Industry Wants Out of the Telecom Taxation Maze

Telecommunications taxation has an unmistakable need for one thing: simplification. The industry has been hit the hardest when it comes to taxation complexities, making compliance for providers a nightmare. And so far, there has been little incentive to simplify compliance regulations. However, the Streamlined Sales Tax Project (SSTP), whose plan involves simplifying the states' sales and use tax system, may be just the inducement the industry needs.
Multiple initiatives are pushing for clearer definitions, more uniform tax laws across the states and easier filing requirements. They are using the momentum gained by the SSTP to encourage governments to reform telecom taxation as well. But making this happen may prove to be a Herculean effort.

Where It All Started

The SSTP's primary goal is to ease the burden of compliance with state sales tax laws for all commerce. As electronic commerce threatened the states' ability to collect sales taxes on goods sold over the Internet, the need to make compliance easier became more apparent. The SSTP has sought to address that need, yet where telecom is concerned that effort only scratches the surface of what industry experts realize is a much greater taxation problem for providers.

Thus, the Telecom Tax Reform Initiative (TTRI), a group of industry and government leaders, has evolved to take a closer look at the taxation issues plaguing the telecom world. And, according to AT&T's Deborah Bierbaum, director and leader of the TTRI, there's no limit to the number of issues.
Bierbaum explains that the TTRI has been providing input for the SSTP, but the SSTP's focus is on sales tax. We, the telecommunications industry, need reform not just for sales taxes but for all the transaction taxes on our services, she says. There's gross receipts taxes, any number of fees and unique taxes that are just on telecommunications.

The Tax Burden

The Committee on State Taxation (COST) is yet another organization involved in telecom tax reform. It consists of 540 major multistate corporations from all sectors of industry conducting both interstate and international business. In 1999, COST's Telecommunications Tax Task Force compiled its first study on telecommunications taxation for the President's Advisory Commission on Electronic Commerce, to outline the onerous federal, state and local level of taxation imposed on telecommunications. The committee is working on its 2001 update, slated to be out in either October or November.

According to COST's latest report, telecommunications service taxes average about 18 percent, while general business taxes are around 6 percent. In addition, providers face three times the total number of taxes that general businesses face-350 different taxes, versus 117. Providers also deal with 2,096 more taxing jurisdictions.
Likewise, from 1999 to 2000 the industry faced an increase in filing requirements, bringing the total number of filings for a provider to 63,879 across the nation, compared with the 8,951 returns that would be filed by goods vendors.

Some state and local governments allow for vendor compensation and reimburse providers for the cost involved in collecting taxes on telecommunications services.
This money is supposed to offset the administrative costs providers' face in collecting taxes. Typically, this money is either a dollar amount or a percentage of every dollar a provider collects, thus operating on a sliding scale where the more tax dollars a provider collects, the more it is compensated. However, Ron Clark, chief operating officer at the tax service bureau Atlantax Systems says, As costs in the industry rise, vendor compensation remains the same. And providers are still faced with purchasing expensive tax systems and updating those systems regularly as the laws change.

The telecom industry is one of the most heavily taxed industries in the United States, pretty much bar none, says James E. Nason, a Deloitte & Touche partner who deals with multistate tax issues. Historically, what has happened is pretty much every jurisdiction along the way would put their hand out and add either a fee or a particular tax or something on top of telephones and telephone service. It was an opportunity to raise taxes, but quietly.

It's like gasoline, says Bob Hartmann, vice president of the Americas at billing vendor Suntec Business Solutions. Whenever government needs a little bit more money they throw a tax on. It's a great revenue stream, because people have to buy gas and people have to make phone calls.

The telcos have the right to be a little upset, because it's so heavily taxed, Nason says. You take a state like California-on a California telephone bill, the last page is all taxes and fees. Florida, however, has simplified bills by rolling up individual state and county taxes into one consolidated amount that telecom providers pay to the state Department of Revenue.

Splitting Hairs Over Revenue

Yet eliminating taxes and thus reducing the collection burden on providers means taking revenue away from the states. Given the current economic atmosphere, states are not likely to concede any of their revenue. Sen. Steven Rauschenberger (R-Ill.) addressed the U.S. Senate Finance Committee discussing the issue of taxation of electronic commerce. In his testimony, Rauschenberger cited findings by the University of Tennessee Center for Business and Economic Research that states stand to lose $11 billion in 2003 through the emergence and growth of electronic commerce. According to the statistics, Florida alone stands to lose $754 million, while Illinois could lose $454 million and Tennessee would follow at $293 million.

In addition, about 40 state governors have been lobbying the U.S. House and Senate this fall to end the Internet Tax Freedom Act's moratorium on Internet access fees and Internet-specific taxes, including those on e-commerce, that are up for review this month.
It is in this climate that telecommunications providers are fighting to decrease the high administrative burdens placed on them. A couple of years ago I think you might have seen the states more willing to lower the tax rate, says Eric Tresh, Andersen's state and local telecommunications tax practice leader. This has become less likely, he says, as the economy has shifted and the huge budget surpluses that were once projected are no longer there.

Once the government-be it the state or federal-starts getting this money, it's tough to take it back, says Hartmann.
Recognizing this, the telecom industry is not immediately seeking to lower taxes collected, but to decrease some of the onerous costs of compliance with multiple jurisdictions.

Inconsistent Definitions

Perhaps the first step of simplification would be for the states to establish uniform definitions of what constitutes a taxable telecommunications service.
[A lack of] uniform definitions, I think, is what causes our customers a lot of pain, because in one state what they are selling is one thing and in another, it's something totally different, and the taxability and the way to apply the tax is going to be affected because of that, says Diana DiBello, manager of transaction taxes at Vertex.

There's a big disconnect in terms of what is a taxable telecommunications service, says Andersen's Tresh. For example, definitions for data transmissions, whether they are taxable and then to what extent are still unclear, as well as whether and how enhanced services and information services are taxable. Some states, like Tennessee for example, have very broad-reaching definitions in terms of what taxable telecommunications services would be, Tresh notes. Florida's new definition is broad.

Some states might exempt residential phone service from tax, Bierbaum of the TTRI points out. If every state has a different definition of residential service, when a provider is building in its tax module and its billing system needs the information, the tax module might have to send in different information for whether something qualifies as residential. If you have uniform rules, there's only one set of information that goes in. If one state only taxes residential and another state exempts it, that's their right, but at least it means the same thing, she says.

The TTRI's industry members have been working on a set of definitions, according to Bierbaum; these will likely be submitted to state government members of TTRI and through them will feed into the SSTP efforts.

Understanding the Technology

Imperative for defining terms for taxing telecommunications services is understanding the technology. In this arena, states often lag. The biggest challenge for us is the interpretive aspect, DiBello says about Vertex. Where the statutes and the ordinances don't specifically state what is included in the definition because they haven't caught up with technology, then we need to go and we need to get clarification from the jurisdictions.

Nason says, We're making leaps and bounds in our technological advances, but the state taxing authorities don't have the same arms and legs. He adds that telcos have to invest an enormous amount of money in keeping track of the taxes and compliance: It's not two cans and a string anymore.

Some states have determined they don't want to tax the Internet, data or enhanced services, Tresh notes. For some taxpayers, that's a very good thing, he says. From a compliance perspective, figuring out where those loopholes are can be difficult, and the reason it's going to remain difficult is because of technology. I think the states need to go one of two ways: tax everything, or specifically delineate what we're going to tax and understand that as technology changes over years, more and more items are going to be developed that lend themselves to gray areas. I don't think there's an easy answer here.
In addition, with technological advances various other providers are increasingly offering telecommunications services. Vertex's Bill Vink, communications tax group leader, notes that cable providers now are providing telecommunications services that don't fall under the same tax burden faced by a regular telecommunications company, because they are not regulated as a telecommunications company. And, he says, the same thing is happening with voice over IP. Cable providers can charge much lower rates because they are not being treated as long distance, and they are getting around the access fees, he says.

Everybody is kind of operating under their own realm, and that's what makes it hard for a business to comply, Nason says.

Effective Dates

The TTRI and the telecom industry as a whole want adequate and timely notice of rates and jurisdictional changes. Changing rates or creating a new jurisdiction would happen only at specific times of the year, not any time a government wanted.

Take, for example, New Hampshire. According to Bierbaum, the state recently had a rate change that would affect telecommunications services effective July 1. The legislature passed the bill before July 1, but the governor had not signed it into law. If the governor signed the bill into law, the providers would not know until after July 1, so this created a dilemma: Should the providers change their systems on the assumption that the governor would allow the bill to become law? If the governor vetoed it, would the provider have charged customers too much? But if the governor did not veto it right away, what would happen? In this case, the tax administrator gave the industry leeway, but similar situations could occur again.

The industry is also asking that states allow a couple of years before effective dates for major changes, so companies have time to change their billing systems. Bierbaum notes that in the SSTP's proposed plan, if a company used certified software, the company would be free from audit. This could be a possible option for telecommunications providers.

Billing Burdens

Right now, to the extent that we have no uniform laws, it would be the amazing billing system that has every state figured out correctly, says Bierbaum.
You have a situation where you have some states with unclear rules and states with different rules, she says. As a result, no matter how perfect you try to make your systems, [a provider] could have mistakes and face wide risks and class action lawsuits from customers. If you have clear rules, rules that make more sense, uniform rules, those risks are substantially reduced.

Yet, Bierbaum says, sometimes providers make business choices: 'I can't program that. We'll take our chance on that,' they tell themselves.

[At AT&T] we sometimes have to manually process certain bills for customers to get the tax right, because of such unique rules in certain states, she says.
If you look at a typical billing system, you're going to have to apply a tax to every call detail record that comes in through your rating system. That's an awful lot of overhead on the billing system, Suntec's Hartmann says. If [the states] ever simplified it enough where you could just maintain it within the billing system, you could eliminate a major cost for external licenses of third-party tax software.

I've dealt with a number of clients who maybe have $50 million or $100 million in revenue, they're doing business in 30 states; but to comply with those taxes, and build the infrastructure to be able to comply with those taxes, is an extremely onerous burden, Andersen's Tresh says. On the flip side, it's no picnic for the very large companies themselves, with tons of products and services. Typically, they'll have more than one billing system, so updating those billing systems becomes fairly difficult-and the states have been typically aggressive with the big companies, because they view that to some extent as revenue generation.

You have to have enormous billing systems, says Deloitte & Touche's Nason. You have to have an enormous amount of information, because all of these tax bases are in play, the call record [and the information in that record] to determine how to tax this call, and you've got to keep track of all that information. The telcos are in a very tough position.

He says that even remitting the 911 tax is a challenge. Each jurisdiction has its own tax that must be remitted, and any provider that wants to provide local services must keep track of the rate, siphon out that small percentage of money and remit it back to each and every jurisdiction.

Providers walk a fine line, because if they get overly aggressive in trying to tax or not tax a call or a service, and try to be kind of competitive in the marketplace or pro-customer, then they are in trouble in an audit, Nason says. They are caught in the middle, because they don't want to get in the position where they have to pay for it, but what happens if consumer advocacy groups and class action types are getting together saying, 'Hey, they billed me this extra 10 cents and they shouldn't have done it'?

We're trying to just do our best to collect the right amount of tax, Bierbaum says about AT&T. We don't want to collect too much from our customers and face action on their part, nor do we want to not collect enough and face audit risks from the states.
The eventual goal is to have consistency from state to state so the billing system and the tax matrices do not need as many special exceptions and rules, because everything will be following the same format, she says.

People working on billing systems, as they're making their changes, need to look at a lot of the stuff we're doing and take into account that, if in the next two years we are successful and get in a lot of these reforms, they will have to make sure their systems will be able to move there, she adds. It will be a better world once we get there, but there will be some costs to get there.

Third-Party Modules

Although many billing products may have a level of tax logic in them, Suntec's Hartmann says, most providers opt for third-party software. For a carrier operating in only a couple of states, it would be very easy to put that into the taxing module and avoid interfaces to a third party. While some of the carriers can afford and prefer to do their own taxing in house, the complexities of changing tax laws rule out this approach for many smaller providers.

Vertex's Vink says that for smaller companies, these taxes have a much bigger impact. They don't have the resources to track and keep up with the tax changes and rates that come out, and it really puts a much bigger burden on the smaller companies than the larger ones-but even the larger ones struggle with keeping up with the taxes, as it is now.

He adds that the burden is not just keeping up with the rates, but also the actual filings that providers have to do with the various governmental bodies. You also have the problem that telecom isn't administered by just one regulatory party, he says. You have to deal with the Department of Revenue, you've got to deal with the PUC, you've got to deal with the local 911 coordinators-you've got all these layers of bureaucracy that you've got to be able to navigate through, to be able to get hold of the information you need. Then once you get it in house, you've got to interpret it.

Even if things are simpler, Vink says, providers will still have the burden of tracking down all the rates in different jurisdictions, and they will still have the problem of updating when tax laws change. Even if you have the definitions standardized, he says, you are not going to have what is taxable standardized, because you will have different special interest groups in different states that will push for little nuances that will alter their taxability.

We have a large department of people whose job is just to get the information in, then we have additional people who have to interpret it-and for a single phone company to do this, it would really eat into their bottom line. Altogether, Vertex employs 450 people, 60 of whom are dedicated to research alone.

Yet third-party tax modules are not always easy to connect to billing systems. The biggest problem I've always found has been the billing system being able to interpret the tax information …, Hartmann says. Maybe applying a tax to something that should be applied exactly that way, it might for some reason be tax-exempt, or there's some special rule because in some states it doesn't apply for a full tax, maybe it's 50 percent of the tax. And it's a lot of work for the billing system to be able to understand all of those rules to apply the tax on a per CDR basis plus your recurring costs, your nonrecurring costs, just all the different rules that have to be in the system.

The Time Frame

So with all this talk of simplification, when can the industry expect change? Even Bierbaum believes simplification will take some time. I don't see anything happening in anything shorter than two legislative cycles, just based on the sheer number of states, she says. And like anything, there will just be a few states that will just take a lot longer for something to happen.

Andersen's Tresh says the reality is that even if interested parties come up with uniform definitions and rates, they still have to be passed by 50 state legislatures: I think the chances of us having true uniformity are probably not too great, although I think we're going to get better… I definitely think it's going to make things easier.
You've got a lot of states and you've got a lot of jurisdictions that you've got to keep happy, because what's good for one jurisdiction bankrupts another, Nason says. He points out that politics and changes in state leadership could weaken the current momentum to simplify.

Yet Tresh believes that the effort really has gone a long way. I don't think you'll ever see 50-state uniformity out there-I don't think that's an option, he says. What I think can come of it, though, is the people can get the environment simplified and better to the point where the compliance burden becomes reasonable. I don't think it's reasonable right now, and I think everyone is hoping for a reasonable standard. I think it benefits both parties: … From an industry perspective, there's clearly a reasonable burden to comply with; … from a state perspective, they are probably likely to get more revenue if they make it easier to comply with the law.