Questions and Answers
Effective July 26, 2009
The digital products bill (ESHB 2075) clarifies how taxes apply to products that exist only as computer bits and bytes. Specifically, it:
- Defines digital products as goods and services transferred electronically.
- Makes the taxation of digital products technology-neutral.
- Includes certain exemptions for businesses and end consumers.
- Requires sellers of digital products to electronically file their tax returns.
- Provides amnesty to those who didn’t collect or pay sales or use tax on digital products that were taxed before the effective date of this act.
What digital products are subject to tax?
While downloaded digital goods (music and movies, etc.) have always been subject to sales or use tax, ESHB 2075 applies sales or use tax to all digital products, regardless of how they are accessed (downloaded, streamed, subscription service, networking, etc.). (See exceptions and exemptions below)
Digital products subject to sales or use tax include:
- Downloaded digital goods (music and movies, etc.)
- Streamed and accessed digital goods
- Digital automated services (DAS)
This bill also covers remote access software which is now subject to sales and use tax.
It does not matter if the purchaser obtains a permanent or nonpermanent right of use. (See sections 301(8) and 305(1)(e) of the digital products bill).
Definition of terms
What is a digital product?
- It is transferred electronically. (See section 201(8) of the digital products bill)
- Digital goods (movies and music, etc.)
- Digital automated services (services that have been automated)
The bill also covers remote access software (See section 201(7) of the digital products bill) which is now subject to sales and use tax.
What is standard information?
Standard information is a digital good consisting primarily of data, facts, or information not generated for a specific client or customer.
What are digital automated services (DAS)?
DAS are services that have been automated and are transferred electronically. DAS is not software, but includes one or more software applications in providing the service.
Examples include:
- Photo sharing services.
- Car history report services.
- Search engines
NOTE: Services that are primarily the result of human effort performed in response to a customer request are not considered DAS.
DAS also does not include:
- Internet access
- Payment processing
- Telecommunications.
For the definition and a complete list of exceptions, see section 201(5)(a) of the digital products bill.
What is remote access software (RAS)?
RAS is prewritten software provided remotely. In other words, the buyer pays the seller for the right to access and use the software, which resides on the seller’s server or the server of a third party. (An Application Service Provider is an example of a business that may provide RAS.) (See section 301(6)(b) of the digital goods bill). Before the effective date of the digital goods bill, income derived from providing RAS was subject to business and occupation (B&O) tax under the Service & Other Activities classification. Effective July 26, 2009, the sale of RAS is classified as a retail sale for B&O tax purposes and is subject to sales or use tax. The purchase of prewritten software is exempt if the purchaser uses the software to provides RAS. (See section 302(2)(f) of the digital products bill).
What is a digital code and how is it taxed?
A code provides purchasers the right to obtain one or more products.
If all the products available through the code are digital and have the same tax treatment, the code is considered a digital code. Digital codes are taxed the same way as the underlying products. (See sections 302(11)(b)(ii), 501, and 601 of the digital products bill.)
If the code provides the purchaser digital products that do not have the same tax treatment, it is not a digital code. In this case, the entire price of the code is subject to sales or use tax if any of the products to be obtained by the code are subject to sales or use tax. If the seller can identify, by verifiable standards, the portion of the selling price that is not subject to sales tax, then tax applies only to the taxable products. This must be based on the seller’s accounting records kept in the regular course of business. (See section 801 of the digital products bill).
How these rules apply
How are prewritten software keys or activation codes taxed?
The sale of prewritten software includes the sale or charge made for a key or an enabling or activation code. Prewritten software and a key or enabling code for prewritten software are subject to sales or use tax. (See section 301(6)(a) of the digital products bill).
What is the value of the digital product for use tax purposes?
The value is the purchase price of the digital product. If the digital product is acquired by means other than a purchase, the value of the digital product is determined by the retail selling price of a similar digital product. (See section 304 of the digital products bill).
Are there any common digital goods that are exempt from tax?
Yes. Digital goods that are not offered for sale are exempt from tax when they are:
- Noncommercial (such as personal e-mail communications).
- Created solely for an internal audience.
- Created solely for the business needs of the person who created the digital good and is not the type of digital good that is offered for sale, such as business e-mail communications. (See section 605 of the digital products bill).
When is a digital product, digital code, or RAS used in the state of Washington for purposes of use tax?
A digital good or digital code is used within this state when the consumer first accesses, downloads, possesses, stores, opens, manipulates, or otherwise uses it within this state. A DAS is used within this state when the consumer first uses, enjoys, or otherwise receives the benefit of the service in this state. RAS is used in this state when the consumer first accesses the prewritten software in this state. (See section 304(6)(d) of the digital products bill).
Sourcing the sale of DAS and RAS is based on where the customer is located, not where the service is being performed. (See sections 304(6)(e) and (f) of the digital products bill).
How are sales of digital products, digital codes, and remote access software sourced?
The standard sourcing rules from the Streamlined Sales and Use Tax Agreement (SSUTA) apply to the sourcing of digital products, digital codes, and RAS. (See section 704 of the digital products bill).
Under the SSUTA, sales of digital products, digital codes, and RAS are sourced the same as other sales. Sales are sourced according to the following hierarchy:
- The seller’s place of business if the purchaser receives the digital product at the seller’s place of business;
- If not received at the seller’s place of business, the location where the purchaser receives the digital product, digital code, or RAS;
- If the location where the purchaser receives the digital product, digital code, or RAS is not known, the purchaser’s address available in the seller’s business records;
- If no address is available in the seller’s business records, the purchaser’s address obtained at the time of sale (e.g., purchaser’s payment instrument); and
- If no address is obtained at the time of sale, the address where the digital product, digital code, or RAS is first made available for transmission by the seller.
The majority of such sales will likely be sourced according to the buyer’s billing address since most businesses will not know the actual location of the buyer at the time of the purchase.
Does placing digital goods or digital codes on a server in Washington establish nexus?
Putting a digital product on a server in Washington does not establish nexus. If an out-of-state person owns the server, then owning the server can be considered to determine nexus. (See section 901 of the digital products bill).
How does B&O tax apply to sales of digital products, digital codes, and RAS?
Taxpayers with nexus in Washington who sell digital products, digital codes, or remote access software sourced to Washington are subject to the B&O tax rate of 0.471% on the gross proceeds of retail sales and 0.484% for wholesaling income. (See section 401 of the digital products bill).
Is the production of digital goods classified as manufacturing?
No. Just like software that is delivered by means other than tangible storage media, the production of digital goods is not manufacturing. (See section 406 of the digital products bill).
Does ESHB 2075 impact property taxes?
No, ESHB 2075 does not characterize digital goods and digital codes as tangible or intangible personal property for purposes of property taxation.
Exceptions and exemptions
Exceptions, including telecommunications and internet access, are not considered digital products. Their tax treatment is not changed by this bill. (See section 201(5)(b) and (6)(b) of the digital products bill).
Exemptions (digital products that are not subject to sales or use tax) include digital products purchased:
- For resale. (Purchaser must provide a resale certificate (reseller permit after December 31, 2009).
- To be ingredients or components of a new product. (Purchaser must provide an exemption certificate.)
- To be given away for free. (Purchaser must provide an exemption certificate.)
- For a business purpose, if the digital product is standard information. (Purchaser must provide an exemption certificate.)
Digital products purchased to become a part of a new product
Sales of digital products used as components of a new product are exempt from sales and use tax. The purchaser must provide an exemption certificate. (See sections 503(1)(a) and 603(1) of the digital products bill).
Digital products given away for free
There is a use tax exemption for the recipient of digital products given away for free. (See 606). There is also a sales and use tax exemption for the person purchasing digital products, digital codes, or remote access software to give it away for free. The purchaser must provide an exemption certificate. (See sections 503(1)(b) and 603(2) of the digital products bill).
Standard information used for a business purpose
If a business purchases a digital good that is standard information for a business purpose, then the purchase is exempt from sales tax. The purchaser must provide an exemption certificate. (See sections 504 and 607 of the digital products bill).
For use within and outside Washington
Businesses purchasing digital products that may be used concurrently within and outside Washington are entitled to the multiple points of use (MPU) sales tax exemption. The buyer must provide the exemption certificate and pay use tax as explained below. The MPU exemption does not apply to purchases for personal use. (See section 701 of the digital products bill).
Based on the buyer’s records, the buyer may apportion the use tax in proportion to the in-state to out-of-state users.
- Number of employees in this state
- Divide it by the number of employees everywhere. (See sections 702 and 703 of the digital products bill). This is not limited to the number of employees that actually use the product.
Thus, even if delivery of the product occurs in Washington, a person eligible for the MPU exemption owes use tax only on the apportioned value. The Department may authorize or require an alternative method of apportionment, supported by the taxpayer’s records, that fairly reflects the proportion of in-state to out-of-state use.
Remote access software
There is an exemption for the purchase of prewritten software by the person who will provide the software remotely. (See section 302(2)(f) of the digital products bill).
M&E exemption of digital goods
“Machinery and equipment” (M&E) includes digital goods. Digital goods used directly in a manufacturing operation are exempt under the M&E exemptions, provided all of the requirements of the exemption are met. (See section 510 of the digital products bill).
Television or radio broadcasts
Television and radio broadcasts of regular programming are not subject to sales or use tax. However, if a broadcaster sells programming on a pay-per-program basis that allows the buyer to access a library of programs at any time for a specific charge, then sales tax applies.
There is an exemption for cable companies’ sales of pay-per-program programming since cable companies are subject to a franchise fee on the gross revenue from the sale. (See section 502 and 602 of the digital products bill). Satellite providers have a federal exemption from local sales and use tax when they sell programming on a pay-per-program basis.
Questions?
If you have tax questions about digital products, e-mail us or call 1-800-647-7706.