The sales tax regulations were formulated in different US states well before the wide use of computers and the internet. As a result, these statutes could not address the issue of taxation on Digital goods and services.

However, in the past 25 years, the sales taxation of Digital Goods has turned out as one of the most prominent and debatable issues in state taxation. That’s because of the rapid growth of digital commerce and the peculiar challenge of imposing taxes on sales of non-tangible goods or services.

US states generally levy tax on all tangible personal property (TPP) unless such a property is exempted by law, and tax specifically enumerated services.

However, with the onset of digital commerce, many digital products did not fit into current sales tax rules of taxing tangible property. To address some of these administrative complexities of imposing a sales tax on digital products, the Streamlined Sales and Use Tax Agreement (SSUTA) was put in place in 2005.

Soon after the agreement came into effect, the SSUTA member states started taxing some of the digital products. Note that the SSUTA agreement does not provide regulations to the states on the type of digital products that must be included or excluded from the state sales tax base. Rather, the agreement provides uniform rules that a state must adopt should it decide to tax digital products.

But in 2007, the SSUTA was amended. It mandated the member states to adopt the SSUTA’s language over the state’s definition of tangible personal property when including certain digital products in its sales tax base. However, it also gave leeway to the member states to include or exclude certain products from taxation based on their own rules. This complicated the sales tax treatment of digital products all the more.

All this indicates that taxing digital products is not straightforward. In this article, we are going to discuss in detail what are digital goods as per SSUTA and what were the key issues about the sales taxation of digital products. Then, we will explain how you need to treat the sales tax on digital goods by state as an eCommerce seller.

What are Digital Products?

As per the SSUTA, the specified digital products include the following:

1. Digital Audio Visual Works

“Digital Audio Visual Works” refer to electronic works that incorporate a series of related images that, when shown in succession, impart an impression of motion, together with accompanying sounds. Products within this definition include movies, motion pictures, musical videos, news and entertainment programs, and live events. Further, the “Digital Audio Visual Works” definition shall not include video greeting cards or video or electronic games.

2. Digital Audio Works

The term “Digital Audio Works” refers to the works that result from the fixation of a series of musical, spoken, or other sounds, including ringtones. Products within this definition include recorded or live songs, music, readings of books or other written materials, speeches or ringtones, or other sound recordings.

Note that a “ringtone” is a digitized sound file that is downloaded onto a device and that may be used to alert the customer concerning a communication.

Further, the term “ringtone” does not include “ringback tones” or other digital audio files that are not stored on the purchaser’s communications device.

Also the term “Digital Audio Works” shall not include audio greeting cards sent by electronic mail.

3. Digital Books

The term “Digital Books” refers to the works that are generally recognized in the ordinary and usual sense as books. Products within this definition include any literary work other than “digital audio-visual works” or “digital audio works,” that is expressed in words, numbers, or other verbal or numerical symbols. Provided the product is generally recognized in the ordinary and usual sense as a “ book”.

Note that the term “Digital Books” includes works of fiction, nonfiction, and short stories. However, it does not include periodicals, magazines, newspapers, or other news or information products, chat rooms, or weblogs.

4. Transferred Electronically

“Transferred Electronically” means works that a buyer obtains through means other than tangible storage media. As per the definition of this term, a copy of the product need not be physically transferred to the buyer mandatorily. As long as the buyer may access the product, it will be considered to have been electronically transferred to the buyer.

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Scenario of State Taxation of Digital Goods and Services

The US states do not define digital products and services with consistency or specificity. Due to the inability on the part of the states to draw a clear distinction between digital goods and services, taxpayers are unable to get clarity on the taxability of digital products.

In the digital economy, most of the value that was previously captured in goods in the industrial economy is now transferred digitally in ways invisible to the eye. Apart from goods, many services have been digitized or automated.

As a result, the state tax authorities have been facing difficulties in defining digital goods and services precisely. Take for instance Netflix. The state authorities face challenges in defining precisely whether the streaming videos are digital goods or services and whether they should be taxed.

In addition to this, what makes the matter regarding sales taxation of digital goods all the more complex is the manner in which the states have been taxing goods and services. Traditionally, states have been taxing goods but not services unless enumerated as taxable.

Besides this, two states, Arizona and Missouri, have passed constitutional amendments prohibiting the taxation of any new services.

Thus, at present, whatever information we have about digital goods and types of digital goods is either provided in the Streamlined Sales and Use Tax Agreement (SSUTA), in states’ specific legislature, and in prominent cases addressing the taxability of digital goods.

Therefore, the ultimate challenge that the state tax authorities have been facing is whether digital goods are a subset of tangible personal property or whether they should be separately defined and regulated.

If the latter is true, then the state tax authorities must define what are the types of digital goods, and should they tax them differently?

Let’s understand what is the regulatory landscape regarding the taxation of digital goods in different states in the US. This will help you as a taxpayer get clarity on how you need to tax digital goods in different US states.

We will try to understand the regulatory landscape from the point of view of the following factors: Type of Digital Goods, Digital Goods as Classified by SSUTA, Digital Goods As Defined By State Statutes, and Software and Digital Goods As Defined By Law.

I. Type of Digital Goods in General

Digital e-commerce covers a variety of goods, including video, audio, cloud computing, information services, data processing, and any website where payment is required for username access and subscription.

Many would consider this definition as too simple and may question putting software and movies or books in the same category.

To define digital goods precisely, the states have come up with many different classifications of digital goods. Let’s consider how five sample states including South Dakota, Tennessee, Texas, Washington, and Wisconsin define digital goods. This will help us understand how each state has its own sales tax rules for digital goods.

Let’s consider South Dakota first.

South Dakota

South Dakota taxes tangible personal property. As defined by the statute, tangible personal property includes electricity, water, gas, steam, and pre-written computer software.

Besides this, South Dakota taxes “product transferred electronically” separately. However, the state fails to differentiate between software, music, and videos. As a result, it puts all of these goods in one category irrespective of the fact whether such goods are provided for temporary or permanent use.

Tennessee

Then Tennessee sales taxation rules follow a more detailed approach to taxing most digital goods. It exempts certain digital goods from sales taxation.

Texas

The Texas sales taxation rules follow yet another approach to the taxation of digital goods. This approach focuses on types of services more than types of digital products.

Texas states in its statute 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”. It maintains that the state will tax the digital distribution of video programming to buyers delivered by any means either now in existence or that may be developed in the future.

Thus, Texas focuses on digital services. It defines digital services as either data processing or information services that are separate from professional services.

Now as per the statute, one may perform digital service with a computer using data or using a computer as a tool. In case these definitions do not help the taxpayers in clarifying the differences between data processing services and professional services, they must contact the tax authorities.

Washington

Washington sales taxation regulation follows a more sophisticated model to define digital goods. It defines the term “digital products” separately as a broader category and points out the differences between downloaded goods and streamed goods as well as digital automated services.

Furthermore, Washington also highlights the difference between these digital services and professional and nontaxable services.

Unlike Texas, Washington excludes data processing services from the definition of what it deems taxable automated services.

Wisconsin

Wisconsin taxes digital goods, except for software as a service (SaaS). But unlike South Dakota, Wisconsin does not treat software and music downloads similarly.

Accordingly, the Wisconsin statute says that electronic delivery of software refers to the downloading of software only. It does not include accessing software. Whereas, electronic transfer of digital goods includes either downloading or accessing.

As per the Wisconsin sales tax laws, the term “transferred electronically” applies to digital goods. Whereas, the term “delivered electronically” applies to prewritten computer software. Further, for sales tax purposes, Wisconsin treats the prewritten computer software delivered electronically as tangible personal property and not a digital good.

Thus, when we analyze these sample states, we get to know how important it is for state legislatures to update their tax laws in terms of modern technology. The policy regarding the taxation of digital goods must consider whether:

• Value delivered digitally is a product or a service
• Software should be treated differently from digitally delivered content
• There should be a difference in tax treatment based on whether the software or content is digitally downloaded or merely accessed;
• It makes sense to differentiate streaming of live content from recorded content and to further differentiate between types of digital content.

Further, digital products must be distinguished from professional services. Also, digital goods can be sold in a bundle along with digital services. Thus, it is important for state statutes to define the following digital goods separately:

• Digital content
• Digital processes
• Digital platforms
• Digital marketplaces
• Digital payment methods or currency;
• Digital highways, internet communications, exchanges, etc

In addition to this, the policymakers must also question whether:

• Software is like a movie film and should be treated the same or differently for tax purposes;
• Software is like digital audio or video works and should be treated the same or differently for tax purposes
• It makes sense to differentiate between customized and canned software
• The delivery of digital content on a permanent or less-than-permanent basis should make a difference
• The method of delivery of software or digital content should make a difference
• Digital content should be treated differently depending on whether it is data, creative content, or an algorithm; and
• The purchase or rental of storage for various digital data is also the purchase or rental of a product or service and under what circumstances

II. Digital Goods As Per SSUTA

24 out of 50 states and the District of Columbia are members of the SSUTA. The primary objective of the agreement is to provide consistent definitions of goods and services, stipulating whether they are either taxable or tax-exempt, and uniform sourcing rules. However, the member states can further supplement the definitions.

The 24 SSUTA states include Arkansas, Georgia, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Ohio, Oklahoma, Rhode Island, Tennessee, South Dakota, Utah, Vermont, Washington, West Virginia, Wisconsin, and Wyoming.

As per SSUTA, the digital products are structured in the following manner for tax purposes:

• Computer Software
  • Prewritten Software or Customized Software
  • Delivered electronically or via load and leave
• Software Maintenance
  • Mandatory or Optional
  • Provides only updates and upgrades, or updates, upgrades, and support services
• Specified Digital Products or Products Transferred Electronically
  • Digital audiovisual works, digital audio works, digital books
  • Sold to users other than the end user
  • With rights for permanent use or right of use less than the permanent use
  • With rights of use conditioned upon continued payments

To understand what are the tax implications of the transactions involving computer software, it is first important to understand the definition of computer software as per SSUTA.

Definitions of Computer Software

1. Computer Software

“Computer software” is a set of instructions existing in the form of machine-readable or human-readable code, recorded on a physical or electronic medium. Such a code directs the operation of a computer system or other machinery or equipment.

Further, the “Computer software” includes the associated documentation describing the code and its use, operation, and maintenance. Such documentation is provided with the code to the user. Note that the definition of “Computer Software” does not include databases.

2. Custom Computer Software

The term “Custom Computer Software” is one that is designed to meet the specific requirements of a single person or a small group of persons. Since it’s custom software, it includes modifications to canned computer software. Further, the user, the outside developers, or both can develop the custom software in-house.

3. Canned Computer Software

“Canned Computer Software,” sometimes also called prewritten or standard software, is computer software that is designed for and distributed “as is” for multiple persons. These persons can use the software without modifying its code. Thus, canned computer software is considered custom computer software.

What About Cloud Computing?

The cloud computing service offerings continue to increase rapidly. However, the states in the US have been slow in addressing the challenges regarding the imposition of sales tax on the different types of cloud computing models.

Due to the lack of discrete sales tax regulations regarding cloud computing, many state sales tax authorities in the US depend upon letter rulings, administrative notices, and audits to define their policy concerning the treatment of sales tax on cloud computing service offerings.

Note that each state has its own sales tax rules. Thus, it’s important for taxpayers to understand what is cloud computing and how each state treats sales tax on cloud computing services.

What is Cloud Computing?

As per the National Institute of Standards and Technology (NIST), cloud computing is a model for enabling ubiquitous, convenient, on-demand network access to a shared pool of configurable computing resources (e.g., networks, servers, storage, applications, and services) that can be rapidly provisioned and released with minimal management effort or service provider interaction.

Cloud infrastructure is the collection of hardware and software that empower the five essential characteristics of cloud computing.

One can view cloud infrastructure as having two layers: one is the physical layer and the other is the abstraction layer. The physical layer includes the hardware resources that are essential to support the cloud services. Hardware typically includes server, storage, and network components.

The abstraction layer consists of the software deployed across the physical layer, which demonstrates the essential cloud characteristics. For your information, the abstraction layer sits above the physical layer.

Further, the cloud model comprises five essential characteristics, three service models, and four deployment models.

The five essential characteristics of cloud computing include:

• On-Demand self-service
• Broad network access
• Resource pooling
• Rapid elasticity or expansion, and
• Measured service

Whereas, the three “service models” include Software-as-a-Service (SaaS), Platform-as-a-Service (PaaS), and Infrastructure-as-a-Service (IaaS). The four deployment models include private cloud, community cloud, public cloud, and hybrid cloud. For detailed information on the essential characteristics of the cloud model, service models, and deployment models, check out the document on NIST Definition of Cloud Computing here.

As it is clear from the above definitions, all you require as a user to access the cloud-based software is the internet and the capability to log into the system via a web browser. It really doesn’t matter what device you use or where you are. As long as you have an internet connection, you can access the cloud-based software on your device.

With the advent of cloud computing, those using cloud-based software like Amazon Web Services (AWS), Microsoft Azure, or Google Cloud, do not have to go through the hassle of owning and operating their own hardware and software assets. Instead, they rely on these third-party cloud service providers who host their software on remote servers where they store and process their data.

Further, cloud service providers offer cloud computing services based on three service models each one having distinct characteristics. These include Software-as-a-Service (SaaS), Platform-as-a-Service (PaaS), and Infrastructure-as-a-Service (IaaS).

Software-as-a-Service (SaaS)

Providers of SaaS offer customers the capability to use software applications running on a cloud infrastructure. The customers can access these applications from various client devices through either a web browser or a program interface. Furthermore, in SaaS, the consumer does not manage or control the underlying cloud infrastructure including network, servers, operating systems, storage, or even individual application capabilities.

Infrastructure-as-a-Service (IaaS)

Providers of IaaS offer customers the capability to deploy onto the cloud infrastructure consumer-created or acquired applications created using programming languages, libraries, services, and tools supported by the provider. In IaaS, the customer does not manage or control the underlying cloud infrastructure including network, servers, operating systems, or storage. However, he or she has control over the deployed applications and possibly configuration settings for the application-hosting environment.

Platform-as-a-Service (PaaS)

Providers of PaaS offer customers the capability to deploy onto the cloud infrastructure consumer-created or acquired applications created using programming languages, libraries, services, and tools supported by the provider.

In PaaS, the consumer does not manage or control the underlying cloud infrastructure including network, servers, operating systems, or storage. However, he or she has control over the deployed applications and possibly configuration settings for the application-hosting environment.

Now, the SSUTA framework is called the inventory approach of defining digital goods uniformly and using product reference codes.

The inventory approach was formulated to increase compliance and to bring uniformity in tax reporting and remittance based on clearly defined and agreed-upon codes.

Furthermore, the idea behind implementing such an approach was to digitize all the transactions, including tax compliance at the time each transaction is processed. Note that each transaction is processed based on the code of product chosen and agreed on by the parties, and verified by third parties.

Now there were some challenges with implementing the inventory approach as stated by SSUTA. Though SSUTA intends to provide uniformity or streamlined definitions, it fails to define the term “delivered electronically”. As a result, each member state has its own definition of the term.

Generally, the term “delivered electronically” in SSUTA does not cover products accessed electronically such as SaaS, remotely accessed software, or vendor-hosted software. Though, SSUTA distinguishes between goods “sold with rights of use less than permanent use” or “with rights of use conditioned on continued payment”. But these definitions apply to “specified digital goods” and not software.

Furthermore, SSUTA also does not address digital codes and numerous other digital products and information services. The member states may have agreed upon the inventory approach in general terms. However, they have not agreed on the uniform treatment of digital goods or services. In fact, it seems that no two states tax digital goods in the same way. For instance, more than a handful of states tax software and specified digital goods; about a handful of states do not tax most digital products; and many states are in between, taxing some but not all digital products.

The following table showcases the scenario of how taxation of digital goods happens in the member states under SSUTA.

Tax Software, Digital Product	Some Tax Software, SaaS, Not Digital Product	Some Tax Not SaaS, Digital Product	Limited Tax Electronically-Delivered Software, Not Saas, Not Digital Product	No Tax Tangible Media, Not SaaS, Not Digital Product
Iowa (Custom and Canned Software Taxable)	West Virginia (Custom and Canned Software Taxable)	Arkansas	Kansas	Georgia
Ohio		Indiana	Michigan	Nevada
Rhode Island		Kentucky	North Dakota	Oklahoma
South Dakota		Minnesota
Tennessee (Custom and Canned Software Taxable)		New Jersey
Utah		North Carolina
Washington		Vermont
Nebraska (Custom and Canned Software Taxable)		Wisconsin
		Wyoming

III. Digital Goods As Per State Statutes

The following table outlines the approaches that different states have adopted for taxing digital goods.

Tax no statute	Tax software, digital product	Some Tax software, SaaS, not digital product	Some Tax software, not SaaS, digital product	Limited Tax software, not SaaS, not digital product	No Tax only tangible media, not SaaS, not digital product
Alabama (Custom and Canned Software Taxable)	Connecticut (Custom and Canned Software Taxable)	Massachusetts	Arkansas (SSUTA)	Illinois	California
Arizona	District of Columbia (Custom and Canned Software Taxable)	New York	Colorado	Kansas	Georgia
Hawaii (Custom and Canned Software Taxable)	Iowa (SSUTA) (Custom and Canned Software Taxable)	West Virginia (Custom and Canned Software Taxable)	Florida	Michigan (SSUTA)	Maryland
New Mexico (SSUTA)	Nebraska (SSUTA) (Custom and Canned Software Taxable)		Idaho	North Dakota	Missouri
	Ohio (SSUTA)		Indiana (SSUTA)		Nevada (SSUTA)
	Pennsylvania		Kentucky (SSUTA)		Oklahoma (SSUTA)
	Rhode Island (SSUTA)		Louisiana		Virginia
	South Carolina (Custom and Canned Software Taxable)		Maine
	South Dakota (SSUTA)		Minnesota (SSUTA)
	Tennessee (SSUTA) (Custom and Canned Software Taxable)		Mississippi (Custom and Canned Software Taxable)
	Texas (Custom and Canned Software Taxable)		New Jersey (SSUTA)
	Utah (SSUTA)		North Carolina (SSUTA)
	Washington (SSUTA)		Vermont (SSUTA)
			Wisconsin (SSUTA)
			Wyoming (SSUTA)

I. Expansion of Tangible Personal Property Definition

Traditionally, states imposed sales tax on tangible personal property and many states also taxed services. However, after the digital economy took over, one needs to see whether the states have expanded the definition of tangible personal property to include digital goods or if they have created separate categories for some or all tangible products.

Well, if one goes through the sales tax statutes of the different states, most states have expanded the definition of tangible personal property. Accordingly, they have included pre-written computer software while defining tangible personal property. But, they did not expand it to include other digital goods such as music, digital books, or movies, which are taxed as a separate category.

This means there is no consistent definition of the term “tangible personal property.” For instance, states like Hawaii, Nebraska, and New Mexico do not define tangible personal property within their sales tax statute.

Then, Mississippi defines “tangible personal property” as a property perceptible to human senses or by chemical analysis and also includes pre-written computer software.

Colorado, Maryland, Nebraska, New York, and the District of Columbia define “tangible personal property” as corporeal property or having some physical existence. Further, Colorado and New York have expanded their definition of corporeal property to include prewritten computer software.

Then, Pennsylvania refers to tangible personal property as corporeal property but broadens the term to include videos whether delivered or streamed. Louisiana refers to tangible personal property as corporeal movable property including canned computer software, electronic files, and on-demand audio and video downloads.

Further, states like Missouri and Virginia define tangible personal property by referring to a list of items referenced in a separate section.

Then 33 states define “tangible personal property” as “property that may be seen, weighed, measured, felt, or touched, or is in any other manner perceptible to the senses.” Out of these 33 states, Arizona, California, and Florida have a TPP definition that does not refer to software.

Further, states like South Carolina include some services and intangibles such as communications in the term “tangible personal property”. Then states like Alabama, Colorado, and Texas include “computer program” or “computer software” in the term “tangible personal property”.

Finally, Massachusetts declares that the transfer of standardized computer software (any electronic transfer) shall be considered a transfer of tangible personal property.

II. Treatment of Prewritten Computer Software

In the US, Twenty-eight states include “prewritten computer software” within the definition of “tangible personal property”. Yet each of these states tax pre-written computer software differently.

For example, Arkansas states that the term “computer software does not include software that is delivered electronically or by load and leave.”

Further, the state defines the term “delivered electronically” as “delivered to the purchaser by means other than tangible storage media.”

Now, most states do not follow the narrow approach of not taxing pre-written software if delivered electronically as practiced by Arkansas. For instance, New Jersey includes pre-written computer software in the definition of tangible personal property, also including if it is delivered electronically. Likewise, Indiana also includes software “electronically transferred” or via “load and leave.”

Then, Iowa separately deals with the pre-written computer software and SaaS by listing SaaS as an enumerated taxable service. However, it treats the pre-written computer software as tangible personal property. Minnesota taxes the transfer of prewritten computer software whether delivered electronically, by load and leave, or otherwise.

Then, Wisconsin includes pre-written computer software in the definition of “tangible personal property” irrespective of how it is delivered to the purchaser.

Note that the US states like Arkansas, California, Colorado, Georgia, Maryland, Missouri, Nevada, Oklahoma, and Virginia tax software, if delivered via tangible medium. Of these states, California and Missouri state that they do not tax SaaS. Then, Nevada taxes hosting and data processing services but has no guidance on SaaS.

Then there are 11 states that tax software if delivered via tangible medium or electronic delivery but indicate either directly or indirectly that they do not tax SaaS or remotely accessed software. These states include Idaho, Indiana, Kansas, Michigan, Minnesota, Mississippi, North Carolina, North Dakota, Vermont, Wisconsin, and Wyoming.

On the contrary, 12 states in the US tax software whether delivered via tangible medium, delivered electronically, or accessed as vendor-hosted software (SaaS).

Further, states including Arizona, Hawaii, New Mexico, and West Virginia tax SaaS based on nonstatutory guidance.

Then, South Carolina does not tax canned software unless delivered through tangible media. However, it would tax software accessed via the cloud as a communication service. However, New Jersey does not tax SaaS unless it qualifies as an information service.

Leaving aside these states that are on one extreme end, there are states that tax software provided such software is delivered either through tangible means or delivered electronically via download, and “load and leave” but do not clearly address SaaS. These states include Alabama, Florida, Illinois, Kentucky, Louisiana, Maine, Ohio, and South Dakota.

Then there are states that tax both custom and canned software. These include Alabama, Connecticut, the District of Columbia, Hawaii, Iowa, Mississippi, Nebraska, South Carolina, Tennessee, Texas, and West Virginia. Idaho, Indiana, and Wyoming tax Specified Digital Goods only if delivered permanently.

Other states tax digital goods whether based on permanent delivery or less-than-permanent delivery, or a usage terminable upon condition. These states include Arkansas, Iowa, Kentucky, Nebraska, and New Jersey.

Further, New Jersey, Ohio, Rhode Island, Tennessee, Utah, and Vermont tax “specified digital goods” delivered or transferred electronically. Whereas, states like the District of Columbia, Iowa, Minnesota, North Carolina, Washington, and Wisconsin tax specified digital goods whether electronically transferred or accessed.

Then, 17 states including Arkansas, Connecticut, the District of Columbia, Florida, Hawaii, Indiana, Iowa, Kansas, Kentucky, Maine, Massachusetts, Minnesota, Nebraska, Pennsylvania, South Dakota, Tennessee, and Texas tax video programming, broadcasting, cable, or television services. Further, states like Maryland or Washington tax pay per view.

Likewise, states like Arizona and Louisiana have developed theoretical structures that include taxation of digital goods which are outside the scope of commonly understood service-type transactions.

IV. Type of Digital Goods As Per Law

a. Software Viewed As Intellectual Property

One of the first debates on digital goods in the court of law was over whether the software is like a movie film. The debate was focused on whether the software is intangible, like an information service that is non-taxable, or whether it is like a film roll that is a taxable physical object. Some law courts viewed software as an information service.

b. Software Types

In an effort to find common ground in defining the different types of software, one of the law courts did not see enough tangible value in software recorded on magnetic tapes or discs. As a result, it concluded that only operating system software, not application software, should be taxed. That’s because such software is required to make the computer hardware function. Even though such software is not tangible, it enhances the value of the hardware.

Another court of law had a completely contrasting viewpoint. As a result, it differentiated between the cases in which the customer paid for customization of the program and the cases in which a program was purchased from a catalog.

c. Software as a Tangible Property Based on The Medium of Delivery

Many courts considered software similar to recorded music or video. Others viewed software as more like a service. This was on the premise that every product is the consequence of the skill and labor or services. Furthermore, many physical components used to create a product may not cost as much as the judgment and expertise of the laborers.

Then, a court pointed out that the software program was sold “off the shelf” and was not a type of personal service that could be viewed as non-taxable. Further, the court pointed out that the tape was tangible and was not different from “other taxable personal property such as films, videotapes, books, cassettes, and records.”

Then the Maryland Court undertook in-depth research to check whether treating software sold on magnetic tapes differently from a book or a movie was valid. As a result, the court concluded that whether it is recorded music or a computer program, these are sets of information in a form that, when passed over a magnetized head, cause minute currents to flow in such a way that desired physical work is accomplished. Hence, these items are taxable.

d. Software as a Tangible Product Based on Its Nature

One of the courts of law questioned whether software should be viewed as tangible personal property or intellectual property. This was kind of a game changer with regards to setting the definition for digital goods.

The court stated that the method of storing computer software was irrelevant. What was relevant was that the software buyer did not merely receive knowledge. But he or she received “a certain arrangement of matter that will make his or her computer perform a desired function”. And this arrangement of matter, physically recorded on some tangible medium, constitutes a corporeal body.

Further, the court also questioned the classification of software as custom or canned. It stated that the nature of the software is the same and that the software sold is often mixed in nature. Later on, courts concluded that software is tangible because it is the “arrangement of matter.” This was concluded despite the many arguments raised against the definition in the court.

e. Level of Usage and Control Of Software

In one of the court cases, the taxpayer and tax authority disagreed with the meaning of the term “deliver”. It also questioned whether such a term includes accessing pre-written computer software.

Finally, the court interpreted the term literally as the delivery of a physical object and tried to find out whether the taxpayer received control over the software code. After undertaking in-depth research, the court concluded that when individuals access computer software, they access the software code in a limited manner.

Thus, such limited access to the software code was not considered an exercise of a right or power incident to the ownership of that code. As a result, individuals accessing the software code did not use tangible personal property and hence owed no tax.

f. Focus on the Value Received, Not the Method Of Delivery

To define computer software, many courts of law in the US have struggled with the issue of whether the software is similar to a movie film or a record player. However, one of the law courts focused on the ultimate value delivered as sufficient proof that a customer received a tangible product rather than focusing on the method of delivery. It concluded that the method of delivery of tangible personal property would not change the taxability determination.

g. Transferring an Idea Vs Transferring a Product

There can be scenarios where a person may enter into a broader licensing agreement that authorizes it to use content in the course of its business.

For instance, a greeting card manufacturer may borrow the artwork from original artists and receive the right to reproduce and publish the images on the greeting cards.

In such cases, the purchase made by the greeting card manufacturer may be accompanied by a physical object, but the jurisdictions may see no occasion for imposing a tax as if it were the sale of a product. The jurisdictions may conclude that the greeting card manufacturer did not purchase a tangible product but indeed acquired an intangible right.

Thus, all the above factors showcase that there is no need for music, motion pictures, digital pictures, or software to be on a tangible medium in order to hear, view, or otherwise use it. These are categorized under digital goods.

The only difference is that some digital products consist of data or information that is characterized as content and is termed software. While others consist of data or information that are characterized as a process or tool that allows the processing and use of content information. Such software is called Software-as-a-Service (SaaS) as it can perform data processing functions.

Now one should not confuse SaaS with the services that are provided to develop software to fit custom needs or other professional services that many states do not tax. The term SaaS should be viewed as a type of digital good that offers not only content but also functions that could be used for content creation, development, processing, or automating tasks. Such tasks previously may have required human effort, judgment, or expertise but can now be reduced to a set of standardized instructions.

Thus, it is clear that states find it challenging to define what is the main purpose of the transaction and how intellectual property is shared or used.

As a result, many states treat the taxation of software and other digital goods in the same way. They tax digital goods based on the goods’ nature or function, their method of delivery or transfer or storage, and the level of control the recipient can exercise over the digital good.

Note that not all states use an inventory approach as determined by SSUTA to develop their regulation of digital goods and services. A few states have not defined each specified digital product as taxable within their state sales tax law and yet have been able to subject digital products to sales tax based on their laws.

For instance, Hawaii and Mexico use such an approach, where Hawaii taxes most goods and services.

Nebraska asserts that it taxes intellectual and entertainment property, which covers most digital goods. Florida can tax many digital goods by taxing communication services, and Arizona has a law under which transmission of sound is viewed as a taxable retail transaction.

Still, both software companies and entertainment companies (Netflix, Hulu, etc.) believe that they are not subject to sales tax obligations in a state unless such a state precisely defines the product, including its method of delivery.

Now such a framework complicates the ability of legislatures to respond to technological changes and keep the cost of tax administration low.

Further, such a framework focuses on the ultimate value received by the end-user rather than focusing on types of computer-related products, digital products, and the mechanisms in which they are delivered and sold.

Accordingly, if the value is in the nature of a product, it is taxed. But if it is in the nature of a professional or manual service customized for each customer, then it is not taxed.

Rather than focusing on the types of computer-related products, digital products, and the mechanisms in which they are delivered and sold, the conceptual approach would rely on the analysis of not the type of product and its sub-variety based on the method of invoicing or delivery chosen by a business but by the ultimate value received by the end-user.

If the value is in the nature of a product, it is taxed, but if it is in the nature of a professional or manual service customized for each customer it is not taxed. Note that the term “digital goods” covers the transfer of value consisting of the components of both products and services.

SSUTA Sales Taxation of Software

The SSUTA treats computer software as a separate category from digital products. It does not consider computer software as a part of digital products. As a result, each state treats transactions involving computer software differently from transactions involving digital products for sales tax purposes.

Besides this, there are other factors that complicate the matter of sales taxation on digital products by the states all the more. These include a lack of guidance on whether the method of delivery of digital goods changes their taxability; a disconnect between taxation of digital goods and “video or television programming” and “streaming services” in some jurisdictions; overwhelming statutes regarding taxation of digital goods and services; and lack of comprehensive guidance on taxation of digital goods and services.

Because of the lack of clear information on the types of digital goods and services, the US states have complicated policies regarding the taxation of digital products.

State Vs SSUTA Taxation of Computer Software

Now, the SSUTA considers “canned or prewritten computer software” as a type of “tangible personal property.” As mentioned above, relative to custom software, prewritten computer software is generally canned or off-the-shelf computer software that is not developed for a specific buyer or a group of buyers.

Now, by considering the prewritten computer software as tangible personal property, the SSUTA categorizes it as a type of personal property.

Note that as per SSUTA, personal tangible property is the one that can be seen, weighed, measured, felt, or touched, or that is in any other manner perceptible to the senses. The “Tangible personal property” includes electricity, water, gas, steam, and prewritten computer software (SSTGB, Streamline Sales, Appendix C. II, 101, 106).

So, by categorizing prewritten computer software as tangible personal property, the tax implications are significant.

Typically, every state imposing sales tax charges tax on the prewritten software. Accordingly, thirty-six states in the US impose a sales tax on prewritten software delivered both in tangible and electronic form.

Furthermore, eleven states impose a sales tax on prewritten software sold in tangible form, but not if the same software is delivered in electronic form. Note that SSUTA allows member states to exempt prewritten computer software delivered electronically or by “load and leave” from sales tax (SSTGB, Streamline Sales, Appendix C. II, 107). Here, load and leave means delivery of the computer software to the buyer by use of a tangible storage media where the tangible storage media is not physically transferred to the buyer.

Accordingly, apart from the NOMAD states, the remaining 45 states and Washington, D.C. in the US impose a tax on the transfer of prewritten software, provided such software is loaded on a CD. Note that software loaded on a CD is considered tangible property. On the contrary, 12 states exempt prewritten software delivered electronically from sales tax. This leaves 33 states and Washington, D.C., that tax prewritten software delivered electronically.

Sales Tax On Digital Goods By State

State	Tax Scenario
Alabama	Alabama has a narrow-to-middle base, taxing prewritten and custom software however delivered, digital products (undefined) as TPP, very limited cloud products, and a narrow set of services.	Prewritten and custom computer software is taxable however delivered. (Ala. Admin Code 810-6-1-.37(4)) Digital goods are taxable as TPP.
Arizona	Arizona has a broad base, with an expansive interpretation of TPP, taxing prewritten software however delivered and most digital and cloud products.	Prewritten software is taxable however delivered. (Ariz. Admin. Code § 15-5-154(B); Ariz. Admin. Code § 15-5-2342) Streaming video is taxable. (Ariz. Private Taxpayer Ruling LR14-001)
Arkansas	Arkansas has a narrow base, taxing prewritten software if delivered on a tangible medium, the Streamlined suite of specified digital products, and limited services or cloud products.	Prewritten software taxed as TPP if delivered in a tangible medium. (Ark. Code Ann. § 26-52-304; Ark. Rev. Legal Counsel Opinion No. 20170708) Specified digital products and di