December 2004

The Latest Taxing Question Concerning IP Services

BY John Cimko

Show me the money!
Like Tom Cruise in the movie Jerry Maguire, some state and municipal taxing authorities are uttering these very words and choosing to apply traditional telecommunications or cable television taxes to IP enabled voice and video services. At the Federal level, the IRS recently sought comment on whether the Federal Excise Tax (“FET”) should apply to the many forms of VoIP. Some of the youngsters at the IRS can be forgiven if they don’t recall — but the FET was originally applied to pay for the 1898 Spanish American War. At that time the tax was imposed on approximately 2,000 telephone lines. Over a hundred years later and hundreds of millions of us are still paying for the six-month long conflict by way of a three percent surcharge assessed on our local and long-distance telephone bills.

After a century it’s easy to forget why most of these taxes were ever enacted, of course, after this long it’s also just as easy to forget what the taxes were intended to apply to. While the FET and hundreds of state and municipal tax laws were imposed on fixed line telecommunications services, most of these laws were crafted well before the advent of the Internet and VoIP and, as a result, they were never intended to apply to these types of services. Although VoIP and other IP enabled services promise to improve productivity and reduce the cost of communications services to small business and residential consumers — at least some are engaging in the folly of suggesting that these laws should now be applied to an entirely new generation of communications services. Such thinking not only ignores the fact that many of these taxes no longer advance the purposes for which they were originally intended — but it also seeks to perpetuate and extend an invisible but perceivable drag on the U.S. economy by taxing the Internet and penalizing innovation that is leading to the deployment of far more efficient communications technologies within this Nation.

Of course it’s not just the ap-plication of the FET that threatens to stifle the growth of Internet video and telephony — it’s an avalanche of countless other taxes as well — the three percent FET; a nine percent Universal Service Fund fee; hundreds of state and municipal telecommunications taxes; and franchise fees that, all totaled, could add upwards of 40 to 50 percent to the total cost to the consumer. It’s this combined taxing burden that led one telecommunications CEO and industry visionary to note during a recent industry conference keynote that bit for bit — the U.S. Postal service still remains the most cost efficient means of delivering information to much of the country.

Perhaps more daunting than the taxes themselves is the cost associated with trying to properly collect them. Assuming that local telecommunications taxes could ever be reasonably interpreted to apply to VoIP services — how should a service provider assess such taxes on a call made using a New York 212 area code, by a customer located in London, with a billing address in Miami to another VoIP caller on her Miami telephone number while physically being located in San Francisco? Does anyone suspect that that the cities of Miami, New York, London, and San Francisco as well as their respective states and counties will all concurrently seek to tax this call? Given possible criminal penalties for failure to collect and pay the “appropriate” taxes, would you be more likely to hire an army of lawyer and accountants or move your existing employees offshore and continue to provide the service? The choices seem obvious to many.

Over the course of the next year, Internet entrepreneurs and their CFOs can expect to face an increasing number of tax questions as state and federal budget offices look to push the limits of reason in their hunt for additional revenue. Unfortunately relief is far from certain. Currently the protections afforded by the Internet Tax Freedom Act protections are no longer effective and the passage of an extension remains in doubt. Although Senator Sununu introduced S. 2281, the “VOIP Regulatory Freedom Act of 2004” the legislation remains tabled until next year. Under the bill, VoIP would have been exempt from a patchwork of multiple and discriminatory state regulations; it would have also preempted the states from imposing upon VoIP applications many taxes of general applicability. The bill further stipulated that the FCC would be permitted to exempt VoIP from Universal Service Fund contributions — a fee that VoIP providers now pay on an indirect basis. The Senator has indicated he will move to introduce the legislation again next year.

John Cimko served for fifteen years at the FCC, and currently practices law at Greenberg Traurig LLP in Washington, D.C. The views expressed are solely those of the author and should not be attributed to his firm or its clients.

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