Will YOU Pay the Netflix Tax?

Can Local Governments Tax Cloud Services?

Do you subscribe to Netflix, Spotify, or Pandora? How about Amazon Prime, iTunes, HBO Go or Hulu? Do you enjoy online gaming via Xbox Live, PlayStation Network, Gamefly, or Google Play? If you answered yes to any of those, you could be paying more for them soon.

In addition to the new taxes on consumer "amusement" services, Chicago simultaneously expanded its unique 9% tax on business property lease payments to include “nonpossessory computer leases.”

That includes Amazon Web Services, Microsoft Office 365, MLS real estate listings, Google Apps for Business and just about any cloud-based business service used from a computer in Chicago. Adding irony to the insult, if you're a Chicago-based law firm and subscribe to LexisNexis or WestLaw online, that means you'll be taxed just for reading the list of new taxes.

City officials are claiming this is not a new tax, but simply a "clarification" of long-standing use tax policies. Right…. The effect is that an $8.99/month Netflix subscription will now cost Chicagoans $9.80/month. That example may be trivial, but Chicago’s tax authorities estimate the “clarified” rules will generate an extra $12 million per year in revenues.

Oddly, the amusement tax is applicable only to streaming services; it does not apply to music or video files purchased outright and downloaded to a Chicagoan’s hard drive. (Purchases are subject to state and local sales taxes.)

Odder still is Netflix’s instant capitulation to the Chicago tax rulings. The company says it’s already working on a way to tack the extra 9% onto its Chicago users’ monthly bills. Other streaming entertainment providers have yet to weigh in on this issue. You'd think Netflix might, for the benefit of their subscribers, at least put up a little fuss. But no.

Less Legalese, Please!

The “nonpossessory computer lease” tax applies to just about any subscription to a searchable Web site. The key is whether the consumer’s control over the remote computer is more than “de minimis,” or negligible. In its new rules, the Chicago tax authority compared a passive stock price feed (which may require a subscription) to a searchable database of real estate listings. The stock price feed would not be taxed but the database subscription would be taxed.

The rules don’t specifically address non-subscription payments for use of remote computing resources. But Chicago’s tortured interpretation of a taxable “lease” could easily encompass one’s monthly eBay, Etsy, or other ecommerce platform bills.

That’s the point, of course. Chicago, like every other municipality, has watched its brick-and-mortar tax base erode over the years. Expanding old sales and use tax laws to encompass new, Internet-based modes of commerce is one way to recoup those lost revenues. And if Chicago gets away with it, other municipalities will certainly follow.

But *can* Chicago get away with this? Legally, the city (and, by extension, all cities) seems to be on shaky ground, according to Catherine A. Battin, a partner in the Chicago office of law firm McDermott Will & Emery LLP; she writes:

“(I)t is questionable whether Chicago can impose tax on the deemed use of hardware and software physically located outside of its jurisdiction, particularly when the control over the hardware and software is so attenuated. Moreover, the tax can be challenged on the grounds that such an imposition of tax exceeds the City’s home rule powers, violates the Uniformity Clause of the Illinois Constitution, the Internet Tax Freedom Act, and the Commerce Clause of the United States Constitution… a challenge to the tax by a taxpayer or a coalition of taxpayers is imminent.”

Just Put it Back in the Mailbox

It's pretty easy for some to evade this tax. Chicago relies on a user’s billing address to determine if he/she is “in Chicago” for the tax’s purposes. So a multi-location law firm, like Battin’s, can simply pay its Lexis-Nexis bill from a non-Chicago location. Netflix users can shift their billing address to an out-of-Chicago friend or family member. But it would be impossible or impractical to do the same for Amazon Prime and all your other online accounts, just to save a few dollars a year.

Finally, this tax is due from users, not providers. Such “use taxes” are notoriously difficult to collect because users simply don’t report themselves voluntarily. Obvious big targets, such as law firms and software developers, will see greater scrutiny from Chicago’s tax auditors. But without the cooperation that Netflix has inexplicably offered, I don’t see Chicago and like-minded municipalities successfully collecting these taxes from many consumers and small businesses.

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