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March 26, 2014
Netflix Streaming Suits Highlight Tax-Tech Mismatch
by David Sawyer

Full Text Published by Tax Analysts®

Netflix and other streaming video services have become a ubiquitous part of U.S. entertainment consumption, but few states have contemplated how purely streaming services should fit within their sales and use tax regimes.
According to Charlie Kearns of Sutherland Asbill & Brennan LLP, tax system concerns must be addressed in a state's statutory framework. Some states have addressed the technology head-on, drafting legislation and guidance to clarify its taxability. Others, including Kentucky and a Louisiana parish, have used litigation.

How states tax digital products generally, and streaming video content specifically, varies. Several impose no sales tax on digital goods. California applies sales tax only to tangible personal property, excluding digital products. Other states have said the sale of streaming video content is not taxable; Missouri and Virginia have ruled that streaming video content is not subject to sales tax or communications services tax.

In statutes, regulations, and administrative guidance, other states have extended the definitions of services and tangible personal property to include digital products. Colorado is among those that have extended the definition of tangible personal property to the digital realm through guidance. Texas, while subjecting most digital products to taxation as tangible personal property, considers streaming video content the sale of an enumerated service. In regulations, the Lone Star State has said "the term 'cable television service' encompasses all forms of video programming, including streaming video, whether provided via the Internet or other technology."

A few states apply communications services taxes to impose a sales tax equivalent on streaming content. Florida exempts digital goods from taxation, but has an expansive communication services tax that encompasses a range of telecommunication and audiovisual services transmitted by any medium. Streaming video content transmitted online is taxable under that broad regime.

Finally, streamlined sales tax states may tax digital products by adopting model statutory language from the Streamlined Sales and Use Tax Agreement defining digital products, including "Digital Audio-Visual Work," defined as "a series of related images which, when shown in succession, impart an impression of motion, together with accompanying sounds, if any." While that definition seems to cover streaming, Minnesota has expanded its definition to include streaming video services -- possibly signaling weakness in the SSUTA definition of digital video.

It seems possible to decipher state approaches to taxing streaming video content, but not all states provide clear guidance or statutory permission to tax new digital goods and services. Instead, many contort their existing statutory definitions to encompass new technology.

One problem is that departments of revenue are writing the law, said Arthur Rosen of McDermott Will & Emery. He said it's troubling that Department of Revenue employees think, "Is there some classification we could try to squeeze this new service into and impose tax?"

An example of that has arisen in Louisiana. St. Charles Parish in November 2013 brought suit in Jeansonne v. Netflix to recover unpaid sales tax on "streaming and/or internet television subscriptions," the sale of which is taxable, according to the parish.

St. Charles Parish ordinances state that the parish may impose sales tax on tangible personal property and some enumerated services, but they make no mention of digital products. It appears that the parish is abiding by rescinded department guidance and construing Netflix's streaming Internet video service as a sale of tangible personal property.

There also is litigation in Kentucky regarding whether streaming video offerings are taxable. Kentucky is a streamlined sales tax state that has adopted digital products definitions. However, the legislature did not adopt the digital audiovisual work definition, so Kentucky's sales tax does not extend to streaming digital content.

That hasn't stopped the Kentucky DOR from trying to tax Netflix streaming subscriptions. In November 2013 Netflix filed an appeal from a final DOR ruling denying a claim for refund of utilities gross receipts license taxes.

The DOR said Netflix's streaming video product was a multichannel video programming service (MVPS) subject to the utilities tax and that the legislature passed that tax to create a flexible framework encompassing future MVPS industry changes. Thus, the statute's definition of MVPS was meant to be interpreted broadly to include any programming comparable to that provided by television broadcast stations, the DOR said.

Because Netflix offers a wide range of movies and television shows via the Internet, the DOR argued that its content is similar to that provided by television broadcast. Customers can purchase plans permitting simultaneous viewing of different content on different devices, demonstrating that the service is inherently multichannel. Finally, the DOR said that according to Netflix's SEC filings, the company's competition includes products like HBO GO and Showtime Anytime -- products viewable in the same manner as Netflix but available only through subscriptions to established MVPS providers.

Streaming may be like cable from a consumer perspective, but there is a fundamental difference between streaming and cable, said Walter Nagel of Crowell & Moring LLP. "Cable is served to customers in a very real, tangible way, but with streaming, there is this nexus piece that is missing," he said. "There is nothing that Netflix really owns that is coming into your house."

While Kentucky's approach to streaming is an outlier, Kelley Miller of Reed Smith LLP said she doesn't think it's far-fetched or far-reaching. She said it may be more appropriate to think of digital streaming video as a telecommunications product.

"[Streaming] is bits and bites going across an Ethernet," Miller said. "If you think of it that way, isn't it like [voice over Internet protocol]?" By default, treating streaming as telecommunications would mean taxing it as a utility, she said. While that approach might seem odd, it may be the direction society is going as people choose on-demand entertainment instead of traditional cable, she said.

States provide at least some guidance for digital video content delivered online, but video distribution technology is far outpacing state sales and use tax laws.

"Unless a legislature changes a state's sales tax laws, a fair number of which were written while television viewing was limited to over the air using rabbit ears, these issues will continue to come up," Kearns said.

A milestone in streamlined developments has been to structure legislation so that a legislature must decide affirmatively to impose tax on digital goods, said Rosen. "Lawmakers have to have the political will to go ahead and impose a tax, and not let the revenue department sneak it in another way," he said.

Even if jurisdictions find the courage to pass statutes saying streaming Internet products are subject to tax, there are more barriers to taxing streaming content than just statutory definitions, Nagel said. For example, states still must show nexus for providers, especially those that are truly remote, he said.

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