Rulings of the Tax Commissioner

June 11, 2019

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

Dear *****:

This will reply to your letter in which you contest the denial of retail sales and use tax refund claims submitted by ***** (the “Taxpayer”) for the period December 2011 through March 2015. I apologize for the delay in responding to your request.

FACTS

The Taxpayer

The Taxpayer sells telecommunications equipment, software and related services. The Taxpayer received a refund claim from ***** (the “Customer”) for sales taxes paid on purchases of telecommunications equipment, software and various services from the Taxpayer. The sales taxes from those transactions were collected and remitted to the Department by the Taxpayer. The Customer claims that the collection of the sales taxes was erroneous based on the application of several sales and use tax exemptions to the purchases made from the Taxpayer. The Customer claims that the exemption for Internet Service Providers (ISP) in Virginia Code § 58.1-609.6 2 applies to many of its purchase transactions with the Taxpayer. In addition, the Taxpayer claims that the exemption set out in Virginia Code § 58.1-648 C for electronically delivered software applies to other transactions with the Customer. 

The Taxpayer issued a credit memo to the Customer for the sales tax refund amount claimed. The Taxpayer filed a refund claim with the Department to recover the erroneous taxes refunded to the Customer. The Department reviewed the Taxpayer’s refund claim. The ISP exemption claimed by the Customer on the purchases of telecommunications equipment was not allowed. The refund of sales taxes paid on certain software purchases was denied because it could not be confirmed that the transactions qualified for the sales and use tax exemption for electronically downloaded software. A refund was approved and issued for an amount of tax that was less than the amount claimed by the Taxpayer. The Taxpayer contests the denial of the remaining refund amounts. In addition, the Taxpayer disputes the Department’s refusal to pay interest on the tax refunds.

The Customer

The Customer is a regional provider of communications services that include television, Internet and landline telephone services. In 1999, pursuant to an exclusive provider agreement, the Customer contracted with a national cellular phone service business (the “Company”) to be the regional provider of the Company’s branded products and services in the Customer’s service territory. The Customer and the Company are not related business entities. The Taxpayer states that the Customer and the Company jointly provide mobile Internet services within the Customer’s service region. The provision of mobile Internet services is the Customer’s basis for claiming the ISP exemption and the basis for the refund requests filed by the Customer and the Taxpayer.

The business relationship between the Customer and the Company is governed by a management agreement. The Company legally controls the core spectrum needed to operate the regional wireless network. The Customer owns and controls the infrastructure necessary to operate the network and provide wireless phone service in its service area. The management agreement requires the Customer to build and maintain the infrastructure necessary to operate, expand and enhance the wireless network in its service territory. The Customer acquired tower, microwave and antenna licenses from the FCC to fulfill these obligations. 

Pursuant to a trademark licensing agreement with the Company, the Customer markets and sells the Company’s products and services and operates retail stores using the Company’s brand. The Customer owns the retail stores and is responsible for providing the staff to operate the retail stores. In addition, the Company and the Customer entered into a services agreement in which the Company provides various support services, such as service activation, customer billing, collections and customer service. The Taxpayer states that the Company makes no direct sales of products and services within the Customer’s territory. The sales of products and services are accounted for as revenue by the Customer. The revenues are reduced by fees owed to the Company for access to spectrum and for the various support services received.

DETERMINATION

ISP Exemption

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. 

Virginia Code § 58.1-602 defines various terms related to this exemption statute.

“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.
 
“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. 

“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.

When interpreting sales and use tax exemptions, the Department applies the rule of strict construction as adopted by the courts and as required by the Virginia Constitution. Based on the statutory definitions cited above and the application of the rule of strict construction, the Department has interpreted the ISP exemption to be applicable only to retail ISPs. Wholesale ISPs are not eligible for the exemption. A retail ISP is one that provides Internet services as defined above to end-users who subscribe or contract with an Internet service provider to receive all of the services listed in the statute, i.e., access to proprietary content, other content, information electronic mail ("email") and the Internet. This policy is set out in Public Document (P.D.) 13-179 (10/11/13) and has been consistently applied to ISPs that sell Internet services directly to end-user subscribers. 

In P.D. 16-167 (8/26/16), which is cited by the Taxpayer, the Tax Commissioner ruled that the ISP exemption in Virginia Code § 58.1-609.6 2 is not restricted to wireline ISPs only. The statutes governing the ISP exemption do not contain language that excludes wireless service providers from being eligible for the exemption. For this reason, P.D. 16-167 concludes that mobile or cellular telephone service providers that sell Internet services to end-user subscribers may qualify for the ISP exemption. The Customer’s refund request to the Taxpayer was based on the contention that it is a provider of wireless phone services that include the sale of Internet services to end-user subscribers. As such, the Taxpayer maintains that the ISP exemption policy set out in P.D. 16-167 applies to the Customer’s business operations. 

The Taxpayer furnished the Department documentation it contends demonstrates that the Customer’s wireless business operations qualify for the ISP exemption. A copy of the management agreement was provided with the Taxpayer’s appeal. This document sets out the terms of the business relationship between the Customer and the Company. The management agreement designates the Customer as the manager of the Company’s wireless business operations in the Customer’s service territory. The agreement requires the Customer to offer and promote the Company’s branded products and services. The Customer must adhere to requirements established by the Company to ensure seamless operations throughout the Company’s network and the uniform and consistent quality of its products and services. The agreement with the Company establishes customer service requirements that the Customer must follow. The agreement also states that the Customer must adhere to marketing, promotion and distribution program requirements for the Company’s products and services.

The terms of the management agreement dictate that the Customer must purchase equipment from a list of products approved by the Company. The agreement states that some products must have proprietary software developed by manufacturers for or by the Company to allow the seamless operability of the wireless network. Further, the Customer operates retail stores under the Company’s brand. The wireless service contracts are between the Company and the wireless customers. The wireless phone handsets are manufactured for use under the Company’s brand and according to the Company’s specifications. Subscriber payments for wireless phone bills are made to and processed by the Company.

My staff conducted further research to help determine whether or not the Customer is a retail provider of mobile or wireless Internet services. My staff reviewed various news releases that state the Customer is a wholesale provider of mobile wireless services. Internet search results for wireless Internet providers in the geographic location of the Customer’s headquarters and in its service area did not include the Customer among the entities listed as wireless Internet providers. The Company was listed as a wireless Internet provider. A review of the Customer’s website revealed that the website is proprietary with respect to the Customer’s wireline, cable television and Internet business segments. However, the website contains no information regarding the availability or the sale of wireless phone and Internet services.

The Company holds the licenses for the operation of the wireless network in the Customer’s service territory. The management agreement, in addition to the other information provided by the Taxpayer, is insufficient to support a conclusion that the Customer qualifies as a retail ISP. Under the rule of strict construction discussed previously, the Taxpayer has not met its burden of proving that the software, amplification, transmission and distribution equipment sold to the Customer was used to provide mobile or cellular Internet services at retail to end-users. As such, the transactions at issue do not qualify for the ISP exemption.

I wish to address the Taxpayer’s contention that the Department agreed that the Customer qualified for the ISP exemption. The Taxpayer was issued an audit report that presented the results of the refund review. A letter dated August 3, 2017 that summarized the Department’s findings for the refund request was also issued to the Taxpayer. The letter included an attachment that contains quoted sections from public documents issued by the Department. The quoted sections of the public documents were intended to explain and illustrate the Department’s policy with respect to the ISP exemption. This attachment was informational only and was not intended to confirm that the Customer qualified for the ISP exemption. Moreover, the letter itself does not state or suggest that the Department concluded the Customer qualifies for the ISP exemption. I apologize for any confusion that the letter and the attachment may have caused the Taxpayer.

Software Delivered Electronically 

The Taxpayer maintains that the Department erroneously denied refunds of sales taxes paid on software products that were sold and delivered electronically to the Customer. The Taxpayer relies on Virginia Code § 58.1-648 C as the basis for this contention. However, this statute is applicable only to the Communications Sales and Use Tax. The Taxpayer cited the exemption in Virginia Code § 609.5 1 with the original refund claim filed with the Department. This is the correct exemption statute and provides, in part, an exemption from the tax for “services not involving an exchange of tangible personal property which provide access to or use of the Internet and any other related electronic communication service, including software, data, content and other information services delivered electronically via the Internet.”  

The Department’s longstanding policy is that the sale of software is exempt from the tax when the product is delivered electronically and there is no transfer of the software by any tangible means, such as by disk, flash drive, tape or other storage medium. This policy only applies in cases where there is no tangible medium provided to the customer before or after the electronic download of the software. For example, a transaction in which a disk with a backup copy of software is provided to a customer after the sale and electronic delivery of the software is a taxable sale. The exemption also applies to software updates delivered electronically to customers when the original software qualifies for the exemption. 

P.D. 05-44 (4/4/05) discusses the taxability of software and software updates that are delivered electronically. P.D. 05-44 sets out the Department’s minimum documentation requirements for confirming the electronic delivery of software products and states that, “at a minimum a sales invoice, contract or other sales agreement must expressly certify the electronic delivery of the software and that no tangible medium for that software has been furnished to the customer.”  I note that the refunds issued to the Taxpayer consisted primarily of transactions that qualified for the exemption in Virginia Code § 58.1-609.5 1. These transactions were determined to meet the documentation requirements discussed in P.D. 05-44.

The auditor noted during the refund review that certain types of software offered for sale by the Taxpayer appeared to include the transfer of that software on a disc or other tangible medium in addition to electronic delivery. The software documentation provided with the Taxpayer’s appeal is not conclusive to establish that the software was available for delivery by electronic means only. The information submitted by the Taxpayer consists of procedures to download software and software license keys. This information does not meet the minimum criteria set out in P.D. 05-44 to support the refund of the sales taxes billed on the software transactions that were not approved for refund.

During the refund review, the auditor also noted transactions in which software charges were billed in connection with sales of equipment or hardware. P.D. 14-178 (10/23/14) discusses the application of the sales and use tax to software sold with hardware in the same transaction. In this determination, the software was transferred to the customer electronically or was downloaded to a thumb drive which was used by a technician that transferred the software to the customer’s equipment. Although the software was transferred electronically, the Tax Commissioner ruled that the software was part of the overall sale of the computer equipment and subject to the tax. The decision was based on the requirement in Virginia Code § 58.1-609.5 1 that, to qualify for exemption, services cannot involve an exchange of tangible personal property. In such cases, the charges are deemed to be services in connection with the sale of tangible personal property and are part of the taxable sales price of the property sold.

Based on the information provided, there is no basis to approve the refund of the sales taxes charged and remitted on the contested software sales transactions.

Refund Interest

The Department did not pay the Taxpayer interest on the tax that was previously approved and refunded. The interest was not paid because the Taxpayer could not provide evidence that the interest was refunded or credited to the Customer’s account. The Taxpayer disputes the Department’s policy that interest on refunds cannot be paid unless the seller demonstrates that a credit or refund for the interest has been issued to the customer. Further, the Taxpayer states that its accounting system does not allow the processing of a credit without a corresponding payment from a customer. As an alternative, the Taxpayer suggests that the refund interest be issued directly to the Customer.

Virginia Code § 58.1833 A states that “[n]o interest will be paid on sales taxes refunded to a dealer unless the dealer agrees to pass such interest on to the purchaser.”  The statute is interpreted in Title 23 of the Virginia Administrative Code (VAC) 10-210-200. Subsection D of this regulation, which mirrors the language in the statute, also references Title 23 VAC 10-20-180 A 2 for more information. Title 23 VAC 10-20-180 A 2 a states that “[w]hen a dealer is applying for a refund of sales tax, the dealer shall attach a list of the purchasers from whom the tax was collected and to whom the refund and interest, if allowed, will be paid.”  [Emphasis added.]

It is noteworthy that the statutory language in Virginia Code § 58.1-1833 A merely states that a dealer will not be refunded interest “unless the dealer agrees to pass such interest on to the purchaser.” The statute does not state that the dealer must first pay the refund interest to the purchaser to be eligible for a refund of interest on the tax to be refunded. Further, the statute states that a dealer must pass on the interest to the customer. This phrase suggests that the dealer will receive the refund interest because it must then be passed on to the customer or purchaser.

In Title 23 VAC 10-20-180 A 2 a, dealers that apply for a sales and use tax refund must identify the customers to whom the refund and interest, if allowed, will be paid. The phrase “will be paid” suggests an action that must occur in the future, rather than the past. The regulation language also supports a conclusion that dealers are eligible for refunds of interest from the Department prior to paying the customer or crediting the customer’s account for the interest.

Based on the plain reading of both Virginia Code § 58.1-1833 A and Title 23 VAC 10-20-180 A 2 a, interest can be refunded to a dealer prior to the dealer refunding or crediting the interest to the purchaser. There is no requirement that the dealer prepay refund interest to a customer to be eligible for a refund of the interest. However, the payment of interest to a dealer is legally contingent on the dealer paying or crediting the interest to the customer. The Taxpayer has identified the Customer as the purchaser that will be paid interest. As such, the Taxpayer will be refunded interest calculated on the tax amounts that were previously refunded. If the Taxpayer has not already done so, the interest amounts should then be refunded to the Customer or credited to the Customer’s account. The Department reserves the right to verify that the interest amounts refunded to the Taxpayer have been passed on the Customer as required by Virginia Code § 58.1-1833 A.

CONCLUSION

As soon as practicable, the Department will calculate and process refunds for the interest due on the tax amounts previously refunded to the Taxpayer. In accordance with this determination, there is no basis to issue the Taxpayer additional tax refunds based on the ISP exemption or the exemption for electronically downloaded software.

The Code of Virginia sections, regulations and public documents cited, along with other reference documents, are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department’s website. If you have any questions concerning this determination, please contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.

Sincerely,

Craig M. Burns
Tax Commissioner

AR/1484.S