July 28, 2015
UPDATE: On September 9, 2015, a lawsuit challenging the streaming services was filed on behalf of seven plaintiffs against the City of Chicago. The plaintiffs argue that because they subscribe to various streaming services, such as Netflix, Hulu and Spotify, they “are harmed because they must pay the tax,” on such services. The lawsuit also claims that the comptroller exceeded his authority to extend the tax, which they claim is a new tax, without a vote from the City Council. They also argue that the tax violates the Internet Tax Freedom Act.
UPDATE: It has been reported that the City of Chicago announced August 7 that it would delay implementation of the tax until January 1, 2016. The tax was originally scheduled to be enforced starting September 1, 2015.
On June 9, 2015, the City of Chicago Department of Finance introduced revisions to the interpretation of how the amusement tax and personal property lease transaction tax are administered to include streaming and cloud services, respectively. The ruling is effective as of July 1, 2015, but will apparently not be enforced until September 1, 2015. Mayor Emanuel’s office forecasts that the two taxes will collectively bring in $12 million in revenue in the first year.
The City defines amusement as, “…any exhibition, performance, presentation or show for entertainment purposes...” Amusement Tax Ruling #5 extends the existing 9.0% tax to “charges paid for the privilege of watching electronically delivered movies, or videos” as well as music and games. The new provision places a tax on streaming services like Netflix, Spotify and other entertainment service providers. The ruling also stipulates that the entertainment provider is obligated to collect the tax from the consumer. More than 30 states tax digital goods and many are starting to tax streaming services like Netflix under various current tax laws. In Florida, the tax falls under the umbrella of the communications tax, but information services are specifically excluded. In Texas the tax is considered part of the cable tax.
The Mayor’s office projected that the amusement tax will generate $126.5 million in revenues in FY2015 not including revenue generated by the ruling. This is an increase of $20.1 million dollars, or 20.0%, over FY2014. The table below shows the revenue trends for both the amusement tax and the personal property lease tax for years FY2005-FY2014 and the projected revenues for FY2015 and again does not include revenues from the change in the tax code.
The Personal Property Lease Transaction Tax Ruling #12 interprets that an existing 9% tax on nonpossessory computers applies to leases “in which the customer obtains access to the provider’s computer and its software to input, modify or retrieve data or information, in each case without the intervention…of personnel acting on behalf of the provider.” Transactions that are subject to the tax include those that provide data to customers, e.g. LexisNexis, and companies that provide storage, e.g. Dropbox.
A spokesperson from the City of Chicago characterized the two rulings as being “consistent with the City’s current tax laws and are not an expansion of the laws.”
The Department of Finance estimated that the City will collect $161.5 million from the personal property lease tax in FY2015 not including the new revenue, an increase of 15.1% over FY2014. It should be noted that in FY2009 and FY2010, the City saw a loss of $7.1 million from FY2008 to FY2009 and $3.8 million from FY2009 to FY2010 in personal property lease transaction tax revenues as a result of the recession. Total estimated revenues for FY2015 for both taxes will be $308.3 million dollars, or a 20.2% increase, over FY2014 and does not include the projected $12.0 million in new revenues.
In National Bellas Hess v. Illinois and Quill Corporation v. North Dakota, the U.S. Supreme Court ruled that the commerce clause of the U.S. Constitution prohibited the states of Illinois and North Dakota from forcing a company that did not reside in the state to collect a sales or use tax from its customers. Some have argued that the streaming and cloud taxes may not withstand similar litigation because, like the sales and use taxes in the aforementioned U.S. Supreme Court cases, taxes on streaming and cloud technology companies that have no physical presence, or nexus, in the state or in the City should not be obligated to collect these taxes. This issue may make the taxes difficult to collect and enforce.
Another potential legal issue is that original personal property lease transaction tax ordinances were levied on tangible personal property. Now many states have started to define specific digital services as a tangible, and therefore taxable, good. Kentucky has become entangled in litigation with Netflix over the tax because the state defined digital services, like streaming movies or music, as tangible goods and therefore subject to the personal property lease transaction tax. However, some argue that services provided by Netflix and other streaming companies are not tangible because they do not own any of the items “coming into your house” like cable companies do.
Last, but not least, some have speculated that the City of Chicago could face litigation based on the 1996 Telecommunications Act and the 1998 Internet Tax Freedom Act. The Internet Tax Freedom Act states, “No State or political subdivision…shall impose any of the following taxes on Internet access, unless such tax was generally imposed and actually enforced prior to October 1, 1998; and…multiple or discriminatory taxes on electronic commerce.”
There is also concern about the transparency involved in the decision to tax streaming and cloud service providers in the City of Chicago. As mentioned previously, Department of Finance officials argued that the taxes are not new taxes, but are simply clarifications to current statutes, so there was no need for the City Council to vote on the changes. Thus, there was no City Council hearing or debate on the rules.
One of the biggest concerns for many observers is whether the personal property lease transaction tax rules will have a chilling effect on Chicago technology start-up businesses. Many of the smaller start-ups rely on cloud technology which is one of the largest expenditures after payroll. Additionally, many start-ups lease computer equipment and resources rather than purchase them adding additional costs. The technology community, e.g. the start-up incubator 1871, has worked closely with Mayor Emanuel to increase Chicago’s presence in the technology industry, but some questioned his intentions with the tax increase. Mayor Emanuel responded that he will ensure that small technology businesses will be exempt from the taxes, but the details of the exemptions are not clear. Some have said that there may be income thresholds such as $5.0 million or $10.0 million or perhaps a rebate.