Netflix, Inc. (Netflix) began a long, arduous battle against the Colorado Department of Revenue (Department) regarding the state’s position on the taxability of Netflix’s streaming services. Now, Netflix is seeking a refund of tax paid to the Department based on three arguments: (1) Netflix’s streaming services do not involve the transfer of a physical product, (2) Netflix’s Terms of Use do not grant tangible personal property to the users, and (3) the services are provided on a month-to-month subscription basis that does not qualify as a sale.
“Netflix’s customers subscribe for the same reason that customers in earlier years went to Blockbuster – they want to watch movies and television shows in their own home.”
Taxability Battle
In 2013, Netflix unsuccessfully sought a private letter ruling from Department on the taxability of Netflix's streaming services as sales of “tangible personal property.” Later, in 2015, Netflix received an audit assessment for $8.5M with respect to its streaming services. However, the Department eventually fully abated this assessment and explained that "the question of whether streamed video content is subject to Colorado sales tax should be addressed through a rulemaking process prior to any enforcement action.”
Accordingly, in 2021 the Department adopted a rule (the Expanded Rule) that broadened the imposition of sales tax to include sales of tangible personal property “regardless of the method of delivery.” Examples of taxable items in the rule include movies downloaded or streamed over the internet, VHS tapes, and streaming services. The rule was codified by the Digital Goods Law later that year.
As a result, Netflix filed a claim for refund for sales tax paid in 2021, which the Department denied. The Executive Director of the Department upheld the denial and Netflix appealed. Now, Netflix filed a motion for summary judgment in Colorado’s district court, arguing that decades of state law support the fact that streaming services are not within the definition of tangible personal property.
Netflix’s Argument
Netflix raised several important points regarding the taxation of its streaming services. A key consideration for the taxability of digital goods is whether the customer receives a license or rights to the digital product. In many states, this determines taxability. Netflix’s Terms of Use grant the customers a “limited, non-exclusive, non-transferable right to access” and no right or title to the content the customer is viewing.
Tax in a Digital World
In its motion for summary judgement, Netflix argues that there was “no valid law that permitted sales tax to be imposed” and that the Expanded Rule and Digital Goods law fail as a legal matter. Netflix argues that if the Department wants to tax streaming services, “they have a valid way to do so: enacting valid legislation.”
Colorado is not the first or only state to venture into the taxation of digital goods. In an increasingly digital world, states are attempting to impose tax on digital goods that are not considered tangible personal property, in a variety of ways. Maryland enacted a “Digital Advertising Gross Revenues Tax” on digital advertising services. Other states have amended their tax laws to include digital goods or products such as digital books, digital games, audiovisual works, software, and of course streaming services.
Admittedly, it is expected that sales tax laws will catch up to the evolution of digital products. The Department stated that “Netflix’s customers subscribe for the same reason that customers in earlier years went to Blockbuster – they want to watch movies and television shows in their own home.”
Takeaway
Throughout the years, Netflix has been clear that it intends to fight this legal battle to the end. Notably, the outcome of this case could have influence on other states and the overall taxability of streaming services.
As the taxation of digital goods and services is a nuanced issue, you may want to monitor developments to understand impacts on your company as well as your individual experience as a user. If you have questions or concerns about the taxation of digital services, please contact us for guidance tailored to your specific situation.