Assistant Professor, University of Nebraska-Lincoln College of Law
The new Pokémon Go app has already generated many discussions regarding the multiple ways that the game intersects with the law. I’ve previously opined on some of the broader issues, but, as a tax professor, my thoughts have naturally focused on that topic. Fortunately, the Surly Subgroup was nice enough to let me present those thoughts here in a guest post.
The tax issues that I’ve been thinking about stem largely from the fact that Pokémon Go is built on a freemium business model. That is, the app is free, but users can pay for certain “premium” features like additional Pokéballs, incense, and lure modules. (If these phrases mean nothing to you, here is a nice primer on the game.) Those purchases are all done through the purchase and use of an in-app currency called Pokécoins. The whole thing might sound silly, but the app is already generating over $1.5 million in daily revenue for its developer, Niantic, Inc. The company will also soon be selling “sponsored partnerships” that allow companies to be listed more prominently in the game. The potential revenue streams look plentiful at this point. So what are the tax issues?
State Tax-Base Issues
The first issue that came to my mind as a state and local guy is how purchases of Pokécoins would be taxed under states’ sales taxes. Those purchases represent consumption, of course, but states are woefully inconsistent regarding whether and how they’ve extended their sales taxes to include purchases of digital items. Even where states have done so, the treatment of Pokécoins raises some interesting questions. Digital versions of tangible objects like movies or books are often addressed in state statutes or guidance, but Pokécoins that can be used to purchase “limited, nontransferable, non-sublicenseable, revocable license[s]” to use in-app upgrades are very different. There is no physical-world analogy that applies quite as neatly. Determining the taxability of these purchases might require a deep dig into a state’s guidance.
If Pokécoins are taxable under state law, the next question is where they are taxable. Would Nebraska tax all of my Pokécoins simply because my billing address is in the state? What if I purchase and use Pokécoins in Colorado while on vacation?
The difficulty of the statutory issues might be potentially limited, in the short term, by existing limitations on states’ authority to require gaming developers to collect their taxes. The Supreme Court currently requires that a vendor have a physical presence in a state before that state can require the vendor to collect its sales taxes. Niantic presumably has a very small physical footprint, and it thus likely doesn’t care about the nuances of states’ guidance on sales of digital property.
This doesn’t mean that the statutory issues don’t matter, of course. They certainly do. For one thing, the Court’s physical-presence rule is facing significant challenge, and its future is uncertain. As I’ve previously written, it is unclear whether and how any change will occur, but if the physical presence rule were overturned, app developers might have to deal with expanded sales tax collection obligations in the future. That might not be a problem for apps as successful as Pokémon Go, but could present a real problem for smaller apps and developers.
I would be remiss if I didn’t also mention that the applicability of states’ laws to digital property also matters for those few of us who worry about paying use tax. I purchased some Pokécoins—for research purposes, of course—and I was not charged sales tax, so I might be the first to self-remit Pokémon Go use tax.
State Income Taxes
State courts have largely rejected the application of the physical-presence rule to taxes other than consumption taxes, and the Supreme Court has yet to intervene in any of those cases. Niantic could thus face state income-tax obligations in states where its users are located regardless of its own physical presence. This will depend on states’ nexus and sourcing rules, but there is a liability potential. No word on whether states are planning to pursue this, but they theoretically could do so.
Data as Currency
In a forthcoming article, I explore the relationship between tax, privacy, and the use of data as a currency in today’s economy. In the article, I focus specifically on services like Google and Facebook, but applications like Pokémon Go present a similar situation. I conclude that the best way to view the provision of these digital products in exchange for consumer data is as a new form of barter transaction. Now, to be clear, I don’t think that we will see these barters being taxed (at least directly), but we should recognize that the failure to do so creates a tax preference for the use of data as a currency. That tax preference benefits companies in this space and is in tension with other regulatory attempts to protect personal privacy. If we are really concerned with the data that these companies collect, eliminating that tax preference might make sense.
In sum, even if you don’t have the inclination to “catch ‘em all,” Pokémon Go and similar digital games raise many tax issues. Some states are already discussing new taxes on digital downloads and those proposed taxes have already been labeled as Pokémon taxes. We will undoubtedly hear more about this in the near future.