Did a cellular-phone retailer have to include franchisor commissions in the Rhode Island sales-tax base when the commissions funded free or discounted phones tied to customer service contracts?

Plain-English summary

The retailer had to include franchisor commissions in the taxable sales price of free or discounted cellular phones when the commissions were directly tied to the customer's phone discount. Sales tax was due on both the amount paid by the customer and the qualifying third-party commission paid to the retailer.

The retailer sold phones for no charge or below regular retail when customers agreed to buy cellular service for a minimum period. The franchisor then paid the retailer one or more commissions based on the service plan. In the examples, the commission equaled or approximated the phone-price reduction and made the retailer whole for the selling price.

Rhode Island's sales-price definition included third-party consideration when the seller actually received it, it was directly related to a price reduction or discount, the seller had to pass the discount to the buyer, and the amount was fixed and determinable at the time of sale. The quoted rule also required one of its listed documentation criteria.

The Division found the commissions directly connected to the handset discount. A customer had to sign a service contract to receive the reduced phone price, the franchisor paid the commission for each phone sold, and a customer buying a phone without service would pay full retail.

The ruling rejected the retailer's double-tax concern. The phone sale and the carrier's telecommunications service were separate transactions occurring at different times with amounts owed to different vendors. The phone tax base included the retailer's third-party discount consideration, while the carrier separately collected tax on the monthly service.

What this means for you

Retailers using third-party subsidies

Do not look only at cash collected from the customer. A manufacturer, franchisor, carrier, or other third-party payment can enter the sales-tax base when it directly funds a price reduction.

Promotion and contract teams

Document how commissions are calculated, whether a service contract is required, how the phone discount is presented, and whether the payment makes the retailer whole for the discount.

Customers and customer-service teams

A free phone can still generate sales tax when taxable third-party consideration funds the discount. The ruling treated that tax separately from tax on the cellular service plan.

Common questions

Were the commissions excluded because the customer did not pay them? No. Rhode Island's sales-price rule included qualifying consideration received from a third party.

Why were the commissions connected to the phone discount? Customers received the reduced phone price only when they bought service, and the commission equaled or approximated the reduction in the phone's retail price.

Could a free phone still have a taxable sales price? Yes. In the ruling's examples, the third-party commission created taxable consideration even when the customer paid nothing for the handset.

Was tax on the phone duplicative of tax on monthly service? No. The Division treated the tangible phone sale and the carrier's telecommunications service as separate transactions with different vendors.

Citations and references

• R.I. Gen. Laws § 44-18-12(a) and (c) — sales price and qualifying third-party consideration tied to discounts.
• R.I. Gen. Laws § 44-18-12.1 — taxable telecommunications service referenced by the ruling.

Source

• Landing page: Rhode Island Declaratory Rulings
• Declaratory order: Declaratory Order 2009-02

Original ruling text

Ruling Request No. 2009-02

Ruling Request No. 2009-02

Request for Ruling Regarding the Applicability of the Sales/Use Tax Law to Commissions Paid to a Retailer by a Franchisor

On behalf of your clients, Company A and Company B (hereinafter “taxpayer” or “taxpayer/retailer”), you request a declaratory ruling pursuant to R.I.G.L. § 42-35-8, as amended, regarding the applicability of the Rhode Island sales/use tax to commissions paid to a retailer by a franchisor when a subscriber signs a subscription contract in conjunction with the sale of a cellular phone.

Facts

The facts set forth in your request for ruling dated July 27, 2009, and the documents attached thereto, form the basis for this ruling.

The taxpayer/retail seller of cellular telephones sells cellular telephone equipment to customers at no charge or for a charge that is below regular retail if the customers agree to purchase cellular telephone services from Verizon Wireless for a predetermined minimum period (e.g.. one or two years). The taxpayer/retailer has an agreement with its Franchisor, Company C, (“Franchisor”), the parent company of Company D, which provides that, when the taxpayer signs up a subscriber for cellular service with Verizon Wireless, the Franchisor will make a payment or multiple payments to the taxpayer. These payments (or "commissions") from the Franchisor to the taxpayer are determined by the type of cellular service plan the customer purchases at the time the customer purchases the cellular telephone and are not, directly or indirectly, determined by the type of cellular telephone purchased by the customer.

For example, if the customer purchases a two-year cellular service plan that costs the customer $9.99 per month, Verizon Wireless pays a commission in the amount of $180.00 to Franchisor. Franchisor in turn pays taxpayer a commission in the amount of $162.00. In this example, Verizon Wireless will collect $9.99 per month for 24 months or $239.76 from the customer. It will collect $16.78 in sales tax from the customer on its purchase of cellular service during that two-year period ($239.76 @ 7%).

If the customer purchases a two-year cellular service plan that cost the customer $99.99 per month, Verizon Wireless pays a commission in the amount of $415.00 to Franchisor. Franchisor in turn pays taxpayer a commission in the amount of $373.50. In this example, Verizon Wireless will collect $99.99 per month for 24 months or $2,399.76 from the customer. It will collect $167.98 in sales tax from the customer on its purchase of cellular service during that two-year period ($2,399.76 @ 7%).

In both of these scenarios, the customer pays sales tax on the monthly cost of his or her cellular service directly to Verizon Wireless.

Presently, taxpayer charges a sales tax on the actual sales price of the equipment plus the commission rising out of the sale of the service plan paid to it by Franchisor. One of the obvious inequities with including the commission paid by Verizon Wireless to the taxpayer (through Franchisor) as part of the "sales price" at the time of sale is that the customer will pay sales tax on the same monies twice; first at the time of sale and again each month when the customer pays for their monthly cellular service. To illustrate the present taxing scheme by the taxpayer, consider the following illustrations. Each illustration assumes that the customer will sign up for cellular service with Verizon Wireless for each telephone acquired.

> (a.) Customer “purchases" four (4) telephones for free.

Taxpayer "sells" four (4) Samsung model SCH-u340 telephones to customer for free. Taxpayer's regular retail price for that telephone is $364.50 each. Franchisor pays taxpayer a commission in the amount of $364.50 for each telephone sold when the customer signs up for wireless service with Verizon Wireless. Even though the customer acquires all four (4) telephones for free, taxpayer charges sales tax on $1,458.00 ($364.50 x 4) and collects sales tax in the amount of $102.06 ($1458.00 @ 7%).

> (b.) "Buy one, get three free."

Taxpayer sells one Motorola model V750 telephone to customer at a reduced price of $19.99 and the customer gets three additional Motorola model V750 telephones for free. Taxpayer's regular retail price for that telephone is $271.99 each. Franchisor pays taxpayer a commission in the amount of $252.00 for each telephone sold when the customer signs up for wireless service with Verizon Wireless. Even though the customer paid only $19.99 total for all four (4) telephones, taxpayer charges sales tax on $1,027.99 ($252.00 x 4 + $19.99) and collects sales tax in the amount of $71.96 ($1,027.99 @ 7%).

> (c.) Customer purchases a single telephone at $19.99.

Taxpayer sells one Motorola model V750 telephone to customer at a reduced price of $19.99. Taxpayer's regular retail price for that telephone is $271.99 each. Franchisor pays taxpayer a Commission in the amount of $252.00 for each telephone sold when the customer signs up for wireless service with Verizon Wireless. Even though the customer paid only $19.99, taxpayer charges sales tax on $271.99 ($252.00 + $19.99) and collects sales tax in the amount of $19.04 ($271.99 @ 7%).

As these typical sales illustrate, a customer who purchases four telephones from taxpayer for free pays more than $100 in sales tax yet the sale price is $0.00. The second customer who purchases one telephone at a reduced cost of $19.99 and gets three additional telephones for free pays more than $70 in sales tax yet the sale price is less than $20. Finally, the third customer who purchases a single telephone at a reduced price of $19.99 will pay almost an equal amount in sales tax. Customers have questioned taxpayer about these scenarios while other customers have called the Division to confirm the charges were legitimate.

Ruling Requested

Whether the commission paid to the taxpayer/retailer of cellular telephones by its Franchisor when new or existing subscribers sign subscription contracts in conjunction with the purchase of a cellular telephone shall be excluded from the “sales price” as construed by §44-18-12 of the Rhode Island General Laws.

Discussion

To address the above issue, § 44-18-12 provides as follows:

> (a) "Sales price" applies to the measure subject to sales tax and means the total amount of consideration, including cash, credit, property, and services, for which personal property or services are sold, leased, or rented, valued in money, whether received in money or otherwise...

(c) "Sales price" shall include consideration received by the seller from third parties if:

> (i) The seller actually receives consideration from a party other than the purchaser and the consideration is directly related to a price reduction or discount on the sale;
>
> (ii) The seller has an obligation to pass the price reduction or discount through to the purchaser;
>
> (iii) The amount of the consideration attributable to the sale is fixed and determinable by the seller at the time of the sale of the item to the purchaser; and
>
> (iv) One of the following criteria is met…
>
> (C) The price reduction or discount is identified as a third party price reduction or discount on the invoice received by the purchaser or on a coupon, certificate or other documentation presented by the purchaser.

In the facts presented, a customer must purchase a service plan in order to receive a discount on the sales price of a cellular phone. It is noted that if a customer purchases a cellular phone without purchasing a service contract, the customer would pay the full retail price on the phone and would not receive the discount as allowed by the taxpayer/retailer to a customer who purchases a service contract.

As stated, the “commissions” paid by the Franchisor are “for each telephone sold”. Also, the “commission” equals or approximates the amount of the reduction of the retail selling price of the cellular phones sold, thereby making the retailer whole for the selling price.

Ruling

The consideration (commission) paid by the third party to the taxpayer/retailer is paid contingent upon the customer purchasing a cellular telephone service plan. In exchange, the customer then receives a price reduction or discount on the sale of the cellular phone. R.I. General Laws §44-18-12 clearly provides that the consideration received by a seller (taxpayer/retailer) from a third party (Franchisor) is included in the measure subject to tax under those circumstances.

Therefore, sales tax is due on both the retail sales price paid by the customer and any consideration (i.e. commission) received by the seller (taxpayer/retailer) from a third party (Franchisor) which is directly related to a price reduction or discount on the sale of the cellular phone.

It is noted that there is no duplication of taxation under the facts presented. The sale of tangible personal property (cellular phones) by the taxpayer/retailer is a transaction separate and apart from the furnishing of the telecommunications service by Verizon Wireless. These transactions occur at different times and the monies are owed to different vendors. The furnishing of telecommunications service is subject to sales tax under R.I. General Law 44-18-12.1 irrespective of whether a cellular phone is sold.

This ruling may be relied upon by Company A and Company B and shall be valid until expressly revoked or until the applicable statutory provisions of law are amended in a manner that requires a different result or the underlying facts described herein change.

**David M. Sullivan

Tax Administrator

September 15, 2009**