The Transaction Tax “Yin and Yang” of the Internet of Things (IoT)
Some say that everything contains Yin and Yang–two opposite yet complementary and interdependent “things”. Yin and Yang cannot exist without the other; they are never separate. So, it is with IoT (“Yang”) and transaction taxes (“Yin”): the growing infusion of IoT technology to make products, like cars for example “smarter” (see a recent article in Business Insider [http://www.businessinsider.com/the-internet-of-things-2017-report-2018-2-26-1], and the growing challenges of companies and their advisors to correctly compute transaction taxes, e.g., sales/use taxes and communication taxes, on such technological enhancements.
It is a perfect time for tax and technology advisors and consultants to sit down with companies and understand better: (1) the role that IoT technology is currently playing and will play in their future business planning [https://sdtimes.com/msft/microsoft-invests-5-billion-internet-things/], (2) how that IoT technology is currently taxed; (3) how it may be taxed in the future, and (4) how tax technology solutions can fit into the company’s overall business planning. And frankly, it will be “all the better” if such tax solutions can get in “on the ground floor” of business planning before such plans are actually implemented.
What are Some of the Challenges of Taxing IoT?
The Illusive Definition of the “Internet of Things”
Before you can tax something, it would be helpful in tax compliance and planning to define exactly what the governments propose to tax. Unfortunately, everyone seems to have a different definition of IoT, and this of course has allowed governments in the US and around the world to devise their own definitions to suit their own tax objectives.
Commerce Department to a Definitional Rescue?…..Not
Given the definitional challenges around IoT, in January 2017 the Commerce Department Internet Policy Task Force and Digital Economy Leadership Team published a green paper, “Fostering the Advancement of the Internet of Things”. [https://www.ntia.doc.gov/files/ntia/publications/iot_green_paper_01122017.pdf]. This paper reflected a broad array of the views of IoT stakeholders – from the private sector, academia, government, and civil society. Unfortunately, it did not provide the clarity that companies and practitioners would like to have in their tax planning and compliance for IoT:
“…There was no consensus among commenters on a formal definition of IoT, or even on whether a common definition would be useful. Definitions vary across industry and across parts of government; the Department agrees with the commenters that emphasized the need to allow the IoT environment to grow without the restrictions of labels or specific definitions that could inadvertently limit the applications, innovations, and overall potential of IoT…”
But unfortunately, from a tax perspective, allowing the “environment to grow” in the above quote doesn’t help companies; it simply adds to the complexity and uncertainty of the tax dilemma: they now must track all those “creative” state statutory definitions and comply with all of them. And so, the company and its advisors are left to their own devices to figure it all out starting with the definitions provided by each state, if states have actually done so.
A Simple Example to Illustrate the Evolving Tax Challenge with IoT
- It’s “just” a product. Let’s say we have a tangible product, a camera, that we sell to customers all over the country. If you can determine that this is just the sale of a tangible personal product, you then work through the complex nexus rules (don’t forget about the Quill nexus standard review that will soon arise [Link or reference to the TL on Quill]), as well as the sales and use tax exemption, taxability and rate rules for each jurisdiction in the country. As we all know, that process in and of itself is very complex and begs for a software solution. If you have the software in place, you can feel confident that you are complying in every relevant jurisdiction.
- It’s a Product and Maybe a Service or both. So now, to grow the business, the company enhances the camera by adding a sensor device that responds to vibrations in a room. Above a certain threshold of movement, it will send a message over the internet through some communications device to a security office outside the home that there may be an intruder in the room. Ok have we now taken a product and turned it into a service? And if we have a service (or even the possibility of a service), we now must review all the rules in each jurisdiction for determining how to tax a service or a product/service combo, or some other such creation. If you are fortunate to have the software in place that can quickly process the transaction as a sale or a service or both, you can still have a high level of confidence that you are complying.
- It’s a product, service and maybe telecommunications. Ok now, the camera is storing and transmitting data over the internet. Are you now subject to some communications tax because some states are defining it as coming under their law? Again, without the tax research and technical expertise to address the problem, the level of confidence that you are compliant must go down.
Analogy with Payroll Taxes
As a practitioner, I know of no company, even companies with revenues of only $12-14M, that do their own payroll taxes. Why? The level of detail required and the penalties for errors on payroll returns just make it bad planning to do it yourself when there are competent third parties that can do that job because that is all they do–payroll. The point of this analogy and the simple example above is to show that IoT enhancements can produce tax results that no one might have anticipated and because of the sheer volume of transactions and rules, it will become virtually impossible to be in compliance without a third-party software solution…just like payroll.
What is a Person To Do with the Yin and Yang of IoT?
The truth of the matter is that this simple example belies the reality that new IoT products and IoT enhancements to existing products are growing exponentially (“Yang”) and along with it, the growth of tax transaction compliance challenges (“Yin”). And so, tax professionals and their advisors and consultants need to be a part of the solution before such business plans are implemented. And there are partners out there who are perfectly suited to keep pace with these changes.
Check out Wolters Kluwer’s white paper Avoiding the Tax Pitfalls of New Communications Services to learn more about identifying the tax consequences of new communications services including IoT.