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Subcommittee on General Taxability of Internet Transactions

Meetings and Methodology Used by General Taxability Subcommittee

Senior tax policy, audit, and revenue and accounting personnel from the Comptroller's Office surveyed existing Texas authority dealing with taxability of Internet transactions. The Comptroller's Office provided redacted copies of Comptroller rulings, releases and other authority that addressed Internet transactions. Subcommittee members organized that data into categories of taxable transactions, and analyzed those results.

In reviewing the Comptroller's policies, the Comptroller's office and the private sector representatives agreed that the existing statutory definitions may require the taxation of numerous Internet activities. However, many activities conducted on the Internet fall into areas that the legislature has traditionally not intended to tax (e.g., advertising). Unfortunately, the current statutory definitions of information services and data processing services (and current Comptroller interpretation of those statutes) appear to mandate that certain activities are subject to taxation, even though the pursuit of similar activities off-line (i.e., conducted through more traditional media than the Internet) are not subject to taxation[12].

Consequently, the Working Group first attempted to develop definitions for use in Comptroller Rules which would insulate these services which should not be taxed. The Group found this drafting task to be an impossibility.

Any definitions designed specifically to bifurcate these services would be extremely technical, and rely - at least to some degree - on the nature of specific technology used over the Internet. The Group concluded that even if definitions could presently be developed, the industry and its technology are changing so rapidly that any definitions developed today would likely be inoperative within a year or less. Thus any compliance with such Rules would be difficult to monitor and difficult for the State to audit. Furthermore, the Group found that the existing statutory definitions for both data processing services and information services were so subject to such a wide range of interpretations that they were wholly inadequate in evaluating Internet activities. Therefore, the Group concluded that under the existing statutory language, there is no way to distinguish between services that were intended to be taxable (e.g. storage of data by word processing) and those intended to be nontaxable (e.g. storage of data by storing an advertisement on the Internet). Considering the negative economic development and retention-of-jobs ramifications of applying the tax across the board, the Group recommends that the sales and use tax on data processing services and information services be repealed.

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Findings

Activity 1:  Present statutory authority provides that charges for providing access to the Internet is taxable.

This analysis assumes that the primary function of an ISP constitutes an information service because some form of providing general or specialized news or electronic data retrievable research capabilities is involved. ISP's also provide services which could be classified as telecommunications services. In some respects, access charges appear to fall within the definitions of each of data processing services, information service, and telecommunications service.

Activity 2:  Current Comptroller policy (1) characterizes charges for creating logos and graphics for a customer's webpage as subject to sales tax, constituting the sale of tangible personal property in the form of finished artwork, but (2) generally does not consider advertising to be subject to sales tax..

The Subcommittee recommends that if its primary legislative recommendation is not adopted, the creation of advertising-oriented web graphics and layouts (which include both image creation and the HTML page creation) for the purposes of advertising be legislatively treated as a non-taxable advertising service. Such non-taxable characterization would have the effect of decreasing the cost of providing professional-quality content on-line and facilitate the making the Internet commercially viable as a communications medium in Texas. Advertisers in general are taking greater advantage of the Internet to sell their goods and services; treating web graphics as a non-taxable service in Texas would facilitate growth of this industry in Texas and remove the competitive disadvantage Texas firms now face in the marketplace. (The repeal of the sales tax on data processing services and information services would effectively remove the need for such a targeted legislative change.)

Activity 3:  Current authority characterizes charges for scanning a customer's data into a computer readable file as a taxable data processing service.

The General Taxability Subcommittee concluded that Texas data processing and information services tax statutes are perceived as taxing a broader array of Internet related services than are taxed by most other jurisdictions[13]. Because so many specific components of the transactions and services relating to the Internet involve taxable data storage and data entry, the Group recommends data processing services be repealed from the list of taxable services. The Subcommittee members are concerned that the electronic commerce industry will view Texas tax statutes as not friendly to business if this recommendation is not followed[14].

Activity 4:  Current authority characterizes charges for creating HTML documents for a customer as the taxable sale of a data processing service.

For a variety of reasons, the Subcommittee recommends that this service be treated as non-taxable, by repeal of the Texas sales tax on data processing services. Unfortunately, there is no effective way to determine the primary purpose for the creation of an HTML document (or a document using any other Internet-related technology). In the Internet today, documents (or web pages) are usually intended to function as advertising a vehicle for providing information, a mechanism for retail sales, or some combination of those three elements. The creation of those documents could be seen as the creation of advertising material, the furnishing of general or specialized information, or the creation of a virtual store. Moreover, with the changes taking place on the Internet every day, even these three classifications may soon become obsolete.

Because of the difficulty of analyzing the intended purpose of this HTML design services, and for the reasons sited under Activity 3, the Subcommittee recommends this service be treated as non-taxable, by repeal of the Texas sales tax on data processing services. Furthermore, the Subcommittee notes that the statutory definitions of information services overlaps with the definition of data processing services in many cases, and even co-opts the definition of data processing services in some circumstances (data retrieval, for example). Therefore, the Subcommittee further recommends the repeal of information services from the list of taxable services. We believe that repeal of either the tax on information services or the tax on data processing services, without the other, renders the legislative relief ineffective.

Activity 5:  Current authority characterizes charges for updating and maintaining a customer's web page as a taxable data processing service.

For similar reasons outlined above in connection with Activity 3 and 4, the Group recommends this activity be characterized as a non-taxable, by repealing the existing sales and use tax on data processing services.

Activity 6:  Current authority characterizes charges for storing a customer's web page on a server as a taxable data processing service.

The Subcommittee recommends this activity be characterized as non-taxable by repealing the sales and use tax on data processing services. Avoiding taxation of these services is especially critical from an economic development perspective. Texas should not discourage the development of the infrastructure needed for efficient Internet access by discouraging the placement of servers in Texas.

Activity 7:  Current authority characterizes charges for transmitting information between automated clearing houses and merchants as taxable sales of a telecommunications service.

To the extent such transmissions are characterized as telecommunication services, the Subcommittee recommends that no change be made.

Activity 8:  Current authority characterizes separately stated fee for licensing and completing applications for domain names as non-taxable.

The Subcommittee recommends that no change be made.

Activity 9:  Current authority characterizes (a) charges of a sponsor of on-line classes as taxable, and (b) charges for participating in an on-line continuing education class, taking examinations or receiving test results as non-taxable.

The Subcommittee supports this non-taxable characterization which applies to students taking on-line classes. The Subcommittee recommends that the taxability of the sponsor of such on-line education, currently characterized as providing a taxable data processing service, be reversed to a non-taxable service by repealing the data processing services tax. The availability of on-line education is particularly important to large and diverse states like Texas because it provides mechanisms for self-improvement even to those in the most isolated parts of the state.

Activity 10:  Current authority characterizes charges for access to the Internet and for information provided through the Internet as the taxable sale of an information service.

The Group recommends that the tax on information services be repealed. This repeal, coupled with a repeal of the tax on data processing services, would effectively repeal the current tax on Internet access charges.

Activity 11:  Current Comptroller policy characterizes charges for maps and proximity data provided by the Internet as taxable information services.

The Subcommittee recommends that the current tax on information services be repealed, as described in connection with Activity 10.

Activity 12:  Current Comptroller policy characterizes charges for software and software sold via the Internet as a taxable sale of a tangible personal property.

The Subcommittee recommends that no change be made.

Activity 13:  Current Comptroller policy characterizes charges for broadcasting a customer's information over the Internet as a taxable sale of telecommunication service, with which position the Subcommittee disagrees.

The Subcommittee disagrees with characterization of this activity as a telecommunication service on the ground that access to information on the Internet should be treated no differently for broadcasters than for others.

Process of Determining Recommendation

1.  The Working Group worked diligently to draft possible amendments to the statute and Comptroller Rules that would exempt Internet related transactions (thus retaining Internet related jobs in Texas) while retaining the existing sales tax system for data processing and information services taxes.

2.  Although the Working Group drafted several proposals to draw new lines, those proposed delineations could only be identified at points near either end of the spectrum - having the effect of taxing every Internet-related activity, or none - which were of very little practical use due to the technicality of definitions.

3.  In detailed discussions of existing authorities the Group concluded that any line distinguishing data processing from information service has all but disappeared in many of the Comptroller's rulings, so that many activities might be characterized as either service. Any legislative effort to protect and encourage growth of the Internet industry in Texas by repealing the data processing services tax would be a hollow exercise unless the information services tax is also repealed.

Recommendations

Consequently, the Working Group unanimously recommends that the Texas Legislature repeal the sales tax on data processing services[15] and information services[16], in order to enhance and maintain a competitive high technology job climate in Texas and to avoid job loss to other jurisdictions. If this recommendation is not fully adopted, more narrow technical legislation described in part III(B) above should be adopted.

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  1. For example, traditional newsprint copies of newspapers are not subject to sales tax. Prior to the October, 1998 enactment of the Internet Tax Freedom Act, downloading the same newspaper from a publisher's web site, was subject to sales tax, if a fee is charged for the download.
  2. See footnote 10 above.
  3. The risk that Texas tax statutes may be viewed as impeding the growth of Internet-related businesses is increased by the actions of Alabama, Arizona, California, Colorado, Connecticut, Florida, Georgia, Illinois, Kentucky, Massachusetts, Missouri, New Jersey, New Mexico, New York, Oklahoma, Pennsylvania, Virginia, Washington, and Wisconsin to insulate all or portions of Internet transactions from taxation in their respective jurisdictions.
  4. Texas Tax Code Sections 151.0101(a)(12) and 151.0035.
  5. Texas Tax Code Sections 151.0101(a)(10) and 151.0038.

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