Rulings of the Tax Commissioner

Re: § 58.1-1821 Application: Retail Sales and Use Tax

Dear

This is in response to your letter in which you contest the Department's denial of a refund of sales and/or use tax paid by ***** (“Taxpayer 1”) and ***** (“Taxpayer 2”) (or collectively, the “Taxpayers”) for the period October 2005 through September 2008. I apologize for the delay in responding to your letter.

I understand that Taxpayer 2 also filed amended returns for the period October 2008 through December 2010. The Department's audit staff, however, has suspended its determination with respect to such returns pending the outcome in this case.

During the periods in question, the Taxpayers held use tax registrations allowing them to report and remit the sales and use tax to the Department. Taxpayer 1 operates an Internet backbone and provides wholesale dial-up and high-speed Internet access service to other Internet service providers. Taxpayer 2 leased equipment to Taxpayer 1 and collected the Virginia sales tax on such leases. Such collected sales tax was reported on Taxpayer 2's use tax returns.

As a result of an audit, Taxpayer 1 was assessed the sales and use tax on certain sales and purchases of tangible personal property. Taxpayer 2 was not similarly assessed. The Taxpayers submitted amended returns to the Department's auditor to claim a credit for the audited period and a refund for the periods subsequent to the audit, i.e., October 2008 through December 2010. After a careful review of such claims, the Department's auditor denied the exemption claims of the Taxpayers on the basis that Taxpayer 1 has not established that it sold Internet services to end-user subscribers and provided proprietary content, other content, electronic mail services and Internet access as a part of a package of services sold to end-user subscribers during the period in question.

The Taxpayers contest the denial of their tax refund claims and maintain that the tax paid on the equipment qualifies for exemption pursuant to Va. Code § 58.1-609.6 2. It is the Taxpayers' contention that certain operating equipment purchased by Taxpayer 2 and leased to Taxpayer 1 is used to provide Internet access services directly to end-user subscribers, as well as enable other companies to provide such services to their end-user subscribers.

Although Taxpayer 1 was assessed the sales and use tax on certain sales and purchases of tangible personal property, it appears that such assessment is not contested. Rather, the Taxpayers only contest the denied refund amounts.

Virginia Code § 58.1-609.6 2 provides an exemption from the retail sales and use tax for the following:

• • Broadcasting equipment and parts and accessories thereto and towers used or to be used by commercial radio and television companies, wired or land based wireless cable television systems, common carriers or video programmers using an open video system or other video platform provided by telephone common carriers, or concerns which are under the regulation and supervision of the Federal Communications Commission and amplification, transmission and distribution equipment used or to be used by wired or land based wireless cable television systems, or open video systems or other video systems provided by telephone common carriers. [Emphasis added.]

This statute was last amended in 1999 by the General Assembly to add a new exemption applicable to certain Internet service providers. Such amendment became effective on and after July 1, 1999, and defined many of the words and phrases set out in the above exemption with respect to the new exemption. (See the emphasized words and phrases above.] These definitions are set out in Va. Code § 58.1-602 as follows:

• • "Amplification, transmission and distribution equipment" is defined to mean, but is not limited to, production, distribution, and other equipment used to provide Internet-access services, such as computer and communications equipment and software used for storing, processing and retrieving end-user subscribers' requests;
  • "Internet' means collectively, the myriad of computer and telecommunications facilities, which comprise the interconnected worldwide network of computer networks;
  • "Internet service" is defined to mean a service that enables users to access proprietary and other content, information electronic mail, and the Internet as part of a package of services sold to end-user subscribers;
  • "Open video system" is defined to mean, an open video system authorized pursuant to 47 U.S.C. § 573 and, for purposes of this chapter only, shall also include Internet service...
  • "Video programmer" is defined to mean a person or entity that provides video programming to end-user subscribers; and
  • "Video programming" is defined to mean video and/or information programming provided by or generally considered comparable to programming provided by a cable operator including, but not limited to, Internet service. [Emphasis added.]

Scope of the Exemption

Rule of Strict Construction

The Taxpayers assert that the Department's interpretation of the statutory term "Internet service" is overly narrow. The Department's construction is consistent with the Supreme Court of Virginia's rules of strict construction mandated for exemption statutes. As such, the Department is required to apply a strict interpretation to all sales and use tax exemptions. That is, where there is any doubt as to the application of an exemption, the doubt is resolved against the one claiming the exemption. See Golden Skillet Corp. v. Commonwealth, 214 Va. 276, 199 S.E.2d 511 (1973).

Under the doctrine of strict construction, it has been the Department's longstanding interpretation that the Internet service equipment exemption is limited to certain tangible personal property used or to be used by eligible Internet service providers (ISPs) that provide Internet access, as well as certain other specific services to end-user subscribers. To be eligible for the exemption, an ISP must provide Internet access, as well as provide access to proprietary and other content and information electronic mail as part of a package of services that it sells to its end-user subscribers. This construction does limit the Internet service equipment exemption to a “retail” type of ISP, i.e., an ISP that sells Internet access services and provides access to proprietary information, other content and email services to end-user subscribers.

The basis for this construction rests upon the statutory phrases “end-user subscriber,” “Internet service,” and “part of a package of services sold to end-user subscribers.” The inclusion of these phrases in the exemption language combine to restrict the exemption to retail ISPs because wholesale ISPs, such as Taxpayer 1, sell or resell services to other ISPs but do not sell or resell services directly to end-user subscribers as required by the statute.

“In construing a statute, the whole body of the act must be examined with a view to arriving at the true intention of each part, and all of its parts must be considered so as to make it harmonious.” Rockingham Co-operative Farm Bureau, Inc. v. City of Harrisonburg, 171 Va. 339 (1938). The statutory construction of the Internet service equipment exemption is unusual in that the exemption is not readily recognizable by reading the exemption language set out in Va. Code § 58.1-609.6 2. Rather, the exemption is defined through terms set out in Va. Code § 58.1-602. All of these parts must be read together to gain a true understanding of the scope of the exemption. In this regard, it is worth noting that the phrase “end-user subscriber” is expressly stated in three of the six statutory definitions used to describe the exemption and is included in the key phrase “Internet service” used to describe the exemption in two other statutory definitions. The inclusion of the phrase “end-user subscriber” in the statutory definitions was intentional for the purpose of limiting the scope of the exemption to retail ISPs.

Furthermore, the General Assembly could have easily eliminated the “end-user subscriber” phrase from the statutory definitions used to describe the exemption but it did not. The exclusion of such phrase would have demonstrated an intent to apply the exemption to an ISP regardless of whether such ISP is engaged for retail or wholesale purposes.

The phrase “end-user subscriber” is not defined in the Virginia Retail Sales and Use Tax Act (the "Act") or in the applicable regulations. While a definition of the phrase “end-user subscriber” could not be found, there are common definitions for the terms “subscriber” and “end-user.” The term “subscriber” is the noun form of “subscribe,” which is defined as follows:

• • To sign one's name to in attestation, testimony, or consent . . . To pledge or contribute (a sum of money) . . . To promise to contribute money . . . To contract to receive and pay for a certain number of issues of a publication. Webster's II New College Dictionary, page 1099 (1995).

Based on this definition, a subscriber may be a person who consents to contribute money to receive something. Thus, the use of the term “subscriber” in the statutory phraseology is intended to demonstrate that the Internet service equipment exemption is limited to retail ISPs that actually offer the Internet services (as such term is defined in Va. Code § 58.1-602) to those persons that subscribe directly with an ISP and pay for and use such services. A wholesale ISP does business with other wholesale ISPs or with retail ISPs. As such, a wholesale ISP does not transact business directly with, or offer Internet services directly to, an end-user subscriber.

In regard to the term “end-user,” there is no definition for such term in the Act or regulations. In the online Merriam-Webster Dictionary (2012), an end user is defined as the “ultimate consumer of a finished product.” [www.merriam-webster.com/dictionary]

Based on these definitions, I would conclude that an end-user subscriber is the ultimate consumer who has contracted directly with a retail ISP to receive and pay for a subscription-based package of Internet services as described and set out in the cited exemption and applicable definitions.

Another part of the basis for the Department's construction of the exemption statute is the definition of “Internet service.” Such definition is instructive in that it demonstrates that the scope of the exemption is limited to those ISPs that sell access to proprietary information and other content, e-mail and the Internet to their end-user subscribers. There is no exemption available to others who do not satisfy these minimum criteria.

Construction of Amendments

“When new provisions are added to existing legislation by amendment, we presume that, in making such amendment, the legislature acted with full knowledge of and in reference to the existing law upon the same subject and the construction placed upon it by the courts.” Burke v. Commonwealth, 29 Va. App. 183, 188, 510 S.E.2d 743, 745-46 (1999) (internal quotation omitted). Virginia Code § 58.1-609.6 2 is one of the original exemptions from the sales and use tax. Courts have consistently applied the rule of strict construction to such exemption. For instance, in Winchester TV Cable Co. v. State Tax Commissioner, 216 Va. 286, 217 S.E.2d 885 (1975), the court denied the exemption to a cable company because it did not broadcast signals into the air. The court's determination was based on the application of the rule of strict construction of the exemption statute. It was not until the broadcasting exemption was subsequently amended that the exemption would be applicable to cable television systems. Also see WTAR Radio-TV Corp. v. Commonwealth, 217 Va. 877, 234 S.E.2d 245 (1977). Accordingly, when the Internet service equipment exemption was added to amend such statute, the legislature is presumed to have known that strict construction rules apply.

The latest amendment to the broadcasting exemption was in 1999 when it was amended to provide the exemption to certain ISPs. Based on the facts set out in the section below [i.e., “Internet Tax Freedom Act (“ITFA”)”], it was never the intent of the legislature to provide an exemption that paralleled the federal definition of “Internet access.” Rather, by not being as broadly worded as the federal definition, the “Internet service” definition is applicable only to a small group of businesses. Furthermore, the inclusion of “end-user subscriber” further restricts the application of the exemption to providers that sell services to end-user subscribers.

Internet Tax Freedom Act ("ITFA")

The Taxpayers contend that the Virginia statutory term “Internet service” is broadly defined by the term “Internet access” in §1104(5) of the ITFA.¹ In 1998, the ITFA defined the term “Internet access” to mean “a service that enables users to access content, information, electronic mail, or other services offered over the Internet, and may also include access to proprietary content, information, and other services as part of a package of services offered to users. Such term does not include telecommunications services.” [Emphasis added.]

In the appeal, the Taxpayers make a distinction between the first part of ITFA's “Internet access” definition and the second part of such definition. In regard to the first part of the “Internet access” definition, the Taxpayers indicate that it is applicable to wholesale dial-up Internet access, while the Taxpayers indicate that the last part of such defined term is applicable to retail Internet access as generally provided by online service providers.² I do not disagree with the Taxpayers' distinction.

Notwithstanding, a distinction must also be noted between the Virginia statutory term “Internet service” and the federal ITFA term “Internet access.” The term “Internet service” is not broadly defined as is the term “Internet access.” Rather, the term “Internet service” is a narrower term because the ISP is required to provide access to proprietary information and other content and e-mail. Moreover, a strict construction of the statutory exemption language is controlling because of the mandates set out in the Virginia Constitution and by the strict construction rules of the Supreme Court of Virginia. The ITFA term “Internet access” does not require a user's access to proprietary information and other content, e-mail and the Internet as a part of a package of services sold to end-user subscribers. The term “Internet service” does have this requirement.

Subscribers' Paid Access

The Internet service equipment exemption does not extend to computer equipment and other tangible personal property used to provide “free” access to Internet services. Rather, the exemption is applicable to such equipment when used to provide “paid” access to proprietary information and other content, e-mail and the Internet when such services are sold to the ISP's end-user subscribers.

The Taxpayers also appear to claim that the Internet service equipment exemption should extend to all ISPs. The Taxpayer makes reference to a report ³of the Federal Communications Commission (FCC). On page 12 of that report, it indicates that “Internet service providers (ISPs), such as . . . America Online, connect . . . end users to Internet backbone networks. Backbone providers . . . route traffic between ISPs, and interconnect with other backbone providers.” On the same page of the FCC report, the Taxpayer cites that “[b]ackbone providers typically also serve as ISPs; for example, MCI offers dial-up and dedicated Internet access to end users, but also connects other ISPs to its nationwide backbone.” From footnote 14 of the FCC report, the Taxpayer further cites that "[d]edicated Internet service providers, which offer a connection to the Internet but no proprietary content, are distinguished from online service providers (such as America Online) that provide access to proprietary content and also allow their users to access the Internet . . . . For purposes of this paper, all of these providers are labeled as “ISPs,” because all of them, as a component of their service, connect end users to the Internet."

While an ISP and a backbone provider, as defined by the FCC report, connect end-users to the Internet, the Internet service equipment exemption requires more than a connection to the Internet. Rather, such exemption requires the sale of Internet services to end-user subscribers. Such sales are the hallmark of retail ISPs or online service providers as noted by the FCC report.

The Taxpayers also reference a declaratory ruling of the FCC. In re Inquiry Concerning High-Speed Access to Internet Over Cable and Other Facilities, 17 F.C.C.R. 4798, 4821, 17 FCC Rcd. 4798, 4821, GN Docket No. 00-185, 2002 WL 407567, (March 15, 2002), the Taxpayers cite the following:

• • In the Universal Service Report, the Commission found that Internet access service is appropriately classified as an information service, because the provider offers a single, integrated service, Internet access, to the subscriber. The service combines computer processing, information provision, and computer interactivity with data transport, enabling end users to run a variety of applications. In the Universal Service Report, the Commission concluded that “Internet access providers do not offer subscribers separate services - electronic mail, Web browsing, and others - that should be deemed to have separate legal status.” [Footnotes omitted.]

Based on this reference, the Taxpayers maintain that “Internet access service” refers to a service that always and necessarily combines computer processing, information provision, and computer interactivity with data transport to enable end-users to run a variety of applications such as email and access web pages and newsgroups. If I understand the Taxpayers' point correctly, the contention is that the Taxpayers are entitled to the Internet service equipment exemption despite the fact that Taxpayer 1 does not sell any Internet services directly to end-user subscribers. The statutory definition of “Internet service” is indicative of a direct commerce link required between a retail ISP and the end-user subscriber. Without such link, it would not be necessary to include the phrase “a package of services sold to end-user subscribers” within the definition of “Internet service.” A retail ISP (regardless of whether a cable television operator, telephone common carrier or video programmer) must provide access to proprietary content and other content, e-mail and the Internet and must sell such services to end-user subscribers in order to satisfy the commerce criteria of the exemption. Only when the commerce criteria of the exemption are satisfied will certain equipment used to provide the Internet services qualify for exemption.

Office of Attorney General (OAG) Opinion

In OAG Opinion 00-005 (3/15/00), the Attorney General opined in regard to the Internet service equipment exemption that “the definitions and exemption are sufficiently broad to include both the entity using equipment to provide Internet access service directly to end users and the entity using equipment to enable other entities to provide such service to end users.”[Emphasis added.] The opinion further states that “[a]lthough tax exemptions generally are to be narrowly construed, it is [the OAG's] view that the language defining the terms in § 58.1-602 generally reflects that the General Assembly intended a broad, rather than restrictive, application of the term “amplification, transmission and distribution equipment.” [Insert and emphasis added.] The opinion concludes that “the sales and use tax exemption in § 58.1­609.6(2) is applicable to both equipment used in providing Internet access service directly to end users and to equipment used to enable other companies to provide Internet access service to end users.”

Thus, the construction applied in the OAG Opinion 00-005 conflicts with the Department's construction of the exemption. See Public Document (P.D.) 00-18 (3/17/00), P.D. 01-29 (3/29/01), and P.D. 04-89 (8/31/04) issued by the Department. To resolve this conflict, we look to the Supreme Court of Virginia, which has long held that “[w]hen a tax statute is susceptible of two constructions, one granting an exemption and the other not granting it, courts adopt the construction which denies the exemption.” Commonwealth v. Community Motor Bus Co., 214 Va. 155, 198 S.E.2d 619 (1973). Thus, the Department in following the guidance of the Supreme Court of Virginia adopts the construction that correctly denies the exemption to wholesale ISPs. As stated in P.D. 04-89, the Department does not acquiesce in or follow OAG Opinion 00-005.

While the OAG opinion asserts there is an ambiguity in the exemption language that allows for a broad construction of the exemption, it is my belief that the exemption language is clear and the strict construction rule is required. A strict construction of the exemption language would recognize that the inclusion of the term “end-user subscribers” and the phrase “a package of services sold to end-user subscribers” in the definitions for the exemption serve to limit the application of the exemption to retail ISPs.

Cisco Systems, Inc. et al v. Thorson Tax Commissioner

The Taxpayers contend that there is no distinction in Va. Code § 58.1-609.6 2 and the terms that define the exemption as set out in Va. Code § 58.1-602 that specifies who is entitled to the exemption. Rather, the Taxpayers assert that the statute only states what is exempt based on how it is used. The Taxpayers rely upon the court's opinion in Cisco Systems, Inc. et al v. Thorson Tax Commissioner, At Law No. 219609, Va. Cir. Ct., Fairfax Cty (August 17, 2005) as support for its contention. The Department does not acquiesce in or abide by the Cisco decision except where it must, i.e., in Fairfax County, Virginia. The Department has declined to apply the circuit court's interpretation on a statewide basis because the Virginia Supreme Court has not reviewed the issue and issued an opinion addressing the scope of the Internet service provider exemption.

Since the inception of the exemption, the Department has made clear that the exemption is only intended for retail ISPs. This position is based on the application of long­standing rules of strict construction as set out by the Supreme Court of Virginia. Such strict construction rules have a constitutional foundation.

The Internet service equipment exemption does not extend to all ISPs. As the Taxpayers have noted, there is a clear difference between dedicated Internet service providers, which offer a connection to the Internet but no proprietary content, and on-line service providers that provide access to proprietary content and also allow their users to access the Internet. For purposes of the Internet service equipment exemption, an on-line service provider is eligible for the exemption when it provides access to proprietary information and other content, e-mail and the Internet as a part of a package of services that the online service provider sells to its end-user subscribers. The facts presented, however, do not establish that Taxpayer 1 provides and sells such Internet services to end-user subscribers as required by the exemption statute. Because the exemption does not apply to wholesale ISPs, Taxpayer 1 is not eligible for the Internet service equipment exemption. Accordingly, the Taxpayers' request for refund is denied.

The Code of Virginia sections, public documents and the OAG opinion cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department's web site. If you have any questions about this determination, you may contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, at *****.

• • • • • • • • Sincerely,

Craig M. Burns
Tax Commissioner



AR/1-5095537418.R

1. P.L. 105-277, §1104(5) – October 21, 1998.
2.The first part is “a service that enables users to access content, information, electronic mail, or other services offered over the Internet. . . .” The second part is “may also include access to proprietary content, information, and other services as part of a package of services offered to users. Such term does not include telecommunications services.”
3.K. Werbach, 29 Digital Tornado: The Internet and Telecommunications Policy, Federal Communications OPP Working Paper Series, page 12 (March 1997).