Last year, the Maryland General Assembly enacted House Bill 932, which made the sale of digital products subject Maryland’s sales and use tax. Maryland is not alone in terms of states broadening the sales tax base to include tax being imposed on digital products. Well over half the of states that impose a sales tax have made changes to their sales tax laws to keep pace with, or at least not significantly lag behind, the digital economy. One of the significant difficulties in imposing a sales tax on digital products is determining where the customer uses the product and how the use in multiples state may impact the taxability (i.e., the sourcing of the sale). These determinations dictate the applicable state tax that applies to the sale.
General Sourcing Rules
Maryland’s sales tax law and the Comptroller’s publication interpreting the law (Business Tax Tips #29), provide that a retail sale of a digital product will be sourced to the “customer tax address.” A tiered approach is used to determine the location of the “customer tax address.” The rules provide that the “customer tax address” for purposes of sourcing the sale of digital products means:
- The seller’s business address, if the digital product is received by a buyer at the seller’s business location (Note that is rule likely not apply very often, as most customers are not purchasing digital products at the sellers business location).
- The address of the primary use location (see below), if the buyer does not receive the digital product at the seller’s business location and the seller knows the primary use location.
- If neither of the above apply or can be determined, then the sale is sourced to:
- the location where the buyer received the product if known by the seller.
- the address of the buyer that is maintained in the seller’s business records.
- the address provided by the buyer during the consummation of the sale, including the address of the buyer’s payment instrument.
- In circumstances where the seller does not have sufficient information to apply any of the rules above, Maryland’s sales tax law provides for the use of an origin-based sourcing rule whereby the sale is sourced to the location of the seller’s U.S. headquarters, location in the U.S. where the seller has the greatest number of employees, or the U.S location where the vendor makes digital products available for electronic transfer.
Thus, a seller of digital products will typically use the address that it obtains from the customer to source it sales. The catchall origin-based sourcing rule would apply to sellers that do not obtain an address from its customers. This may occur, for example, when an online purchase is made where only an email address needs to be provided by the customer. A similar origin-based sourcing rule is reflected in the Streamline Sales and Use Tax Agreement (SSUTA), which has been adopted by more than 20 states. However, the origin-based rule used by SSUTA is an election that can be made by sellers that meet certain requirements.
From a consumer’s perspective, the use of a origin-based sourcing rule could present audit issues in the state where the digital product is actually used. This is especially the case for businesses prone to being audited by the state where they are principally located. Although a credit for taxes paid may be available on audit to offset any potential assessment, these types of issue can make an audit go less smoothly than one would hope. Further, if the buyer is located in a state with a lower sales tax rate and purchases a digital product from a Maryland-based seller that does not collect an address during the consummation of the sale, the buyer will pay additional tax than would otherwise be due.
Digital Products Used in Multiple States
The Comptroller has also provided guidelines for businesses that purchase a digital product where the employees of the business will use the digital product in multiple states. In this case, a seller of a digital product is permitted to prorate the Maryland sales tax charged to the buyer vendor if the buyer provides a written statement at the time of the sale indicating the percentage of use by employees or equipment in Maryland. The Comptroller has not created a specific form for buyers to complete, so a buyer will have to prepare a letter to be provided to the seller. Others states have similar rules to this, and are typically referred to as “multiple points of use” exemptions. This is most likely to occur when a business purchases a software product that will be used in offices located in more than one state, or by employees working remotely in various states.
Additional information regarding Maryland’s taxation of digital products can be found in Aronson’s first three blogs in this series. In part one of this blog, we discussed what is and what is not a digital product. Part two examined the taxation of electronically delivered software and SaaS as digital products, while part three looked at the controversial taxation of certain online educational events.
If you have questions about Maryland’s imposition of sales tax on digital products, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301-231-6200.