Applying the correct indirect tax on sales of downloaded or online products presents a considerable challenge for global companies. This article endeavors to offer a brief overview of the different approaches taken in the United States (“US”) and the European Union (“EU”) regarding the proper tax treatment of such items. Before we begin, when using the term “digital products,” we are talking about items downloaded or accessed via an electronic device rather than sold via a tangible format. Examples include downloaded or accessed software, digital books, music, videos, or database access.
Location of the Sale
When a company sells a digital product in the US, for sales and use tax, the sale will generally be sourced to the state of destination, i.e. the state where the customer receives or utilizes the digital product. For example, if a customer in Georgia downloads software from a Massachusetts provider, any possible sales and use tax is due in Georgia and not Massachusetts. If the state has local taxing jurisdictions, there are sometimes additional complexities associated with determining which local sales and use tax might be implicated, as this determination varies from state to state.
When a company sells a digital product in the EU, for VAT the supply will sourced to the country of destination, i.e. the country where the customer is established or if not available, where the customer has her permanent address or usually resides. For example, if a customer in Hungary downloads software from a Luxembourg provider, VAT is due in Hungary and not in Luxembourg. So far, the approaches in the US and the EU seem fairly similar. However, the similarities largely end here.
Obligation to Collect
In the US, only a seller with nexus (i.e. physical presence) in the state must collect sales tax. Therefore, if the Massachusetts seller of digital products does not have nexus in Georgia, it has no obligation to collect Georgia sales tax.
In the EU, the concept of nexus does not apply. Rather the obligation to collect turns on whether the customer is a taxable person (generally a business with a valid VAT registration number) or a non-taxable person (e.g. a private consumer). If the sale is to a taxable person, then the supplier is not required to collect VAT. However, if the sale is to a non-taxable person, the supplier must collect the VAT in the customer’s country. Turning to our earlier example, if the Hungarian customer is private person, the Luxembourg seller must collect the applicable Hungarian VAT on the supply.
Taxability
In the US, even assuming the seller has obligation to collect at the location of the sale, whether sales tax applies on the digital product varies from state to state and from product to product. For example, even when the Massachusetts seller has nexus in Georgia, it still does not collect sales tax on the sale of downloaded software because Georgia considers the sale to represent the transfer of a non-taxable intangible. If the sale is to a customer in Pennsylvania, the seller with nexus in Pennsylvania must collect the applicable Pennsylvania tax because electronic software is taxable under Pennsylvania law.
In the EU, digital products are considered electronically supplies services and under the EU VAT Directive 2006/112/EC, these services are taxable at the applicable standard rate. Therefore, the Luxembourg supplier must collect the 27% Hungarian VAT on the transfer of downloaded software to a private customer in Hungary.
This article covers just some of the surface level complexities surrounding selling digital products in the US and the EU. Sovos Compliance provides comprehensive support for the sales of digital products globally, ensuring that your business remains compliant in this complex area of indirect tax.
