Telecom Taxation: Top 10 Challenges for 2006 By Dr. Jerry Lucas December, 2005
Telecom taxation is extremely complex, administratively prone to filing errors and ever changing. And 2006 will usher in even more complexity, confusion and change. For that reason, it's worthwhile to look at the top 10 challenges facing service providers' tax, marketing and billing system teams. But before we get to that, why should service providers in general care about taxation? First, telecom taxation ranks just behind fuel and sin taxes. State and local taxes can be as high as 30 percent of a consumer's bill (as in Virginia), and they average 18 percent nationally. The complexity (or absurdity) is that those taxes can change, depending on how services or products are presented or described the on the bill. Second, the tax rate changes depending on how a business is defined (telecom, cable or ISP). So if Verizon, Comcast and Google are offering the complete service bundle (voice, data, video and wireless), their individual tax rates will vary from zero to 30 percent, depending on how they define their business. And third, tax changes in 2006 will challenge every service provider's legacy billing system. So why is telecom taxation so complex, error-prone and ever changing? Consider the driving forces of telecommunications in general -- politics, money and technology -- and apply them to taxation. Politics Telecom taxation politics breaks into two camps: service providers and government organizations (not just agencies but also the associations that represent them or government officials). An analogy can be made here to a politician running for office (service providers) and special interest groups (different government interest groups). First consider the service providers. Regarding taxation issues, Tier 1 service providers (RBOCs, wireless providers and cable companies) are united except over local video franchising fees, which are not really considered taxes anyway. The smaller service providers, like VoIP over broadband players, have no seat at the table with government players. (Who's going to waste time negotiating with service providers that think VoIP shouldn't be taxed?) So back to the election analogy. Here you have the candidate (OK, a collusion of nine Tier 1 players) wooing the special interest groups (government agencies and associations) to gain election support (equal taxation among all players and less compliance red tape, tax audits, administrative overhead, litigation and more). Now for the special interest groups. All government executive branches (federal, state and local) share one thing in common with regard to telecommunications taxation: they love it. Where else can you have some entity (telecoms) collect your taxes and then also take the blame when taxes are raised? Since many consumers don't understand the charges on their bill, in particular, taxes and only look at the bottom line for what they owe, they just assume that their service provider is raising their rates when they see an increase. The unity of government organizations ends here, however. The state governments don't trust the federal government, and the local governments don't trust the states. But all these segments of authority have their own groups to champion their interests. There is the National Governors Association (NGA), representing state executive branch interests; the National Conference of State Legislatures (NCSL), representing state legislators; and the list goes on, with organizations representing mayors, counties, municipalities, state budget offices, you name it. In the election analogy, in order for the candidate (the telecom) to win the election (tax clarification), it has to woo the interest groups -- and in this case the special tax interest groups are the NGA, NCLS, and others. For example, to win support from the governors' group (the NGA), the telecoms have to support the repeal of the Internet Tax Freedom Act (ITFA) that removes taxes on eCommerce, access, etc. But Congress and many powerful Washington politicians love the ITFA. Bottom line, there is no consensus among government organizations regarding tax reform, and lots of new tax legislation is pending in year 2006. Money The government raised nearly $ 100 billion in taxes, surcharges and fees from telecom service providers. That's their good news. The bad news is that this goldmine will shrink unless they do something, such as imposing higher or new taxes. Why? VoIP over broadband reduces wireline customers -- the highest source of taxes -- as does "free voice" via Skype and other such services. It's a lot easier politically and operationally to raise telecom taxes and let the telco be the collection agent than to introduce new non-telecom taxes. So, Tier 1 telecoms can expect more tax compliance confusion, more filings and more audits. For the VoIP over broadband and ISP voice service providers, expect to see some hefty tax bills in 2006. Note that AT&T (the pre-SBC version) filed more than 55,000 tax returns every year. A small carrier couldn't cope with this burden. And for small VoIP over broadband players not filing tax returns, the tax collectors in many states can go back as far as three years to get their money. Bottom line, the money forces alone will make taxation more complex in year 2006. Technology New telecom technologies that create new services further cloud the taxation process. Here are some crazy tax examples. Ringtones versus music downloads: The first ringtones were delivered by transmitting software plus music content to create a ringtone on a wireless phone. So ringtones were taxed as a software product in some states. However, a complete song is considered content and not taxed. Then the technology changes. Ringtones now are just a snippet of a complete song and not delivered with software. Yet today a ringtone is taxed, and a song download isn't. Presence: Today, with the new Session Initiated Protocol (SIP)-based services, a phone call can cause your office phone, mobile phone, soft-client laptop, home phone or other device to ring. If these devices are scattered all over the country and one of them answers the call, is it an intrastate or interstate call? Some states tax intra-state traffic only. How do you classify this call? Peering: VoIP peering can be done differently than PSTN carrier peering, and the revenue settlement models are different. Consider the tax reduction when VoIP carriers financially clear like ISPs (bill and keep, meaning no cash is exchanged), or when enterprises clear VoIP traffic with no carrier revenue generated and no money changing hands. "Free" doesn't generate tax dollars. Top 10 Taxation Challenges Politics, money and technologies will drive change in telecom taxation. So what challenges will confront tax, marketing and billing system teams and their vendors in 2006? Here are my top 10. 1. Digital Services Versus Goods Differentiation Some industry generalists like to say in the digital age that bits are bits, regardless of what they represent. Of course, from an engineering perspective, quality of service considerations make this statement incorrect. But also, from a taxation and billing perspective, bits are not just bits. Digital service (voice or data) and digital products (movies, recordings and more) must be differentiated for taxation and billing. The real challenges occur when these bits are sent as IP packets using SIP. With this protocol you can add and delete services or digital goods at a keystroke, adding taxation to the complexity of rating and billing. 2. Same Service, Different Classification Every state and local government has its own classification scheme for digital service and goods. A downlink loaded ringtone in some locations may be classified as software, content or communications. Tax too low or not at all, and you are subject to an audit. Charge taxes when you shouldn't, and you are subject to a class action lawsuit. For example, AT&T overcharged 74 cents for a tax it shouldn't have applied, got sued by a consumer and ended up in court (Allen vs. AT&T). The judge certified a class action suit covering 25 states. AT&T spent millions in legal fees, internal resources and public relations capital. As service providers grow their IP product mix, expect the tax people and class action lawyers to be watching. 3. Geographic Phone Numbers Phase Out Just like Social Security numbers once held geographic significance, but don't today, so will be the case for phone numbers. Providers of VoIP over broadband will give you a number that makes you look to the caller like you are from any city in the United States. You can also get virtual numbers that make every call look like a local one. Worse yet, telephone numbers will give way to IP addresses, which have no geographic significance. Knowing what is interstate or intrastate for taxation purposes will be more challenging than ever. 4. VoIP Peering In the good old circuit-switched world of peering, clearing and financially settling for traffic exchange between service providers was straightforward except for phantom traffic (where service providers change call originating or jurisdictional data in order to avoid access charges). The new world of VoIP peering will be different. It will resemble the way ISPs peer. Most traffic is financially cleared as bill and keep: I'll bill my customer and keep the money, you do the same, and we'll exchange packets and not money to complete transactions. Also, peering will be done at the LAN level, and will be multilateral and not bilateral as in the PSTN world. Peering businesses are emerging to do this, and enterprises can join in. Not only will long distance revenues go down (reducing the tax base), but how do you classify for taxation a peering company that operates a LAN in a building with no outside network? And how do you classify inter-enterprise networking with no carrier in the middle, just a peering point? 5. Presence One of the main drivers for IP Multimedia Subsystem (IMS) architecture is that a service provider can tie together wireline and wireless networks and deliver presence-based services. Envisioned simplistically, your call can be completed to your cell, home or office phone with simultaneous ringing, or the network can identify your "presence" and route the call directly to you. The challenge for taxation is that if the call rings to an out-of-state phone but is answered on an intrastate device, how do you tax this event, with different intra- and interstate tax requirements? 6. VoIP Equipment VoIP changes a lot of things in the tax world. Notably, a VoIP PBX (IP- PBX) or public switch (softswitch) is just a server in an all-IP network that can be located anywhere and can change location in almost real time. How do you deal with property tax or prime place of business for taxation purposes? 7. E-911, CALEA Fees and Broadband In order to support automatic location for nomadic VoIP E-911 as well as CALEA, you have to get the provider of broadband access involved. Once this is accomplished, and it will be no small challenge, you need a mechanism to add on E-911 and CALEA support fees. You've got to disclose the CALEA fee as an overhead fee, otherwise customers will call in and ask, "Why am I paying a 'Wiretap Fee'? Does this mean you are tapping my phone?" In the end service providers will love it, because as a broadband blanket surcharge they can keep part of the revenue to pay for CALEA and next-gen E-911 infrastructure costs, and government will see this as another source of levy revenue without calling it a tax. The challenge for tax people is, how do you use this service metric (broadband access) as a tax metric, with the Internet Tax Freedom Act passed by Congress prohibiting taxes on Internet access? 8. New Legislation Taxation is the United States is a mess regarding compliance, filing, auditing and litigation, not only for telecoms but also for retailers, manufacturers and just about every line of business. Congress and state and local governments are of course aware of these problems. As such there are many tax issues facing U.S. businesses that Congress and others are addressing with new legislation. You have the Streamlined Sales Tax Project (SSTP), Business Activity Tax (BAT) and Internet Tax Freedom Act, and much more at the state and local levels. The challenge for telecom tax teams is interpreting these general tax laws and applying them to telecommunications. 9. Defining Your Company It will be a big stretch to define your telecom business based on tax law, a gigantic case of the tail wagging the dog. But the Googles, Yahoos and Microsofts are entering the telecom business without being labeled telecom companies. Note: Cable companies pay franchise fees (in the 5 percent range) and no utility taxes like telecoms (high taxes). Maybe calling yourself a cable company, if you have a FTTP network-based service, has its advantage. The less extreme approach, for tax strategists with corporate definition clout, is to create separate subsidies in order to reduce or avoid taxes. 10. Service Bundles Lastly -- and probably the most important challenge to deal with -- is valuing service bundles for tax purposes. How do you take a digital service/goods bundle and allocate charges among tax categories? Further complicating allocation is the type of network access service (wireless, wireline, Internet and so on). Note that telecom taxation is not network technology-agnostic, and further complicating matters are all the new tax requirements generated by SSTP, BAT, ITFA and others. If you would like to hear what tax experts have to say about these Top 10 Tax Challenges for 2006, tune in to the TeleStrategies Service Provider Club Webinar on January 10. If you want to understand how to allocate bundled service charges among taxable categories under MTSA, SST, ITFA and more, tune in to the TeleStrategies Special Tax Webinar on February 7. Go to www. telestrategies.com for more information -- and good luck with your taxes in 2006. Copyright 2005 Telestrategies, Inc. Billing World and OSS Today
