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| Vol. 41, No. 5 -- May 2006 | |||||
Vol. 41, No. 5 -- May 2006
Collect call: New telecommunications tax law required a giant leap of faith
By Frank Shafroth
EDITOR’S NOTE: This story is the first of two parts about a new law dealing with taxation of the telecommunications industry in Virginia. An article by Roger Wiley, an attorney who worked extensively on the telecommunications tax law on behalf of VML, will appear in next month’s issue. It will address in detail what actions local governments need to take between now and when the law takes effect on Jan. 1.
After more than four years of discussion and negotiations with local governments, industry and legislators, the 2006 General Assembly passed legislation overhauling how the telecommunications industry is taxed in Virginia.
When it takes effect on Jan. 1, HB 568 will replace a labyrinth of state and local communications taxes and fees with a centrally administered Communications Sales and Use Tax and a uniform statewide E-911 tax. It will lower taxes on communications services for a majority of citizens in the state and spread the tax burden over a broader base. Some services not previously taxed will be subject to a new 5 percent communications sales and use tax. Most taxpayers who incur new taxes on these services will see an offsetting decrease on other services. The new legislation is one of the most comprehensive efforts by any state to deal with the tax ramifications of converging communications and media technologies.
Last year, telecommunications tax reform legislation quickly encountered major obstacles. This year, the tax reform bill passed the House 65-33 and the Senate unanimously. Its original Republican godfather, former state Sen. Preston Bryant, is now a member of Democratic Gov. Tim Kaine’s cabinet. It was shepherded through the 2006 session by Republican Del. Sam Nixon of Chesterfield County.
Taxation of commerce
Historically, each new communications medium has been taxed uniquely or exempted by federal and state law. Virginia’s tax reform is a giant step toward simplification and uniform treatment of communication mediums. It diversifies the local tax base, which in the past has only taxed local and cellular telephone service and collected franchise fees from cable TV. But portability of telephone numbers has accelerated the drop in land phone lines in recent years. Cellular units, Voice Over Internet Protocol (VOIP), and other mobile communications are replacing traditional telephones.
Taxing communications has been a vexing issue since the beginning of the nation. In the earliest days of America, for example, private messengers generally handled communications in the South. The tax was usually a hogshead of tobacco against the owner of any plantation owner who failed to relay mail to the next.
Fast-forward to earlier this year. U.S. Senate Commerce Chairman Ted Stevens told a group of state and local regulatory authorities that a rewrite of the 1996 Telecommunications Act should simplify the role they play in issues that extend across state lines. Stevens said that federal telecommunications legislation should not sacrifice the benefits of local regulation. He also contended that it is necessary to reduce complications by establishing national standards and processes on key issues. In a rapidly evolving type of iPod world, however, defining bright lines of federal, state and local tax authority can be increasingly challenging.
The issue is especially important to local governments. In Virginia, they levy about 89 percent of all communications taxes. Nationwide, states and municipalities tax communications services at an average rate of 14 percent, bringing in more than $20 billion per year to government coffers, according to the Congressional Budget Office. Those state and local taxes apply to traditional telephone business and not other rapidly growing types of telecommunication services. A 164-page survey released last year by the Council on State Taxation (COST) suggested that the federal government take drastic steps, if necessary, to end the discriminatory tax treatment imposed on telecommunication services and consumers by state and local governments. The COST study, the State Study and Report on Telecommunications Taxation, concluded that state and local telecommunications taxes are applied inconsistently and administered unevenly, both within the telecommunications field and as compared to other taxable business enterprises. The report claims the average state and local effective tax rate on telecommunications services is 14.2 percent, compared to 6.1 percent for general business nationwide. That revelation prompted the organization’s tax counsel, Steve Kranz, to state: “Telecom tax laws in the states are antiquated and take money out of the pockets of every American telecom consumer… The tax system is unworkable, inequitable and unequal. Telecom has nearly double the tax rate of other general businesses.”
Virginia, along with Maryland, Illinois, California, New York and Texas, has consistently been listed in the Top 10 by COST and other organizations for the presumed inequity of their communication taxes, with combined state and local rates on telecom products and services reaching 29.3 percent. “In Virginia,” Kranz has been quoted as saying, “the telecom tax is higher than that of tobacco, like a sin.” Those taxes, however, have not applied to local satellite, VOIP services available from cable companies, or specialized VOIP carriers.
Put another way: “The overtaxed world of traditional telecom companies and services is colliding with the minimally taxed world of the Internet and other communication alternatives,” according to a report to Congress by the U.S. Telecom Association. Because so many jurisdictions tax communications services, a nationwide telecom service provider is required to submit more than 60,000 tax returns annually.
Loss of landlines
Portability of telephone numbers has accelerated the drop in land phone lines in recent years. AT&T projects a 3 percent drop in wire line revenue this year. Traditional phones are being replaced by cell, VOIP and other mobile communications. The number of Arlington County’s landline phones, for example, has dropped by at least 17 percent since April 2003. Effective Jan. 1, telecommunications customers will pay a 5 percent sales and use tax in lieu of most other state and local taxes and fees. The new sales and use tax will replace current local taxes on landline, cell phone and cable TV service. It will be a new tax on long distance and VOIP phone service and satellite TV and radio service. Federal law bars the 5 percent tax on Internet service hookups.
Call for change
A joint legislative committee in Virginia embarked in 2002 upon a Quixote quest. The mission: To “examine state and local taxes imposed on the telecommunications industry and its customers to ensure that the taxes ... are fair and equitable to all elements of the ... industry, and its customers, and are relatively easy to administer and collect.” The committee was to propose changes that were as revenue neutral as possible. In addition, it was to allow for future revenue growth and preserve the ability of local governments that had not imposed some of the telecommunications taxes to impose such taxes in the future.
The taxes reviewed at the state level, which average about 3 percent, included the corporate income tax, the minimum tax on telecommunications firms, and the relay center assessment. Local taxes, which average about 25 percent, included the local consumer utility tax, the local utility license (gross receipts) tax, the E-911 system tax, the public rights-of-way use fee, and the video programming excise tax. Not all of the taxes and fees are imposed by all localities. The public rights-of-way use fee, for example, is only authorized in localities where the public streets and roads are maintained by the Virginia Department of Transportation. Also, the local utility license tax is not imposed in all localities. The committee found that the tax burden varies between competing communications companies. For instance, long distance, satellite and paging companies do not pay any of the local telecommunications-related taxes, while wireline, wireless and cable television companies do.
The challenge was stark. Any comprehensive tax reform would have to negotiate the shoals between different and emerging industry sectors, urban and rural interests, and state and local government versus industry interests.
Meeting the challenge
The new Virginia law repeals the local Consumer Utility Tax on landline and wireless telephone service; local E-911 tax on landline telephone service; the Virginia Relay Center Assessment on landline telephone service for the costs of a telephone relay service for the hearing impaired; the portion of the local Business, Professional, and Occupational License (BPOL) tax on public service companies exceeding 0.5 percent currently billed to customers in some grandfathered localities; the local Video Programming Excise Tax on cable television services; and the local Consumer Utility Tax on cable television.
The new Virginia Communications Sales and Use Tax (communications tax) will replace this hodgepodge of taxes. The communications tax will be levied on landline and wireless telephone services (including VOIP); paging; cable television; and satellite television. The communications tax will be a state administered and enforced tax imposed on customers of communications services at the rate of 5 percent of the sales price of the services. The new tax will appear as a line item on customers’ bills. The bill will also impose a new E-911 tax on landline telephone service. The E-911 tax will be administered by the state and enforced by the Tax Department. The E-911 tax will be imposed on the end user of each access line at the rate of $0.75 per access line, and also will appear as a line item on customers’ bills. Providers will be allowed a dealer discount of 3 percent of the amount of the E-911 tax revenues. The state wireless E-911 fee will not be affected.
The communications tax will be collected by all communications service providers that are subject to the rules that apply to the retail sales and use tax. Providers will register the same way as all other sales tax dealers. Each provider will separately state the amount of the tax and add that tax to the sales price of its service, at which point the tax would be a debt from the customer to the provider until paid. The bill sets a mandatory procedure for customers to resolve erroneous billings of the communications and E-911 taxes and includes accounting rules for transactions where services subject to different tax treatments are sold for a non-itemized charge. If the charge is attributable to services that are taxable and services that are nontaxable, the portion of the charge attributable to the nontaxable services will be subject to tax unless the communications services provider can reasonably identify the nontaxable portion from its books and records kept in the regular course of business.
The sales price, for purposes of calculating the communications tax, will not include:
- the excise taxes on communications services that are permitted or required to be added to the sales price of such service, if the tax is stated separately;
- a fee or assessment that is required to be added to the price of service if the fee or assessment is separately stated;
- coin-operated communications services;
- sale or recharge of a prepaid calling service;
- air-to-ground radiotelephone services;
- a providers’ internal use of communications services in connection with its business of providing communications services;
- charges for property or other services that are not part of the sale of communications services, if the charges are stated separately from the charges for communications services;
- sales for resale; and
- charges for communications services to the Commonwealth, any political subdivision of the Commonwealth, and the federal government and any agency or instrumentality of the federal government.
The new law provides that the following will not be considered taxable communications services:
- information services;
- installation or maintenance of wiring or equipment on a customer’s premises;
- the sale or rental of tangible personal property;
- the sale of advertising, including but not limited to, directory advertising; bad check charges;
- billing and collection services; Internet access service, electronic mail service, electronic bulletin board service, or similar services that are incidental to Internet access, such as voice-capable e-mail or instant messaging;
- digital products delivered electronically, such as software, downloaded music, ring tones, and reading materials; and
- over-the-air radio and television service broadcast without charge by an entity licensed for such purposes by the Federal Communications Commission.
Coming in the same session in which the legislature also adopted cable franchise legislation, this bill prohibits any cable franchise agreement entered into or renegotiated after July 1, 2006, from including a franchise fee. Cable franchise agreements in effect as of July 1, 2006, are grandfathered until their expiration. Instead of remitting franchise fee payments directly to local governments, franchisees will include with their monthly communications tax remittance to the state Tax Department a report listing by locality the franchise fees due that month. The Tax Department will, in turn, distribute the franchise fees to localities after deducting its administrative costs and the costs of the Telecommunications Relay Service – but prior to making other calculations and distributions from the fund. Local governments will retain the right to audit cable franchisees and to otherwise enforce franchise agreements. The state Tax Department will disburse funding for the Telecommunications Relay Service for the costs of the telephone relay service for the hearing impaired. Any funds held by the State Corporation Commission for the Telecommunications Relay Service as of Jan. 1, 2007 will be transferred to the fund.
This bill requires the Auditor of Public Accounts to determine the amount of revenues received by every locality for Fiscal Year 2006, at rates adopted on or before Jan. 1, 2006, for each of the following taxes and fees:
- the local Consumer Utility Tax on landline and wireless telephone service;
- local E-911 tax on landline telephone service;
- the portion of the local BPOL tax on public service companies exceeding 0.5 percent currently billed to customers in some grandfathered localities;
- cable television franchise fees;
- local Consumer Utility Tax on cable television; and
- video Programming Excise Tax on cable television services.
Additionally, the APA will collect data annually from local governments and providers to determine changes in market areas and numbers of customers served, types of services available, population, and possible local reimbursement. The APA will report annually on its findings to the chairmen of the House and Senate Finance Committees.
The revenues from the Communications Tax and the E-911 tax will be collected and remitted monthly by communications services providers to the Tax Department and deposited into a new Communications Sales and Use Tax Trust Fund. The funds are to be distributed to local governments, after: (1) transferring the tax revenues from the fund to the Tax Department to finance the direct costs of administering the communications tax, (2) after payment to the Department of Deaf and Hard-of-Hearing to fund the telephone relay service center and (3) after distribution of any franchise fee amount due to localities in accordance with cable television franchise agreements.
Each local government’s share of the net revenue is to be distributed as soon as practical after the end of the month, based on that government’s share of total local revenues received. This bill mandates all cable television providers to pay the state Public Rights-of-Way fee, which is to be collected from subscribers and remitted monthly for deposit into the fund.
Risky chasm
Years ago, in one of the first meetings hosted by Illinois State Sen. Steve Rauschenberger to assess whether the National Conference of State Legislatures should pursue the streamlining of state and local sales and use tax laws, the senator asked if the feat could be accomplished. He was told that at the end of immense travail, any final proposal to be adopted would require industry, state and local government leaders to divest themselves of many of their garments, hold hands, and leap off a cliff together. While it was easy to see that the current system no longer made sense, the disruption of so many vested interests and the uncertainty of the effect of any new system would require such a leap of faith.
In Virginia, the panoply of competing state, local and industry interests pitted urban versus rural communities; satellite and cable versus wireless and landline; and local fears of ceding control of own-source revenues to the state. It meant that cities worked to see the legislation passed while counties remained neutral. It meant that some local governments focused on the short term revenue losses over the likely long-term stability. While there was general recognition that the current exemption of emerging communications services was unfair -- creating competitive disadvantages for some segments of the telecommunications industry -- who wants to give up a revenue or tax advantage? How can one be certain that the benefits of acting in this case will outweigh the disadvantages?
In the end, a combination of the personal leadership of Del. Sam Nixon, the commitment of a number of local officials, and the unleashing of a boatload of concentrated lobbying by Verizon made the difference -- all the difference in the converging telecommunications world.
NOTE: A version of this article appeared in the March 15, 2006 edition of State Tax Notes. Reprinted by permission. 39 State Tax Notes 987 – “Hello, Tax Operator? State Telecommunications Tax Reform.” (Release Date: March 15, 2006) (Doc 2006-4964)
About the author: Frank Shafroth is director of intergovernmental relations for Arlington County. He is the former director of state-federal relations for the National Governors’ Association and the former director of policy and federal relations for the National League of Cities. In addition, he is an adjunct professor in public policy, advocacy and budget at George Mason University. He writes a weekly column, ‘The Tax Doctor,’ for ‘State Tax Notes.’
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