Online educational content is exempt from North Carolina sales tax

The evolution of sales tax on digital goods and services in North Carolina hit a new milestone on June 5, 2020, when a measure exempting digital educational content from North Carolina sales tax was signed into law.

HB 1079 was introduced shortly after Governor Roy Cooper announced public schools would remain closed through the end of the school year due to the coronavirus (COVID-19), and it sailed through the legislature. As in many states, remote learning is now the only option for public school students in North Carolina. 

An educational service is not taxable digital property

The bill clarifies that, as of the effective date of the bill (June 5, 2020, unless otherwise noted) “an educational service” is not “certain digital property” subject to North Carolina sales tax.

It reads: “The delivery of instruction or training, whether provided in real time, on demand, or at another set time, by or on behalf of a qualifying educational entity,” is not a taxable service provided at least one of the following conditions applies:

• The instruction or training is part of the curriculum for an enrolled student;
• The instruction or training is encompassed within the institution’s accreditation or prepares an enrolled student for gainful employment in a recognized occupation;
• The participant is evaluated by an instructor (does not include being graded, scored, or evaluated by a computer program or interactive, automated method); or
• The participant is connected to the presenter or instructor via the internet or other networks, allowing the participant to provide, receive, or discuss information through live presentation, contemporaneous with the presentation.

The measure defines “qualifying educational entity” as an elementary school, secondary school, or institution of higher education as defined by the United States Code. It also clarifies that sales of a digital audio work or digital audiovisual work to the operator of a home school are exempt from retail sales and use tax, provided the sale is a qualifying education expense.

Finally, HB 1079 states that electronic sales of a digital audio work or digital audiovisual work consisting of “nontaxable service content” are exempt, provided the transfer occurs “contemporaneously with the provision of the nontaxable service in real time."

Clarification needed even prior to COVID-19

While the mandatory distance learning created by COVID-19 may have been the catalyst for HB 1079, the need to clarify the state’s tax policy on digital products and services predates the pandemic.

North Carolina’s first foray into taxing digital property (e.g., electronic books and magazines, audio works, and audiovisual works) was tied to the physical world. Digital property with a taxable tangible counterpart was subject to retail sales and use tax; digital property with an exempt tangible corollary was exempt.

It made sense. The problem, of course, is that not all digital property necessarily has a tangible counterpart. For example, learning materials sold in conjunction with an online course often have no physical counterparts.

Realizing this policy “created confusion,” the North Carolina Legislature removed the phrase “would be taxable … if sold in a tangible medium” from the sales tax code last year. As of October 1, 2019, certain digital property is subject to North Carolina sales tax even if it has no “tangible corollary.”

While helpful, this didn’t eliminate all confusion. Representatives of the University of North Carolina wondered if the school’s online classes (either live-streamed or pre-recorded videos) should be taxed. Were they exempt educational services? Or taxable digital sales?

HB 1079 provides the answer. Online educational services meeting the above conditions are exempt.

Grace period for certain continuing education and professional development providers

Effective retroactively to October 1, 2019, the North Carolina Department of Revenue shall not assess sales and use tax on retail sales of digital audio or digital audiovisual works that consist of either:

• Continuing education instruction approved by an occupational licensing board; or
• Professional development instruction for school board members, administrators, or staff.

Additional details are provided in the text of HB 1079.

Will other states follow North Carolina’s lead?

Given the uptick in online education triggered by COVID-19, other states could reevaluate or clarify how their sales and use tax laws apply to distance learning. While educational services are exempt in most states, the digital products and services used to teach online may not be.

Learn more about the impact of COVID-19 on virtual education and events.