24 May 2011
7 min read

Is an iTune Taxable in California?

How About in Other States? Back in 2008, we wrote that the CA legislature was contemplating a change to its sales tax statutes to tax downloaded software. As it turned out, they didn’t change the law after all and electronically downloaded music and other digital goods in CA remained exempt from sales/use taxation. Meanwhile, a […]
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How About in Other States?

Back in 2008, we wrote that the CA legislature was contemplating a change to its sales tax statutes to tax downloaded software. As it turned out, they didn’t change the law after all and electronically downloaded music and other digital goods in CA remained exempt from sales/use taxation. Meanwhile, a song purchased on a CD has always been taxable in CA. That may seem a bit unfair. If you buy a song on iTunes and download it to your iPod, you owe no tax in CA, but that same song on a CD is taxable in CA.

This may seem arbitrary and capricious, but there is a reasonable explanation for the different tax treatment.

It’s a good general rule in most states that the purchase/sale of tangible personal property is, by default, taxable. The distinction between tangible and intangible property is always tricky. Is software tangible? Can you see it, touch it, smell it or sense it? Most people would say no. As intangible property, software would not be taxable. So, many states, to get around this, have focused on the media on which the software is delivered and have simply passed a law saying that software on some sort of tangible media is by definition “tangible personal property.” In fact, many states don’t even bother with the whole tangible media part; they simply call software “tangible personal property” and tax it regardless of how the software is delivered. California was one of the few states remaining that drew a line based on how the software was delivered, if delivered by electronic means, then it wasn’t tangible property.

Well, thanks to the recent Nortel case in CA, things may be changing. The Nortel case may mean that songs on CD’s are not taxable either. The Nortel case may mean that most software, even software delivered via diskette or other media, is not taxable. We will be keeping a sharp eye on how the State Board of Equalization reacts to this case because the effects of it may be far reaching indeed. Perhaps even songs on CD’s will be deemed nontaxable. Interestingly, the Nortel case did not take the tack that the software taxed in their audit was intangible. They argued (successfully) that it was exempt because it was subject to a “technology transfer agreement”.

The appeals court agreed with them and when the CA Supremes refused to take up the appeal, the ruling became final. The Nortel case may mean that even software delivered on tangible media is nontaxable.

This case has prompted a lot of questions on the taxability of digital goods in general. As technology has evolved, businesses have devised new ways to sell goods (electronic downloads) and governments have scrambled to devise new ways to tax those products. Read on for a more complete explanation of this change in CA and for how digital goods are taxed in other states.

What is a Digital Good?

The term digital good pops up every so often in the tax world, increasingly so as the usage of the Internet in business has exploded. The term has been loosely interpreted, with varying definitions depending on the state you ask. According to the DOR website for the state of Washington for example, digital goods include downloaded goods like movies and music, as well as software that is streamed or otherwise accessed. A recent ruling amended the description of digital goods to also include photographs sent via electronic means. But this is just one state. Contrast Washington’s take with that of Missouri, where a recent ruling of the Administrating Hearing Commission (AHC) in FileNet Corp. v. Director of Revenue, held that software was intangible and therefore could not be taxed with a traditional sales tax. We wrote about this issue back in October, 2010. You would be hard pressed to find identical definitions (or a single unified definition for that matter) for digital goods/products anywhere.

In an almost eerie symmetry, state tax departments are nearly 50/50 on the issue. Where some states are unapologetically aggressive, others are (perhaps) uncharacteristically generous. According to a CCH review of the taxability of digital products, of the 45 states and Washington D.C. that charge a sales tax, 24 have declared the sale of digital goods to be generally tax exempt, while the other 22 have declared them to be generally taxable. Maybe it’s just us, but it sounds like there’s some disagreement on the issue. What are the implications for the average consumer? What about all the businesses who regularly buy software, and from more than one state? And how does your state deal with the sale of digital goods?

For the sake of time, we have chosen to highlight some of the more prominent and interesting state positions on digital goods. To obtain a copy of the whole CCH chart, simply let us know, and we will be happy to make it available to you.


Digital goods are exempt, but digital products that fall within definitions of "electronic information services" or "electronic publishing" are taxable when sold for use in a business. As explained by the Ohio Revised Code, “Electronic information services means providing access to computer equipment by means of telecommunications equipment for the purpose of either of the following: (1) Examining or acquiring data stored in or accessible to the computer equipment; (2) Placing data into the computer equipment to be retrieved by designated recipients with access to the computer equipment.”

"Electronic publishing means providing access to one or more of the following primarily for business customers, including the federal government or a state government or a political subdivision thereof, to conduct research: news; business, financial, legal, consumer, or credit materials; editorials, columns, reader commentary, or features; photos or images; archival or research material; legal notices, identity verification, or public records; scientific, educational, instructional, technical, professional, trade, or other literary materials; or other similar information which has been gathered and made available by the provider to the consumer in an electronic format. Providing electronic publishing includes the functions necessary for the acquisition, formatting, editing, storage, and dissemination of data or information that is the subject of a sale.


Digital goods are “exempt [only] if [the] tangible equivalent is exempt.” According to the Tennessee Sales Tax Guide, “The retail sale, lease, licensing, or use of specified digital products transferred to or accessed by subscribers or consumers in this state shall be subject to the tax levied by this chapter on the sales price or purchase price thereof at a rate equal to the rate of tax levied on the sale of tangible personal property at retail by the provisions of Section 67-6-202.

Retail sales subject to tax under this section shall not include any sale, lease, licensing, or use of a specified digital product if the sale, lease, license, or use of the equivalent in a tangible form would be exempt as a sale for resale, sublease, or subrent, including any further broadcast, distribution, license, or retransmission of the digital product by a provider of video programming services, who shall not be deemed a subscriber or consumer for purposes of this section.”


Digital goods are taxable. Additionally, “Digital goods that are streamed or remotely accessed are also taxable. Digital goods include photographs transferred electronically to the end user.”
A special notice issued by the Washington DOR explained that, “Digital products, since the passage of ESHB 2075, are all subject to sales and use tax, although there are exclusions and exemptions. Digital products include downloaded digital goods, streamed and accessed digital goods, and digital automated services.

Digital automated services (DAS) are services that have been automated and are transferred electronically. DAS is not software, but includes one or more software applications in providing the service.

SHB 2620 specifically excludes the following services from DAS:

  • Data processing services
  • Live interactive presentations
  • Advertising services
  • Web hosting, storage, and back up

This legislation also clarifies that sales of photographs by a photographer who takes the photo and sends the photo electronically are sales subject to sales tax, as long as the customer is the end user.”


Digital goods are taxable. For tax purposes, a “Taxable item means tangible personal property and taxable services. Except as otherwise provided by this chapter, the sale or use of a taxable item in electronic form instead of on physical media does not alter the item's tax status.”


Digital goods are exempt with a few exceptions*. In a State Board of Equalization publication, it was explained that, “Your sale of electronic data products such as software, data, and digital images is generally not taxable when you transmit the data to your customer over the Internet or by modem. However, if as part of the sale you provide your customer with a printed copy of the electronically transferred information or a backup data copy on a physical storage medium such as a CD-ROM, your entire sale is usually taxable.

For example, if your company sells canned (non-custom) software programs to customers who download them from a server, those sales are generally not subject to tax. However, if you also provide your customers with a backup copy on a CD-ROM, the entire transaction is taxable. Similarly, if you transmit a stock (non-custom) database to your customer over the Internet and also provide a printed copy of the contents, the entire sale is subject to tax.”

So What?

Well if you’ve been paying attention to recent events in California, you will be aware of the Nortel decision. The ruling by the State Supreme Court to deny the State Board of Equalization’s petition for review in Nortel Networks, Inc. v. State Board of Equalization is a big deal. For those who have missed it, the ruling comes as a frustration to state tax authorities, but a boon to businesses. Essentially, the decline by the state supreme court to hear an appeal of the Nortel case means that all software in California that is covered by a Technology Transfer Agreement (TTA) is exempt from state sales/use taxes. The SBE had issued a regulation that canned software could not be exempt under the TTA exemption, but this case overruled that SBE policy.

Now this doesn’t mean that anyone who has paid sales tax buying Windows 7 in the last 3 years can just rush out and expect a check from the state. On the contrary, you can expect the SBE to use every means of bureaucratic resistance to delay and distract businesses from obtaining refunds. However if you have made some investment in software in California for which you paid tax, there is a potential opportunity for refunds. As in most matters with the state, we recommend getting someone involved that has the time and resources to devote to getting results and securing refunds. If you have questions regarding refunds, or would like more information about how this ruling might affect your company, feel free to contact Peisner Johnson & Company at our website, send us an email, or call us at 800-940-9433.

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