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State and Local Tax

Thorny State Digital Tax Issues Dominate Villanova Tax Forum

Niki Ford, J.D., LL.M.  Checkpoint Catalyst Editor/Author

· 10 minute read

Niki Ford, J.D., LL.M.  Checkpoint Catalyst Editor/Author

· 10 minute read

The Villanova University Graduate Tax Program hosted its second annual State and Local Tax Forum on Thursday, June 6, 2024. The forum brought together in-house practitioners, lawyers, accountants, administrative and legislative officials, judges, and scholars to discuss the most pressing issues surrounding state taxation of the digital economy. Over the course of five panel sessions, participants discussed the various ways that state and local tax systems are approaching the taxation of digital goods and other new technologies.

The panel sessions included:

  • A discussion of the way digital technologies can be classified as tangible personal property, a service, an intangible, or something else, led by Tom Donnelly, Senior Vice President of State & Local Tax at Comcast Corporation; Jeffrey Friedman, Partner at Eversheds Sutherland; Kathy Revel, Director of the Delaware Division of Revenue; and Jennifer Karpchuk, Shareholder and SALT practice co-chair at Chamberlain Hrdlicka.
  • A session on whether digital technologies are subject to sales tax, led by Eric Anderson, Managing Director and Partner at Andersen Tax; Todd Faciana, Senior Deputy Attorney General, Tax Litigation Section, Pennsylvania Office of Attorney General; Danielle Johnson, Director of Indirect Tax at Fanatics, Inc.; and Jonathan Liss, professor at Drexel Law School, adjunct professor for the Villanova Graduate Tax Program and former Senior Revenue Policy Analyst for the City of Philadelphia Department of Revenue.
  • A panel on the income tax implications of digital technologies, led by Rebecca Kennedy, Director of US State Direct Tax at Nestlé; Jess Morgan, Senior Manager at Ernst & Young LLP’s National Tax Department; Marita Sciarrotta, Acting Director of the New Jersey Division of Taxation, Andrew Woodman, Head of Tax – Americas at Sumitomo Mitsui Banking Corporation; and Drew VandenBrul, Managing Director of State & Local Tax at Grant Thornton.
  • A conversation around how legislators define digital technologies, led by Patrick M. Browne, Secretary of Revenue for the Pennsylvania Department of Revenue; Andrea Carter-Virtanen, Managing Tax Counsel at Cheniere Energy, Inc.; Greg Matson, Executive Director of the Multistate Tax Commission (MTC); Patrick J. Reynolds, President & Executive Director of the Council On State Taxation (COST); and Joseph C. Bright, Member of Cozen O’Connor.
  • A panel discussing how courts interpret tax laws involving digital technologies, led by Hon. Sara J. Agne, Presiding Judge of the Arizona Tax Court; Matt Boch, Chief Tax Commissioner with the Arkansas Department of Inspector General; Hon. Martha Wentworth, Senior Judge at the Indiana Tax Court; and Michael Semes, Of Counsel with BakerHostetler LLP and Professor of Practice at the Villanova Graduate Tax Program.

Throughout the panel sessions, several themes emerged that highlight the various legal and practical considerations that taxpayers and practitioners face when buying, selling, and using emerging digital technologies.

Should states continue to rely on tangible personal property as a taxation touchstone?

One theme reiterated throughout the forum was the idea that the definition of “tangible personal property,” upon which myriad state and local taxing statutes rely, is not an appropriate method for taxing new types of digital technologies, such as cryptocurrencies, non-fungible tokens (NFTs), artificial intelligence products, and others. In both the income tax and sales tax realms, whether an item is classified as tangible personal property has significant tax implications. Most obviously, within the sales tax context, taxability often turns on whether or not an item is tangible personal property, and thus properly characterizing an item is crucial for taxpayers and taxing authorities. However, even in the income tax context, classifying an item as tangible personal property can have significant consequences; for example, the protections of Public Law 86-272 apply only to companies that sell tangible personal property, and sales of tangible personal property are often sourced differently from sales of services or sales of intangibles. Several panelists pointed out that many state definitions of “tangible personal property” for both sales tax and income tax purposes have not changed for several decades, while the types of technologies that states are trying to shoehorn into these definitions have grown exponentially.

Jeffrey Friedman of Eversheds Sutherland summed up the issue succinctly, stating that the prevailing definition of tangible personal property rests on a “rickety foundation.” Friedman and other panelists argued that, instead of relying on several-decades-old definitions of tangible personal property, states should enact new laws that directly address the taxability of digital technologies. Of course, as panelists on both the practitioner and the tax administrator side pointed out, the legislative process often lags years behind advancements in new technology, so for the foreseeable future, taxpayers and their advisors may have no choice but to apply old definitions of tangible personal property to technologies that were not contemplated when those definitions were codified.

Artificial intelligence is the next frontier of state taxation.

Nearly every panelist spoke to advancements in artificial intelligence (AI), which they widely considered to be the next great frontier in state taxation. In fact, the second panel characterized the coming years as the “AI Age” for tax practitioners. As the panels noted, one legal question that arises within the context of AI usage is whether the use of AI to produce a tangible item should be taxable. Eric Anderson, managing director and partner at Andersen Tax, opined that the taxability of AI should depend on the “true object” of what is produced by the AI. Anderson provided the example of an AI bot that is asked to produce a unique digital image, and analogized this to a person being hired to produce a custom manuscript. While a mass-produced book may be taxable when sold, the commissioning of a unique manuscript is generally viewed as a nontaxable professional service. Thus, employing AI to produce a unique digital image, according to Anderson, should be likely be treated similarly.

AI use raises practical concerns for taxpayers and practitioners as well. As panelists in the judicial panel pointed out, current court and administrative tribunal rules of procedure may not expressly address the use of AI to produce documents submitted to the court or tribunal. Panelists suggested that best practice may be for litigants to disclose that they used AI to produce memoranda or other submissions. However, Matt Boch of the Arkansas Tax Appeals Commission pointed out that, whether or not AI was used in the production of submissions, at the end of the day the lawyer or taxpayer appearing before the tribunal is responsible for the submission. Overall, taxpayers and practitioners were cautioned that AI-created or AI-assisted documents should be reviewed carefully, particularly while rules around the use of AI are still being formulated.

Taxpayers want certainty, but can governments keep up?

Another common theme among panelists, particularly those working in-house, was their desire for certainty around how digital technologies will be taxed. Several panelists pointed out that complying with state and local tax laws-both in the direct and indirect tax context-is expensive, and that these expenses only increase the more uncertainties there are. Panelists from both the corporate and government side acknowledged that most taxpayers want to comply with the law; however, when it comes to new and emerging digital technologies, the issue of how to comply is often unclear.

As several panelists acknowledged across various sessions, governments’ ability to provide certainty to taxpayers is hampered not only because advancements in technology wildly outpace tax departments’ ability to respond, but because tax department guidance may not be afforded deference by a reviewing court. Multiple panelists acknowledged that the Chevron doctrine, which for four decades has required courts at the federal level to defer to reasonable administrative interpretations of ambiguous statutes, may soon be overturned by the U.S. Supreme Court, while also noting that many states already do not follow Chevron and apply a lesser deference standard. While arguments were made both in favor of and against a Chevron-type deference standard, panelists agreed that when agency pronouncements are not afforded deference, litigants on both sides of a tax dispute face an increased level of uncertainty concerning how the law will be interpreted by a reviewing tribunal.

Expansive applications of digital taxation remain controversial.

The final theme dominating the forum was the continued controversial nature of expanded taxes on digital products and services. Several panelists observed that states have expanded their sales tax bases to include digital technologies within their scope, either legislatively, such as Washington’s taxation of digital automated services, or administratively, such as Texas’s expansive interpretation of taxable data processing services. Panelists also addressed the continued attempts by states (most notably Maryland) to enact digital advertising taxes, which have been the subject of frequent judicial challenges. Patrick Reynolds from COST addressed these taxes in no uncertain terms, stating that digital advertising taxes are “wrong on so many levels.” Reynolds pointed out that although taxes on digital advertising and other digital services first gained popularity in the European Union, the EU states were frequently unable to impose income taxes on many of the large corporate players that they were targeting. States within the U.S. do not face the same constraints against corporate income taxation, and therefore his view is that digital advertising taxes are simply unnecessary.

The takeaway.

Overall, the discussions featured on the various panels highlighted that while digital technologies continue to evolve at a rapid pace, state and local tax laws do not, and therefore taxpayers, practitioners, and tax administrators must often resort to answering taxability questions using outdated and often ill-fitting tax statutes. This mismatch of the state of the digital economy to the state of the applicable law leads to inevitable uncertainties for taxpayers and administrators alike. However, as many participants in the forum explained, frequent open communication between taxpayers, their advisors, and representatives at the state level should be taking place so that these uncertainties can be eliminated, or at least addressed, to the extent possible. Luckily for the tax community, the Villanova Graduate Tax Program Forum provided an excellent opportunity for these lines of communication to be established and for ideas on best practices for taxation and tax compliance to be exchanged.

Checkpoint resources.

For a granular state-by-state consideration of some of these and other digital tax issues, Checkpoint Catalyst subscribers may wish to consult:

Recent State Tax Updates on related subjects include:


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