Anyone with a Netflix subscription can tell you that the ease of staying in and streaming is something that really can’t be beat. And Chicago lawmakers took notice, that’s why they started taxing the practice. But a new lawsuit hopes to challenge all that.
The tax was put into place last year, when Chicago became the first major city to enact a 9 percent “cloud tax” on digital entertainment services like Netflix, Twitch, and Spotify. Technically the “new” tax was an extension of the city’s amusement tax, which was traditionally applied to things like movie and Cubs tickets. Which is part of the displacement problem Chicago was trying to solve.
The city argues that the tax could bring in $12 million per year, which for cash-strapped cities looks pretty good. Especially as, with the advent of the internet, consumers turn their attention and dollars away from local entertainment—theaters, bars, even television which can bring ad revenue to neighborhood facilities—into online services that have no anchor to the city. Telecom tax revenues have faced a steep fall off as more and more consumers skip the landlines in favor of just a cellphone. It’s no wonder that in the 21st century, the entertainment tax structure might look a bit differently for cities looking to regain that income.
That’s why Chicago doesn’t seem to be alone in this respect anymore. August saw Pennsylvania extend its sales tax to digital downloads; services; and more, while in January Pasadena will fall in line with a handful of California cities that adopt a “video services” tax.
But neither the digital platforms nor consumers are taking it easily. Netflix—in a move that’s come to be signature with internet companies—passed along the Chicago tax to their subscribers’ bill, letting them know that they could join the streaming giant in the fight against it.
Only now those subscribers are getting in on the action. Customers of popular streaming services, including Xbox Live and Spotify, filed a challenge in Cook County last week saying that the tax violates the Internet Tax Freedom Act (which prevents states and cities from imposing discriminatory, internet-only taxes) by treating streaming services differently from DVD-rental services or other various live entertainment experiences.They joined other services including Amazon Prime, Hulu, Spotify, and Xbox Live in filing a lawsuit claiming that the tax penalties violated city policy and unfairly punished consumers. It led Chicago to refine their “Netflix Tax” proposal, as well as delay some implementation to next year in order to give businesses more time to address billing issues.
It’s basically one more notch in the belt of unpopular cyber-taxes, which in the past have led states like Massachusetts to repeal their bill to tax the cloud in 2013, and resulted in Pasadena walking back their commitment to their cloud tax. While states perceive a gap in funding and an in with taxes, it’s another prime example older laws failing to account for the internet.
“There is no good reason to exempt digital goods and services whose tangible counterparts are taxed,” Michael Mazerov wrote in a report for the Center on Budget and Policy Priorities in 2012. “These tax exemptions exist not for any policy reason but rather because sales tax laws and regulations have not been updated to reflect the Internet age.”
As Reed Smith attorneys wrote in a legal alert last year, there was a lot to be wary of with Chicago’s tax enforcement:
Nonetheless, there are strong arguments that both rulings run afoul of provisions in the Federal Telecommunications Act, the Internet Tax Freedom Act, and federal and Illinois constitutional limits on taxation. In addition, the rulings gloss over many details of applicable federal law and how telecommunications and computer networks operate, and assume the simplest factual scenarios that do not realistically comport with how many providers and their customers transact business. As a consequence, the time to look at the impact of these rulings is now, before mounting exposure and interest accrual makes challenging these positions economically infeasible.
But as they also note, there’s not exactly a guiding light here for Chicago. While the Supreme Court has held that a “physical nexus” needs to be present for a local tax to be valid, cities and states have been broadly and in some cases aggressively extending the definition of what that “nexus” can be defined as. What’s more, state and localities are all over the map with taxes like these, sometimes applying them to certain software as a service and application provider software, but not online delivery of software. And in absence of clarification from the Supreme Court, governments are likely going to keep pushing these taxes as far as they can get away with them.
The new suit filed by Cook County consumers could be the start of an actual definition of power cities and states are held to when it comes to taxing the internet economy. At the very least, it should help Netflix drama return to simply the latest original content.
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