Pokémon GO: “Gotta Catch ‘em All”—Salestaxusaur and the Attention of State Legislatures?

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Tax Policy

Pokémon GO took both the digital and real world by storm this July, sending players on a hunt around their neighborhoods for pocket monsters. In this article, McDermott Will & Emery's Stephen P. Kranz, Diann L. Smith, Mark W. Yopp and Eric D. Carstens highlight several of the key state tax issues raised by the advent of the game.

Stephen P. Kranz Diann L. Smith Mark W. Yopp Eric D. Carstens

By Stephen P. Kranz, Diann L. Smith, Mark W. Yopp and Eric D. Carstens

Stephen P. Kranz is a partner, Diann L. Smith is counsel, Mark W. Yopp is a partner and Eric D. Carstens is an associate at McDermott Will & Emery. The authors focus their practice on state and local tax and unclaimed property matters.

As we enter the third month since Pokémon GO was released in the United States, the initial hype over the app-based augmented reality game has died down, relatively speaking. Metrics recently released by Axiom Capital Management (citing data from Apptopia) indicate that the number of daily Pokémon GO users worldwide has now plateaued at around 32 million users daily, down from over 45 million at its peak in mid-July. Despite this reality check (pun intended) in terms of growth, revenue estimates cited by App Annie Intelligence indicate that users are still spending upward of $10 million per day on PokéCoins, which are in turn used to make in-app purchases of Poké Balls, Egg Incubators, Eggs, Potions, Razz berries, Lure Modules, Incense and Bag Upgrades, all items that expedite a user’s path to Pokémaster. Notably, through the end of August, Pokémon GO remains the top grossing app in the United States on both the Apple iOS App Store and Google Play according to Apptopia’s Top Charts. Perhaps even more impressively, a recent research report released by Cowen Group analyst Doug Creutz found that Pokémon GO is on an annual revenue run rate of more than $1 billion.

While the average American simply sees a wildly popular (and addicting) game that takes a traditionally inactive endeavor and encourages participants to get out and “GO,” state tax departments and legislatures are likely to also see a large—and possibly untapped—$ 1 billion revenue source. Suffice it to say, we predict that state legislatures will be active in the digital download area in 2017, especially after remaining relatively quiet in 2016.

In this article, we highlight several of the key state tax issues raised by the advent of Pokémon GO, including tax characterization, nexus and sourcing. Because these issues are not new and states have considered them (in varying degrees) in the digital context over the past decade or so, we provide a broad overview of the current (disparate) treatment of digital content taxation across the 50 states, concluding with more focused insight on recent developments in Alabama and Pennsylvania.

Pokémon GO—Overview of State Transaction Tax Issues Raised
Tax Policy Issues

At the outset, Pokémon GO raises the fundamental question of whether digital and virtual content should be taxed (at all) under the current sales and use tax regimes. A customer who purchases a plastic Poké Ball at a brick and mortar retail store would almost certainly pay state sales tax on that purchase in all states that impose a sales tax on “tangible personal property,” because that is exactly the type of tangible item mid-20th century state legislatures envisioned when they enacted the sales tax. For a complete list of when your state’s sales tax was adopted, check out this awesome map from our friends at the Tax Foundation. However, for better or for worse, the same customer purchasing a digital Poké Ball through the Pokémon GO app will likely not pay tax in at least half of the states, depending on how it is characterized and sourced, of course (more on that later). This fact does not represent some sort of tax policy injustice—it’s simply a product of the fact that sales tax applies to tangible items and has rarely been expanded to cover most services and intangibles.

The typical justification for taxing digital content on the basis that it is the “digital equivalent” of a taxable tangible item presents significant problems, particularly in the Pokémon GO context. For example, can we really say there is a tangible equivalent of a digital Poké Ball purchased for use in augmented reality? Attempts to use this logic in other contexts (i.e., CD’s are taxable, therefore digital music downloads should be, too) should be avoided, as arbitrary inconsistencies and differences in what is being sold arise based on whether something actually exists in the real world. For example, the better “IRL” analogy may be the purchase of tickets at an arcade and the use of those tickets to play an arcade game. Such activity would not be taxed under traditional sales tax principles. Thus, rather than relying on tangible equivalency justifications, legislatures should make a policy decision on whether they would like to tax digital content on an item-by-item basis and if so, enact language that clearly imposes tax according to the legislative intent (preferably without defining digital content and items as tangible personal property—which unnecessarily convolutes and confuses the world further).

The ever-increasing shift from tangible to digital commerce has led many state revenue departments to find creative (and often highly suspect) ways to capture digital content under old laws; the visibility created by Pokémon GO will further tease out efforts to stretch current law. State revenue authorities argue they need interpretive flexibility to address an economy that moves rapidly, creating new property types faster than a Ninjask. But assertion of such flexibility denies the legislative process its prerogative. From a policy prospective, states should affirmatively consider whether they want to and should adopt sales tax statutes that apply to digital content. In fact, when that has happened, numerous states have gone the other direction and have rejected the idea that all of the digital world should be subject to tax. For example, Iowa specifically exempts digital products from sales and use tax. See Iowa Code § 423.3(67) (exempting “[t]he sales price of a sale at retail if the substance of the transaction is delivered to the purchaser digitally, electronically, or utilizing cable, or by radio waves, microwaves, satellites, or fiber optics”). Even the National Conference of State Legislatures (NCSL) has cautioned legislators to thoughtfully consider the appropriate approach to taxing the digital world and to avoid allowing such decisions to be made administratively. For an insightful policy-focused reference tool on the “right way” to tax digital content, we suggest the NCSL's Cloud Based Services Principles.

Characterization Issues

As we highlight in more detail below, states are far from uniform in their treatment of digital content for sales and use tax purposes. The in-app purchases available as part of the Pokémon GO app highlight some of the concerns raised by these inconsistencies. In app purchases are not the purchase of an app or digital video game, but are they or should they nevertheless still be considered software transferred electronically? Are they instead a digital product (such as a digital audio-video work) delivered electronically? The uncertain nature of what is being sold, and how states view in-app purchases of augmented reality content will lead to compliance confusion and audit risk that could be avoided were legislatures to weigh in now.

Another characterization issue that comes into play in the Pokémon GO context stems from the payment for the in-app goods via virtual currency (PokéCoins). Many states have not explicitly addressed the proper treatment of virtual currency, leaving the door open for the state to take the position that payment for the virtual currency itself is taxable. The theory being that whether a virtual ball or virtual currency is purchase, it is all just downloaded software. Those states that have taken a position have special rules that don’t necessarily resolve all the potential discrepancies. For example, California takes the position that “if a retailer enters into a contract where the consideration is virtual currency, the measure of the tax for the sale of the product is the amount allowed by the retailer in exchange for the virtual currency (generally, the retailer’s advertised price of the product).” See Special Notice, “Accepting Virtual Currency as a Payment Method,” L-382, Cal. State Bd. of Equalization (June 2014). The problem with this in the Pokémon GO context is there is no advertised price in U.S. dollars for Lures and other items for sale in the in-app Shop. Therefore, in order to figure out the tax base, some other calculation has to be made to calculate the tax base for each transaction. Does the calculation need to be real-time if the value of PokéCoins fluctuates? New York, on the other hand, considers sales via convertible virtual currency to be a barter transaction, and takes the position that the currency is not taxable by classifying it as an intangible. See New York Technical Service Bureau Memorandum No. TSB-M-14(5)C (Dec. 5, 2014).

With most states silent on the issues surrounding virtual currency, it is conceivable that a state could take the position that both the initial PokéCoin purchase and the subsequent in-app purchase of virtual Razz berries and Eggs are each taxable transactions (perhaps as software or a more broad classification like data). While we don’t know of any state that currently takes this position, as the popularity of virtual currency increases, and more states begin to weigh in, the concerns could become real. It is also interesting to note that the Uniform Law Commission is currently considering the first-ever Regulation of Virtual Currency Businesses Act. The definition of “virtual currency” in the most recent draft expressly excludes “digital units used within a game or game platform.”

Nexus Issues

Despite efforts by state government representatives to pass federal legislation undoing Quill v. North Dakota, 504 U.S. 298 (1992), and the more recent efforts to re-litigate the validity of its physical presence rule, the reality is that Quill remains good law and requires an out-of-state seller to have physical presence in order to be subject to a sales and use tax collection obligation (2016 Weekly State Tax Report 27, 9/2/16). As such, to the extent Niantic, Inc. (the company offering Pokémon GO) does not have a physical presence in a state, the state cannot force the company to collect and remit sales tax from app users. Pokémon GO users in California, where the company is headquartered, are free from tax on in-app purchasers as the California Board of Equalization takes the position that electronic data products, such as software and data transferred via the Internet, are not taxable unless some physical storage medium is provided in conjunction with the sale (think a USB drive or CD). See California Cal. State Bd. of Equalization, Publication 109, Internet Sales (November 2015). Pokémon GO users in states that do impose a use tax on digital products may have to self-report.

Of course, the nexus rules and tax collection obligations could all change if Congress passes one of the remote sales tax bills that continue to be discussed on Capitol Hill.

Sourcing Issues

If PokéCoins and in-app purchases made using them are taxable under state law, the next question is where they are taxable. In order to answer this question, sellers must look to the state sourcing hierarchy applicable to the particular type of digital content (after the classification has been determined). One model (contained in the Streamlined Sales and Use Tax Agreement or SSUTA) looks to the following hierarchy:

  •  1. When a purchaser receives a product in an over-the-counter transaction at the seller's business location, the sale is sourced to that business location;
  •  2. When (1) does not apply, the sale is sourced to the location where the purchaser receives the product—typically, the purchaser’s “ship to” or delivery address—if the seller knows the location;
  •  3. When (1) and (2) do not apply, the sale is sourced to the purchaser’s address if it is available from the seller’s business records;
  •  4. When (1), (2) and (3) do not apply, the sale is sourced to the purchaser’s address obtained during the consummation of the sale (including the address of the purchaser’s payment instrument);
  •  5. When none of the foregoing rules applies, the source of the sale is its origin (i.e., the point from which property was shipped, from which digital products were transmitted, or from which services were provided. See SSUTA, General Sourcing Rules, Sec. 310 (as amended through May 4, 2016).

Obviously the first prong of the hierarchy is not applicable in the digital download or Pokémon GO context. Therefore, in determining whether a state with this hierarchy has jurisdiction to tax the in-app purchase or digital content, the first (practical) possibility to source would be the location where the purchaser receives the product. Normally the identification of receipt location in a digital world is not practical (or even possible) and could be anywhere in the mobile world. But Pokémon GO is different because the essence of the game is a dependent on the user’s real world location. Should sourcing therefore hinge on geolocation information that might exist in the augmented reality environment? The same arguments could be said for a known location based on IP address in the context of an Internet purchase. Nevertheless, the current reality is that even if the location information is available for the technology to perform its function in the game, that information is not—and likely could not currently be tied to the billing system and tax engine.

The practical and legal result is that the next step of analysis must be followed and a determination made as to what address is available from the business record of the seller. While no address is required to sign up for the game, consumers must enter a billing address for any credit card used to pay for PokéCoins in the Shop. This address is the best anyone can do under the circumstances. But all should realize that the billing address of the credit card does not necessarily tie to the location of the consumer when the purchase is made, much less when the PokéCoins are ultimately used. You can easily imagine a scenario where the account is opened using a parent’s credit card address in Ohio, the son or daughter lucky enough to have such parents buys PokéCoins while attending college in New York, and then uses the PokéCoins to buy Poké Balls and Incense while catching Pokémon on spring break in Texas. While each of these three jurisdictions has some claim to tax the relevant transactions, the seller only has information related to Ohio—thus driving the reality that only Ohio should be able to tax this transaction. Fortunately the SSUTA facilitates that reality and, under the hierarchy, sets forth that all of the transactions would be taxed by Ohio, a participating Streamlined state—even though the other two jurisdictions have a legal basis upon which they could impose tax.

Unfortunately this means that with respect to the Pokémon GO augmented reality paradigm, and other digital content, more than one state could attempt to tax a portion or all of the economic activity. To end that risk, and provide authority to states like Ohio who are getting tax on economic activity that occurs outside their borders, the digital industry has been supporting the Digital Goods and Services Tax Fairness Act (H.R. 1643; S. 851), federal legislation that would provide a framework for sourcing sales of digital content and services. At a high level, this legislation would authorize states in Ohio’s position to tax the transaction described and would prevent other states from doing so. Without a national framework for sourcing digital content and services the confusion and risk that exists today will continue.

State of the States—Taxation of Digital Downloads

To show the state of inconsistency across the United States regarding taxation of digital content, the map below contains an up-to-date graphic characterizing how each state treats “digital products” (i.e., downloaded movies, music and books).

Digital Products

While the in-app purchases in the Pokémon GO world do not necessarily align with the states’ treatment of the content in the above map, it is indicative of the state of chaos amongst states in making taxability determinations in this area. Digital downloads are not a new phenomenon—yet states are still unsettled as to whether and how they are taxed.

The map below shows the taxability of electronically delivered canned (prewritten; not custom) software. While more states have moved in the direction of taxing such software and clarifying the rules, it is unclear whether the in-app purchases in Pokémon GO could be characterized as canned software.

Recent Digital Download Updates

Finally, there have been at least two significant developments this year impacting the taxability of digital downloads going forward.


After considering two bills that would have exempted certain digital downloads and one bill that would have imposed tax, the Alabama Legislature adjourned sine die in May without passing any legislation on the topic.

Amid this legislative tumult, Alabama Commissioner Julie Magee sent a letter to Senate leadership vowing not to move forward with any new audits or finalize any preliminary assessments of those taxpayers taking the position that digital transactions are not taxable. According to the Commissioner, the temporary suspension in enforcement was being pursued to allow for a holistic approach to the issue of defining and taxing digital transactions in preparation for legislative consideration in 2017.

Following that letter, Senate President Pro Tempore Del Marsh formed a digital goods working group, with the goal of allowing all interested parties to come together and agree on language to be considered in the next legislative session (beginning Feb. 7, 2017). The first study group meeting is scheduled for October 12, 2016, in Birmingham and will set the stage for the future taxation of digital content in Alabama. (It is unclear whether representatives from Team Mystic will attend).


In July, a legislative conference committee was appointed to approve an already agreed-upon $1.3 billion revenue package that was negotiated behind closed doors. Shortly thereafter, both the House (116-75) and Senate (28-22) approved the conference committee’s report, which was sent to Governor Wolf for approval. The governor signed off on the revenue package the same day (2016 Weekly State Tax Report 18, 8/5/16).

The final report included a new sales tax covering most digital content and services. Unfortunately the approach taken was to define such content and services as tangible personal property.

a. The Approved Digital Download Language.

The language passed by the Pennsylvania General Assembly specifically provides that tangible personal property “shall include the following, whether electronically or digitally delivered, streamed or accessed and whether purchased singly, by subscription or in any other manner, including maintenance, updates and support:

  •  i. video;
  •  ii. photographs;
  •  iii. books;
  •  iv. any other otherwise taxable printed matter;
  •  v. applications, commonly known as apps;
  •  vi. games;
  •  vii. music;
  •  viii. any other audio, including satellite radio service;
  •  ix. canned software, notwithstanding the function performed; or
  •  x. any other otherwise taxable tangible personal property electronically or digitally delivered, streamed or accessed.”

This language took effect August 1, 2016.

b. Taxability Changes.

While this proposal (derived from the governor’s first budget proposal in 2015) had been tossed around Pennsylvania for over a year, there were a few unexpected modifications to the language in the last days of negotiation. Notably the language was expanded to include streamed content, “maintenance, updates and support” charges and satellite radio services. Magazines, newspapers, and mailing lists were removed from the prior iteration, but a catch-all provision was included for “any otherwise taxable printed matter.” That language limits the taxation of digital versions only to the extent the print version is taxable. Because print newspapers and subscriptions to periodicals (such as magazines) are exempt, their digital counterparts are not part of the tax base expansion that took effect August 1.

As a result of the legislation, digital goods/products such as movies, music, books delivered electronically (i.e., downloaded) are now subject to tax when sold in Pennsylvania. Streamed audio and video services, whether offered by subscription or otherwise are also subject to tax. Because the mere access to digital items is considered tangible personal property under the revised definition of tangible personal property, online video game play and remote access to canned software and apps is also captured by the new digital imposition. In Pennsylvania at least, the state has caught ‘em all, and those playing Pokémon GO will be paying tax to exercise their rights.

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