Market for Tax-Related Software Products and Services Thriving; Small and Mid-Sized Communications Service Providers Often Stuck in Quagmire of Federal, State and Local Communications Tax Codes

Communication service providers have many demons to keep them up at night. Punching pillows, they fret over the difficulties in retaining customers in the highly competitive communications marketplace, toss while thinking of the costs and risks of upgrading legacy network and billing operations, turn while worrying about the changing whims of regulatory entities. But in the land of chronic business nightmares, there's one that new or growing carriers are finding difficult to keep under the bed. The name of the beast is Tax Compliance, and its number is...well, that really depends on what state and local jurisdiction you're in. And what services you offer. And the way you interpret regulations. And, don't forget about those fees that act like taxes...

When it comes to tax calculation and compliance, today's communications providers are divided into the haves and the have nots. On the one hand are the large, entrenched firms-primarily local exchange carriers (LECs) such as Southwestern Bell Communications, Bell Atlantic, BellSouth, US West and Ameritech, and IXC/CLECs such as GTE, AT&T, WorldCom and Sprint. These firms have the resources (i.e., personnel and funding) needed to quickly identify changes to the existing tax and fee structure, implement the necessary billing system changes, test the system alterations, send remittance and compliance documentation accurately and promptly, and pay leading tax consulting firms to audit the process.

On the other hand, there are the smaller providers and new entrants to the communications space (for example, personal communications services (PCS) license holders, small CLECs and resellers), and other firms whose subscriber growth has expanded both the size of their operations and-importantly-their geographic footprint. Lacking longstanding relationships with federal, state and local tax authorities, these companies often find it difficult to understand confusing issues such as what taxes to apply, where and when. Even if they can mine this data, billing system configuration, compliance and auditing concerns remain. Each can carry a hefty price tag.

Third-party help is available to solve these problems. On the front end, a handful of companies offer sales and use tax packages to allow providers to calculate those taxes in an automated fashion. However, only two firms currently offer tax software for calculating communications-related taxes: the well-entrenched Vertex, which in a short seven years since the launch of its CommTax software, has come to virtually own this market; and newcomer BillSoft, which someday hopes to compete on a level basis with Vertex. To date, however, there are marked differences between what these two firms can offer carriers.

On the back end, industry sources pointed to a universe of two firms currently offering services to communications firms for remittance and tax compliance-Atlantax and State Tax Resource Group (STRP). Here again, is a large company versus a small one; STRG serves a much smaller client base than Atlantax. Running across these functions is the ongoing auditing function. Most carriers interviewed said they conduct some form of self-audit at key points in the billing process as well as quarterly or yearly, but most carriers employ an outside tax consultant as well. The larger firms can afford the price tags for firms such as PricewaterhouseCooper, Arthur Andersen, KPMG and Deloitte & Touche. The smaller carriers often must look elsewhere.

For Large Carriers-Business As Usual

For the largest service providers, handling the complexities of taxation is all in a day's work, apparently. BellSouth is among those that handle all aspects of taxation in house, beginning with a full time department geared toward uncovering changes to the federal, state and local use, sales and communications-related taxes. This structure has developed over time, according to Gay Blaylock, manager of tax billing systems for BellSouth Telecommunications. Time, of course, is a luxury emerging carriers cannot afford.

Within BellSouth's tax department are employees tasked with supporting various BellSouth business silos. Some of these billing systems are now using Vertex for tax calculations, but in-house IT staff still maintain others. Blaylock said BellSouth is "not pursuing" a strategy in which Vertex will be used ubiquitously across all lines of business.

Bell Atlantic is typical of carriers with many lines of business spanning wide geographical regions, because the business process for uncovering and implementing changes to taxation calculations is well established. "We have a pretty structured environment," said Debbie Sharpe, director of software engineering services for billing usage in Bell Atlantic's northern region. Bell Atlantic employs a "billing change manager" for regulatory and finance-related charges (think of fees vs. taxes), who is responsible for staying on top of inevitable changes. Once a change is identified, the billing change manager brings a request for a system change, in the form of a "business requirements document," to the IT department.

The changes are then reviewed, prioratized and repackaged, Sharpe said, and brought forward to the many subject matter experts in the legacy billing operations department. That group then responds with estimates for a "level of effort" (in staff-hours) and a general design for what changes will need to be made to the billing system. In some areas of Bell Atlantic, changes are hard coded into the system, but in other areas, ones that employ menu-driven rating tables, a single change can be made to effect several different regions. The changes are then added to a tax and tariff release, which is delivered in odd-numbered months to the tax authorities.

An applications designer will pass his work to an applications programmer, who makes changes in a test environment. If all goes well, the changes are made in the production environment, and then audited. The bottom line for carriers with the size and history of a Bell Atlantic or a BellSouth is that taxation "doesn't present issues that are hard for us," BellSouth's Blaylock said. "We've been in business a long time, and have a good staff that works full time on those issues. It's really not a problem."

Although there may be some down the road. Local number portability will shake things up a bit even for the large, established service providers, as area codes lose their identity as a geographic locator. For ILECs, moving into long-distance and other services such as cable and utility will bring new challenges. Still, these firms can rely on a wide base of experience and expertise in these matters. Emerging carriers-and resellers, who often look to the ILECs for help with taxation issues, only to be rebuffed-have a more difficult row to hoe. For those firms, as Sharpe concedes, "just finding out what you are liable for, [especially on a town, municipality or village level], must appear impossible."

Looking for Help

Smaller local, long-distance and wireless carriers by and large appear to agree. To get around this problem, they use several solutions. Some subscribe to tax-related newsletters and bulletin boards from both private and government sources, although most report that, except for a few sources, state and local reporting mechanisms for communications tax issues are woefully inadequate and rarely aggregated. Others bite the financial bullet and hire local tax consulting firms.

Many combine their own efforts with a reliance on their billing system provider. Billing service bureaus such as those provided by ITDS and Convergys (formerly CBIS) can take the tax calculation headaches out of a carrier's hands, but that does not mean they accept the burden for errors, which are nearly certain to occur, carrier sources said.

One source within the tax department of a medium-sized cellular carrier said, diplomatically, that its service bureau was less than helpful. "If it looks to us like taxes have been misbilled, we call them up, and they don't call us back for a few weeks," the source said, adding that errors of this magnitude are "relatively rare." For example, "They'd neglect to calculate a city tax, so we'd have to recalculate manually after the bill had been sent, and eat those costs ourselves...the billing vendors must not have tax people on staff when they write these systems."

For some vendors, that's true. Many billing system vendors today are following the "link to best-of-breed third-party providers" mantra, using outside firms to supply billing/OSS related modules for areas such as service activation, fraud prevention and, of course, taxation. But unlike other areas, when it comes to communications-related taxation calculation modules, the market is a breed of one. Ask a billing system vendor how it handles taxation (at least in North America) and the response invariably will be, "We link to Vertex."

Total Domination

"We haven't found one system that is better," said John Hart, vice president of marketing for billing vendor Saville Systems, who, like several other billing vendors, has spent time and energy to more closely integrate Vertex's CommTax software into its systems. This has helped cut down the customization necessary during implementations to "hundreds of hours, not thousands."

Billing vendors still shy away from going any further to help carriers with their tax compliance problems. "As a software provider, we really can't tell someone, 'Here's what your tax should be,'" said Martin O'Byrne, vice president for the Americas, Sema Group. "That would be financial advice, and we can't do that. Unfortunately, smaller operators often don't have the expertise to take a position [on taxes], either." Service providers seeking that kind of expertise should not look to Vertex, either, for the company does not directly provide tax consulting services. However, its does partner with the Big 5 and other consulting firms through its CONSALT Program, through which it trains and certifies these consultants on implementing and providing tax services around the Vertex software.

Although Vertex performs the invaluable function of keeping tax rating algorithms up to date, the system is by nearly all accounts far from perfect, even after the June 1998 release of CommTax 21, an upgrade to the original CommTax, which was released in 1990. One does not need to dig deep to find dissatisfied Vertex customers, a fact of which the company seems well aware.

In response to customer grumblings, Vertex released surveys a year ago to better understand what changes were needed, said Jim Krebs, director of industry marketing. "We did it to get a better handle on what our priorities should be. By and large, customers said we should be focusing on increasing the functionality of the product, while there was a lower level of priority given to rearchitecting the system." Included in the CommTax 21 release were increased granularity for wireless taxes and improved APIs for connection to modern billing systems, many of which are written in C or C++.

Therein lies one of the problems with Vertex, sources familiar with the product said. Because the product was originally written to connect to large, often mainframe systems, Vertex chose to use COBOL. The new version remains COBOL. "It's better, but they basically took an old COBOL program and dressed it up to meet the needs of wireless providers," said one source. "But it's still COBOL. And their customer support is still woeful."

"[Customer support] is certainly an area we've been targeting for improvement and have made progress over the past year in bolstering our customer support capability in areas like improved response time, training, and technical documentation," said Vertex's Krebs. "We are also in the process of working with partners to add new services like on-site implementation, so we are definitely looking to address broader customer needs in this area."

Krebs added that customer feedback has prompted Vertex to develop both tax and technology training programs for telecommunications customers, telecom billing system partners, and Big 5 partners. These training classes are scheduled to be introduced during the first quarter of next year, he said.

Despite longstanding perceptions of problems, Vertex has attracted no competitors until only recently. For a clue to why, consider that most of the big tax firms, except for Deloitte & Touche, have by and large gotten out of the off-the-shelf retail tax calculation software business. It is easier to make money consulting or installing a system such as those provided by Vertex or Taxware International than to carry the administrative overhead of a staff dedicated to unearthing minute, often underpublicized changes to the communications tax code for the thousands of U.S. tax jurisdictions. Vertex has a staff of more than 60 dedicated to this kind of tax excavation, which is nearly equal to the size of its technical department. According to one tax consultant, "It just ain't easy [some jurisdictions apply as many as 18 taxes or fees to a single call detail record], and it's definitely expensive."

Entering the Fray

Despite the barriers to entry (complexity, cost, the existence of a powerful incumbent), startup BillSoft, a private firm partially owned by an unnamed telco, hopes to become a threat to Vertex's dominance in the communication industry. The response to the BillSoft's product, released in March 1998 and written in C, is so great that, "We have had to terminate our marketing efforts, because we can't keep up with the demand we've already seen," said Tim Lopatofsky, principal for BillSoft. Not surprising, considering that BillSoft is 15 employees strong-one-fourth the size of Vertex's tax research department.

With this demand as a backdrop, Vertex is planning to re-write its system in a more modern language in the near future, Krebs said. "We clearly recognize the need to move to newer technologies," he said. "The fact of the matter is that the majority of our customers currently operate in traditional computing environments using languages such as Cobol and RPG. Therefore, we must respect their needs as we look to provide a technology platform to better support all of our customers in the future."

Except for long-distance service providers, however, carriers looking for a Vertex replacement will have to wait. Only long-distance tax calculation is available in the current incarnation of BillSoft's product. The company is researching local tax codes in 31 states, but has "finished" only 10 thus far, Lopatofsky said. A beta site has been set up for one unnamed local service provider. BillSoft will add paging and fax tax calculations capabilities later this year, he added, and the firm is "in negotiations for the purchase of tax data for wireless, and we should have that this year, except for the local tax components."

Although Lopatofsky claims that service providers have warmly received the company's product launch, billing vendors appear less enthusiastic. To date, BillSoft has integrated with Switch Solutions, EXL, U.S. Telecom and Verabill (formerly Moscom). Talks with larger billing firms have yet to bear fruit, and many of those vendors told Billing World they are not considering a switch. Pat Howard, product manager, wireless marketing for Convergys, which uses Vertex as part of its service bureau offering, gave a typical response. "The new product [from Vertex, CommTax 21] is much more granular than the last, with expanded category codes," he said. "We are happy with Vertex, and aren't considering BillSoft right now." Obviously, Vertex's established relationships with billing vendors, carriers and consultants is a huge plus for the company.

Don't Forget Compliance

Once a service provider has discovered what taxes to pay for which services under what circumstances and in which geographic region, and then has configured its system to correctly rate each event on its network, the provider's work is still not done. Ongoing updating and maintenance of the previously mentioned functions is always necessary, as is the back-end task of compliance. For that task, carriers can employ companies such as Altantax and STRG.

Although Atlantax and STRG carry out the function of tax compliance-filling out the proper forms, sending information and checks to the correct institutions at the exact addresses-the firms have some major differences. One is size-Atlantax employs nearly 70 people, while STRG is shy of 20. Another is scope; Atlantax provides telecom tax consulting and tax rating services (using Vertex while providing carriers a service bureau arrangement) as well as compliance services (using its own software) such as book balancing and check cutting. The smaller STRG takes a different angle, said Ted Esau, senior partner with STRG. "Where they [Atlantax] are diversifying vertically in telecom, our approach is different," he said. "We are staying narrow in our focus, but diversifying in types of clients."

Another difference is STRG's relationship with BillSoft. "We think it's good for the industry to have two strong competitors," said Esau. "BillSoft is small and growing, very entrepreneurial, just like us. Vertex has taken on that big company persona, where it's hard to get a person on the line sometimes, whereas Tim [Lopatofsky] will be there on a Saturday night if a client needed him."

Information Remains the Bottleneck

Although solution providers and tax consultants are at the ready for communications services providers, the lack of readily available information will continue to hinder vendor and carrier efforts alike. "At the state level and the national level, we can get information pretty easily," said Atlantax President and CEO Gary Rhodus. "When you get down to local taxes, few government entities have wanted to take the time to compile information on thousands of jurisdictions. The states really need to step up and take responsibility for providing this information."

As if the issues previously presented are not daunting enough, technological advances are further exacerbating the problems. Many taxing statutes tax "telephony" or "telephone services" says Larry Fee, Partner, Telecom Tax Implementation Services for PricewaterhouseCoopers LLP. "Especially with the move to all digital networks, it becomes almost impossible to differentiate between taxable voice communications and frequently non-taxable data transmissions. Taxing authorities also are woefully slow in issuing interpretations of tax laws to new telecom technologies."

While taxation is not a problem dear to the hearts of communications service providers, it's one that will not go away. "Let's face it, nobody got into the telecom business because they wanted to get involved in taxes," said John Tower, president of the Tower Group, a consulting firm that helps service providers implement Vertex. "There's a lot of complexity to deal with."

That complexity will only become worse, several vendors warned, when utility services become part of the mix. Just so you know...

COMPANIES PROVIDING OFF-THE-SHELF OR SERVICE BUREAU
TAX-RELATED SOFTWARE PRODUCTS TO THE COMMUNICATIONS ARENA
Company
Headquarters
Notes
Web Site

Taxware International (Formerly AVP Systems)
Salem, Mass
Taxware offers a family of products for mainframe, midrange and PC computer platforms. The company's systems for automated tax compliance include modules that address sales/use, consumer's use, Internet, international taxation, address verification, exemption processing, automated returns, property and payroll tax. [call out]
www.taxware.com

Deloitte & Touche Tax Technologies
Woodland Hills, Calif.
Many Fortune 500 companies use CorpTax, which Deloitte & Touche purchased from FDSI and later upgraded, but not for sales and use taxes. Currently, the product does not calculate communications taxes, although a company spokesperson said future versions would focus on industry silos, communications among them. Such a targeted product appears years away, however, the spokesperson conceded.
www.corptax.com

Computer Language Research
Carrollton, Texas
CLR, a subsidiary of Tompson Corp., offers software programs for income, sales and use, property and fixed asset taxes for corporations. The company also provided products for tax accounting and bank trust departments. No communications-specific tax programs are available. The FastTax family was originally designed by PricewaterhouseCoopers.
www.clr.com

BillSoft
Overland Park, Kansas
Startup BillSoft, a private firm partially owned by a telco, provides communications taxation software for long distance service providers. The company is working on a local component, but the product will not be ubiquitous across all 50 states in its first version.
Web site is under construction.

Vertex
Berwyn, Penn.
Along with its industry-leading communications tax packages, CommTax and CommTax 21, Vertex offers software for sales and use, property and payroll tax calculation. Many fo the top communications billing vendor products integrate with the CommTax family.
www.vertexinc.com

Atlantax Systems
Atlanta, Ga.
Atlantax offers tax complience and consulting services. Its TaxPac Telecommunications Tax Compliance service includes automated monthly processing of tax data, monthly Federal excise tax deposits and quarterly filings, preparation, filing and payment of returns for gross receipts, sales and use, property, and telecom taxes. Atlantax also offers a tax calculation service bureau, using the Vertex CommTax product line.
www.atlantax.com

State Tax Resource Group
Irvine, Calif.
STRG aids communications and other firms in jurisdiction registration, the preparation and filing of sales/use, gross receipts and excise taxes, and payment preparation. STRG links to BillSoft's product for long distance communications tax calculation, offering a service bureau arrangement.
www.strg.com

Note: the companies in the above chart are not the only firms providing tax compliance software, but do comprise the leaders in the field for the communications industry, according to industry sources.

State Tax Authority Web Sites

State
URL:
Alabama
Alaska
Arizona
Arkansas
California
Colorado
Connecticut
Florida
Georgia
Hawaii
Idaho
Illinois
Indiana
Iowa
Kansas
Kentucky
Louisiana
Maine
Maryland
Massachusetts
Michigan
Minnesota
Mississippi
Missouri
Nebraska
Nevada
New Jersey
New Mexico
New York
North Carolina
North Dakota
Ohio
Oklahoma
Pennsylvania
Rhode Island
South Carolina
South Dakota
Tennessee
Texas
Utah
Vermont
Virginia
Washington State
West Virginia
Wisconsin
Wyoming
http://www.ador.state.al.us/
http://www.revenue.state.ak.us/
http://www.revenue.state.az.us/index.html
http://www.state.ar.us/revenue/
http://www.ca.gov/s/
http://www.state.co.us/
http://www.state.ct.us/drs/
http://sun6.dms.state.fl.us/dor/
http://www2.state.ga.us/Departments/dor/
http://www.state.hi.us/tax/tax.html
http://www2.state.id.us/
http://www.revenue.state.il.us/
http://www.ai.org/dor/
http://www.state.ia.us/government/drf/index.html
http://www.ink.org/public/kdor/
http://www.state.ky.us/agencies/revenue/revhome.htm
http://www.rev.state.la.us/
http://janus.state.me.us/revenue/
http://www.comp.state.md.us/
http://www.magnet.state.ma.us/dor/
http://www.treas.state.mi.us/
http://www.state.mn.us/ebranch/mdor/
http://www.mstc.state.ms.us/
http://www.state.mo.us/dor/tax/
http://www.nol.org/revenue/
http://www.state.nv.us/
http://www.state.nj.us/treasury/taxation/
http://www.state.nm.us/tax/
http://www.tax.state.ny.us/
http://www.sips.state.nc.us/
http://www2.state.nd.us/taxdpt/
http://www.state.oh.us/tax/
http://www.oktax.state.ok.us/oktax/
http://www.revenue.state.pa.us/
http://www.tax.state.ri.us/
http://www.dor.state.sc.us/
http://www.state.sd.us/state/executive/revenue/revenue.html
http://www.state.tn.us/revenue/
http://www.window.state.tx.us/
http://www.tax.ex.state.ut.us/
http://www.state.vt.us/tax/
http://dit1.state.va.us/
http://www.wa.gov/DOR/wador.htm
http://www.wvweb.net/taxdiv/
http://www.dor.state.wi.us/
http://www.revenue.state.wy.us/

Different Strokes for Different States

Taxation of telecommunications is a very complex business, and the rules vary widely among the various states, counties, districts, and cities. Following are two examples of how different jurisdictions would tax an intrastate telephone call. The two examples are Hartford, CT, and Los Angeles, CA. Determination of taxing jurisdiction is based on the "two out of three" rule (When any two of: Origin, Termination, or Billing Jurisdiction, are the same).

1. Hartford, CT (Standard 2 of 3) for all taxes
* Federal Universal Service Fund Surcharge (1.54%)
* Federal Excise Tax (3%)
* State of Connecticut General Sales Tax (6%)

2. Los Angeles, CA
* City of Los Angeles Utilities Users Tax (10%)1
* State of California 911 Tax (.72%)2
* State of California PUC Tax (.11%)3
* State of California Universal Service Fund Surcharge (2.4%)3
* State of California Telecommunications Relay Service Surcharge (.41%)3
* State of California Deaf Tax Surcharge (.25%)3
* State of California High Cost Fund Surcharge (2.87%)3
* Federal Universal Service Fund Surcharge (1.54%)
* Federal Excise Tax (3%)2

The above are two small examples, that don't even involve county, or district taxes. Furthermore, a different type of transaction such as an interstate phone call, or a cellular call, etc., within the same jurisdiction carries different taxing rules. You can begin to see what a complex task it is for the Tax Manager to keep up with all this, considering how many municipalities, counties, districts, and states there are. The tax exposure can be immense.

1 Only if "Billing" and "Taxing" jurisdictions are the same.
2 It is not simply a matter of taking the cost of the phone call and applying this percentage. All the five taxes in bold and underlined must be calculated, and the results must be added to the base cost of the phone call before applying the percentage!
3 Only when all three jurisdictions are the same (Origin, Termination, and Billing).