August 26, 2016
Re: § 58.1-1821 Application: Retail Sales and Use Tax
Dear *****:
This is in response to your letter submitted on behalf of ***** and other related entities (collectively, the “Taxpayers”), in which you appeal the contested portion of the retail sales and use tax assessments issued to the Taxpayers as a result of an audit for the periods September 2008 through September 2011 and November 2010 through September 2011. The denial of certain offsetting adjustments and the associated refund request are also appealed. The non-contested sales tax portion of the audit has been paid. I apologize for the delay in responding to your appeal.
FACTS
According to Form 10-K reports filed with the United States Securities and Exchange Commission for the periods in question, the Taxpayers provided landline and cellular telephone services and sold wireline and wireless Internet access and other communication services to residential and retail business end-users, as well as to wholesale communication carriers. For the reception of wireless Internet services, end-users used handsets or cell phones. An audit resulted in the assessments of consumer use tax on equipment used in the provision of wireless Internet access and network services.
The Department's auditor held that the Internet service exemption codified under Va. Code § 58.1-609.6(2) is not applicable to the Taxpayers on the basis that this exemption does not extend to wireless Internet services. The Taxpayers disagree and maintain that the contested equipment qualifies for the exemption.
A refund is also requested for tax erroneously paid on equipment that the Taxpayers contend is used to provide “wireless” Internet services.
DETERMINATION
Burden of Proof
Virginia Code § 58.1-205 provides that “[a]ny assessment of a tax by the Department shall be deemed prima facie correct.” The Department has consistently interpreted this provision to mean that the burden of proof is upon a taxpayer to establish a correction to an assessment.
Statutory Construction
The courts have long established that exemptions from the retail sales and use tax are subject to the rule of strict construction. When a tax statute is susceptible of two constructions, one granting an exemption and the other not granting it, the courts adopt the construction that denies the exemption. See Commonwealth v. Community Motor Bus, 214 Va. 155,198 S.E.2d 619 (1973).
Wireline versus Wireless
Virginia Code § 58.1-609.6 (2) provides an exemption from the retail sales and use tax for:
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.]
The emphasized terms or phrases are defined in Va. Code § 58.1-602 to make it clear that an exemption is available for certain Internet service providers (ISPs). Although the terms “Internet services,” “Internet,” and “video programming” do not appear in the text of the above cited exemption, these terms are defined in Va. Code § 58.1-602 to further clarify the extent of the ISP exemption. Together, these definitions specifically create a limited exemption for certain ISPs as follows:
“Amplification, transmission and distribution equipment” means, 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 world-wide network of computer networks.
“Internet service” means 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. [Emphasis added.]
“Open video system” means an open video system authorized pursuant to 47 U.S.C. § 573 and, for purposes of this chapter only, shall also include Internet service regardless of whether the provider of such service is also a telephone common carrier. [Emphasis added.]
“Video programmer” means a person or entity that provides video programming to end-user subscribers.
“Video programming” means 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.]
The Department has consistently interpreted the above cited ISP exemption as applicable only to a retail ISP, such as those providers who sell Internet services directly to end-user subscribers. Such interpretation is based on the terms and phrases emphasized above. Examples of the Department's consistent interpretation are set out in Public Documents (P.D.) 00-18 (3/17/00), 01-29 (3/29/01), 08-133 (7/30/08), 10-12 (2/9/10), 13-179 (10/11/13), and 14-92 (6/16/14). These documents also demonstrate the Department's consistent denial of the exemption for equipment used in connection with the provision of wholesale Internet services, such as when an ISP sells Internet services to communication carriers who purchase such services for resale to their end-user subscribers or for resale to other carriers.
Notwithstanding the Department's interpretation and its correct application of the strict construction rule adopted by the courts for interpreting an exemption, the Circuit Court for Fairfax County, Virginia in Cisco Systems et al v. Thorson Tax Commissioner, at Law Number 219609 (8/17/05), ruled that the ISP exemption is applicable to both retail and wholesale ISPs that offer Internet services as defined in Va. Code § 58.1-602. The Department, however, 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 ISP exemption. The Department, however, has issued P.D. 13-179, which explains the basis for limiting the ISP exemption to retail ISPs who satisfy all of the criteria of the Internet service definition.
The Taxpayers indicate that they provide a service that enables users to access proprietary content and other content, information electronic mail, and the Internet as a package of services. When the Taxpayers sell Internet services to their end-user subscribers, I find that such services are provided at retail and the equipment used in the provision of such services would generally qualify for the exemption. However, when the Taxpayers sell Internet services to communication carriers who purchase such services for resale to their end-user subscribers, I find that such services are provided on a wholesale basis and the equipment used in the provision of such services would DM generally qualify for the exemption.
Based on the above discussion, I find no reason to conclude that the exemption is not applicable to wireless Internet services. The statutory language does not impose a wireline restriction on open video services. Accordingly, the Taxpayers are eligible for the ISP exemption with respect to the provision of wireless and wireline retail Internet services. Furthermore, I find that the Taxpayers are engaged as video programmers as defined in the statute because the video and/or information programming provided via cell phones or handsets by the Taxpayers is comparable to programming provided by a cable operator. However, the provision of wireless personal communication services (PCS) via pagers would not be comparable to programming provided by a cable operator and thus, would not be entitled to the ISP exemption.
Tax Proration
Based on the foregoing, the Taxpayers do not completely satisfy the statutory definition of “Internet service” because they sell their services to end-user subscribers as well as to communication carriers. While some of the equipment at issue may be used to provide Internet access services only to end-user subscribers that have contracted directly with the Taxpayers to receive such services, it may be that some of the equipment at issue was used to provide such services to both end-user subscribers and communication carriers. Such dual usage, however, was not clarified by the audit. Thus, the auditor must determine the equipment used to provide both retail and wholesale Internet services and will need to prorate the tax between the percentage of time used in exempt activities (retail Internet services) and the percentage of time used in taxable activities (wholesale Internet services). It also may be that some equipment was used to provide both telephone and Internet services. In such instances, the tax must be prorated for the equipment and towers used in the provision of retail Internet services (an exempt use) and the provision of telephone services (a taxable use). For equipment used only for wholesale Internet services and/or telephone services, the full amount of tax applies to the cost price of such equipment.
Equipment that is leased or purchased for use only in the provision of Internet services would be totally exempt if used within the jurisdiction of Fairfax County, Virginia. If the Taxpayers' coverage area for the audit period included the locality of Fairfax County, Virginia, the Taxpayer would need to establish for the auditor as to whether such usage existed during the audit period and identify the Internet service equipment held taxable in the audit that was used in such locality in order to remove it from the audit. If any equipment in such locality was used in the provision of telephone services and Internet services, the tax would need to be prorated between the taxable activity (telephone services) and the exempt services (Internet services).
Refund
Based on the foregoing, the Taxpayers are entitled to a refund of tax erroneously paid on equipment used in the provision of retail Internet services via wireless transmission. In the event equipment is used in a dual taxable and exempt capacity, the tax must be prorated as discussed above.
In addition, the Taxpayers have furnished a listing of tangible personal property that is claimed to be eligible for the ISP exemption. In reviewing such listing and the accompanying descriptions, the auditor will need to verify that all of the listed equipment would qualify for the ISP exemption.
The Taxpayer has listed the contested equipment in four categories: Data network capacity upgrades and enhancements, Internet distribution equipment, radio transmission equipment, and broadcasting towers. Based on the descriptions furnished and the prior court rulings involving the broadcast exemption, I am concerned as to whether the exemption is applicable to some of the contested items. In WTAR Radio-TV Corporation v. Commonwealth of Virginia, 217 Va. 877, 882, 234 S.E.2d 245, 248 (1977), the Supreme Court of Virginia held that the broadcasting exemption applies “only to broadcasting equipment and accessories thereto used directly in the act of disseminating a signal into the air, not to the equipment and accessories used to create the material which may be disseminated.” [Emphasis added.] Thus, equipment used indirectly in broadcasting is not eligible for the exemption. Also see Winchester TV Cable Company v. State Tax Commissioner, 216 Va. 286, 290, 217 S.E.2d 885, 889 (1975).
Furthermore, the General Assembly of Virginia requested the Department to provide analyses of the exemptions applicable to the Virginia retail sales and use tax. As part of such analyses, the Department examined the broadcasting exemption in its Virginia Sales and Use Tax Expenditure Study (December 1991, Volume 1, No. 3). On page 69 of such study (copies of, pages 68-73 are enclosed), the Department stated that “[t]he Court specifically rejected the proposition that broadcasting encompasses all items of personal property that are necessary and essential to put a program on the air.” As such, I must conclude that the General Assembly of Virginia was aware of the court's narrow interpretation of the broadcasting exemption when it subsequently enacted the ISP exemption by amending the broadcasting exemption. Furthermore, the Department has long held that equipment used by cable television systems must play a direct role in broadcasting, amplification, transmission or distribution in order to qualify for the exemption under Va. Code § 58.1-609.6 (2). See P.D. 90-184 (10/12/90). For these reasons and relying upon the rule of strict construction of sales and use tax exemptions, I would interpret the ISP portion of the exemption under Va. Code § 58.1-609.6 (2) as applicable only to broadcasting, amplification, transmission, distribution and production equipment, accessories to broadcasting equipment, and towers that are used directly in the provision of Internet-access services or Internet services as defined in Va. Code § 58.1-609.6(2). Equipment used indirectly in the provision of Internet services would not qualify for the ISP exemption.
While the Department's auditor will need to obtain more information from the Taxpayer to further examine the facts for the contested equipment listed, examples of equipment that may potentially be used indirectly in the provision of Internet services are, but are not limited to, the following:
- · A data management system used to monitor data network performance unless also used to directly control outgoing signals or process Internet services;
- · A trouble-shooting tool used for service assurance on the data network unless also used to directly control or process Internet services;
- · Optimization tools, such as a video and web optimization tool used to improve data delivery on the network;
- · A management platform used to maintain data equipment systems for administrative purposes; and
- · Radio frequency diagnostic tools used to tune network elements to optimize data traffic throughput.
I would note that P.D. 96-302 (10/25/96) treats tools, cable ties, cable clips, and wall plates as not directly used in an exempt activity and are thus taxable. In P.D. 93-96 (4/12/93), certain amplifying equipment and other items are deemed used indirectly in broadcasting and thus taxable. In P.D. 90-184, the tax is prorated on computer equipment used to control the distribution of cable signals (an exempt activity) and invoice customers for cable services (a taxable administrative activity). The same determination taxes equipment racks used to hold equipment for broadcasting and other furniture items as taxable because of indirect usage in broadcasting. In P.D. 87-208 (9/15/87), cable tools used in the installation and repair of cable television service were not accessories to broadcasting equipment and held taxable. However, such determination exempted distribution test equipment used in the analysis, adjustment and monitoring of outgoing cable signals. Accordingly, the auditor will take all of the foregoing into account in revising the audit.
CONCLUSION
The audit will be revised in accordance with this determination. Revised bills, with interest accrued to date, will be sent to the Taxpayer. The outstanding balances should be paid within 30 days of the bill date to avoid additional interest charges. The Taxpayer should remit its payment to: Virginia Department of Taxation, 600 East Main Street, 151h Floor, Richmond, Virginia 23219, Attn: *****. If you have any questions concerning payment of the assessment, you may contact ***** at *****.
Please note that failure to remit full payment within the 30-day period may result in the imposition of an additional 20% penalty on the tax due under the terms of Virginia's Amnesty Program. See the enclosure entitled “Important Payment Information”.
The Code of Virginia sections and public documents 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, please contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1-6049644830.R