Sales Tax Slice: Tennessee Levels Up by Taxing Remote-Access Video Games and Software


Major tax reform swept through Tennessee last week when Gov. Bill Haslam signed H.B. 644 (the “Revenue Modernization Act”), as reported in the Daily Tax Report by Andrew M. Ballard on May 21. Among the many ways in which the act broadens Tennessee’s tax base, a notable change to the sales and use tax law applies to software and video game transactions.

Before the act, Tennessee subjected to sales tax what one might call “traditional” software and video game transactions, meaning transactions in which a user purchases software or a video game either physically in a Tennessee store or by downloading it to an in-state computer or server. Now, Tennessee pushes the envelope a bit further: the state also taxes transactions in which a user pays to access software or a video game remotely without actually downloading it.

If you find it difficult to envision an example of how this might play out, you are probably not alone. Perhaps it would affect, for example, subscribers of cloud-based “freemium” games, meaning games in which a user accesses free software over the Internet and pays only if he or she wants additional optional content. Or consider how it might apply to massive multiplayer online games purchased without a download and accessed on the selling company’s out-of-state server. In both cases, Tennessee would presumably assert that a taxable transaction has occurred.

This change—along with several others in the act—increases the reach of Tennessee’s tax law. To further solidify its position, the act also declares that the legislature intends to impose sales tax “to the fullest extent allowed” under the U.S. and Tennessee Constitutions. Although Tennessee reported lower-than-average connectivity rates in a 2011 U.S. Census Bureau survey, one might expect substantial additional revenues to flow to the state in the near future.

Tennessee is not alone in eagerly increasing its tax base and re-examining sales tax on software and video game transactions. Across the country,   states are struggling to keep up with the realities of a changing economic marketplace. The states  vary significantly with respect to software transactions, and the logic behind these sales tax nuances has not always been clear.  For example, some states tax purchases of physical CDs but not in-state downloads of an identical product, as shown in a 2014 Tax Foundation map. Others distinguish between prewritten and custom software. It all causes multistate retailers significant compliance headaches. So perhaps even if Tennessee’s aggressive, all-in approach subjects some game retailers to sales tax for the first time, at least it is a modern understanding.

Continue the discussion on LinkedIn: How should state sales tax laws address remote-access video game and software transactions?

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by Ryan J. Voorhees