Chicago on a roll of Cloud and Netflix tax revenue (1)

Chicago’s bold move in 2016 to tax two features of the digital economy is reaping significant rewards, while the city’s more conventional tax programs have languished during the pandemic.

Chicago’s unique cloud computing tax revenue is about four times higher than five years ago, grossing nearly $ 120 million last year, according to figures provided to Bloomberg Tax by the Budget Office and city management. The city’s tax on streaming entertainment has more than tripled during this period, with consumers increasing their subscriptions to services such as Netflix for video, PlayStation for games, and Spotify for music. The city has collected more than $ 30 million in taxes on streaming services for the current year.

Both taxes are small shards of the $ 1.5 billion in local taxes planned for the city in fiscal year 2022, but a rare “bright spot” on Chicago’s business tax menu. hotels, restaurants, recreation, telephones and utilities, said Laurence Msall, president of the Civic Federation, a think tank on taxation and tax policy.

The so-called “cloud tax” and “Netflix tax” were particularly effective sources of revenue for Chicago during the pandemic, when collections related to accommodation, transportation and conventions plunged. The city deserves credit, Msall said, for developing innovative tax regimes for digitally delivered services despite legal limitations.

“Chicago’s unique approach using a rental transaction tax and an amusement tax has allowed it to tap into revenue streams that would not be accessible to a municipality when considering the tax laws of Chicago. Illinois sales, ”Msall said.

Leases and entertainment

The Chicago Department of Finance jumped six years ago by reinterpreting two long-standing tax programs. Under Decision No.12, the city extended the personal property rental transaction tax – previously imposed on automobiles, commercial equipment, and other leased items – to “possession-less computer leases.” . The tax extends to a wide range of IT models, including platform as a service (PaaS), infrastructure as a service (IaaS) and software as a service (SaaS).

The new tax, at 5.25%, came into effect in 2016. The rate rose to 7.25% in 2020 and 9% in 2021 as the city sought additional taxes.

At the same time, the ministry issued Decision No. 5 on the Amusement Tax. While the city had for many years applied the 9% tax on tickets for recreational activities and theatrical performances, the ruling extended the tax to “electronically delivered amusements”.

While a handful of states and towns across the country have extended their sales taxes to cloud computing and streaming, Illinois law does not allow this application of sales taxes. Chicago has used its important domestic authorities to find another way – through taxes on rentals and entertainment. This makes it the only large municipality with this approach.

Income bonanza

Creativity pays off, according to data provided by the Chicago Office of Budget & Management.

The Netflix tax grossed $ 9.4 million in 2017, its first full year of service. Revenues reached $ 28.8 million in 2020. Collections for the fiscal year ending June 30, 2021 totaled $ 31.2 million. A total of 47 companies are registered to collect and remit taxes on entertainment delivered electronically.

The cloud tax brought in $ 30.5 million in 2017, its first full year of service. Revenue growth has since galloped at annual rates of over 40%, earning the city $ 73.7 million in 2020 and $ 117.2 million for 2021.

Rose Tibayan, spokesperson for the city’s Office of Budget and Management, attributed the rapid growth to both rate hikes and rising compliance rates. A total of 1,098 companies pay taxes on the rental of cloud products.

Compliance with both taxes has accelerated in part thanks to active Chicago enforcement efforts and a recent “economic nexus” statement.

In January, the Department of Finance issued a bulletin saying it expects out-of-state companies doing business in Chicago and meeting the new economic presence standards, or nexus, to comply. fully to both taxes on a prospective basis, effective July 1. The bulletin included a legal analysis of tax programs in the context of the 2018 U.S. Supreme Court ruling South Dakota vs. Wayfair, which allowed states to impose tax collection obligations on distant retailers based on economic activity rather than physical presence.

The guidelines also describe a haven for small businesses selling entertainment and computer services in Chicago. Businesses with Chicago customer sales of less than $ 100,000 in the previous year should not be in compliance.

“It is too premature to predict the full impact of the guidelines, but the overall response has been positive and some companies have indeed become more willing to come into compliance after reviewing the bulletin,” Tibayan said in an email. .

Prosecutions and audits

Even as collections and compliance increase, the two tax programs remain controversial. The Netflix tax has been the subject of litigation since it was first imposed.

In 2015, a libertarian legal advocacy group known as the Liberty Justice Center challenged the tax on constitutional grounds on behalf of Chicago users of Netflix, Hulu, and Spotify. The Entertainment Software Association filed a similar challenge in 2017, but then dropped the litigation. Chicago survived the challenge of the Liberty Justice Center, winning the lower court and appeals court decisions. In March 2020, the Illinois Supreme Court declined to review the appeals court decision, which found nothing inappropriate about the Chicago agenda.

Despite this precedent, tech giant Apple Inc. is doing everything possible to separately challenge the Netflix tax in Cook County circuit court. The next hearing in the case is tentatively scheduled for December on Chicago’s dismissal request.

Sony Interactive Entertainment LLC, the games division of Sony Corp., opposed the tax on streaming services, saying it lacked connection to the city. The company eventually surrendered and began collecting the tax in 2018. Sony also paid the city $ 1.2 million as part of a confidential settlement.

When it comes to cloud tax, Chicago has been particularly aggressive in its audits, initially focusing on providers and later targeting consumers of cloud services, said David Hughes, local and national tax partner at Legal Counsel HMB.

“It’s not because we’re a Chicago law firm and we see so many tax audits on rental transactions in Chicago,” said Hughes. “I think the city is really very aggressive in enforcing this. We have seen it in other jurisdictions, but not to this degree.

Despite the Economic Link bulletin, important questions remain about Chicago’s position on taxes and penalties for previous years. These issues are frequently debated during audits and the city’s views are applied inconsistently, said Samantha Breslow, national and local tax associate at HMB.

“There is a question of whether a seller without a physical presence in the city has or had an obligation to collect before July of this year and if he has done so, how far back does this obligation to collect go?” she declared.

Chicago-based company deputy tax advisor Wes Hanscom said the “safe harbor” in the newsletter, waiving compliance for remote vendors with less than $ 100,000 in revenue from Chicago customers, resolved many of the concerns expressed by taxpayers in recent years.

“With a safe port, we were basically saying, ‘If you’re below that threshold, you don’t have to worry about it and we don’t have to worry about it,” said Hanscom.

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