In July of 2015, a new tax went into effect in the city of Chicago. The tax epitomizes the desire of governments to gain revenue through the taxation of modern technology and presents potential implications on the federal government’s restrictions on Internet taxation. Colloquially referred to as the “Cloud Tax” or the “Netflix Tax”, the new tax in Chicago levies 9% on several online streaming and cloud-based services. However, the city was quick to point out that the Cloud Tax is not a new tax being imposed upon these services, but an extension of the city’s existing amusement tax resulting from two recent rulings from Chicago’s Department of Finance. The city’s amusement tax currently applies to “[o]wners, managers, [and] operators of amusements or places where amusements are conducted,” and, while the city’s amusement tax does include “paid television programming,” the new rulings extend the amusement tax’s coverage to “electronically delivered amusements” (services such as Netflix, Hulu, and Spotify), and “nonpossessory computer leases” (services such as “Amazon Web Services or Lexis Nexis”).
Unsurprisingly, Chicago residents are not pleased with the newly expanded amusement tax, and, just a few months after the expansion, a lawsuit was filed to challenge the Cloud Tax. The lawsuit, filed by the Liberty Justice Center, presents two arguments for why the new amusement tax expansion creates an invalid tax. The first challenge is purely procedural. The lawsuit argues that the new tax expansion is invalid as it never went before the city council and was thus never voted on. The lawsuit’s second challenge is more substantive, as it argues that the expansion of the city’s amusement tax violates the federal Internet Freedom Tax Act. While the lawsuit’s first challenge certainly presents an important argument for preserving the democratic process in applying new taxes, the lawsuit’s second challenge will have the broadest implications.
Originally enacted in 1998, the Internet Freedom Tax Act (IFTA) was created to prevent state and local governments from “taxing internet access” or from “imposing multiple or discriminatory taxes on electronic commerce.” Originally enacted as a three year tax prohibition, IFTA has been extended five times since the Act’s original enactment, and, as of 2016, a bill seeking to extend IFTA permanently has passed the House of Representatives and is awaiting a vote in the Senate. The original IFTA included a grandfather clause that allowed states already taxing Internet access to continue the imposition of such taxes. At the time of IFTA’s original enactment this grandfather clause included fifteen states, but, as of 2015, the number of states included in the grandfather clause is now at seven.
Worth noting is the fact that one of IFTA’s primary focuses is on preventing states from creating discriminatory taxes on Internet services. This “discriminatory” language, as it is used in IFTA, prohibits products from being taxed differently simply because they were purchased over the Internet. For example, purchasing a movie online cannot be taxed at a higher rate than purchasing that same movie within a physical store. While several of the shows or movies available online can be attained through physical purchases or cable television, millions of Americans use online streaming and cloud-based services every day, and some Chicago residents may not find the 9% tax on these services to be insignificant.
The three big streaming services are Netflix, Hulu, and Amazon Instant Video. While most may subscribe to just one service, some may mix two or even subscribe to all three. As of 2015, subscribing to all three of these services would cost a user $291.00 per year. After Chicago’s amusement tax expansion, this means a Chicago resident subscribing to all three services would be charged $26.19 in taxes annually to access the exact same content simply because of where they live.
Chicago Mayor Rahm Emanuel has stated that fairness is one of the reasons for expanding the city’s amusement tax to include these online services, as the use of televisions and movie theaters that deliver the same content have long been taxed in a similar manner. However, the lawyers challenging Chicago’s Cloud Tax are using the discriminatory language from IFTA to argue that the Cloud Tax violates the federal act because it taxes the content available online at a higher rate than if someone were to access the same content by other means.
Whatever the outcome of this case, the reasoning is likely to be fairly influential in determining what online services can be taxed in the future. A judgment in favor of Chicago may influence other municipal or state government to enact similar taxes, especially considering the city’s projected yield of $12 million as a result of the Cloud Tax. Taxing online services presents new opportunities for government to increase revenue or to make up for lost revenue that may occur as a result of more business taking place online; and while Internet-based services and entertainment are more and more convenient and accessible, the law on Internet taxation has enough ambiguity for governments to attempt to gain increased revenue through the taxation of these services.
Published on March 1, 2016.