Internet Transactions Unlikely Public Finance Source

New Jersey Law Journal  October 29, 2015  

By Jonathan Bick Bick is of counsel at Brach Eichler in Roseland. He is also an adjunct professor at Pace and Rutgers law schools, and the author of "101 Things You Need to Know About Internet Law" (Random House 2000).

Public finance law allows governments to collect revenue, normally in the form of taxes, from those who benefit from public goods and services, and to use those funds for the production and distribution of public goods and services. Two major focuses of public finance law are bond financing and public disclosures; these are associated with virtually every industry in the United States coupled with public financing. State departments of taxation regularly assess people who have failed to pay excise tax, or sales and use tax on Internet purchases, and are starting to assess Internet transactions.

In June, the city of Chicago's Finance Department issued a ruling extending the city's 9 percent Amusement Tax to cover Internet-based streaming video services such as Netflix. At that time it also started to tax Internet-based streaming audio and music services such as Spotify, and Internet-based gaming services like Xbox Live.

Typically, a state Department of Local Government Finance is responsible for ensuring tax assessment and local government budgeting are carried out in accordance with state law. These departments are charged with publishing property tax assessment rules and annually reviewing and approving the tax rates and levies of every political subdivision in the state, including all counties, cities, towns, townships, school corporations, libraries and other entities with tax levy authority. The courts have limited the application of taxes to the extent specifically allowed by the statute.

Taxation is one of two ways local governments raise revenue, the other is borrowing. A tax is a financial charge imposed on an entity by a governmental agency due to legislative authority. There are various types of taxes; the most significant include excise tax (tax levied on production for sale, or sale of a certain good), sales tax (tax on business transactions, especially the sale of goods and services), income taxes and property taxes.

The city of Chicago's Finance Department cited authorization based on the Chicago Amusement Tax (Municipal Code Reference: 4-156). A brief review of the tax statute in question suggests that owners, managers, operators of amusements or places where amusements are conducted collect tax from patrons for witnessing or participating in amusements, and resellers of tickets collect tax on the markup if they paid tax on the face value when they purchased the tickets. Some exemptions apply: certain live cultural performances; also certain amusements sponsored by religious, charitable and not-for-profit organizations for fund-raising purposes, for example. This lawsuit challenges that ruling for exceeding the finance department's authority, and as a violation of the federal Internet Tax Freedom Act, 47 U.S.C. §151 (2015).

However, in this case, arguing pre-emption due to the Internet Tax Freedom Act may not be necessary. The underlying technical elements of the Internet in general, and specific requirements of the Amusement Tax in particular, seem to demonstrate the inapplicability of local taxes to Internet transactions.

First, consider the nature of the transaction, namely, streaming services. Streaming services are software programs that allow content to be constantly received by and presented to an end-user, while being delivered by a provider, rather than downloaded and then viewed. Streaming services are not amusements, rather potential conduits for amusements. Thus, the streaming services owners, managers, and operators do not own, manage or operate amusements as required for taxation by the Chicago Amusement Tax statute. Rather, they own, manage or operate software which in conjunction with Internet service providers allows content (such as movie) owners to communicate with Internet users.

The ruling states that streaming service providers that receive charges for electronically delivered amusements are considered owners or operators. Despite the fact that "the medium is the message"—a phrase coined by Marshall McLuhan, meaning that the form of a medium embeds itself in the message, creating a symbiotic relationship by which the medium influences how the message is perceived—the courts have repudiated the application of this concept to Internet service providers since the enactment of Section 230 of the Communications Decency Act of 1996 (47 U.S.C. §230(c)(1)). That section provides immunity from liability for providers and users of an "interactive computer service" that publishes information provided by others. In short, it indicates that no provider or user of an interactive computer service shall be treated as the publisher or speaker of any information provided by another information content provider.

Next consider what constitutes an "amusement" for tax purposes. The Chicago Municipal Code divides the activities subject to its Amusement Tax into three categories: (1) any exhibition, performance, presentation or show for entertainment purposes, including, but not limited to, any theatrical, dramatic, musical or spectacular performance, promotional show, motion picture show, flower, poultry or animal show, animal act, circus, rodeo, athletic contest, sport, game or similar exhibition such as boxing, wrestling, skating, dancing, swimming, racing, or riding on animals or vehicles, baseball, basketball, softball, football, tennis, golf, hockey, track and field games, bowling or billiard or pool games; (2) any entertainment or recreational activity offered for public participation or on a membership or other basis including, but not limited to, carnivals, amusement park rides and games, bowling, billiards and pool games, dancing, tennis, racquetball, swimming, weight-lifting, bodybuilding or similar activities; or (3) any paid television programming, whether transmitted by wire, cable, fiber optics, laser, microwave, radio, satellite or similar means.

The streaming service providers do not own, manage or operate said amusements, rather they provide telecommunication, broadcasting or publishing services. None of these services constitutes amusements, according to the Chicago Municipal Code.

The third consideration is whether the streaming service providers, managers and/or operators of places of amusement were conducting their business in a location that is subject to Chicago local taxation. The Chicago Municipal Code identifies what constitutes a place where amusements are conducted for tax purposes and hence subject to local taxation. Due to the protocols of Internet communication, it is difficult to argue from a technical perspective that streaming service providers actually own, manage or operate said places where amusements take place. Alternatively, it is equally difficult to show that Internet technology results in said places within the taxing jurisdiction of Chicago. Similarly, it is unlikely to demonstrate that Internet streaming services are resellers of tickets and hence covered by the Chicago statute in question.

Generally, local municipal codes do not authorize local officials such as the comptroller, in the case of Chicago, to impose new taxes that the government legislatures (such as the City Council, in the case of Chicago) have not authorized through statute. The administrative officials may not use rule-making power to adopt a rule that is inconsistent with or exceeds the specific language in the ordinance.

Rules that are inconsistent with the ordinance under which they are adopted are invalid. In the matter of the Chicago Amusement Tax, the statutory definition of "amusement" does not include video services streamed from the Internet and provided to a customer on a computer, mobile device or other electronic device. Nor does the ordinance's imposition of a tax on amusements "within the city" authorize a tax on video services streamed from the Internet, which may be provided anywhere, simply because the end user's billing address in the city of Chicago.

The Chicago Amusement Tax matter is an example of a local administrative official exceeding the authority granted under the ordinance by issuing a rule that imposes a new tax that the appropriate legislative body did not authorize. Thus, while the Internet Tax Freedom Act, which provides that no state or political subdivision of a state may impose multiple or discriminatory taxes on electronic commerce, may be a basis for pre-empting the implementation of the application of the Chicago Amusement Tax, it may not be necessary.