Tax Cybrary

Telecommunications Tax
Tax Implications of the Telecommunications Act of 1996

The Telecommunications Act of 1996 calls up some pretty significant taxation issues for telecomm providers. There are lots of new questions, lots of new challenges -- keeping in compliance the most important.

Note: The following document is approximately 8 printed pages. You may want to print it for future reference.

The Telecommunications Act does not modify current methods of taxation, nor does it create any new taxes. It also does little to alter the rights of states and local jurisdictions to apply their own taxes. However, by opening the doors to new competition and allowing existing companies to enter new areas of the industry, the bill will amplify many of the issues that have faced telecommunications companies for many years.Among the taxation issues that telecommunications providers must deal with in everyday business are:

• Keeping up-to-date on tax rules and rate changes.
• Determining which calls and services are subject to tax collection.
• Determining which state and local authorities have jurisdiction over the call or service.
• Calculating the tax due and accurately billing customers.
• Filing tax returns and making appropriate payments to tax jurisdictions.

As new companies and services enter the telecommunications industry, applying existing tax laws and regulations will become increasingly complex. Specifically, the Telecommunications Act of 1996 presents all players in the industry with both long- and short-term challenges regarding the taxation of telecommunications services. In the long term, both the telecommunications industry and state and local governments must work together to develop new tax strategies appropriate for current and future technologies and business environments.

For the short term, telecommunications providers must learn to deal with the myriad of federal, state and local jurisdictions that impose taxes on the services they provide. This article deals with short-term challenges that face both existing service providers and newcomers to the industry.

The Current State of Taxation

Consumers pay about $120 billion each year for local and long distance telephone service. Of that amount, about $50 billion goes to local telephone companies and $70 billion to long distance carriers. The long distance carriers, in turn pay approximately $30 billion each year back to local providers in access fees.

With such large amounts of money spent each year on telecommunications services, it is not surprising that states and local jurisdictions have come to view the industry as a growing source of revenue. Consequently, many states are responding to deregulation of the industry by implementing more aggressive audit procedures to track and enforce compliance.

Several states (including Texas, Florida and Connecticut) have kept pace with current technology- and provide clear guidelines on what types of services are subject to taxation. Others, such as Kentucky, have been less progressive and simply group telecommunications services with other utilities. These states generally provide little specific guidance on the taxes that apply to specific services and carriers. Finally-. another group of states are in the midst of revising their current tax regulations to catch up with technology.

As one of the states with progressive tax regulations that are appropriate for current technology, Texas clearly defines what services may be taxed. Some examples of telecommunications ser-vices that are subject to both state and local taxation in Texas are:

• Basic local exchange service
• Installation and service connection fees
• Interstate long-distance telephone calls
• Call Waiting
• Call forwarding
• Internet access
• Paging services
• Mobile telephone services
• Fax services

State, county, city and transit district sales tax rates may be applied to telecommunications services in Texas. However, local taxes apply only when they are specifically approved by the governing body of each jurisdiction. As a result, within the state of Texas, there may be dozens of different local tax scenarios that providers must know and understand to be in compliance.

In addition to the taxes imposed by state and local jurisdictions in Texas, telecommunications companies subject to the state's Public Utilities Commission are also subject to the state's "Utility Gross Receipts Assessment." This tax, if passed on to the consumer, must be itemized on each customer's invoice. Two surcharges are also imposed on a state level: a tax to fund 911 emergency service and a Poison Control surcharge.

Finally, Texas imposes an additional tax called the "Telecommunications Infrastructure Fund Assessment." For the fiscal year that began September 1, 1995. and continuing until August 31, 2004, the state will collect $150 million annually from local exchange and interexchange carriers, as well as commercial mobile service providers. The tax rate for each company is determined using a ratio of the taxable communications receipts reported by each company to the taxable receipts reported by the telecommunications industry as a whole. Each telecommunications provider is required to pay the tax in quarterly installments.

By examining taxation in Texas, it is easy to see how difficult it can be to comply with tax regulations in just one state. Telecommunications companies that operate in more than one state will find similar, or even more difficult, situations in other states.

New Services Bring New Questions

As long distance carriers move to provide local service, local service companies begin to offer long distance, and others such as cable or video service industries enter the telecommunications marketplace, the question of which provider is subject to taxation will become more difficult to answer.

For example, will long-distance service providers who begin to offer local service be subject to the same taxes? When local providers offer long-distance services, how will that affect their tax situations?

To help answer those questions, states have used the concept of nexus to determine who is subject to taxation.By applying three criteria to every telephone call, states are able to determine who has tax jurisdiction over the call The three criteria are:

• Where the call originates.
• Where the call terminates.
• Where the service address is that the call is charged to.

Courts have held that whenever two of these three criteria occur in a single state, the call is subject to that state's tax regulations. For example, if a caller in Pennsylvania calls a person in Illinois and the call is charged to a service address located in Illinois, than the call is subject to Illinois taxes. If the call is charged to a service address in a third state, the call may not be taxable in any state.

By applying this test, states can be sure that any call they tax is not being taxed by another state. In 1989 the United States Supreme Court (Goldberg et. Al. V. Sweet, Director, Illinois Department of Revenue, et. Al.) upheld an Illinois law saying that by taxing only calls that meet two of three criteria, there would be no possibility of two states taxing the same telephone call. The Illinois law recognizes that recent technology has created situations where a single telephone call could take one of millions of paths to reach its destination.

Electronic Commerce Provides New Challenges

The concept of nexus has also been applied to the collection of sales tax for mail-order retailers who accept orders via the telephone. Sales taxes are usually collected when the retailer has a physical presence in the same state as the buyer.

With the growth of technology and deregulation, both companies and consumers are anticipating more business activity on the Internet. Many of the companies at the forefront of electronic commerce are retail and catalog companies. The growing use of telecommunications as a commerce medium has important implications for them.

For example, if a retailer in Ohio sells products to a consumer in Arizona, there would normally be no sales tax collected because the seller does not have a physical presence in the same state as the buyer. However, if the same buyer orders products through the Internet and uses an Internet Service Provider (ISP) based in Arizona some regulators may contend that the ISP provides a physical presence for the retailer and sales tax should be charged. To date, there has been no conclusive resolution of this issue, although the Direct Marketing Association is working to encourage states to apply the same tax concepts to electronic commerce as to phone and mail order sales.

The Challenge of Mixed Services

Wired and wireless telecommunications services are taxed differently in many jurisdictions. When mixed technologies are used to complete a single telephone call, the call may be taxed at a flat rate. As deregulation allows different carriers to provide the different services that go into completing a single call, it is not clear how that flat rate will be apportioned.

At the same time, new services made possible by the Telecommunications Act - such as telecommunications and Internet access offered by cable operators, video services offered by telecommunications services, and electronic commerce over the Internet- present new tax implications and challenges. Companies that have never had to calculate, collect and remit telecommunications taxes will be forced to do so as they enter the industry. Others, such as cable operators who offer telephone service, will have to collect one tax for the cable television services they provide, and another for the telecommunications services they offer.

With more than 5,600 different state and local taxes levied on telecommunications in the United States, it is virtually impossible for all but the largest providers to track accurately the regulations and changes that occur. Yet, it is the responsibility of service providers to obtain reliable tax data, collect and remit taxes accurately, and remit tax receipts to these state and local tax authorities.

The states themselves generally offer little help. Most states have not kept up with current technology, nor do they have enough employees who are knowledgeable about the telecommunications industry and taxation. One option for companies, however, is using tax compliance software, which can provide up-to-date information on tax regulations, calculate taxes accurately, and provide the reports that are needed to file accurate tax returns.

Based on where the call started, where it terminated, and the service address of the customer, the software determines the proper taxing jurisdiction for the call. Then the tax software searches its database of tax rates and calculates the tax that should be collected. Equally important is the database itself. A research staff must track the changes in tax regulation and regularly update the database.

In addition to the accurate calculations provided by the software, a dedicated research staff must track changes in tax regulations and update the database files on a regular basis. Thus, users can be sure they are receiving accurate tax calculations that are based on up-to-date information.

In the long-term, the industry may see state and local jurisdictions revise and update existing regulations to bring themselves more aligned with current technology and business environments. However. the Telecommunications Act of 1996 will not have a significant short-term impact on the tax structure of the telecommunications industry. As a result, it will be up to service providers in the telecommunications industry to ensure that they are in full compliance with existing taxation laws and regulations.

This article first appeared in the August 1996 edition of Billing World

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