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Digital-goods taxation data unreliable, leaves fate of bill uncertain

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A lack of reliable data on the impact of a bill to forgo sales taxes on certain digital goods has again stymied legislators trying to settle the issue in state law.

A similar bill was stopped in its tracks a year ago, when the League of Arizona Cities and Towns estimated more than $100 million in revenue would be lost by an effort to exempt digital items like videos, cloud-based software and other streaming and hosting services from state and local sales taxes.

Now some lawmakers feel SB1460, which awaits a vote on the Senate floor, is bogged down by the same uncertainty.

League officials have again predicted dire consequences if the bill is approved. They estimate the state would lose more than $65 million in revenue, while cities stand to lose nearly $27 million, though they admit their analysis is imperfect – it’s an aggregate figure based on data from companies that self-report taxes.

Last year, League estimates dominated the debate over taxing digital goods by default. State budget analysts were unable to crunch the numbers and come up with their own fiscal impact because the Department of Revenue failed to provide meaningful data.

DOR finally delivered last week with an analysis that predicts $33.1 million in lost revenues to the state, roughly half of what the League estimated.

But just as the League acknowledged the shortcomings of its own study, the department’s analysis is riddled with signs that the estimate is incomplete and speculative.

ADOR analysts wrote that they used the “intent of the bill” as told by those backing it to estimate the fiscal impact. That’s because, as written, “the only way to estimate the fiscal impact (of the bill as written) is to make assumptions about interpretation and intent.”

That’s not good enough for Senate President Karen Fann, who noted that ADOR gave the bill a poor rating for “substantive” and “technical” issues.

“That tells me we’re back to the same problem… That we didn’t have policy in place to give DOR direction about what is taxable and what isn’t,” the Prescott Republican said.

The discord over the bill’s impact highlights the underlying disagreement between the League, which wants to continue taxing certain digital goods, and the Arizona Tax Research Association, the driving force behind the legislative effort to exempt digital services from taxation. Further complicating the issue, they even disagree over what’s a digital good and what’s a digital service.

Nick Ponder, the League’s legislative director, said his organization has tried to reach a compromise with ATRA that would minimize the loss in revenue to municipalities, while providing clarity in law for businesses who want to know what’s taxable and what’s not. For the League, it’s crucial that “software as a service” be labeled as taxable – software suites such as Office 365 and Google Apps are an example – as well as cloud-based storage.

At Fann’s request, the League drafted an amendment to SB1460 to make those distinctions, while also clearly defining other digital goods to avoid ambiguity in the law, in what Fann hoped would be a compromise.

Sean McCarthy, senior research analyst for ATRA, said the amendment was far from a compromise, and it would’ve been “insulting” to a coalition of business groups backing SB1460 to engage the League.

“The League’s version of compromise is that all (digital products) are taxable, and they’ve cynically tried to offer a couple of exemptions to some companies involved,” McCarthy said.

Ponder said ATRA may simply be trying to get as many digital goods as possible exempted from taxation.

That leaves the groups at a stalemate, while lawmakers try to sort out the difference. Sen. Michelle Ugenti-Rita, the bill’s sponsor, said she’s working on an amendment to address what the Department of Revenue described as “critical” concerns, but it’s unclear what those concerns are. The Scottsdale Republican said it’s up to ADOR to identify the issues, and ADOR officials declined to comment specifically on what needs fixing.

Meanwhile, ATRA sent an email to lawmakers on Wednesday urging them to accept SB1460 as a means to avoid potentially dangerous litigation. Several pending lawsuits are challenging ADOR’s positions on what’s taxable and what’s not, and losing in court would be worse than resolving the issue legislatively.

If that convinces enough lawmakers to vote for SB1460, Fann said she’ll bring the bill to a vote on the Senate floor despite her own reservations. But for now, Fann said she’s not sure the support is there.

Democrats seem universally opposed, and it only takes a few skeptical Republicans to leave the bill shy of passage.

Even if the bill clears the Senate, Fann noted it faces an even stiffer test in the House, where one Republican can defect and leave Republicans one vote shy of passing legislation on party line votes.

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