The Next Debate: Taxation of Digital Goods and Services

By Jennifer Jensen, CPA, and Adam DoVale, J.D., LL.M

Editor: Sarah McGahan, J.D., LL.M.

This is a digital world. People read books on digital readers. They listen to music on phones and tablets, some downloaded and some streaming. They turn off the lights and lock the doors in their homes remotely while standing in the office. They download apps to help with everything-cooking, running, driving, and entertaining. Digital goods and services are becoming more and more integrated into people's lives.

Consider the following facts about sales of digital goods and digital services:

  • In 2008, 10 million ebooks were sold in the United States; in 2012, 457 million ebooks were sold. 1
  • A 2013 music industry report showed that digital album sales made up 43% of all album sales in the first six months of 2013. In addition, there were over 50 billion audio and video streams in the first six months of 2013. 2
  • Apple Inc. recently announced that customers spent over $10 billion in the App Store in 2013. Customers downloaded almost 3 billion apps in the month of December alone. 3
  • Netflix generated more than $2.7 billion in revenue from its domestic streaming segment in 2013. This represented a 26% increase in revenue generated from the same segment in 2012. 4

With states looking for ways to increase revenue, a natural source may be the burgeoning area of digital goods and services. It is reasonable to ask, therefore, how states apply their sales and use tax provisions to these digital goods and services. Often the answer is not clear. This column begins by considering how states define digital goods and services.

Defining Digital Goods and Services

What are digital goods exactly? States generally tax the sale of tangible personal property and enumerated services. Into which of these buckets do digital products fall? Are they tangible personal property? Are they services? Does it make a difference if the digital good is downloaded to a purchaser's device or streamed over the internet?

Not surprisingly, after reviewing various states' definitions, it is apparent there is no agreement on defining digital products and services. The states take different approaches. These approaches include taxing digital goods and services under a state's definition of tangible personal property, taxing items as the equivalent of tangible personal property, using the Streamlined Sales and Use Tax Agreement's (SSUTA's) definitions of specified digital products and codes, and taxing items as services.

Tangible personal property: Many states have statutes that define tangible personal property broadly to include "anything perceptible to the senses." Some states have been using this definition to tax digital goods. For example, a Louisiana statute defines tangible personal property as including anything "perceptible to the senses." The state uses that broad language to tax digital goods. 5

A Louisiana regulation further expands the definition of tangible personal property to include " 'canned' computer software, electronic files, and 'on demand' audio and video downloads." 6Streaming music or video appears to fall under the definition of tangible personal property because streaming music or video is perceptible to the senses. However, unlike regularly downloaded digital content where the purchaser owns the rights to the content that is either stored on the purchaser's devices or in the cloud, streaming audio and video content is only heard or viewed by the purchaser for a limited time. This would be more akin to a lease, which is a temporary use of tangible personal property. However, in this case, the property may reside on a server in another state and is simply heard or viewed over the internet.

Tangible personal property equivalents: Other states tax digital goods if the tangible personal property equivalent is taxable. Texas, for example, defines the term "taxable item" to include tangible personal property and taxable services. The definition goes on to state that the sale or use of a taxable item in electronic form instead of on physical media does not alter the item's tax status. 7This broad definition allows the state to subject certain digital goods and services to sales tax without having to clearly define what constitutes a digital good and service.

SSUTA definitions: The Streamlined Sales Tax Project (SSTP) has tried to create uniform definitions of digital products across the states. The SSTP was organized in March 2000 with the charge to simplify and modernize sales and use tax laws in the United States. Over 40 states contributed to the drafting of the SSUTA. Under the SSUTA, member states must adopt specific definitions; other states may adopt these definitions voluntarily. Currently, there are 23 full member states.

Included in the SSUTA are definitions for "specified digital products" such as "digital audio-visual work," "digital audio works," and "digital books." 8 Items such as digital cards, music, movies, pictures, and ringtones are specifically identified as meeting the definitions of digital products. As mentioned previously, SSUTA member states are required to adopt these definitions. If member states want to tax digital products that fall outside these terms, they must specifically tax them by statute. In addition, the SSUTA provisions discuss the sale of a "digital code." The term "digital code" is defined to mean a code that provides a purchaser with a right to obtain one or more digital products within one or more of the "specified digital product" subcategories and is subject to the same tax treatment within the member states as the related specified digital products.

The SSUTA allows a member state to extend its sales and use tax to digital products sold regardless of whether the purchaser has a right to permanent use. 9 This language appears to be broad enough to allow the taxation of streaming products or products for temporary use that mirrors the tax treatment of digital audio-visual works, digital audio works, and digital books purchased for more permanent use in member states. 10

Service: As mentioned above, some states may not treat digital sales as sales of property but rather classify the sales as sales of services. For example, Texas issued a letter ruling that determined the subscription fees for the right to stream videos is subject to sales tax as a sale of cable television services and that the subscription fee for "borrowing" electronic books is subject to sales tax as a sale of information services. 11 This example and the above example of Texas taxing the sale of digital goods with tangible equivalents demonstrate how one state can tax different types of digital transactions differently and clearly highlight the compliance challenges faced by businesses in this industry.

With these various positions and definitions among the states, a retailer of digital goods must perform a state-by-state analysis to determine the various tax treatments of its products. The analysis is further complicated for retailers that offer digital services such as streaming music or video content. These transactions involve situations where not only are no tangible goods exchanged, but also the user does not even receive the right to permanently use the music or videos purchased.

Sourcing of Digital Goods and Services

While determining how a particular state defines a digital good is a cumbersome task for any taxpayer, there is yet an additional burden to consider: how to source the sale of that digital good or service. Many states have not directly addressed the sourcing of digital goods, but rather rely on the sourcing provisions that apply to the sale of tangible personal property. This approach can cause many problems when sourcing digital goods and services because the transactions may not be constrained to a single taxing jurisdiction (e.g., the user might be mobile). In addition, the ability for multiple users to use a single digital good also creates unclear sourcing situations.

For example, consider the sale of a digital good that is purchased from a retailer that has a server in State X by a user whose billing address is in State Y, but the user is located in State Z when the digital good is purchased. Using the general sourcing rules that apply to tangible personal property, all three states may claim the transaction should be sourced to their state.

In addition, customers could use multiple devices to view the streaming content at the same time. What if one child is streaming video from a college dorm room away from home while another sibling is watching the same video from the parents' basement, and the video was purchased on a family account? What happens when a customer has a different billing address from his or her physical address?

In an attempt to preempt some of the complications of sourcing digital goods, the SSUTA provides the following general sourcing guidance for digital goods: 12

  • If the digital good is received by a purchaser at a location of the seller, the seller is to source the sale to that location.
  • If the product is not received at a location of the seller, the seller is to source the sale to the location where the purchaser receives the product, so long as that location is known to the seller.
  • If neither of the above rules applies, the seller is to source to a location for the purchaser available from the seller's business records or to an address for the purchaser obtained during the consummation of the sale.
  • If none of the above rules applies, the seller is to source to the location from which the product was provided.

The SSUTA goes on to define the word "receipt" or "receive" to mean taking possession or making first use of digital goods, whichever comes first. 13 However, the SSUTA also allows states to use an origin-based sourcing method for purposes of sourcing digital goods. 14 Origin-based sourcing allows a retailer to source a sale of digital goods to where the order is received by the seller if certain criteria are met. 15 While the SSUTA offers some guidance for sourcing sales of digital goods, the guidance may still result in multiple taxation since the SSUTA allows both destination- and origin-sourcing methods to be used and different states may adopt different rules.

Solving These Issues

Lawmakers at the federal level have seen the need for a consistent framework for states to use regarding the sale of digital goods and digital services. Sens. Ron Wyden, D-Ore., and John Thune, R-S.D., introduced the Digital Goods and Services Tax Fairness Act of 2013, S. 1364. The bill seeks to promote neutrality, simplicity, and fairness in taxing digital goods and digital services. It provides separate definitions for "digital code," "digital good," and "digital service." The bill also provides sourcing rules for purchases of digital goods and digital services. However, similar legislation has been introduced in previous years with little result. Therefore, it is uncertain that Congress will enact the Digital Goods and Services Tax Fairness Act.

When reviewing this bill and the language included in the SSUTA, inconsistencies arise. For example, the SSUTA has adopted different definitions and sourcing rules for digital goods than the federal legislation contains. Therefore, if the bill becomes law, states that adopted the SSUTA's definitions would have to modify their laws to meet the federal definitions.


State laws and regulations defining digital products are often unclear, resulting in situations where the same product may be considered tangible personal property in one state and a service in another. Sourcing these transactions using current sales and use tax law may also result in multiple taxing jurisdictions having a claim to tax the transaction. Consequently, taxpayers often struggle to determine the taxability of digital products and services.

As digital product sales continue to grow, more states will look to these transactions as a much-needed revenue source. States that have yet to define digital goods and their sourcing may consider the option of using the SSUTA as a guideline. Congress may also become a key player in the taxation of digital goods.


1 "E-Book Sales Are up 43%, but That's Still a 'Slowdown,' " USA Today (May 16, 2013).

2 Nielsen Holdings N.V., "Nielsen Entertainment & Billboard's 2013 Mid-Year Music Industry Report" (July 18, 2013).

3 Miller and Neumayr, Apple Inc., "App Store Sales Top $10 Billion in 2013" (Jan. 7, 2014).

4 Netflix Inc., Form 10-K for the period ending 12/31/13 (Feb. 3, 2014).

5 La. Rev. Stat. §47:301(16).

6 La. Admin. Code tit. 61, part I, ch. 43, §4301.

7 Tex. Tax Code §151.010.

8 Streamlined Sales and Use Tax Agreement, Appendix C, defines "Digital Audio-Visual Works," which means a series of related images that, when shown in succession, impart an impression of motion, together with accompanying sounds, if any; "Digital Audio Works," which means works that result from the fixation of a series of musical, spoken, or other sounds, including ringtones; and "Digital Books," which means works that are generally recognized in the ordinary and usual sense of "books."

9 Streamlined Sales and Use Tax Agreement, §332.D(4).

10 Streamlined Sales and Use Tax Agreement, §332.G.

11 Texas Comptroller of Public Accounts, Letter No. 201207532L (7/31/12).

12 Streamlined Sales and Use Tax Agreement, §310A.

13 Streamlined Sales and Use Tax Agreement, §311B.

14 Streamlined Sales and Use Tax Agreement, §310.1A.

15 Streamlined Sales and Use Tax Agreement, §310.1.B.


Sarah McGahan is a senior manager, state and local tax, with KPMG LLP in Washington. Jennifer Jensen is a director with PwC in Washington. Adam DoVale is a senior tax associate with PwC in Boston. Ms. McGahan is the chair and Ms. Jensen is a member of the AICPA State & Local Tax Technical Resource Panel. For more information about this column, contact Ms. Jensen at


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