Wireless Taxation: From Middle Management Frustration to CEO Arrests

Imagine this: You are the proud and industrious CEO of a growing company that offers wireline, wireless, Internet and paging services. You are in your office, taking a few minutes to catch your breath after a whirlwind meeting with your vice presidents, each of whom had great things to report.

Your administrative assistant taps lightly against your open door and says, “There are a couple of policemen here to see you.” Suddenly you are in handcuffs, under arrest for failing to pay taxes. Not your personal income tax—but taxes long past due to one of the hundreds of taxing jurisdictions in which your wireless company terminates or originates calls.

Although rare, such rude interruptions in an executive’s day can happen. “I have heard of situations where states have had warrants out for the arrest of officers of the company,” says Robert Dumas, president of Tax Partners LLC in Atlanta. “I have heard of situations where they have padlocked the doors of telecom companies, and shut them down. Other jurisdictions have held up the proceeds from company sales, to pay the big tax penalties and interest that get assessed.”

It’s usually not that any company officer intentionally dodges the company’s tax bills, nor ignores written warnings that legal action will be taken unless taxes are paid. It’s simply unfeasible for many carriers to track the flood of tax bills and assessments that arrive at their front door.

Wireless Taxation Tough to Track

The world of wireless taxation is a place of dangerously shifting sand. Wireless carriers, especially low- to mid-tier carriers, find it nearly impossible to keep up with the thousands of taxes, fees and other extractions levied nationwide. There are 7,000–8,000 taxing jurisdictions in the United States, which constantly change their multiple tax structures and continuously redraw their boundaries. According to Vertex Inc., roughly 900 rate changes occur each year. In 1998, there were more than 4,400 jurisdictional, boundary-related changes, including ZIP code changes, annexations, and the like.

And there is debate as to which jurisdiction should have the right to tax wireless calls. Is it the town, county and state from which the call originated, or where the call terminated? Traditionally, none of the jurisdictions through which the signal simply travels can collect taxes on the call, but there are rare exceptions to that rule.

‘Two Out of Three’ Is Out of Date

A 1989 U.S. Supreme Court decision, based on the Goldberg v. Sweet case in Illinois, created what has become known as the Two Out of Three Rule: “The tax act imposes a tax on the gross charge of interstate telecommunications if (1.) originated or terminated in Illinois; and (2.) charged to an Illinois service address, regardless where the telephone call is billed or paid.”

“There must be two points within the state for the state to be able to collect the tax,” says Diana DiBello, research product manager for telecom taxation at Vertex. “For instance, I live in Pennsylvania, I make a call from Pennsylvania to New Jersey, and my ‘bill to:’ address is in Pennsylvania, then Pennsylvania will pick up the tax.” “It’s the age-old law of the land, based on wireline technology,” says Jerry Allison, CommTax project leader for Vertex. “As soon as you introduce cellular and wireless into that, those positions become very tricky. You’re cruising down the highway at 60 mph talking on your cell phone; where’s your origin? You’re calling someone else zipping down the road in another state, where are they? What’s their termination point?”

There is a movement afoot among carriers as well as government organizations to adopt a method known as uniform sourcing, which simplifies the taxing of roaming calls. “What uniform sourcing says is that all the wireless transactions are deemed to take place in the customer’s area of primary use, such as his home address or business address,” says Pamela H. Cook, director of state and local tax for BellSouth Corp. There are other ideas floating around to simplify wireless taxation, including a flat tax in states. (See sidebar.)

Carriers, especially startups, channel resources into marketing and sales, and often overlook the importance of getting their taxes right and paying them on time. They must invest in some form of taxation compliance, or face the consequences. Some wireless carriers buy tax rating software that attaches directly to their in-house billing systems, while others send their CDR data electronically to compliance services that manage their taxes and help them avoid penalties, late assessments, or worse.

Start at the Top

Most carriers have a good handle on recurring federal taxes, such as the federal excise tax, that 3 percent that applies to toll services, traditional long distance service, 800, 888, and so on—and virtually all wireless services except paging and facsimile. Then there’s the Universal Service Fund (USF), to which all carriers must contribute. The fund helps maintain averaged phone rates nationwide and subsidizes phone service for low-income users. Carriers are responsible for some 20 or so taxes at the state level, depending on the state, according to Gary Rhodus, president and CEO of Atlantax Systems Inc. of Atlanta. The company, which rated more than 660 million records in 1998, collects carriers’ tax data records and writes the appropriate returns for thousands of jurisdictions. It also provides tax consulting services, including tax matrices development, retroactive liability negotiations and audit resolution.

State taxes, Rhodus says, tend to fall into two categories: sales taxes and excise taxes. Sales taxes are broad-based, while excise taxes are targeted at certain products and services—e.g., fuel, electricity and, of course, telecommunications. Add to that gross receipts taxes and 911 fees. “Virtually every state has a tax levied on telecommunications; 45 states and the District of Columbia have sales tax, and these typically include cellular and wireless services,” Rhodus says. “If there’s a wireline tax, it’s probably applicable to wireless communications, too. The nightmare is pretty much the same for everybody.”

Taxes Abound in States

For instance, Alabama has the Dual Party Relay Fund for CLECs, at 10 cents per access line per month; the Emergency Telephone Service Charge; and the Commercial Mobile Radio Service Fund, which must be remitted to the CMRS Emergency Telephone Services Board. California—the Kingdom of Mordor when it comes to state telecom taxes—levies, among others, the California Relay Service and Communications Device Surcharge, the Universal Lifeline Telephone Service (ULTS) surcharge, the California High Cost Fund A and High Cost Fund B (which provides subsidies to carriers of last resort for providing basic local telephone services to residential customers in high cost areas), the Teleconnect Fund and 911 fees.

The real confusion begins at the county and municipal level. In the years since the Telecom Act passed, local governments have grown to realize that telecom taxes are a great way to raise revenue. And they don’t seem to be slowing. “At the local level is where things really begin to explode,” Rhodus says. “There’s a myriad of taxes, 911 fees, municipal utility taxes. Tampa, Fla., has a flat local tax that everybody who sells telephone services within the city of Tampa must charge 7 percent against the applicable phone charge.” Towns and counties usually shove telecom taxes into a general fund, which can be drawn on to pay for curb repair, manhole covers, to build new playground equipment in the city park, ad infinitum. One jurisdiction in Texas uses the tax for labeling containers containing chemicals so children don’t accidentally poison themselves

Getting the Address Right

“Every month, some companies are required to process, bill and remit up to 200,000 different taxes,” says Tim Lopatofsky, president of BillSoft Inc. BillSoft develops and licenses EZTax compliance software, which handles federal, state, and local taxes. BillSoft keeps up with changes in nearly 8,000 tax jurisdictions and sends monthly updates, usually on CDs or other electronic media, for clients to update the databases attached to their billing systems. The company released a wireless and enhanced services tax rating product in August, Lopatofsky says. The company also offers a service bureau environment to low-volume billers who don’t have the resources to keep up with tax changes.

“The real difficult part of local taxation that we found was making absolutely sure to get the local person’s address correct and the local taxes correct, because you can have the jurisdiction change on the street address, and you charge them the wrong E-911, Telecommunications Relay Fund or Telecommunications Assistance Fund.” BillSoft and other compliance services will also produce reports that spell out taxing jurisdictions, including country name, state, county, and the tax type, tax level and other data if carriers want to perform compliance filing in-house. It also has interfaces with Atlantax and Ernst &Young’s State Tax Resource Group.

How to Keep Up with Changes

But how do compliance services such as BillSoft and Tax Partners keep up with all the changes? How do carriers with in-house taxation systems do it? Answer: Research. The companies have a department of accountants and specialists who track the changes through state revenue Internet sites and by phoning tax officials nationwide. Some states mail updates of their tax codes monthly to those who subscribe.

Researchers often have to call out-out-of-the-way places in their quest for new information. “Some of the taxes, especially the local taxes in small communities such as E-911, are the responsibility of the local sheriff,” Lopatofsky says. “We had one guy in Illinois, the researcher called the sheriff’s house and the wife answered and said, ‘Hold on a second, he’s out in the field plowing.’ ”

CenturyTel of Monroe, La., which serves wireless customers in 21 states, obtains its data from several sources. Tax bills for gross receipts and property taxes all come through the mail, as well as some state pronouncements of rate changes. But at least 75 percent of the information is generated internally using a tax module, says Bill May, supervisor of state and local taxes at CenturyTel.

The carrier has 11 employees in its tax department, and a dozen people in the legal department that track legislative and judicial developments, May says. “If there are changes that need to be made, the billing director will receive information from our legal staff, the tax department and other avenues and make the changes” to the billing system, he says. He has this advice for companies considering adding wireless services to their offerings: “Seek expert advice, and make sure that you have a very competent staff.”

Jurisdictional Changes Constant

Jurisdictional changes are another headache. Florida in one year witnessed at least 300 annexations, which shifted thousands of addresses to new communities. “As far as jurisdiction information goes, it is complex,” DiBello says. “The important thing to remember when trying to identify a taxing jurisdiction is to equate a mailing address with a geographical jurisdiction. The difficulty in that is that postal boundaries and geographical boundaries often do not coincide. Having city, state and ZIP code doesn’t necessarily mean that you are associating an actual location—for example, an end user lives in a town called Linfield, Pa., but his mailing address is in nearby Royersford. Now when you look at transactional taxes, most of it is done based on postal address information. That’s where the complexity comes in; that’s where a lot of these carriers are struggling, because they’re accepting postal data and trying to equate a geographical jurisdictional boundary to it.”

Using Geocodes to Determine Jurisdiction

Vertex, whose CommTax 21 software supports a range of wireless telecommunications services, as well as expanded wireline services, uses proprietary geographical code data to track jurisdictional boundaries, says Jerry Allison. Using NPA-NXX data, Vertex matches proprietary geographical information with the switch location. “We have a pretty comprehensive list of NPA-NXXs that are in force now, or were in force recently,” he says. “We cross-reference those to our proprietary geocodes and look at the location of the switches, and we plot that onto the geopolitical boundaries. It’s not as granular as it could be, but it’s as granular as the industry provides. If all the CDRs in the billing systems are NPA-NXX, that’s what we have to work with.”

ZIP+4 Gaining Ground

Another method used to track jurisdictional boundaries, ZIP+4, offers more detailed postal information—which is not necessarily a good thing, DiBello says. “The problem with ZIP+4 is that it’s more granular postal information. The limitation with that is all kinds of boundaries don’t follow streets—especially where streets were created after these geopolitical boundaries have been out there for years,” she says. “ZIP+4 does cross county lines, which is where a lot of people think it can buy them some information. We have identified ZIP+4 has having granularity, and there is a lot of industry energy around that. But we want to be more granular.”

Two-Part System

CommTax is delivered to its partners—including ITDS, Convergys, and other large billing vendors—in two parts, Allison says. The first is a database of rates and rules, and the second contains the code, the calculations module and related support structure. The system can reside virtually anywhere on a billing system, he says. “The calculation module sits on the billing system at whatever logical point the billing system requires taxation, and that will vary between billing systems,” Allison says. “Whatever point in the billing system that taxation is required, that’s where the exit point is designed for CommTax to receive the information from the billing system, and then immediately return that tax at that logical point. That way we’re not encumbering the billing system by forcing it to do a little dance to get taxes the way we want the tax. The billing system can gather the taxes from us when we need it. The same rules apply in the wireless world. They can have roaming charges, the long-distance piece, the airtime piece—it all depends on how the billing system is written and how comprehensive it is, as to whether those pieces are handled in the same place or in a different module.”

DPC Delivers Database, Desktop Look-up

DPC Computers Inc. of Monsey, N.Y., is another player in the tax compliance module game. Its Zipcomm Database provides detailed, telecom-specific sales, use, excise and utility tax information “in every location throughout the U.S. and its territories,” says David Polatseck, president of DPC. As in other tax modules, the ZIPcomm tax data is mapped to ZIP code and NPA-NXX, and federal, state, county, city and all special districting taxes are covered in separate detail. The system also provides ZIP code cross-reference down to the ZIP+4 level and is available in ASCII format.

The company, whose customers include AT&T, Cellular One and GTE, recently released an automated billing system, API Calc Module, for use with the ZIPcomm database. “The module comes in the form of a callable DLL and enables Windows-based billing systems to access DPC’s telecom tax data,” Polatseck says. “The module contains all of the functionality required to run a full billing session.” An API for other platforms was to be released in August.

DPC’s customers also get monthly tax and jurisdiction updates for the modules via the Internet. DPC posts them on its secure site so customers can simply download the new data into their systems, Polatseck says. DPC also offers a desktop look-up functionality that lets tax managers look up all taxes and changes independent of a billing system.

Strategic Tax Management

Tax Partners’ typical clients include carriers who have a strong taxation and accounting infrastructure “but realize that filling out sales and utility tax forms are not their core business,” Dumas says. “So they outsource it to us and we provide them with state and local tax and reconciliation management reports, so they can manage taxes from the appropriate strategic level.” Other clients aren’t in such good shape. “One, they’re not compliant and they’re scared,” he says, “or basically they’re compliant, but the process has become so overwhelming that that they come to us to take on the whole state and local tax compliance function for them.”

Tax Partners either extracts the data from the client databases via FTP or receives the data through e-mail or CDs. “Typical clients FTP the data to us; we set up secure FTP sites for each of our clients,” Dumas says. But there’s always the old-fashioned way: “In some cases, we’ve had some clients that have months and months of unpaid taxes, and we’ll just go to their offices and go through cardboard boxes of tax records, late notices, requests for tax registrations and unfiled tax returns. We’ll clean them up and keep them current, by managing the monthly tax compliance process.”

Once carriers send their billing data or CDRs electronically, Tax Partners uses its Tax Remittance and Compliance System (TRACS), which automatically rates each record to calculate current period gross tax liability, checks trend and variance in the data, identifies monthly returns and calculates net taxes due. It also produces written returns, writes checks, produces reports on management and reconciliation, and posts them on its secure Web site (www.taxpartners.com). Customers can access their data via user ID and password. “The carrier’s tax data go in one end, and returns, checks, and management reports come out the other end,” Dumas says.

Getting Out of a Bind

In addition to straightening out records and writing returns for its clients, Atlantax also performs an operations review by analyzing a company’s business, the jurisdictions where it occurs, how the company bills its customers, the kind of tax returns it has been filing, and the taxes it should be filing. For clients who are in trouble for not paying taxes, voluntary disclosure is not uncommon. “Based on what we find in taxes that should have been paid, we take the client into voluntary disclosure on an anonymous basis,” Rhodus says. “We tell the state that we represent the client and that the company wants to clean up its tax liabilities. This is not uncommon. Most states have a wide penalty abatement attitude. We mitigate the tax damage.”

There is also the question of liability when it comes to service bureau contracts and taxing software. Who is liable if bad data is used to calculate taxes and the carrier is assessed penalties and back taxes? Overall responsibility lies with the carrier to supply the service bureau with accurate tax and rate data, and ultimately with the carrier’s finance department or tax manager, a tax expert says. “In the taxing jurisdiction’s eyes, the [carrier] has the obligation to collect and remit the proper taxes,” says Chris Savage, a telecommunications lawyer with Cole, Raywid & Braverman LLP in Washington, D.C.

Tax liability is a vital part of any contract, whether a carrier uses a service bureau or licenses a module for its billing system, Savage says. “It depends on the terms and conditions when you license the software. I can imagine a provision saying that if an underpayment of taxes occurs, the tax software provider or service bureau says, ‘You use this [tax software] as is, but you’re responsible for paying your taxes correctly.’ ” Other vendors might tell carriers that they stand by their software and will offer to pay the difference if tax data is incorrect and the carrier ends up owing a jurisdiction, he says.

“If an issue arises in the first place, the affected carrier should look at his contract to see if there is any basis it can recover [losses] from the software vendor. If I was the software vendor I would be remiss if I didn’t want to limit my liability substantially,” Savage says. Meanwhile, the carriers would want to negotiate a contract that would hold the software provider or service bureau liable at some level. Nor do states want to be held liable if they produce the wrong tax data. The California Public Utilities Commission lists nearly 500 utility tax rates levied across municipalities with this caveat: “The commission disclaims responsibility for the accuracy of this data furnished by the taxing [jurisdiction].”

Unpaid taxes spell trouble, and not just for that corporate officer served with a warrant. They can halt initial public offerings, stymie mergers and acquisitions, and freeze a company in its tracks. “If you have any aspirations for selling your company or going public, these kinds of things will come back to haunt you,” Rhodus says. “In a due diligence situation, if you’ve not paid your taxes, and you’re looking for a buyer or planning to go public, it’s not going to happen until those taxes are cleared. It can be a huge hit against your revenue stream from the sale or going public.”