Digital Unrest Legislation, Litigation and Other Policy Changes Impacting the Tech Sector

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Digital Unrest – Legislation, Litigation and

Other Policy Changes Impacting the Tech

Sector

Michele Borens, Partner Charlie Kearns, Counsel June 17, 2014

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Agenda

• Industry Trends Related to Digital Goods and Services

• Expansion of Telecommunication Taxation • Impact on Taxation if ITFA Expires

• Sales Tax Risks and Other Non-Tax Considerations

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Overview

• States continue to enact legislation which expands sales and use tax and other taxes to cloud-based goods and services, and digital goods and services • However, there continues to be significant differences

in those states that tax such goods and services

• In addition, some states have alternative tax regimes where it is often unclear whether the regime is

intended to tax digital goods, services and other items (e.g., excise taxes, telecommunication type taxes,

etc.)

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Overview

• Why does characterization matter? Taxability and Sourcing

• What are you selling/buying?

 Telecom Service

 Digital Good or Service

 Software

 Data Processing or Information Service

 Tangible personal property

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Streaming Video Subscription

• State and local jurisdictions have issued assessments to streaming video providers based on varying

theories, of which most were not made public by ruling or regulation prior to the audit

• Netflix is the lead taxpayer in several of the pending controversies, including:

 Kentucky – Telecom Taxes

 St. Charles Parish (Louisiana) – Local Sales Tax

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Streaming Video Subscriptions

• Texas adopted regulatory amendments redefining the scope of taxable cable television services. 34 Texas Admin. Cd § 3.313

 The revised regulation defines for the first time several terms related to the cable television services industry; adopts a destination-based sourcing rule for intrastate sales of streaming video; and taxes “bundled cable services.”

 The Comptroller defines a “cable system” as the “system through which a cable service provider delivers cable television or bundled cable service” and states that it may comprise “any or all of the

following: tangible personal property; real property; and other media, such as radio waves, microwaves, or any other means of conveyance now in existence or that may be developed.” Texas’s regulatory

definition of “cable system” now exceeds the scope of the term as defined by the FCC

 The amended regulation also revised the definition of “cable television service” to encompass all forms of video programming, including

streaming video, whether provided via the Internet or other technology

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Streaming Video Subscriptions

• Missouri issued guidance regarding streaming videos. Missouri Dep’t of Rev., Letter Rul. No. 7338 (Dec. 20, 2013)

 The sale or rental of streaming video content is not subject to Missouri sales or use tax

 The service in question allowed customers to purchase or rent video content and to stream the content through

devices like computers and televisions via the Internet

 Analogizing the service to prewritten computer software—which is not taxable when delivered in any medium other than TPP—the Department found that streaming content is likewise not taxable

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Introduction

• All states and most local governments impose taxes and/or fees on the sales of telecommunications

services, whether on the charges or gross receipts, or on a per line or access basis, to varying degrees.

• States generally do not assert regulatory authority (outside of general police powers such as consumer protection or deceptive trade practices) over

non-utility telecommunications providers.

• Many states define “telecommunication services” or “communications services” in a broad manner for tax purposes, typically more expansive than under their regulatory regimes

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Evolution of Telecom Taxation (Voice)

Cloud-Based – Nomadic VoIP –

??

VoIP – Fixed/Interconnected –

Vonage (2004)

Wireless Telecom – MTSA (2000)

POTS – ILECs/CLECs – Utility/Non-Utility – Goldberg (1989)

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Voice Taxation

Voice providers may be taxed differently based on regulatory

differences, lack of clarity for sourcing, and constitutional limitations.

Cable Internet

Protocol

Wireless Traditional

Telecom Satellite Digital Voice (VoIP) Vonage, Skype, IBM Verizon Wireless, T-Mobile, Sprint, AT&T AT&T, Verizon, CenturyLink Partner with Telecom

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Internet Access Taxation

With the Internet Tax Freedom Act set to expire in 2014, non-grandfathered states may attempt to tax Internet access at that time. Until then,

clarification of federal preemption may be needed with respect to “Internet access” definition and “multiple and discriminatory” taxes on e-commerce.

Protocol

Telecom Satellite High Speed Cable Internet, Cable WiFi, Wireless Internet

Clear Fiber Optic

Internet Wireless Internet DSL Internet, Wireless Internet Partner with ISP

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Data Storage/Transmission Taxation

Few states statutorily tax or exempt data storage, thus leading to confusion as to the character and sourcing of the service. Issues related to nexus may also arise.

Protocol

Telecom

Satellite

thePlatform, Charter Cloud Drive,

Navisite

Amazon Verizon/EMC/

Terremark

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“Telecom Services” Defined

• Many states define “telecommunication services” (or “communications services”) in a broad manner for tax purposes

• Based on these definitions, many states may impose various transaction taxes, as well as other taxes and fees, on largely unregulated telecommunications

service providers and other sellers of telecommunications-related products.

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“Telecom Services” Defined

For example, the Streamlined Sales and Use Tax Agreement defines “telecommunications service” as:

[T]he electronic transmission, conveyance, or routing of voice, data, audio, video, or any other information or signals to a point, or between or among points. The term “telecommunications service” includes such transmission, conveyance, or routing in which computer processing applications are used to act on the form, code or protocol of the

content for purposes of transmission, conveyance or routing without regard to whether such service is referred to as voice over Internet protocol services or is classified by the Federal Communications Commission as enhanced or value added.

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“Telecom Services” Defined

Products typically excluded from the “telecom” definition (possibly subject to the general business regime or

special rules):

• Internet access

• Video and radio programming

• Data processing and information services • Digital goods and services

• Installation services • Advertising

The emphasis is on the transmission of data, not on the content

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Application of Telecom Definitions

• Washington State – Qualcomm, Inc. v. Dept. of Revenue, 249 P.3d 167 (Wash. 2011)(taxpayer’s

service is an information service because its “primary purpose” to the customer is to manipulate and convert transmitted information into a usable form)

• Tennessee – IBM Corporation v. Farr, Civil No. 09-2144-I (Davidson County, Tenn. Chancery Ct. filed July 20, 2012) (court applied “true-object” test to determine taxpayer’s WAN services was a telecom service- no creation of information- just transmission)

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Application of Telecom Definitions

• New York State – New York Advisory Opinion, TSB-A-09(60)S, 12/15/2009 (taxpayer’s sales of Network

Services, multi-protocol conversion services, and access services were taxable “sales of telephony and telegraphy and telephone and telegraph service of whatever

nature….”)

• New Jersey – Aetna Burglar & Fire Alarm Co. v. Dir.,

Division of Taxation, 16 NJ Tax 584 (N.J. Tax Court, 1997) (burglar and fire alarm systems connected to taxpayer’s network center via customer’s existing telephone service were taxable telecom, defined as “the act…of originating or receiving messages or information through the use of any kind of…communication”)

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Taxability – Compliance

• The number of taxes imposed on telecom services is almost 3x that of general business transactions

• Telecom service providers have over 1,100 more tax bases and 6,600 jurisdictions than general business transactions

• Over 40,000 tax/fee filing requirements for telecom providers, compared to approximately 7,500 for

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Missouri Letter Ruling – UCaaS

• The DOR determined that a company’s

telecommunications services provided to customers on its cloud computer network are subject to sales tax. L.R.

7248, Mo. Dept. of Rev. (May 24, 2013)

• The company hosted its cloud network on servers located outside of MO, and customers accessed the network

through public telecommunications lines and through the customers’ internal network; customers separately

purchased the necessary hardware and Internet access • Services provided to customers through the cloud network

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Missouri (cont’d)

• The DOR determined that the company is providing

taxable “telecommunication services” because it transmits information through its services that direct and control its customers’ hardware and because it stores messages on its server, which are taxable events in Missouri

• The DOR also noted that customers would not be able to use their equipment without the company’s software and hosting unless the customer was willing to engage another telecommunications company or built its own in-house

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Internet Access

• The federal Internet Tax Freedom Act (ITFA) prohibits three types of state and local taxes: (1) taxes on

Internet access; (2) multiple taxes on electronic

commerce; and (3) discriminatory taxes on electronic commerce.

 The “Internet access” moratorium does not apply to

“grandfathered” states and certain modified gross receipts taxes

• ITFA is set to expire November 1, 2014 … Will Congress renew ITFA? What would happen if Congress allows ITFA to expire?

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Internet Access

• How will states define “Internet access” if ITFA expires?

 Most Streamlined Member States

 Specific definitions or ITFA cross-references

• For those states that do not define “Internet access,” will they narrow the ITFA definition?

 ITFA definition is broad, including e-mail, personal storage, and video clips

 ITFA protects telecom purchased, used, or sold to provide Internet access is subject

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Internet Access

• With respect to the Internet access moratorium, issues if ITFA expires*:

 Which states will automatically tax Internet access?

 Which states would treat Internet access as a taxable bundled of transport (i.e., telecom) and access?

 Which states would tax wholesale transport as telecom “purchased, used, or sold” to provide access?

 What local taxes will apply? *Non-grandfathered states

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Sales Tax Risks

• New Risk Environment

 Traditional risks associated with compliance obligations vs. new risks associated with third party enforcement actions

 Ambiguous state and local transaction tax laws present unique conundrums

• Conservative collection may no longer be the best answer

 Risk of overcollecting

 Risk of not collecting

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Sales Tax Risks

Third-Party Enforcement Actions

• Class Actions

 Charter Missouri Case

 AT&T New Jersey Case

 AT&T Mobility and Target California cases

• False Claims Act Suits

 Sprint New York Case (below)

• Whistleblower/Qui Tam Suits

 New York, Illinois Cases

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Questions?

Michele Borens, Partner

Sutherland Asbill & Brennan LLP 202.383.0936

michele.borens@sutherland.com Charlie Kearns, Counsel

Sutherland Asbill & Brennan LLP 202.383.0864

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