Department of Revenue says digital taxation bill will cost Arizona millions

By: - March 19, 2019 3:53 pm

The Arizona Department of Revenue determined that legislation to exempt certain digital goods and services from sales taxes could cost the state at least $33 million in 2020, an analysis that could help the bill’s opponents keep it from moving forward in the Senate.

Currently, the state collects sales taxes on a host of digital services under a policy that some critics say is vague and unclear about which goods and services should be subject to taxation. Senate Bill 1460 would explicitly outline which of those digital goods can be taxed.

The legislation, sponsored by Sen. Michelle Ugenti-Rita, R-Scottsdale, would apply sales taxes to downloaded software; digital books, movies and music; and streaming services such as Netflix and Amazon Prime.

A handful of products that the Department of Revenue currently taxes would be exempted under the bill. Exempted items would include things like cloud computing and storage, and services that provide users with access to software or other programs, but don’t give them exclusive control of the programs, such as the accounting program Quickbooks Online or the web conference program Citrix GoToMeeting. Such programs are often known by the acronym SaaS, which stands for “software-as-a-service.”

According to the Department of Revenue’s analysis, exempting those items from sales tax would cost the state an estimated $33.1 million in 2020. The agency said there’s a possibility that the bill would lead to an “intermediate” reduction in corporate income tax revenue.

Ugenti-Rita told Arizona Mirror that the revenue isn’t the most important issue, and declined to speculate on what effect the agency’s analysis would have on her effort to find the votes needed for her bill to pass. The issue, she said, is that she believes the Department of Revenue lacks statutory authority to impose such taxes without legislative authorization.

“These are ill-gotten gains. This is money that the state should not be collecting. I am so tired of this idea that, because we’re used to collecting money we’re not supposed to, that’s a credible argument against the reform. I don’t care how much money we’re collecting. If we’re not doing it legally, that has to change,” Ugenti-Rita said.

Ugent-Rita said she’s close to having the 16 votes she needs, but is still a few shy. While her preference is to put the bill up for a vote regardless, she said Senate President Karen Fann doesn’t want to bring it to the floor until she has secured the needed votes.

The deadline for the bill to be heard in a House committee is March 29, meaning the Senate must pass it and send it over to the House with enough time for that to happen.

Fann, R-Prescott, said she needs senators to take a look at the Department of Revenue’s analysis and determine whether they’re comfortable with the bill.

“We’re still working on it. I’m hoping maybe that we can try and get it up if the votes are there,” Fann said. “I hate to put something up there if we know for a fact it’s not going to pass.”

Fann noted that the Department of Revenue raised some concerns with SB1460 in its analysis. The agency wrote that its analysis relies heavily on the stated intent of the legislation, and that the only way to determine the bill’s fiscal impact is to “make assumptions about interpretation and intent.” And the agency wrote that it won’t be able to implement the bill “without critical amendments being made.”

Ugenti-Rita said she’s working on an amendment to address the Department of Revenue’s concerns.

Software-as-a-service and similar services like cloud computing are the main sticking point for both sides, said Nick Ponder, the lobbyist for the League of Arizona Cities and Towns. He said the use of software-as-a-service and cloud computing is growing steadily.

“I think the line in the sand that neither party is willing to cross is they want an exemption for software-as-a-service and cloud storage, and we don’t think that the state should give that away,” he said.

Ponder rejected the notion that the Department of Revenue is currently collecting taxes without legislative authority, saying the agency’s decisions are guided by pre-existing statutory guidance. State law applies sales taxes to goods that can be “seen, weighed, measured, felt or touched or is in any other manner perceptible to the senses,” and Ponder said the agency’s job is to determine which legal classifications digital goods fall under.

By showing that the bill will cost the state tax revenue, Ponder said the Department of Revenue analysis will help keep the bill from advancing. He said he believes Ugenti-Rita won’t be able to win over Republican holdouts, making SB1460 dead for the 2019 legislative session.

The League of Arizona Cities and Towns argues that the Department of Revenue’s estimate is low, and that the actual loss to the state will be about $65 million. And the agency’s estimate doesn’t include tax revenue that cities and towns would lose, which the League estimates to be nearly $27 million.

Meanwhile, the Joint Legislative Budget Committee concluded in February that there’s no way to determine what kind of fiscal impact SB1460 would have.

The Arizona Tax Research Association, which is urging Fann to bring SB1460 to the floor, took issue with the Department of Revenue’s fiscal analysis.

Sean McCarthy, an analyst with ATRA, said because current law is unclear about what should and shouldn’t be subject to sales tax, many companies aren’t paying the taxes that the state is imposing. By eliminating that uncertainty for the items that will be subject to sales tax, McCarthy argued that Ugenti-Rita’s bill could generate new tax revenues that would offset the losses calculated by the Department of Revenue.

McCarthy said there’s no way to really quantify that figure.

“They don’t know what they don’t know,” he said.

SB1460 would help resolve several ongoing lawsuits. In February, Netflix sued the state over the Department of Revenue’s policy of imposing sales tax on streaming services. An administrative law judge ruled in the department’s favor on the matter in October. The website  hosting company GoDaddy and payroll services company ADP are also suing the Department of Revenue.

If the bill doesn’t pass and Netflix prevails in its lawsuit, McCarthy said the state will lose around $70 million in annual sales tax revenue from streaming services, a significantly bigger loss than the Department of Revenue estimates the state would realize from the passage of SB1460.

“It’s just a matter of deciding who’s going to sort it out – the Legislature or the courts,” Ugenti-Rita said.

This isn’t Ugenti-Rita’s first attempt to resolve the complex issue of taxation of digital goods. In 2018, she ran similar but more far-reaching legislation, House Bill 2479. Among the differences were that the 2018 bill did not tax streaming services. The House of Representatives passed the bill last year, but it died without getting a hearing in the Senate Appropriations Committee.

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Jeremy Duda
Jeremy Duda

Jeremy Duda is a Phoenix native and began his career in journalism in 2003 after graduating from the University of Arizona. Jeremy Duda previously served as the Mirror's associate Editor. Prior to joining the Arizona Mirror, he worked at the Arizona Capitol Times, where he spent eight years covering the Governor's Office and two years as editor of the Yellow Sheet Report. Before that, he wrote for the Hobbs News-Sun of Hobbs, NM, and the Daily Herald of Provo, Utah. Jeremy is also the author of the history book “If This Be Treason: the American Rogues and Rebels Who Walked the Line Between Dissent and Betrayal.”