Internet Access Service Not Subject to Sales Tax

New York Law Journal, June 19, 1997


Copyright 1997 New York Law Publishing Company  
New York Law Journal

June 19, 1997, Thursday


LENGTH: 1954 words

HEADLINE: Internet Access Service Not Subject to Sales Tax

BYLINE: JONATHAN BICK; Jonathan Bick is an attorney with IBM in White Plains, N.Y. The views expressed in this article are his own.

GOVERNOR PATAKI proclaimed in a January press release n1 that he had directed the State Department of Taxation and Finance to implement recommendations for exempting Internet access service from New York sales taxes. n2 The announcement begs the question: were Internet access service charges ever subject to the application for state sales tax?

n1 See Governor: Internet Services Providers Free From Sales Tax State of New York Executive Chamber Press Release, (Jan. 10, 1997) [which can be found on].

n2 Office of Tax Policy Analysis, New York Department of Taxation and Finance, Improving New York State's Telecommunications Taxes: Final Report and Recommendation (1997) [herein called the Telecommunications Report].

An Internet access service charge is understood to be a monthly subscription or usage fee to provide a convenient means of using the Internet. n3 Typically, users are provided with a local telephone number which can be used in conjunction with a computer and an access code or security password.

n3 The Internet is a network of computers which permits global interactive communication. See Julian S. Millstein, "Staying Interactive in the Hi-Tech Environment" Update on Software Licensing (Nov. 19, 1996) page 1 and see E. Parker Brown, II "State Taxation of Telecommunications: The New York Experience," Syracuse Law Review Volume 47 Number 3 (1997).

Since Internet access services were never specifically identified as taxable under state law, Internet access service charges, in all probability, never were subject to the application for state sales tax. This is important information to the nearly 100 New York Internet access service providers n4 and their thousands of New York clients n5 who are subject to sales tax audits for the period prior to 1997.

n4 The New York State Department of Taxation and Finance staff identified 73 Internet service providers that sold Internet services in New York and filed a sales tax return during at least one tax quarter in the June 1, 1995 to the May 31, 1996 tax period, Supra note 2 at 62.

n5 Based on the estimated $ 4 million of New York sale tax revenue which was associated with the 73 Internet service providers noted above, Supra note 2 at 62, and the relatively low cost of Internet access (typically $ 20 per month), tens of thousands of New York taxpayers are probably at risk of an adverse audit due to the fact that few Internet access service providers have billed sales tax on Internet access service charges and it is unlikely their clients have remitted use tax.

Several weeks after the Governor's announcement, the Department of Taxation and Finance addressed the application of state and local sales tax to Internet charges in a single memorandum.

In TSB-M-97(1) C and S, n6 the Department stated that as of Feb. 1, 1997 it would consider Internet access charges as unremunerated service and thus not subject to the state and local tax. In addition, Internet access service charges will not be considered a telecommunications service subject to the telecommunications excise tax. n7 The memorandum did not address taxation for the period prior to Feb. 1, 1997.

n6 The memorandums are of interest because they define Internet access for tax purposes they stated that: "Internet access is the connection provided to the Internet usually by a 'dial-up' service using a modem or a direct connection. Access is often referred to as the 'on-ramp' to the information superhighway. Internet access charges may also include items such as communications/navigation software, E-mail privileges, news headlines, and certain website services. When these services are furnished as part of a combined Internet access charge, they are deemed incidental to the provision of Internet access and the charge is not subject to sales tax." They also stated that: "Nexus with the state is not created merely by having a non-New York company's advertising appear on a New York server or through a New York Internet service provider. This applies to both the corporate franchise taxes and the sales and use taxes."

n7 New York Tax Law Section 186 (a) and (e).

Prior to these actions, taxpayers have been subject to sales tax assessments as a result of Internet access service charge transactions despite the fact that it is unlikely such transactions were subject to tax.

It is not surprising that the Tax Department did not appear to have a consistent policy. On one hand, its auditors regularly assessed state and local tax on Internet service access charges as either information services or telecommunications services. On the other hand, it issued some private letter rulings which stated that charges for Internet access service charges were not subject to New York sales tax.

IN ONE such letter, the Department reasoned that the access charges were not enumerated services, thus not taxable. It further stated that any associated information services, which would be in and of themselves taxable, were "only incidental." n8

n8 Deputy Commissioner and Counsel File No. LBW-4280 March 4, 1997 responding to a taxpayer's letter dated February 11, 1997.

The inconsistency in policy would have been eliminated if the memorandum had contained retroactive application language. Since it did not, taxpayers may still face the Department's attempt to assess sales tax on Internet access charges.

Several arguments could be used to refute the state's position that such charges are subject to taxation.

New York State, in combination with certain local jurisdictions, can impose up to an 8.5 percent retail sales tax on certain enumerated services. n9 In 1965 the Legislature imposed a sales tax on " . . . the receipts from every sale, other than for resale, of . . . telephony and telegraphy and telephone and telegraph service of whatever nature except interstate and international telephony and telegraphy and telephone and telegraph service. . . . " n10

n9 See New York Tax Law Chapter 60, Article 28, Section 1105(b) and Article 29, Sections 1210, 1211 and 1212.

n10 See New York Tax Law Chapter 60, Article 28, Section 1105(b).

Since Internet access charges did not exist in 1965, it must be an unenumerated service which is not subject to tax. This position was substantiated by the Department of Revenue's Office of Tax Policy when it reported that as a new medium, the Internet was not contemplated when New York enacted its sales tax in 1965, and was certainly not a part of the sales tax's depression-era roots.
Telecommunications Service

The application of sales tax is likely a settled issue if Internet access is considered an unenumerated service. However, on the question of whether an Internet access charge is considered a telecommunications service, the tax result is less clear.

The Tax Department has used its regulatory power to expand the scope of this tax to cover receipts from intrastate communication by means of devices employing the principles of telephony and telegraph. To be specific, the Department stated that service transactions involve the use of any apparatus for transmission of sound, code or other signals, such as dispatch services, n11 paging services, message switching services, facsimile transmission services and teletype services. n12

n11 A dispatch service is a communication system which is commonly used by taxicab companies and trucking firms to provide two-way voice communication between a base and mobile units. The communication system seldom uses a telephone system.

n12 See Title 20, Chapter III, Subchapter J, Part 525, Regulations Section 527.2(d)

Section § 1105(b) of the Tax Law imposes a tax on the receipts from telephony and telegraphy and telephone and telegraph service of whatever nature. n13 Since the imposition statute contained the words "of whatever nature" it is not unreasonable for the Department to be given latitude in determining what is taxable. The inclusion of the word "service" indicates that the Legislature intended to tax a broad spectrum of telecommunications services.

n13 See New York Tax Law Chapter 60, Article 28, Section 1105(b)(ii).

While tax regulations do not address services like electronic mail, voice mail and data transmission services, the Department has intermittently interpreted these services as telephony and telegraphy, and such transactions have been subjected to tax. n14

n14 See TSB-A-89(25)S, TSB-A-89(45)S and Telecommunication Report, Supra note 2 at 53.

In one case the taxpayer provided a network through which its customers could electronically send, receive, store and retrieve messages using a telephone system. n15 Receipts from this service were deemed taxable. In another case, the taxpayer provided clients with access to a computer, through which they could send and receive oral messages. n16 This service also was found to be a taxable telephone service.

n15 G.T.E. Telemessanger Inc., State Tax Commissioner, Petition No. S890808C, TSB-A-89(45)S (Nov. 20, 1989).

n16 Tigon Corporation, State Tax Commissioner, Petition No. S890202A, TSB-A-89(25)S (July 28, 1989).
Distinct Service

However, Internet access service charges are distinguishable from telecommunications services charges. While both may provide a transmission for a fee, a telecommunications service provides that the transmission be between specific sets of points. The Internet access service allows content providers to transmit to nonspecific sites and for content users to retrieve the content from nonspecific sites. Neither the Internet transmission originator nor the transmission receiver generally knows or cares about where the transmission comes from or where it goes.

In addition, the traditional telecommunications service charge provides that the transmission be made without a significant change in either the form or the content. What is sent is expect to be what is received.

The Internet access service charge does not provide that the transmission be made without a significant change in either the form or the content. Given the use of different formats, the Internet transmission is likely to be changed.

While telecommunications-like services may be a component of Internet access services, it is a minor one. Other components, such as file transfers, information access and retrieval and protocol conversions which allow communication with a variety of users, are the true essence of Internet access services.

It should also be noted the underlying transmission services provided by telecommunications carries are already subject to specific taxes in New York. Both non-telecommunications and telecommunications services are subject to the transmission service tax. n17

n17 See New York Tax Law Sections 183, 184 and 186 (a) and (e).

Section 183 imposes a tax on firms which engage in telephone and other transmission business and § 184 imposes an additional tax on firms engaged in local telephone and other transmission businesses. Section 186 imposes an excise tax on the sale of telecommunications services.

Finally the Internet is defined to be enhanced service according to the Federal Communication Commission, whereas telecommunications services are considered to be basic services. n18

n18 See Telecommunication Act 1996.

Even with an expansive definition of telecommunication services, internet access service charges are still not subject to sales tax. The factual distinctions noted above should be sufficient to deflect a tax assessment based on the Department of Taxation and Finance telecommunications regulations.


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