Texas Rules That Online Game is Subject to Sales Tax

September 27, 2019

A recent Texas decision imposing sales tax on charges for online games highlights the difficulty of applying old sales tax provisions to new services as well as the importance of responding to requests for information issued by a state taxing authority.

By Kristen Davis, SALT Associate

The growth in online gaming has exploded over the last few years, and while many of these games are free to play, some do cost money. Therefore, providers of online games must determine whether the charge for the game is subject to sales tax.  On June 17, 2019, the Texas Comptroller of Public Accounts (Comptroller) issued a Comptroller’s Decision, in which it determined that the taxpayer was required to collect sales tax on charges for its online game.[1]

The taxpayer in that case was a Virginia corporation that “develops and maintains web properties that provide an interactive social gaming experience for registered users.”  The Comptroller, having determined that the taxpayer had at least one employee in the state, requested that a nexus questionnaire be completed. The taxpayer failed to respond, causing the Comptroller to issue an assessment, to which the taxpayer appealed.

The first issue addressed was whether the taxpayer had nexus, and it was determined that nexus existed due to the fact that the taxpayer had at least one employee working in the state. When a business has employees working in a state, this typically creates physical presence nexus and obligates the business to collect and remit sales/use tax.[2]

The Comptroller next addressed whether the service is considered taxable. Texas sales tax is imposed on, among other things, “amusement services” that are defined to include “participatory games” and “games of skill.”[3]  Therefore, the Comptroller determined that the taxpayer’s online gaming experience qualified as amusement services.  The taxpayer argued that Texas sales tax did not apply because the services were provided at its headquarters located outside Texas.  The Comptroller disagreed, noting that Texas rules are clear that sales tax applies where the amusement service is delivered, not from where it originated.

Finally, the taxpayer requested that the Comptroller exercise its discretionary authority to waive penalties.  In determining a penalty waiver, the Comptroller looks to many factors that address whether the taxpayer exercises reasonable discretion to comply with the tax laws.  These include the taxpayer’s audit history, the sophistication of the taxpayer, changes in law or policy, and reliance on advice from the state. In this case, the Comptroller did not waive the penalty in large part due to the fact that the taxpayer failed to respond to the Comptroller’s initial nexus questionnaire.

This case demonstrates how sales tax laws and regulations, most of which were drafted before the growth of technology-related services, are being applied in today’s technology-rich environment.  For example, the “participatory games” section of the regulation defining amusement services lists over 15 examples, such as bowling, billiards, and miniature golf, and the “games of skill” example is under the heading “fairs or carnivals” and actually reads “games of skill, at a circus, carnival, etc.”  The regulation does make clear that these are just examples of amusement services by stating that “Amusement services and places that offer amusement services include, but are not limited to, the following.”  Nonetheless, a technology business could easily overlook the possibility that its service could be viewed as taxable based on that regulation.

Another point worth nothing about this decision is that you should not ignore requests for information issued by a state taxing authority.  Even if you suspect that you don’t have nexus or don’t have any exposure with the state, it is important to speak to your tax advisor about your situation and get assistance with drafting a response.  Failure to do so will likely result in a tax assessment[4] and be the reason that the state does not waive penalties.

Aprio’s SALT team understands how to analyze sales tax rules and their potential application to technology-driven services in order to provide our best professional judgment on taxability.  That way, your business can operate knowing that it is in compliance with state sales tax obligations and should not incur unexpected tax liabilities and penalties.  We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Kristen Davis, SALT associate, at kristen.davis@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the September 2019 SALT Newsletter.

[1] Texas Document No. 201907010H, CPA Hearing No. 114,493 (June 17, 2019).

[2] It is worth noting that the years at issue in this decision predate the Wayfair decision.  However, even post-Wayfair, the presence of an employee in the state would create nexus since the Wayfair decision does not eliminate nexus due to physical presence, it just adds that nexus may also exist due to economic presence.

[3] See Texas Tax Code §§ 151.0101(a)(1) and 151.0028; 34 Tex. Admin. Code § 3.298(a)(1)(D) and (a)(1)(E)(iv).

[4] Procedurally, it is much more difficult to get an assessment reduced or dismissed than it is to work with the state prior to the issuance of an assessment.

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

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