Video-Streaming Companies See the “Netflix Tax” Going into Effect Around the Country to the Dismay of “Cord Cutters”

by Butler Snow LLP
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If you are like many other Americans, then you may have “cut your Cable TV cord” and turned to streaming movies and shows through your accounts with Netflix, Amazon Prime, Hulu, HBO GO, SlingTV, or other video streaming tech companies. However, many “House of Cards” and “Orange is the New Black” lovers across the country will likely have to pay a tax before they log in to their Netflix account.

This tax, called a “Netflix Tax” in popular culture, is often promulgated under existing amusement taxes, sales taxes, and utility taxes. The Netflix Tax is an effort by cities and states across the country to capture some of the revenue lost when cord cutters flock to tech companies that provide video-streaming services. America’s largest cities were taking in an average of $6.12 in monthly taxes and fees at an average tax rate of 11.69 percent. Chicago, for example, was taking in $3.75 in monthly taxes and fees with a tax rate of 7.16 percent per cable subscriber. While every cable subscriber has not cut the cord, the rate of attrition is picking up for the pay-TV industry and cities and states are losing revenue.

Chicago was one of the first cities to implement a Netflix Tax. On June 9, 2015, the City of Chicago’s Finance Department extended the city’s 9 percent amusement tax to cover not only the services provided by Netflix, Hulu, and the like, but also to audio and music streaming services such as Spotify and to gaming services like Xbox Live. The amusement tax was previously applied to sales on sporting events and concerts. The new tax, higher than the city’s cable services tax, is expected to generate $12 million annually.

Pennsylvania was one of the first states to adopt a Netflix Tax. As of August 1, 2016, Pennsylvania cord cutters will have to pay a Netflix Tax under a series of new taxes extended to digital downloads and video streaming services like Netflix and Hulu. The Pennsylvania Netflix Tax is triggered when a customer uses an account with a Pennsylvania billing address. The tax applies to music, e-books, apps, online games, and ringtones, but excludes magazine subscriptions, newspaper subscriptions, and digital versions of the Bible.

In early 2015, Southern cord cutters watched as Alabama Department of Revenue officials briefly advocated for extending Ala. Code § 40-12-220 to the rental of digital media products, including Netflix subscriptions. The Alabama Legislative Council, a body made up of representatives from both the Alabama House and Senate, signaled its disapproval of the proposed Netflix Tax.

Pasadena, California may be the newest city to adopt a Netflix Tax. City officials recently released memos addressing a potential adoption of a “video services” tax in January 2017 under Pasadena’s utility user tax. The utility tax is defined as a “tax collected for the City based on a percentage of electric and water charges,” but city officials have ruled that the city could tax video streaming services at the same rate as cable services through a new interpretation of the tax. This ruling states that the utility user tax applies to “video programming” regardless of the technology used to deliver such programming.

It would allow the city to tax Netflix at a rate of 9.4 percent, which would add almost $1 per month to a standard Netflix subscription.

According to the Los Angeles Times, there are about forty-five other California cities with utility tax codes that might allow for a Netflix Tax, including Sacramento, Culver City, Glendale, and Santa Monica, with rates ranging from 1 percent to 11 percent of the bill.

Other states, such as Idaho, also are contemplating a Netflix Tax.

Internet advocacy groups and cord cutters question the legality of these measures.

On September 9, 2015, Chicago Illinois residents filed suit for declaratory and injunctive relief against the City of Chicago. The Chicago cord cutters argue that the Chicago Finance Department violated the federal Internet Tax Freedom Act, 47 U.S.C. § 151 note, enacted just last year in 2015, by requiring cord cutters to pay more for Amazon Prime, Netflix, Hulu, and Xbox Live. These cord cutters argue that the Chicago Netflix Tax treats streaming services differently than DVD-by-mail services and imposes a higher rate than live forms of entertainment.

The Internet Tax Freedom Act provides that no state or political subdivision of a state may impose taxes on internet access or multiple or discriminatory taxes on electronic commerce.

The Act defines a discriminatory tax to include:

1) taxes that are not generally imposed and legally collectible by a State or a political subdivision on transactions involving similar property, goods, services, or information accomplished through other means;

2) taxes that are not generally imposed and legally collectible at the same rate by such State or such political subdivision on transactions involving similar property, goods, services, or information accomplished through other means, unless the rate is lower as part of a phase-out of the tax over not more than a 5-year period; or

3) taxes that  impose an obligation to collect or pay the tax on a different person or entity than in the case of transactions involving similar property, goods, services, or information accomplished through other means.

Whether these Netflix Taxes are considered discriminatory taxes under the Internet Tax Freedom Act will likely be an issue tech companies will need to keep an eye on.

Analysts estimate that the pay-TV industry lost 566,000 subscriptions from April to June 2015. This trend continued into 2016, with 812,000 subscribers leaving their pay-TV services in the second quarter alone.

As cord cutters continue to subscribe to their services, video streaming tech companies will need to be aware of Netflix Taxes veiled in existing utility, sales, and even amusement taxes. Tech companies and their growing constituency will likely continue to encounter these kinds of taxes until sales tax laws and regulations are updated or enacted to reflect the ever-changing landscape of commercial internet law.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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