Sales Tax Slice: Has the ITFA Outlived Its Purpose?

Now extended several times and having a current expiration date of October 1, 2015, the Internet Tax Freedom Act (ITFA) was originally signed by President Bill Clinton in October 1998. At the time, AOL was just beginning to accrue huge use tax liabilities on CD-ROMs promoting its dial-up Internet service, the smartphone as we know it had not yet been introduced, and Cher had just released her hit song “Believe”, which would forever change the way we view digital pitch correction.

Fast forward nearly 17 years: Broadband is the standard. The iPhone is in its sixth generation. And fans can download all 26 of Cher’s solo albums over 4G wireless networks.  

The ITFA was a Republican Congress’s effort to protect the fledgling Internet economy from crippling taxation by preventing any new taxes on Internet access. Since initial passage of the ITFA, the services available through the Internet have proliferated and the nature of Internet access service itself has changed significantly. As Michael Mazerov of the Center on Budget and Policy Priorities has pointed out, Internet service has in some instances been used to replace other taxable services, such as cable television, which has resulted in inconsistent taxation of functionally interchangeable services.

It may be that the pendulum is beginning to swing the other way, with Internet-based cross-device services being substituted for otherwise nontaxable Internet services. While such services arguably fall within the ITFA’s broad definition of protected “Internet access service”, states seem increasingly likely to tax them the less they resemble traditional dial-up service. 

For example, the Missouri Department of Revenue recently ruled that a cloud-based service by which text messages would be routed to and from a purchaser’s computer was a taxable telecommunication service. If this service had involved only computer-to-computer communication, it would clearly have been nontaxable as Internet service. Because it instead involved computer-to-phone communications, it was determined to be taxable. 

As the distinction between computers and phones diminishes, the distinction between Internet service and phone service may make less sense. If the effect of the ITFA is to disfavor cross-device communication services by perpetuating this distinction, the result may be a tax preference for the technology of yesteryear. With this in mind, one might question whether the ITFA has outlived its purpose. 

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: Does the Internet still need protection from excessive taxation? If so, does it make sense to limit this protection to more traditional forms of Internet access?  

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