Sales, Use and International Tax Activity Update - July 2009

Cell Phone Provider Learns “Nothing is Free” When it Comes to Washington Use Tax

A taxpayer that provided cell phones to customers free of charge in order to promote the sale of wireless service plans was found to be taxable and the phones were subject to use tax. The taxpayer, Activate, sold cellular telephone equipment and wireless service plans in Washington at shopping mall kiosks. Activate served as a representative for AT&T Mobility (AT&T) and ran promotions that allowed retail customers to purchase a cellular phone at a substantial or full discount, provided the customer agreed to purchase one of AT&T’s wireless calling plans.

During the period in question, Activate purchased cellular phones from its suppliers and manufacturers in Oregon; however, it did not pay Washington sales tax on its purchases of the phones. Activate charged and collected sales tax when customers purchased enhanced or upgraded phones, but did not charge tax on the phones it gave away free of charge to customers. Upon audit, the DOR assessed use tax on those phones that were given away free. Activate appealed the assessment, which was upheld by the DOR and then filed a refund claim which was denied by the County Superior Court. Activate then appealed the decision to the Court of Appeals.

Activate first argued that it qualified for the resale exemption because it purchased the cellular phones for resale in the regular course of business. However, Activate did not sell the phones at issue for money to the retail customer; it gave them away for free. Activate contended that despite the fact that no money was exchanged in the transaction, the inherent value of the transaction was the executed AT&T service agreement that was sold along with the cellular telephone. However at trial, Activate failed to cite authority in support of its contention that consideration need not come directly from the retail customer or that a customer’s promise to enter into a service agreement with a third party meets the statutory definition of “valuable consideration” under RCW 82.04.040(1). In addition, the DOR stated, and the court agreed, that Activate made intervening use of the phones before they were resold and therefore the phones could not be purchased for resale. There was intervening use before the phones were sold because Activate withdrew the cellular phones from its warehouse or distribution center in Oregon, transferred the phones to its kiosks in Washington, and used the phones in promotional marketing in order to attract business. The court held that actual use or consumption of the goods was not required to find that “use” had occurred for tax purposes.

Finally Activate did not qualify for the competitive telephone service exemption. Even though the phones qualified as eligible telecommunications equipment or apparatus as defined under the definition of “competitive telephone service” in RCW 82.04.065(1), the statute required that a separate charge must be made for these telephones in order for this exemption to apply. A separate charge was not made, because the phones were given away for free.

Activate failed to qualify under the resale exemption and the competitive telephone service exemption. The Court found in favor of the DOR.

(Activate, Inc. v. Washington Department of Revenue, Washington Court of Appeals, Division II, No. 37329-7-II, 6/16/2009)

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