Sales Tax Slice: ‘Pwnage’ or Game Over?—States Are Slow to Address Taxation of Virtual Goods


As sales of virtual goods climb each year, it appears that states could be missing out on imposing sales or use tax on a significant revenue source.

Broadly speaking, virtual goods are non-physical objects or products purchased for use in online communities or games.  A World of Warcraft gamer could purchase, for example, a more powerful sword for her avatar, or a Cityville gamer could use City Cash to buy new buildings for her city.

Game developers often structure games so that a person can acquire the virtual item either by playing the game or by simply purchasing it outright.  And the latter is big business these days—people are more than happy to pay hard cash for virtual goods.  For example, Facebook reported in its 2014 Form 10-K a staggering $970 million in revenues from “payments and other fees,” the company’s term for virtual goods purchases.  That figure represented about 7% of the social media giant’s total revenues during 2014.

Retailers want to know how to treat these transactions.  Last week in Kansas, the Department of Revenue released a Private Letter Ruling  (PLR) with taxpayer-specific guidance in this area.  The PLR advised that the Kansas Retailers’ Sales Tax did not apply to, among other things, access codes redeemable for in-game content.  Because the access codes were not prewritten software, neither purchasing nor redeeming them would trigger tax.  The result was not a change from its 2011 PLR on the matter, although the department’s earlier guidance had instead explained that the sale was a fee charged for electronically accessing information on a remote server.

Kansas is not the only state to address this issue, as the Illinois Department of Revenue issued a General Information Letter in late 2010 responding to a nearly identical request for guidance.  Unfortunately, Illinois’ analysis was not as clear. The department explained that cards or coupons are themselves nontaxable intangibles, but the seller incurs a Retailers’ Occupation Tax liability if the purchaser redeems the card or coupon for tangible personal property.  The department provided the state’s tax rules for electronically downloaded information, prewritten software, and custom computer programs, but it did not explicitly state that redeeming the access codes would not be a taxable event.

In other states, finding guidance on the tax treatment of virtual goods sales remains difficult.  With significant tax dollars at stake in these transactions, these states would be wise to explore the area in more detail.

Continue the discussion on the BBNA State Tax Group on LinkedIn: How should states treat sales of virtual goods?

by Ryan J. Voorhees

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