Can a cellular reseller buy phones it later gives away 'free' or at a discount with a service contract tax-free as a purchase for resale, rather than paying tax on the phones upfront?

Plain-English summary

America One Communications resells cellular phone service through direct mail marketing across New York (with its call center and mailing address both located outside the state). After a credit check, customers choose from various service plans requiring at least a one-year contract; some plans bundle in a "free" cellular phone or a discounted phone, while others charge the customer a fee (sometimes the actual cost the company paid) for the phone. Plans with "free" phones are priced so the company recoups the phone's cost over the life of the contract, and customers who cancel early pay a contract-breakage fee that offsets the phone's cost. All phones ship directly to customers from out-of-state warehouses. The company asked three related questions: does it owe sales/use tax when it originally buys the phones, can it use the resale exclusion to avoid tax on that purchase even for phones given away "free" or at a discount, and what's the correct sales tax base for phones sold at a reduced price or free alongside a service contract?

The Department applied the standard resale-exclusion analysis, but distinguished this case from typical promotional giveaways. New York generally treats tangible property purchased and given away for free promotional purposes as a taxable retail purchase to the GIVER, not a tax-free resale -- because a company that isn't actually in the business of selling that item, or that sells it for a token amount that doesn't reflect its true value, is using it as an advertising expense rather than reselling it. But America One Communications regularly sells cellular telephones as part of its actual business, and it deliberately prices its service packages (including the "free" phone terms) to recoup the phone's cost and turn an overall profit, with a contract-breakage penalty backstopping that cost recovery if a customer leaves early. Because this isn't a token freebie disconnected from real value, the phones are genuinely being sold -- just bundled into the pricing of the service contract -- so America One Communications can buy the phones tax-free as a purchase for resale (using a Resale Certificate, Form ST-120, given to its suppliers within 90 days of purchase), regardless of whether the customer ultimately pays full price, a discount, or nothing extra for the phone itself. Sales tax is instead collected on the company's actual retail transaction: the full amount it bills the customer for cellular telephone service, including any early termination fees, since those are considered part of the service charge.

What this means for you

Telecom, subscription, and similar resellers bundling "free" or discounted hardware with service contracts

If your business genuinely sells the hardware in question, and you price your service contracts (with mechanisms like early-termination fees) to actually recoup the hardware's cost, you can buy that hardware tax-free as a purchase for resale -- even when it's marketed to customers as "free." The key distinction from a taxable promotional giveaway is whether you're truly recouping the item's value through your overall pricing, not giving it away as an unrelated marketing expense.

Businesses considering "free gift with purchase" promotions

Contrast your situation with this ruling carefully: if you're NOT in the business of selling the "free" item, or you're not pricing your overall package to recoup its true cost, the item is a taxable promotional purchase to you, not a tax-free resale -- the Department's own Example 2 (bank account-opening premiums) and Example 3 (subsidized catalogs) in the regulations illustrate the taxable-giveaway scenario this ruling deliberately distinguishes itself from.

Accountants and tax professionals

This ruling extends the resale-exclusion analysis from Anthony J. Ragusa Jr. d/b/a The Stereo Advantage, TSB-A-93(6)S, and two KPMG Peat Marwick opinions, TSB-A-94(23)S and TSB-A-94(51)S, confirming that a bundled "free" hardware-with-service pricing model doesn't convert a genuine resale into a taxable promotional purchase, as long as the seller's overall pricing strategy demonstrably recoups the hardware's cost.

Common questions

Q: Can a company buy hardware tax-free for resale if it's later given away "free" with a service contract?
A: Yes, if the company genuinely sells that type of hardware as part of its business and prices its overall package (including any early-termination penalties) to recoup the hardware's real cost -- this isn't treated as a taxable promotional giveaway.

Q: What's the difference between this and a taxable "free gift" promotion?
A: A taxable promotional giveaway involves a company NOT in the business of selling the item, or pricing it far below true cost with no real cost-recovery mechanism -- here, the reseller's pricing strategy and contract-breakage fee affirmatively recoup the phone's value.

Q: What does the reseller charge sales tax on if the phone itself is nominally free?
A: The full cellular telephone service charge billed to the customer, including any early termination fees, since those charges are considered part of the taxable service.

Q: Does this ruling apply to my bundled hardware-and-service business?
A: Not automatically. An Advisory Opinion binds the Department only for the taxpayer and facts it was issued to, and it can't be relied on by anyone else. Whether your pricing genuinely recoups hardware costs (versus being a true giveaway) depends on your own facts.

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1997.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a97_84s.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-97(84)S
Sales Tax

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE

ADVISORY OPINION

PETITION NO. S970806A

On August 6, 1997, the Department of Taxation and Finance received a
Petition for Advisory Opinion from America One Communications, 2980 Fairview Park
Drive, Suite 1400, Falls Church, VA 22042-4525.
The issues raised by Petitioner, America One Communications, are:
1.
Whether Petitioner must pay sales or use tax on the purchase of
cellular telephones which will ultimately be transferred as part of a cellular
telephone service package.

2. Whether Petitioner will be entitled to utilize the resale exclusion
   from sales and use tax on the purchase of cellular telephones which it will offer
   for "free" or at a reduced rate as part of a cellular telephone service package.
3. What is the correct sales tax base for the cellular telephones sold by
   Petitioner to its customers at a reduced price or at no charge in conjunction
   with a contract providing for the cellular telephone service.
   Petitioner submits the following facts as the basis for this Advisory
   Opinion.
   Petitioner is a corporation that resells cellular services. Petitioner
   engages in direct mail marketing throughout the State of New York. The direct
   mailing material provides that, in order to request the cellular services,
   potential customers should phone into a call center or complete and return the
   application enclosed in the original mailing. The call center and the return
   address are both located outside the State of New York.
   If the potential customer passes the initial credit screening process, then
   Petitioner offers the customer a wide variety of service plans and options from
   which to choose. All of the service plans require that the customer contract for
   at least one full year of service. Some of the options include the purchase of
   a cellular phone and the choice of services such as call waiting, call forwarding
   and voice mail. Certain service plans may also include "free" minutes and/or a
   "free" phone. The service plans that include "free" cellular telephones are
   priced to recoup the cost of the cellular telephones within the life of the
   contract. Customers who prematurely terminate their contracts incur a contract
   breakage fee to offset the cost of the phone. Other plans require that the
   customers pay a fee for the cellular telephones.
   The fee charged for the
   cellular telephone is usually a discounted amount based on the package selected,
   but in some cases the customer will be charged the actual cost paid by
   Petitioner. The cellular telephones are shipped to customers directly from the
   seller's warehouses. All sellers used to supply the cellular telephones fulfill
   orders from warehouses that are located outside the State of New York.

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Sales Tax

Petitioner sells some of its customers a bundled package that includes the
cellular telephone and a contract for cellular telephone service. The cost of
the cellular telephone and the service fees are both considered by Petitioner
when it determines its pricing strategy. Petitioner prices the package to yield
a gross profit, even when the cellular telephone is provided "free" or at a
reduced price.
Applicable Law and Regulations
Section 1101 of the Tax Law states, in part:
Definitions.-- ... (b) When used in this article for the purposes of
the taxes imposed by subdivisions (a), (b), (c) and (d) of section
eleven hundred five and by section eleven hundred ten, the following
terms shall mean:
*

*

*

(4) Retail sale. (i) A sale of tangible personal property to any
person for any purpose, other than (A) for resale as such or as a
physical component part of tangible personal property. ...
Section 526.6 of the New York State Sales and Use Tax Regulations states,
in part:
Retail sale. (Tax Law, §1101(b) (4)) (a) The term retail sale or
sale at retail means the sale of tangible personal property to any
person for any purpose, except as specifically excluded.
*

*

*

(c) Resale exclusion.
(1) Where a person, in the course of his
business operations, purchases tangible personal property or
services which he intends to sell, either in the form in which
purchased, or as a component part of other property or services, the
property or services which he has purchased will be considered as
purchased for resale, and therefore not subject to tax until he has
transferred the property to his customer.
*

*

*

(4)(i) Tangible personal property which is purchased and given away
without charge, for promotion or advertising purposes is not
purchased for resale. It is a retail sale to the purchaser thereof,
and is not a sale to the recipient of the property.
(ii) Tangible personal property which is purchased for promotional
or advertising purposes and sold for a minimal charge which does not
reflect its true cost, or which is not ordinarily sold by that
person in the operation of his business, is a retail sale to the
purchaser thereof, and not a sale to the recipient of the property.

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TSB-A-97(84)S
Sales Tax

(iii) A resale certificate may not be used by the person making the
purchases described in subparagraphs (i) and (ii) of this paragraph
for such purchases.
Example 2: A bank has purchased premiums which will be given to
depositors upon the opening of an account in a new branch. As the
bank is not in the business of selling such items, and as it in fact
does not sell such items to its customers, the sale to the bank of
such items of tangible personal property is a retail sale which is
taxable at the time of purchase. The bank has not purchased these
items for resale.
Example 3: A vendor purchases catalogs and distributes them to his
potential customers for a minimal charge, which does not reflect the
cost to him.
He is the retail purchaser of the catalog, and is
required to pay the tax thereon. He cannot charge his customer tax
on the charge for the catalog.
Opinion
In this case, Petitioner does not give away cellular telephones for
promotional or advertising purposes.
Petitioner regularly sells cellular
telephones in the operation of its business. The cost of the cellular telephone
and the service fees are both considered by Petitioner when it determines its
pricing strategy. Petitioner prices the service package to recoup the cost of
the phone, even when the cellular telephone is provided "free" or at a reduced
price. Therefore, Petitioner's purchases of cellular telephones for sale to
customers at a reduced price or for inclusion at no charge to the customer in
conjunction with the customer's purchase of a contract for cellular telephone
services are not considered to be purchases of property for promotional or
advertising purposes and are not considered to be sold for a minimal charge which
does not reflect the property's true cost. Anthony J. Ragusa, Jr. d/b/a The
Stereo Advantage, Adv Op Comm T&F, January 7, 1993, TSB-A-93(6)(S); KPMG Peat
Marwick, Adv Op Comm T&F, May 3, 1994, TSB-A-94(23)S; KPMG Peat Marwick, Adv Op
Comm T&F, December 20, 1994, TSB-A-94(51)S.
Accordingly, Petitioner's purchases of cellular telephones are considered
to be purchases for resale regardless of whether the telephones are sold
separately or sold in conjunction with the sale of a cellular telephone service,
and such purchases are not subject to sales or compensating use tax. Anthony J.
Ragusa, Jr. d/b/a/ The Stereo Advantage, supra; KPMG Peat Marwick, supra; Section
526.6(c)(1) of the Sales and Use Tax Regulations. Where Petitioner purchases
telephones from a supplier required to be registered for New York State sales tax
purposes Petitioner must give to its supplier a properly completed New York State
Resale Certificate (Form ST-120) within 90 days from the date of purchase.

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Sales Tax

Petitioner must collect tax imposed under Section 1105(b) of the Tax Law
on the total receipts from the sale of the cellular telephone service to a
customer, including any early termination fees or other charges billed to the
customer when such service is to be provided within New York State, excluding
interstate or international services. Early termination fees and other service
related charges are considered to be an adjunct or component of the charges for
cellular telephone service.

DATED: December 29, 1997

NOTE:

/s/
John W. Bartlett
Deputy Director
Technical Services Bureau

The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.