Taxing Tech: Apple's Battle Against Texas Sales Tax
Austin, Tex. – Apple Inc. is suing the State of Texas, claiming the state’s sales tax on “data processing services” violates state and federal law. Apple is requesting a refund of ~$4.7 million and ~$747,000 in interest.
Texas says the federal law is unconstitutional as it violates the Tenth Amendment and that iCloud+ and iTunes Match are data processing services under state law.
Apple has filed lawsuits with similar claims against:
State of Maryland (seems to be ongoing)
Orleans Parish (Apple won this case; the ruling stated, in part, the ITFA preempts local law)
City of Chicago (settled, Apple will pay taxes)
The Facts:
Apple filed the lawsuit in August of 2020 after two years of unsuccessful appeals with the state Comptroller of Public Accounts (CPA), and lost a hearing with The State Office of Administrative Hearings (SOAH).
Apple argues the sales tax Texas imposes on iCloud+ and iTunes Match violates the Internet Tax Freedom Act (ITFA), which was first enacted in October of 1998 and amended six times since. The ITFA prevents states from imposing a tax on e-commerce transactions when the state does not also tax services/goods that is the same or similar to e-commerce. The ITFA grandfathered applicable taxes that were in effect before October 1, 1998; the grandfather clause ended on June 30, 2020.
The ITFA defines e-commerce as “any transaction conducted over the internet or through internet access.”
The ITFA defines “internet access” as:
"(5) Internet access. -The term 'Internet access'-
(A) means a service that enables users to connect to the Internet to access content, information, or other services offered over the Internet;
(B) includes the purchase, use or sale of telecommunications by a provider of a service described in subparagraph (A) to the extent such telecommunications are purchased, used or sold-
(i) to provide such service; or
(ii) to otherwise enable users to access content, information or other services offered over the Internet;
(C) includes services that are incidental to the provision of the service described in subparagraph (A) when furnished to users as part of such service, such as a home page, electronic mail and instant messaging (including voice- and video-capable electronic mail and instant messaging), video clips, and personal electronic storage capacity;
(D) does not include voice, audio or video programming, or other products and services (except services described in subparagraph (A), (B), (C), or (E)) that utilize Internet protocol or any successor protocol and for which there is a charge, regardless of whether such charge is separately stated or aggregated with the charge for services described in subparagraph (A), (B), (C), or (E); and
(E) includes a homepage, electronic mail and instant messaging (including voice- and video-capable electronic mail and instant messaging), video clips, and personal electronic storage capacity, that are provided independently or not packaged with Internet access.”
Apple stated the following in their lawsuit:
“If a user takes a picture with her iPhone, she can later access that picture on her iPad because of the iCloud service. iCloud's purpose and its value to an Apple customer is just that--being able to access your own personal content wherever you are on whatever device is in hand” and that “Apple's customers access iCloud and retrieve personal data through their own personal devices. Apple does not advertise or market iCloud as a data processing service. Instead, it presents iCloud as enabling users to access all their personal content on all of their devices.”
“iTunes Match is a service that allows Apple's customers access to all their music on more than one device, including songs purchased from other digital sellers or copied from physical media sources. When a customer subscribes to iTunes Match, software resident on the customer's device scans the device's storage and compiles a list of the songs stored on the device. iTunes Match then matches the listed songs on the device to songs in the iTunes catalog and makes those songs available on the customer's other devices that have iTunes Match enabled. Only when a song is unavailable in iTunes's 60-million-song catalog is it uploaded to and stored in the customer's iCloud account and made available on the customer's linked devices.”
“Both iCloud and iTunes Match provide services similar to offline, non-internet based services on which Texas does not impose limited sales, excise, and use taxes.”
“For example, Iron Mountain provides physical storage services that are similar to iCloud's personal content access service: they are available to the public and allow customers to store their physical property for a monthly fee that varies based on the amount of space needed. ln fact, customers of any number of personal self-storage facilities operating in Texas---including Extra Space, CubeSmart, and Public Storage---can rent storage units for a monthly charge with the amount of the monthly charge increasing with the size of the storage unit.”
“…ITFA further defines the term ‘Internet access’ to include ‘personal electronic storage capacity. . . provided independently or not packaged with internet access.’ ITFA § 1105(5)(E); see Pub. L. No. 110-108, § 4, 121 Stat. 1024 (2007).”
CPA referred the case to SOAH after Apple appealed CPA’s finding that iCloud+ and iTunes Match are taxable under Texas law on August 23, 2019.
“Data Processing Services” is not defined in the state statute, but the CPA has exclusive jurisdiction to interpret the enumerated taxable services listed in the statute, including data processing services. The CPA promulgated a rule that define the data processing services as “the processing of information for the purpose of compiling and producing records of transactions, maintaining information, and entering and retrieving information. It specifically includes word processing, payroll and business accounting, and computerized data and information storage or manipulation. The charge for data processing services is taxable regardless of the ownership of the computer…[d]ata processing does not include the use of a computer by a provider of other services when the computer is used to facilitate the performance of the service or the application of the knowledge of the physical sciences, accounting principles, and tax laws... [d]ata processing services does not include Internet access services or data processing services provided in conjunction with and incidental to the provision of Internet access service when billed as a single charge.”
Apple argued during the SOAH case that:
iCloud and iTunes Match services do not involve data processing because those services only store data and does not process the data, and is therefore not subject to data processing sales tax
A service would have to meet all three activities listed in the rule above (“processing of information for the purpose of compiling and producing records of transactions, maintaining information, and entering and retrieving information”) to be subject to the data sales tax
That the law only applied to technology that existed when the law was passed in 1987
The Administrative Law Judge (ALJ) that heard the SOAH case disagreed with those arguments, stating: “[Apple’s] assertions all raise novel contentions that are not supported by the plain meaning of the applicable statute or rule and have been directly and consistently contradicted by Comptroller precedent and policy… failed to prove, by a preponderance of the evidence, that the iCloud and iTunes Match services do not perform taxable data processing services” and that Apple “argued the essence of iCloud and iTunes Match services, what its customers were buying, was access to data, not data processing. The use of a computer to facilitate the movement and access to the data, [Apple] maintained, did not transform the services into taxable data processing. The ALJ disagrees. The services at issue functioned to upload, store, organize, and maintain digital data for access and download by customers. Using the services, [Apple] customers had the ability to store, organize, and access data on the customers' device(s) or download the data to the customers' device(s) for use or storage and backup. The essence of these functions, from the perspective of the customer, not only included data storage but data searching and compilation as well as processing information for the purpose of compiling and producing records, all data processing activities as outlined above. Considering the evidence in the record, the ALJ concludes that the essence of the iCloud and iTunes Match services was taxable data processing services….”
Apple also argued that the sales tax violated the ITFA ban on discriminatory taxes. The ALJ found the following: “[Apple’s] argument is founded on its payment of nontaxable fees to a storage company, Iron Mountain, for the physical storage of IBM cartridges containing customers' digital data. Therefore, Petitioner contends, [CPA] assessments of fees paid for iCloud and iTunes Match services, to the extent they include the storage of customer data, violate the ITFA and should be dismissed. The ALJ disagrees. As discussed above, the computerized storage of digital data is a taxable data processing service. The transmission and retrieval of the data through the internet is not determinative. For example, if [Apple’s] customers delivered their data to [CPA] on physical media and Petitioner backed up the data to its servers, the computerized data storage, without any use of the internet, would be considered a taxable data processing service. See STAR Document No. 200908438L (August 3, 2009) (the storage of physical tape media is not taxable unless performed as part of computerized data back-up, a data processing service). The ALJ concludes the ITFA prohibitions regarding discriminatory taxation are not applicable to the assessments of the fees charged for the iCloud and iTunes Match services….”
Texas argued in the resulting lawsuit that “Congress does not have the constitutional authority to issue direct orders to states,” citing the Supreme Court decision in Murphy v. National Collegiate Athletic Association.
Per the Congressional Research Service: “In Murphy, the Court held that a provision in the Professional and Amateur Sports Protection Act that made it “unlawful” for a state to authorize sports betting violated the Tenth Amendment’s anticommandeering doctrine. Some legal scholars expansively construe Murphy to extend the anti-commandeering doctrine to statutes like the ITFA that prohibit state legislatures from taking a specific action. Other legal scholars read Murphy narrowly—Murphy does not suggest that the anti-commandeering doctrine should be applied to invalidate a valid federal preemption provision under the Supremacy Clause. Thus, the doctrine might not invalidate a valid exercise of an enumerated power conferring a federal right on private actors to be free from a specific state law that conflicts with federal law. As applied to the ITFA, a court might view the ITFA as a valid exercise of the Commerce Clause that confers rights on private actors to be from specific state taxes interfering with interstate commerce.”
The lawsuit is ongoing.
