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Technology and Taxation: Keeping Up With the Tax Implications of the Fast-paced Changes in Telecommunications and the Internet
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For many years, federal, state and local governments have obtained significant revenues from taxes imposed on telecommunications services and telecommunications providers. Many telecom-related taxes are linked to specific technologies or regulatory definitions; sometimes they depend on the type of provider and/or pricing structure, rather than on the underlying functionalities that the services provide. As a result, small changes in any of these conditions can result in profound and often unanticipated tax and revenue increases or decreases. Because of the many subtle distinctions involved, attempts to adjust or reinterpret telecommunications taxes to mesh with current technologies and services can result in unintended consequences.
A case in point is the federal telecommunications excise tax imposed on local service and toll telephone service (i.e., long distance). In order to distinguish taxable “toll calls” from non-taxable services (such as private lines), the federal tax code defined “toll calls” as those whose prices were based upon call duration and distance. But as very high capacity fiber optics and digital switches replaced legacy transmission and switching technology, distance all but dropped out as a cost driver and, by the end of the 1990s, most long distance calls were priced solely on the basis of call duration. Several taxpayers challenged the applicability of the excise tax to toll calls once the “distance” element dropped out and, following several years of litigation, the IRS ultimately conceded...
However, by this time, many telcos were offering “all distance bundles” of local and long distance services for a single monthly charge. In a ruling effective August 1, 2006 (and retroactive, upon request, to March 1, 2003), the IRS determined that the excise tax should not be collected either on long distance service priced solely on a time-sensitive basis or on bundled service provided under a plan that does not separately state the charge for local service. However, the tax remains applicable to stand-alone local telephone service charges. This, of course, creates a distortion favoring bundled services and the providers capable of offering them.
Another example: Many states have historically applied franchise-type taxes to telephone companies based upon the book value of their plant-in-service (“rate base”). Prior to the break-up of the Bell System in 1984, that “rate base” included customer premises equipment. But when CPE was spun off and eventually sold off to customers, taxable plant values declined, and state and local tax revenues took a sudden – and unanticipated – hit.
More recently, with the substitution of DSL or other broadband Internet service for second residential phone lines that had previously been used for dial-up Internet access, the elimination of secondary (and some primary) residential lines in favor of wireless “family plan” packages, and the increasing use of Internet-based services (phone, e-mail, texting), there has been a significant decrease in the total number of residential wireline access lines in service. These demand shifts can have major tax consequences for state and local ad valorem property tax revenues. For example, many of these taxes are based upon the value of physical wireline infrastructure, but have not been applied to electromagnetic spectrum – a direct substitute for physical copper, coaxial cable, or fiber infrastructure. Hence, as wireless technology supplants traditional physical distribution and interoffice plant, the property tax base is diminished and the associated tax revenues fall.
Over time, advances in technology, changes in competitive conditions, and blurred lines between what is “telecom” and what is not have created increasing complexity for both those doing the taxing and those being taxed. “Telecommunications” is no longer a neatly or easily defined term, and what the FCC may define as “telecommunications” may or may not correspond to the manner in which taxing authorities view such services. A blurred understanding as to whether or not a service is “telecommunications” can lead taxing authorities to miss out on revenues or taxpayers to overpay.
Within the next several years, anticipated regulatory and market changes may result in opportunities or exposures in the taxation of telecom and related services. In particular, revenue shortfalls in state and local governments may engender reevaluations of tax policies that have, up until now, shielded Internet services and many Internet-based transactions from taxes that apply to other economic sectors. Among the issues that may arise are the following:
• Definitions contained in state laws and regulations may not mesh with the way that telecom services are provisioned or billed.
• Changes in industry structure may result in the shifting of revenues from one industry segment to another.
• Jurisdictional “sourcing” of calls, which has been an issue in the mobile telecommunications area, is also likely to be exacerbated with the expansion of Internet-based telecom.
• Traditional “utility” status of wireline telecommunications companies has conferred on them certain unique (and often advantageous) tax treatment. Will the bundling of traditional voice service with Internet and video services result in the reevaluation of such tax laws?
• There is ongoing uncertainty as to how far the Internet Tax Freedom Act extends into telecom and how federal policies will affect states’ ability to tax Internet-related activities.
• If the FCC reclassifies Internet access services as telecommunications (rather than “information services”), will there be a corresponding change in the tax treatment of these services?
• How long and on what basis will the moratorium on the application of sales tax to Internet purchases continue?
Legislatures and taxing authorities can make these transitions easier or harder, depending on how well they understand the underlying technical and market complexities and can capture them accurately in laws and regulations. Imprecise language in tax laws or regulations makes them more difficult to enforce and invites protracted and unnecessary litigation. It is also important that tax treatments not result in unintended distortions of economic decisions by favoring one particular technology or business model over others. Stakeholders (i.e., taxpayers and potential taxpayers) with a sound understanding of industry technologies and market conditions can help by identifying potential unintended consequences of proposed legislation or regulations before they are enacted.
Still, even when the language of tax laws and regulations is clear at the outset, enforcement and compliance may be complicated by new technologies or industry relationships not originally contemplated. Taxpayers that understand the interplay between existing tax laws and regulations and evolving technologies and market conditions are in a better position to avoid paying excess taxes on telecommunications and telecommunications-related activities.
If you would like more information on this subject, please contact Helen E. Golding.
Read the rest of Views and News, June 2010.
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About ETI. Founded in 1972, Economics and Technology, Inc. is a leading research and consulting firm specializing in telecommunications regulation and policy, litigation support, taxation, service procurement, and negotiation. ETI serves a wide range of telecom industry stakeholders in the US and abroad, including telecommunications carriers, attorneys and their clients, consumer advocates, state and local governments, regulatory agencies, and large corporate, institutional and government purchasers of telecom services. |
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