the states to expand the scope of their sales tax legislation and impose sales tax on digital products. We only need to look at the software industry to discern a definite trend. When computer programs were first commercially developed, they were always sold on punch cards, tapes, diskettes and finally CD's. However, with the rapid growth of the Internet and the ability to deliver programs electronically, many software developers began to switch from tangible formats to digital delivery. At first, many of these transactions were not subject to sales tax as the programs were no longer supplied as TPP. While you can perceive a CD, you can't perceive an electronically delivered software program. When you consider that a software application license fee can range in the millions of dollars, the tax revenue loss when delivery shifted from tangible format to electronic was certainly noticed by the state revenue departments.

Many states responded by changing their definitions of TPP to specifically include canned (prewritten) software programs, no matter how they are delivered. Currently, 32 states and the District of Columbia tax electronically delivered software programs. However when the states enacted these changes for software, they frequently did not address the issue of digital products.

Currently, only 20 states and the District of Columbia impose a sales tax on digitally delivered music. However, there is a strong movement among more states to include digital products in their tax base. Nebraska began taxing these transactions on October 1, 2008 . Indiana, South Dakota, and Utah have also recently imposed tax on these transactions - so the trend is definitely moving toward bringing these digital products back into the fold.

Conclusion
Although the sales tax system of the United States was developed during a less technological period, the states are catching up and bringing digitally delivered items into the scope of taxable transactions. As technology continues to advance, the future remains uncertain. The one thing that remains constant is a state's authority to charge tax on individual items.