Digital Products Rule Adopted
The Department of Revenue adopted a new digital products rule, which was effective March 28, 2013. Additionally, the Department adopted a new computer hardware rule and a computer software rule.
The Department amended WAC 458-20-15501 (Rule 15501), adopted two new rules (Rules 15502 and 15503), and repealed one rule (Rule 155) to explain the impacts of the 2009 and 2010 legislation, and to address other tax issues related to computer hardware, computer software, and digital products.
Digital Products ETAs
- ETA 3176 Digital Products - General Implementation
- ETA 3177 Digital Products - General Analysis of Tax Liability
Questions and Answers
Effective July 26, 2009
The digital products bills (ESHB 2075 & SHB 2620) clarify how taxes apply to products that exist only as computer bits and bytes. Specifically, they:
- Define digital products as goods and services transferred electronically.
- Make the taxation of digital products technology-neutral.
- Include certain exclusions and exemptions for businesses and end consumers.
- Require sellers of digital products to electronically file their tax returns, as well as pay their taxes online.
- Provide amnesty to those who didn’t collect or pay sales or use tax on digital goods that were taxed before the effective date of this act, and explains how a credit or refund of B&O tax paid in excess of the proper amount due works.
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 and SHB 2620 apply sales or use tax to all digital products, regardless of how they are accessed (downloaded, streamed, subscription service, networking, etc.). (See exclusions from the definitions and exemptions from retail sales and use tax 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)
The bills also cover remote access software which is now subject to sales and use tax. (See section 201(7) of ESHB 2075 or section 203(7) of SHB 2620)
It does not matter if the purchaser obtains a permanent or nonpermanent right of use. (See sections 301(8) and 305(1)(e) of ESHB 2075).
Definition of terms
What is a digital product?
- It is transferred electronically. (See section 201(8) of ESHB 2075 or section 203(8) of SHB 2620)
- Digital goods (movies and music, etc.)
- Digital automated services (services that have been automated)
The bill also covers remote access software, which is now subject to sales and use tax. (See section 201(7) of ESHB 2075 or section 203(7) of SHB 2620)
What is a digital good?
- Sounds (music)
- Images (movies, pictures)
When these are transferred electronically, they are digital goods. (See section 201(8) of ESHB 2075 or section 203(6) & (8) of SHB 2620).
Digital goods do not include:
- The representation of a personal or professional service primarily involving the application of human effort
- Internet access
- Computer software
For the definition and a complete list of exclusions, see section 203(6)(b) of SHB 2620.
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.
- Photo sharing services.
- Car history report services.
- Search engines
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
- Data processing services
- Live interactive presentations
- Advertising services
- Web hosting, storage, and back up
For the definition and a complete list of exclusions, see section 203(3)(b) of SHB 2620.
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 ESHB 2075 or section 201(6)(b) of SHB 2620). Before the effective date of ESHB 2075, 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 provide RAS. (See section 302(2)(f) of ESHB 2075 or section 201(6)(b) of SHB 2620).
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 ESHB 2075.)
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 determination must be based on the seller’s accounting records kept in the regular course of business. (See section 801 of ESHB 2075).
What are data processing services?
Data processing services are primarily automated services provided to a business or other organization where the primary object of the service is the systematic performance of operations by the service provider, on data supplied in whole or in part by the customer, to extract the required information in an appropriate form or to convert the data to usable information. Data processing services include check processing, image processing, form processing, survey processing, payroll processing, claim processing, and similar activities. Charges for data processing services are subject to service and other activities B&O tax as a professional service (sales tax does not apply).
What are web site development or hosting services?
"Web site development service" means the design and development of a web site provided by a web site developer to a customer. Charges for web site development services are subject to service and other activities B&O tax as a professional service (sales tax does not apply).
What is digital data storage?
"Digital data storage services" means the service of a provider offering server space to host a customer's web site or a customer's electronic data. Charges for digital data storage services are subject to B&O tax under the service and other activities classification (sales tax does not apply).
What are online advertising services?
"Advertising services" means all services directly related to the creation, preparation, production, or the dissemination of advertisements. Advertising services include layout, art direction, graphic design, mechanical preparation, production supervision, placement, and rendering advice to a client concerning the best methods of advertising that client's products or services. Advertising services also include search engine optimization, web campaign planning, the acquisition of advertising space in the internet media, and the monitoring and evaluation of web site traffic for purposes of determining the effectiveness of an advertising campaign. Charges for online advertising services are subject to B&O tax under the service and other activities classification (sales tax does not apply).
How these laws apply
How are prewritten remote access 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 ESHB 2075).
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 ESHB 2075).
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 ESHB 2075).
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 ESHB 2075).
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 ESHB 2075).
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 ESHB 2075).
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.
Does placing digital products, digital codes, or software 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, rents, or leases the server, then ownership interest of the server can be considered as a factor in determining nexus. (See section 901 of ESHB 2075 and section 701 of SHB 2620).
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 receipts. (See section 401 of ESHB 2075). If digital products are licensed to someone who is not an end user, then those gross receipts are likely subject to the Royalties B&O tax. (See section 302 of SHB 2620).
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 ESHB 2075).
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. (See section 1201 of ESHB 2075).
Exclusions and exemptions
Exclusions, including telecommunications and internet access, are not considered digital products even though they are transferred electronically. These activities and items are excluded from the definition of digital products. Their tax treatment is not changed by these bills. (See section 201(5)(b) and (6)(b) of ESHB 2075 and section 203(3)(b) and (6)(b) of SHB 2620).
Exemptions (digital products that are not subject to sales or use tax) include digital products purchased:
- For resale. (Purchaser must provide a reseller permit).
- To be components of a new product. (Purchaser must provide a reseller permit.)
- To be given away free of charge for the use or enjoyment of the general public. (Purchaser must provide an exemption certificate.) "General public" generally means every individual and not a limited or restricted class of individuals, except that general public also includes: all individuals residing or owning property in a state, political subdivision of a state, or a municipal corporation; a group of individuals identified by minimal restrictions that any person can meet, such as a free registration requirement; and library patrons.
- Digital goods purchased solely for a business purpose. (Purchaser must provide an exemption certificate.)
Digital products purchased for resale or to become a part of a new product
Purchases of digital products for resale or to be used as components of a new product for sale are not subject to sales and use tax, but are subject to wholesaling B&O tax on the seller. The purchaser must provide a reseller permit or an exemption certificate. (See sections 503(1)(a) and 603(1) of ESHB 2075 and sections 201(11)(a), 401, and 501 of SHB 2620).
Digital products given away for free
There is a use tax exemption for the recipient of digital products obtained free of charge. (See 606 of ESHB 2075). 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 to the seller. (See sections 503(1)(b) and 603(2) of ESHB 2075 and sections 401 and 501 of SHB 2620).
Digital goods purchased for a business purpose
If a business purchases a digital good (only digital goods, NOT digital automated services or remote access software) for business purposes, then the purchase is exempt from sales tax. Digital codes can be purchased exempt from sales tax as well, as long as only digital goods are obtained through the use of the code and the digital goods will be used solely for business purposes. (See sections 402 and 502 of SHB 2620).
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 ESHB 2075).
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 ESHB 2075). 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 ESHB 2075).
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 ESHB 2075).
Television or radio broadcasts
Television and radio broadcasts of regular programming are not subject to sales or use tax and are subject to the Service & Other Activities B&O 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 and Retailing B&O 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 ESHB 2075). Satellite providers have a federal exemption only from local sales and use tax when they sell programming on a pay-per-program basis. Satellite providers do not have a state sales and use tax exemption and therefore their sales are subject to the state rate.
If you have tax questions about digital products, e-mail us or call 1-800-647-7706.