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  • February 6, 2023
  • By Toby Bargar Senior Communications Tax Strategist at Avalara
  • Blog

Compliance Challenges On The Horizon: How The Rise of Ad-Based Streaming Will Lead To New Tax Obligations

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With streaming viewership surpassing cable TV for the first time in July 2022, giants like Netflix, Hulu, and Prime Video have been able to kick back and reap revenues from a growing collective of cord-cutters. However, the growth rate for subscription-based streaming services has been slowing over the past few quarters.

One of the biggest reasons for this change is that fewer people are stuck at home binge-watching shows, leading to falling subscriber revenue. This consumer shift has been discussed for a while, but what’s been less clear is how this change could affect government collection of communications taxes on streaming services.

Free and cheaper services mean shrinking tax revenues for jurisdictions already struggling to keep up with the shift from cable to streaming — and states looking to recoup their losses have to follow the dollars. As the landscape shifts, policymakers will turn to ad-supported streaming as an additional source of revenue.

Examining the shifting landscape

Tax revenue from cable television service providers has been a consistent and reliable source of revenue for government coffers throughout the past few decades. But most streaming services are offered “over-the-top” of a customer’s internet connection, which alters taxability and poses new questions about the difference with the various taxes and fees associated with cable.

Utility taxes, regulatory, and franchise fees associated with pay-TV are often imposed on the basis of public policy rationales around the physical cable lines using public rights of way and traditional communications infrastructure to reach customers. But most streaming providers can avoid directly using any of this infrastructure and sidestep traditional taxes and fees.

States and local jurisdictions are still adjusting to the way streaming services have cut into tax revenues, but they’re not sitting idle. Tax authorities are going back to the drawing board, which likely will create new uncertainty and complexity for all of the streaming industry stakeholders.

Governments are plowing ahead

Many states and local jurisdictions are using laws already in place to gain revenue from streaming providers, while others are pioneering new policies. The state of Florida is using its definition of pay TV to assert that streaming services are subject to state and local communications taxes, which were historically collected from phone and cable companies. The city of Chicago uses its amusement tax to collect 9% of subscribers' fees for paid television programming. And most recently, a number of municipalities across the country, including in Texas, have filed lawsuits claiming that streaming companies should be subject to cable franchise fees.

Maryland is an example of a state crafting new policy to adapt to the growth in streaming services. In 2021, the Maryland legislature overrode a veto from Governor Larry Hogan to enact a digital advertising gross revenues tax, with revenue meant to education reforms in The Old Line State. The law applies to “persons with global annual gross revenues equal to or greater than $100,000,000 who must pay a tax on the portion of those revenues derived from digital advertising services in the state of Maryland.”

In October 2022, a judge in Maryland struck down the tax, saying it violates the U.S. Constitution’s prohibition on state interference with interstate commerce and discriminates against certain companies. But the fight isn’t over. This May, the Maryland Supreme Court will consider whether the state’s tax on digital advertising is a constitutional violation. The rest of the country will be watching closely, as the result could have a ripple effect across states.

Just a few weeks ago, lawmakers in Connecticut introduced legislation that would establish a tax on annual gross revenues derived from digital advertising services for any business with annual revenues above $10 billion. The proposal, which if enacted would take effect on October 1, would impose a 10% tax on annual gross digital advertising revenue of any business with annual gross revenue above $10 billion.

Staying ahead of streaming tax complexities

As taxing jurisdictions start to catch up with these shifts, streaming content providers will need to be prepared to meet new requirements as they emerge. It’s incumbent upon finance, tax, and compliance departments to keep up with changes in every jurisdiction where streaming services are sold. For most of the major players in the industry, this means thousands of jurisdictions across the country. Missing just one new ruling at the federal, state, county, or local levels could result in costly overpayments or audits and fees.

Because each governing body takes its own approach to streaming taxes, the requirements can vary greatly from one jurisdiction to another. This is one area where it pays to be cautious and take the time to thoroughly document your decisions to back them up in the event of an audit.

Providers also need to ensure the solutions they use — whether they’re existing platforms or new services — are equipped to handle the many nuances of specialized streaming taxes. Communications taxation is much more involved than sales and use tax, and getting it right requires frequent updates. Using the right automation software today can help businesses with continued compliance no matter how often the landscape shifts.

While it can be easy for companies to get caught up in the influx of widespread streaming adoption and increased revenue, shifting tides of the industry means it’s also important to keep tax liabilities top of mind. Streaming taxes are evolving in real-time, and companies will be facing a whole new world of complex communications and specialized streaming taxes — a trend that will continue to accelerate over the next year.

Toby Bargar is a senior communications tax strategist at Avalara. As part of Avalara’s Communications business unit, he has spent years assisting clients with complex transaction tax issues, particularly in the field of communications tax and regulatory cost surcharges.

[Editor's note: This is a contributed article from Avalara. Streaming Media accepts vendor bylines based solely on their value to our readers.]

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