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‘Netflix Tax’ Could Spread From Chicago as Cities Crave Revenue

June 19, 2020, 8:46 AM

Stung by revenue losses from the closure of movie theaters, concert halls, and stadiums during the Covid-19 pandemic, cities across Illinois are considering ways to capture tax dollars from streaming entertainment. The trend has implications for cash-strapped governments across America.

The city of Evanston recently joined its much larger southern neighbor, Chicago, expanding the reach of its amusement tax ordinance to take advantage of surging consumer demand for movies on Netflix, music on Spotify, and gaming on PlayStation Now.

Other cities could broaden their tax bases to online entertainment in the coming months to replenish coffers strangled by the public health crisis. The Illinois Municipal League is supporting the effort with a model ordinance.

States have been trying to figure out how to tax streaming services for years, and the issue is only getting more urgent as digital conversion grows. An analysis by the Urban-Brookings Tax Policy Center found 33 states tax online entertainment through their sales taxes, but the rest, including Illinois, have struggled to tax this emerging feature of the economy.

“Local governments in Illinois have been feeling financial stress for some time, and of course now it’s even worse,” said Carol Portman, president of the Taxpayers’ Federation of Illinois. “So it’s no wonder they’re looking for alternative revenue sources.”

Alex Thorpe, revenue manager for Evanston, said cities in “downstate Illinois” frequently conform to tax innovations developed in Chicago and its suburbs.

Evanston, which prides itself as a tax policy trendsetter, made several changes to its amusement tax on June 8. The city established a new 5% tax on streaming entertainment and a new tax rate of 7% on large events. Chicago and Evanston are the only jurisdictions in the country that tax electronically provided entertainment the same way they tax tickets for movies, concerts, and carnivals.

“I could see this picking up traction in a lot of Illinois communities,” Thorpe said. “They read the same publications we read, and they are waiting for the first domino, like Evanston, to fall. So after our tax clears in a couple of months I would imagine you’ll see some communities move it forward.”

‘Let the Lawsuits Begin’

Still, Illinois cities following Evanston’s lead could be placing themselves in legal jeopardy, said Stephen Kranz, a partner in the Washington office of McDermott Will & Emery LLP.

Kranz, who is representing tech giant Apple Inc. in a legal challenge to Chicago’s so-called Netflix tax, said Evanston’s law and the model pushed by the Illinois Municipal League suffer from “serious legal infirmity” under the commerce clause of the U.S. Constitution and the Internet Tax Freedom Act.

“Let the lawsuits begin,” Kranz told Bloomberg Tax.

Despite such warnings, towns and cities have been emboldened by an Illinois Supreme Court decision at the end of March declining to intervene in a constitutional challenge to Chicago’s Netflix tax, Thorpe and Portman said.

Legal Threat Gone

Users of Netflix, Hulu, and Spotify argued that Chicago’s Amusement Tax Ruling No. 5, a revenue program created in 2015 to impose the 9% amusement tax on streaming entertainment, should be voided because it treats taxpayers inconsistently. The plaintiffs called the tax an illegal and extraterritorial exercise of the city’s taxing authorities.

In October 2019 a unanimous three-judge appeals panel affirmed an earlier circuit court ruling, finding the tax program had no unconstitutional extraterritorial effect. The court also rejected alleged violations of the federal tax freedom act, which generally prohibits political jurisdictions from imposing discriminatory taxes on electronic commerce.

“In my view, some folks held back on this because the court case was still active and people wanted to see what the outcome would be,” Thorpe said.

Municipalities throughout the country are taking a keen interest in streaming entertainment taxes as the industry flourishes during the pandemic, said Toby Bargar, a senior consultant with the tax compliance company Avalara.

Some jurisdictions have applied their sales taxes to the sector, but that hasn’t been possible in states and cities that don’t tax services. In response, creative approaches have emerged by which existing tax structures are stretched over digitally delivered products and services, including Chicago’s Netflix tax, California’s public utility users tax, and Florida’s communications services tax.

“We are seeing local home-rule jurisdictions finding interpretations that fit this activity within existing broad definitions,” Bargar said. “That’s what Chicago did, that’s what some of the California home rules have done.”

To contact the reporter on this story: Michael J. Bologna in Chicago at mbologna@bloomberglaw.com

To contact the editors responsible for this story: Jeff Harrington at jharrington@bloombergtax.com; David Jolly at djolly@bloombergtax.com

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