Sunday, October 08, 2006

Taking a Bite at the Apple

Russ Fox of Taxable Talk reports that New Jersey has extended its sales tax to cover music downloads. Following the links back, you get to this April 13, 2006, story in CNET, The Tax Man Cometh After iTunes. According to CNET, at the time of publication, 14 states and the District of Columbia imposed sales tax on music (and, presumably, software) downloads. New Jersey would be the 16th jurisdiction to do so.

The Supreme Court's holding in Quill v. North Dakota poses a significant hurdle to the states' efforts to impose sales tax on electronic media of any sort. In essence, that opinion requires that there be some significant physical contact with a state before the state can establish sufficient nexus to impose a sales tax. With respect to iTunes, the states probably can effectively impose a sales tax because Apple has sufficent contacts with almost every state to meet the nexus requirements of Quill. However, that is principally because Apple sells and services its computers and MP3 players throughout the country. If Apple were merely in the business of selling the music, it would likely not have a physical presence in any state that imposed sales tax on electronic media. Effectively, the states could not tax these sales.

However, as Apple's relative market share declines (it now controls about two-thirds of the market), the ability of the states to collect tax on the sale of electronic music will also decline since market share will inevitably be gained by companies whose only business is the sale of electronic media over the internet. (Note: Theoretically, the states would lose nothing since consumers who fail to pay sales tax are required to pay use tax. Consumer self-reporting and payment of use tax is, for all intents and purposes, however, non-existent.)

There have been bills introduced in Congress that would overide Quill and allow states to impose sales taxes on internet sales. While such legislation might work with respect to internet sales of tangible property, intangibles, such as software and electronic music downloads, would still be problematical. After all, so long as the servers that provide the downloads are located outside of the U.S., the purchase of downloads would still be sales tax free.

Of course, I once again have a good excuse to post a link to my favorite tax song, "Sales Tax," performed by the Mississippi Sheiks. Since the download is free, it is not subject to sales tax in any state.

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