(Editor’s Note: Jonathan S. Marashlian is the head of the regulatory practice of Helein & Marashlian (News - Alert), LLC, The CommLaw Group. He counsels clients engaged in the IP-enabled communications industry in all aspects of state and federal regulatory and telecommunications tax compliance matters. This is part two of a three-part series on Voice over Internet protocol, or “VoIP” provider compliance with taxation and regulatory fees. This installment focuses on taxes and fees imposed on VoIP service.)
It is not uncommon for many providers to mistakenly equate regulatory fees, like the FCC’s (News - Alert) Universal Service Fund fee, to a tax. Much of the confusion arises because people talk about USF and Internet taxes interchangeably, as if the two are one and the same. However, there are important distinctions between regulatory fees and taxes. One of the most notable differences is that the vast majority of regulatory fees are owed by the regulated carrier, whereas taxes are owed by the ultimate retail consumer.
The distinction between fees and taxes can get blurry because the billing & collection processes for both are similar, if not identical; carriers “pass through” regulatory fees and they “collect” taxes, but the process for both is the same. Carriers are permitted to pass through regulatory charges to consumers, and carriers are legally obligated to act as the billing and collection agents for state taxes. Not only do regulatory fees and communications taxes share commonalities in billing, they also share a similar enforcement regime – which is referred to as “supply chain enforcement.” The importance and implications of supply chain enforcement are discussed below.
Historically, the Internet has been considered a “tax-free” zone. But as the Internet and Internet-facilitated commerce has developed during the past decade, the concept of a “tax-free” zone is becoming a historical relic. The Internet Tax Freedom Act, as amended, does still place a moratorium on the taxation of Internet access at the state and local level and protects e-commerce from sales tax for out-of-state transactions. The Internet Tax Freedom Act’s moratorium has been extended until 2014. As applied to VoIP communications services, at most, the moratorium would arguably prohibit the taxation of the Internet Access component of the VoIP service, but it does not cover the communication service itself. Furthermore, the Internet Tax Freedom Act has not prevented the FCC from using its “ancillary” Title I jurisdiction to assess regulatory fee contribution requirements in support of federal programs on I-VoIP providers (claiming that the “public interest” so requires), nor has it stopped the Universal Service Administrative Company and the FCC from imposing supply chain enforcement on IP-in-the-Middle providers.
There are no federal taxes on VoIP communications services. A number of states, however, do impose taxes on VoIP services, such as general sales, use and excise taxes. In addition, states have been increasingly interpreting their tax statutes to extend the application of tax obligations specific to the telecommunications industry to VoIP service providers (i.e., state communications taxes).
In order for a business entity to be subject to taxation by a state or local government, the Due Process and Commerce Clause provisions of the U.S. Constitution require that a business maintain certain minimal contacts or a presence in the taxing jurisdiction. State and federal jurisprudence has helped to identify and clarify the many activities which can create the jurisdictional right to tax, referred to as “nexus.”
Different states have developed different interpretations of what types of business activities constitute sufficient nexus to impose their tax obligations on out-of-state businesses. The states’ determination of sufficient nexus is an extremely fact-driven analysis and, even within the same state, seemingly similar business activities can result in dramatically different tax obligations.
Although most states apply some sort of tax burden to VoIP services, there remains significant ambiguity because many state statutes and related regulatory provisions fail to spell out how VoIP services will be treated for tax purposes. Notable exceptions are Illinois and New Jersey, whose general tax statutes specifically encompass VoIP, and Louisiana and New York, whose tax laws have recently been interpreted by the state’s tax collection agencies to encompass VoIP.
The way state and local governments define “taxable telecommunications” is central to how they tax VoIP. These definitions can be broad and do not necessarily follow the definitions of “telecommunications” used by the FCC or state public utility commissions. For example, state and local tax definitions of telecommunications often include transmission of voice and data regardless of media or protocol.
Because many state taxation authorities are applying tax obligations to VoIP services by simply reinterpreting the existing language of their tax statutes and regulations to include VoIP services within their definition of telecommunications, some states, such as New York (see below), are applying these additional tax burdens on VoIP providers retroactively, arguing that the applicable state statutory definitions have always encompassed VoIP services and providers should have been paying taxes on such services all along, even in the absence of any regulatory guidance or clarification on the issue.
The states have not been reluctant to impose general fund and communications-related transaction taxes on I-VoIP providers. The ability of states and localities to impose such taxes usually turns upon:
1. the existence of a nexus between the I-VoIP provider and the state;
2. the precise definition of “telecommunications” or “telephone service” in the state’s tax laws and regulations; and
3. whether taxable services are bundled with non-taxable services.
Complications in State Taxation
While general fund and telecommunications-related taxes may have been infrequently applied to VoIP services in their infancy, in light of increasing budget shortfalls resulting from the current recession, many states are increasingly resorting to vigorous enforcement of tax mandates against VoIP service providers as part of their efforts to find new sources of revenue. As traditional telecommunications industry services are already heavily taxed, state treasury departments must seek alternative means to refill their depleted coffers. This desperation, however, can lead, in some cases, to questionable application of existing statutes, as many of these interpretations derive from state departments of taxation, rather than directly from legislative mandates.
The applicability of a state telecommunications tax to VoIP services is further complicated by the broad range of specific services offered within the VoIP category. VoIP includes a wide variety of IP-based services, such as peer-to-peer voice communication, private intra-company voice communication, calls originating or terminating on the PSTN but incorporating IP-based transmission, and calls between an IP-based telephone and a PSTN user. Traditionally, regulators have limited basic telephony to services connected to the PSTN. Thus, the extent to which an IP-based service is integrated with the PSTN may play a role in the classification of the service for tax purposes.
Likewise, service providers often bundle the basic telephony component of VoIP with Internet Access and enhanced features, such as directory assistance, call forwarding and voice-to-email or fax messaging functionality, making classification of the service for tax purposes even more complicated. It is unclear, under many existing state laws, whether a bundled VoIP-based service is, or should qualify, as a taxable telecommunications service. Further, treatment of taxable and non-taxable goods and services bundled together itself can be a challenge because states do not have a uniform policy regarding the taxation of bundled goods and services.
The various standards used by states to deal with bundled products include “true object” tests, de minimis tests, “primary object” tests and “essence of the transaction” tests. As a result, the same bundled service offering can result in vastly different tax obligations depending on the taxing jurisdiction.
One mechanism states are using to collect taxes on VoIP services is to pressure those providers at the top of the supply chain, the “Tier One Providers,” to either pay state taxes on VoIP and other IP enabled services or to require that their customers provide sufficient proof that they, themselves, are both registered with the states and are paying applicable taxes. As a result, this pressure is now trickling down from the Tier One Providers to the IP-in-the-Middle/platform providers and down the line to the ultimate retailer. However, in contrast to the federal USF requirements, where providers are only faced with reporting and contribution requirements from one entity, supply chain enforcement of state taxation involves navigating and complying with the requirements and tax schemes of potentially fifty-one different jurisdictions, which share little to no uniformity amongst their applicable tax laws.
In order to better position themselves for tax purposes, many Tier One Providers now offer separate and distinct packages for origination and termination services. To avoid exposure to audits and adverse findings from state taxation authorities, many Tier One Providers are taking the initiative and classifying certain aspects of their services, namely enhanced origination services, as enhanced intrastate service for tax purposes. Most of these providers are already registered in every state and have nexus with such states, so their willingness to classify aspects of their service offerings as intrastate poses no real adverse compliance obligations on them – particularly since these providers pass state and local taxes onto their customers.
In determining how to classify their own services, wholesale provider customers of Tier One Providers (IP in the Middle/Platform Providers) have little choice but to follow the dictates of their underlying carriers. In other words, these wholesale Platform Providers are increasingly unable to structure and classify their services to best suit their needs or the needs of their customers because the Tier One Providers have already dictated the path that must be followed. Thus, the Tier One Providers are often dictating the business models and product offerings of their downstream wholesale customers.
This evolving landscape is not without consequences for the downstream customers. First, should the FCC disagree with a Tier One Provider’s determination that its enhanced origination services are intrastate and not subject to federal USF obligations, downstream providers are likely to feel the effect of such adverse finding in the form of pass throughs. In addition, to the extent that platform and retail providers’ federal USF reporting obligations likewise are impacted by the practices of Tier One Providers and by resulting FCC and USAC findings, these providers could face adverse action for past reporting deficiencies.
Second, these downstream providers, particularly the Platform Providers, face a Hobson’s choice of either agreeing to the pass throughs imposed by the Tier One Providers or facing potentially astronomical costs related to supply-side enforcement. For strict application, the supply-side enforcement mechanisms would require companies that have no nexus with the states to potentially register and create nexus, for the sole purpose of providing exemption certifications to their underlying carriers. Because of the ubiquitous nature of IP-enabled communications, for many providers, this could involve registration in almost every state.
Finally, under this scenario, downstream providers are exposed to the risk of double taxation in jurisdictions that do not recognize or allow for deductions for amounts such providers have paid in the form of pass throughs to their upstream carriers. Moreover, this scheme permits the indirect taxation of providers, through pass-throughs, whose ultimate service may not actually be taxable.
Federal Regulatory Fees
While the federal government does not impose taxes on VoIP services, it does impose an alphabet soup of regulatory fees on providers, including USF, TRS, NANP and LNP support, and annual fees. Each of these support mechanisms are FCC creations that are administered by USAC. To collect federal regulatory fees, the government also turns to a variety of billing and collection agents, such as the National Exchange Carrier Association and Neustar.
State Regulatory Fees
In addition to the federal regulatory regime, some states also apply regulatory fees on VoIP services – particularly on companies that provide “fixed VoIP” services, like those typically offered by the facilities-based broadband providers such as cable companies and Verizon (News - Alert) FIOS. In addition, there are quite a few states that are seeking to impose regulatory fees on nomadic, over-the-top VoIP, though their road has been much tougher in light of FCC and court pronouncements questioning whether states’ regulatory authority can be extended to such services. Note, however, that a state’s authority to tax such services, as distinct from imposing regulatory requirements and obligations, has faced little challenge.
One area in which states have not had much difficulty extending their regulatory reach is 911 fees. But the way in which the states exercise such authority is not cut and dry.
Some states impose 911 fees the same way taxes apply. And like taxes, 911 fees are payable to each city, county and municipality within the state.
Some states impose 911 as a regulatory fee.
In one state, Vermont, 911 support is funded by the same pool of carrier contributions earmarked for state universal service.
See below for a look at the states that can impose 911 surcharges.
States often delegate the right to collect 911 to the local authorities that collect the surcharges and administer local 911 funds.
Some states roll their 911 fund obligations into other fees such as state USF. Determining whether 911 charges will apply to a particular VoIP service provider requires a detailed state-by-state analysis.
Because many jurisdictions do not consistently enforce their regulatory obligations, a company that handles compliance in-house may not be aware of compliance obligations that are not being currently enforced. These companies can be in for a nasty surprise when a jurisdiction begins to enforce its obligations, especially if it is in the context of a notice asking whether the company has or has not been paying 911 support fees in the past.
Jonathan S. Marashlian is the head of the regulatory practice of Helein & Marashlian, LLC, The CommLaw Group. To read more of his articles, please visit please visit his columnist page.
Edited by Michael Dinan