Law360, New York (July 8, 2015, 5:00 PM ET) — Perhaps the largest tax issue facing telecommunications companies is the sheer number of taxes levied on them at the federal, state and local level and the bewildering complexity of complying with them.
According to a touchstone study performed by the Council on State Taxation in 2004, telecommunications companies are subject to three times as many taxes as regular businesses, and face an average combined effective rate of 18 percent, compared with 6 percent for other businesses.
The discrepancy in taxation stems from the days when telecommunications companies were heavily regulated monopolies that mostly provided landline telephone services, according to Arthur R. Rosen, a partner with McDermott Will & Emery LLP.
While some states have enacted a patchwork of measures to bring the tax treatment of telecommunications into the modern era, the law still lags behind, he said.
“It’s really shocking when you see the numbers all together,” Rosen said.
Here, experts provide four tips to help telecommunications companies stay one step ahead of authorities and on top of their tax liabilities.
One of the most important things for telecommunications companies to do is to spend some time to figure out exactly what taxes they are subject to in each jurisdiction they operate in, Rosen said.
In addition to sales and use taxes, telecommunications companies can be charged excise taxes, franchise taxes, gross receipts taxes, emergency services taxes and others. The taxes are often levied on consumers, but service providers are responsible for collecting them and remitting them to tax authorities, Rosen said.
These pass-through taxes require a thorough analysis because if a company does not know it is liable for a tax and doesn’t charge the consumer for it, the company will be on the hook for it later, Rosen said.
“Once the company has lost the opportunity to collect the tax from the consumer, the company as a practical matter is going to have to pay out of its own pockets,” Rosen said.
Because of the complexities of complying with the assortment of taxes imposed on telecommunications companies, some companies outsource their tax collection and remittance duties to third-party firms that specialize in the area, Rosen said.
Jonathan S. Marashlian, the managing partner of telecommunications-focused Marashlian & Donahue LLC, said companies that come from a brick-and-mortar background are often surprised to learn that traditional nexus concepts do not apply in the world of telecommunications services taxation, where many tax authorities will find the existence of nexus based on the fact that the service provider is delivering communications to a customer that originate or terminate in a state and bill the customer for services.
On top of the staggering number of taxes faced by telecommunications companies, tax authorities are aggressively taxing companies for services that fall into a legal grey area, according to Allison D. Rule of Marashlian & Donahue.
As telecommunications technologies have advanced, companies are providing more and more services that don’t fit the traditional rubric, such as Voice over Internet Protocol phone service, Rule said. Although statutes are ambiguous at best about whether the new services should be subject to traditional telecommunications taxes, tax authorities are taking an aggressive stance and taxing them anyway, she said.
For example, many providers are offering so-called hosted telecommunications services based in the Internet to businesses, Rule said. While the revenue hosted service providers receive from phone calls is likely taxable, they also provide clients with other services such as the ability to access voicemails over email, which is a data service that falls outside the traditional definition of taxable communication services, she said. Auditors, however, commonly take the position that the entire hosted services package is taxable, she said.
Rule said despite the expense, she advises companies to take a conservative approach to their tax compliance to reduce their exposure to unpaid tax liabilities. If a company offers a bundled service, it is probably wise to take the position that the entire package is taxable and collect and remit taxes accordingly, she said.
Even though some tax authorities’ treatment of telecommunications services is contrary to law, the costs of litigation can be prohibitively expensive considering the number of jurisdictions in play, Rule said.
“Companies are being forced basically to either pay taxes based on questionable interpretation by auditors, or pay for costs of appeal,” Rule said. “It’s really a shakedown.”
Or Be Prepared
Many companies, when confronted with a small tax liability in a distant jurisdiction amounting to mere dollars, are unwilling to spend the hundreds of dollars required to register, bill, collect and remit taxes to the state or local revenue agency because the cost of compliance far exceeds the consequences and costs of not complying, Marashlian said.
Even though a conservative approach may be advisable from a legal perspective, companies might not see it as the best business decision, Rule said. Especially for new businesses, being conservative can put them at a competitive disadvantage, she said.
“If you are doing strict compliance, you end up paying taxes in every jurisdiction where you have nexus,” Rule said.
Other businesses, meanwhile, may wait until they reach a certain sales threshold in a jurisdiction before paying taxes there, Rule said. While that is a perfectly valid business decision, companies who take an aggressive stance toward compliance need to have a plan for when auditors come knocking, she said. That means companies need to be able to explain their method of allocating taxes by jurisdiction and have documentation that supports their position, she said.
“Chances are you’re going to get caught — it’s a matter of if, not when,” Rule said. “The more support you have, the better chances you have.”
Telecommunications companies need to have a plan for how to comply with taxes in each jurisdiction they’re in from the beginning, Rule said. Companies that wait to comply with taxes until they reach a certain threshold get used to not having to report and remit taxes and then never get around to implementing a solution when they grow big enough to draw attention from auditors, she said.
If companies don’t collect taxes upon entering a market and then start charging for them later, it can be difficult to explain to customers why taxes are suddenly showing up on their bills, Rule said.
If a company doesn’t collect taxes and gets audited in one state, it can have a domino effect since state tax administrators talk to one another, increasing costs even more, Rule said.
One client of hers got examined in one state and shortly thereafter was facing audits in six states, she said.
“Everyone thinks it’s so expensive to comply at the outset,” Rule said. “When you have to hire an attorney and have an auditor come on sight to review your books and records, it can be substantially more expensive.”
–Editing by Emily Kokoll and Katherine Rautenberg.