Sales Tax Rules on Digital Sales Need to Be Sorted

Whether digital goods are subject to sales tax sometimes depends on who you ask. Regardless, states need to sort out sales tax policies on digital products sooner than later.

The following case, which focuses around decisions being made in Mississippi and their Department of Revenue in particular, illustrates why states need to clarify tax policies related to digital products. Most states tax at least some digital products, but as the Multistate Tax Commission (MTC) notes, “they have taken very different approaches.” To underscore this point, it quotes “an important article on the subject”: “How do the states define, tax, and exempt from taxation digital goods and services? Each and every way. The end.”

The MTC is therefore working to identify “potential best practices and areas for increased uniformity” with respect to sales taxation of digital products. It will take time. Step one will be the creation of an outline for a white paper on the issue, which the MTC will present during its November 2021 meeting.

Focus on Mississippi

The Mississippi Department of Revenue maintains sales of digital photographs are generally taxable. In 2016, the department held a wedding photographer liable for $44,533 in unpaid sales tax, plus penalties and interest, for the period of January 1, 2011, through January 31, 2016. The Board of Tax Appeals later upheld the sales tax assessment, but upon appeal, the Mississippi Supreme Court found in favor of the photographer.

So, are digital photographs taxable in Mississippi, or not? As described in this notice of appeal (hat tip to Eversheds-Sutherland), the photographer contends they sell predominantly wedding photography services, not goods or tangible personal property, and that photography services are “expressly absent from the list of taxable services set forth in §27-65-23 of the Mississippi Code.” Thus, they hadn’t registered for a sales tax permit or charged their clients sales tax.

The Mississippi Department of Revenue contends the photographer “engaged in the sale of tangible personal property, which is taxable under §27-65-17 of the Mississippi Code.” Furthermore, the photographer failed to prove photography isn’t a taxable service or that it shouldn’t be subject to tax under 35.IV.4.04, which reads, in pertinent part: “Photographers and videographers are taxable at the regular retail rate of sales tax on retail sales to consumers of photographs, pictures, videos, diskettes and other tangible personal property.”

It seems a reasonable argument, and the Board of Tax Appeals agreed that it was. Yet, the Mississippi Supreme Court disagreed. The court made several interesting points:

1. The list of a photographer’s taxable retail sales in 35.IV.4.04 doesn’t include “specified digital products.”

2. Although Mississippi’s laws and regulations have been updated and amended numerous times, photography services weren’t added to the list of taxable services in the state.

3. When Mississippi decided to tax “specified digital products,” it didn’t include digital photography or the images produced as a result of digital photography in the statute.

It’s true that digital photographs aren’t named in the state’s definition of specified digital products (§27-65-26), although “electronically transferred digital audio-visual works, digital audio works, and digital books” are:

• “Digital audio-visual works” means a series of related images which, when shown in succession, impart an impression of motion, together with accompanying sounds, if any.
• “Digital audio works” means works that result from the fixation of a series of musical, spoken, or other sounds, including ringtones. “Ringtones” means digitized sound files that are downloaded onto a device and that may be used to alert the customer with respect to a communication.
• “Digital books” means works that are generally recognized in the ordinary and usual sense as “books.”

The Mississippi Department of Revenue is appealing the Supreme Court decision, and it will be interesting to see what happens. According to Scott Peterson, vice president of government relations at Avalara, “Generally, the burden to prove a purchase or sale is exempt falls on the person seeking the exemption and the burden to prove something is taxable falls on the state.”

In the meantime, the department is working to amend the regulation on photographers and film developers to clarify that “photographers and videographers are taxable at the regular rate of sales tax on retail sales to consumers of photographs, pictures, videos, disc, and other tangible personal property or specified digital products” (italicized text is new).

The amended regulation, as proposed, can be found here (another hat tip to Eversheds-Sutherland). If adopted, the change would take effect October 1, 2021.