Does the Internet service provider (ISP) equipment exemption cover wholesale Internet sales and mixed-use equipment, and can a refund be denied for unverified transactions?

Plain-English summary

This telecommunications company sought a refund of sales tax it paid on equipment used to provide Internet access, for September 2008 through June 2011. A refund verification audit granted part of the claim but denied the rest, and the company appealed on three points: the ISP exemption, vendor certification requirements, and the mixed-use equipment allocation method.

The ISP exemption is for retail, not wholesale. Va. Code Sec. 58.1-609.6 2 exempts certain equipment used to provide Internet access, and Va. Code Sec. 58.1-602 defines "Internet service" as a service sold to end-user subscribers. Reading those terms together (and construing exemptions strictly, Community Motor Bus), the Department has long limited the exemption to retail ISPs that serve end users. The auditor found much of this taxpayer's equipment was used to provide access to intercompany entities on a wholesale basis -- sales to entities that resell the service -- which the exemption does not cover. Those transactions were properly denied (consistent with P.D. 00-18, 01-29, 13-179, 16-167).

Mixed-use equipment must be prorated. The Internet exemption has no predominant-use requirement, so equipment used both in exempt and taxable ways cannot be 100% exempt -- the tax is prorated. Proration is normally by percentage of time, and when time cannot be measured, by revenue (P.D. 13-136, 92-28, 93-229, 96-238). The taxpayer argued its equipment was dedicated 100% to Internet service and, alternatively, offered a revenue-based spreadsheet. The Commissioner rejected both: mixed-use equipment is by definition not 100% exempt, and the alternative revenue method was unsupported by documentation. So the auditor's allocation stood.

Vendor certification -- a partial point, but verification still required. The taxpayer's 2014 refund request came before the Department's June 2017 refund guidelines, so it was not required to submit vendor certification forms (the 2014 Appropriation Act, Item 3-5.05, let ISPs request refunds directly). But the Department still must verify the refund: that the sales tax was actually charged and remitted, and that the local tax portion is credited to the correct locality. Where the Department could not verify the amount or the locality, the refund was properly denied.

One of a three-ruling set. The Department issued three materially identical companion determinations the same day (May 12, 2020) to related Internet service providers -- this P.D. 20-80 and its companions P.D. 20-81 and P.D. 20-82 -- each reaching the same result on the same facts.

What this means for you

The ISP exemption stops at the retail line

Equipment used to provide Internet access to end-user subscribers can qualify. Equipment used to provide access wholesale -- to entities that resell it -- does not. If you operate at both levels, expect the Department to separate them.

There is no predominant-use shortcut for mixed-use equipment

Because the Internet exemption lacks a predominant-use rule, equipment used partly for taxable purposes is never fully exempt. Be ready to prorate, and to document your allocation -- whether by time or by revenue. An undocumented 100%-exempt or revenue claim will lose.

A pre-2017 refund claim skips the certificate forms -- but not verification

Even without the vendor certification forms, you must give the Department enough to verify that tax was charged, remitted, and allocated to the right locality. Unverifiable transactions get excluded.

Common questions

Why was my wholesale Internet equipment denied? The ISP exemption is limited to retail service to end-user subscribers. Equipment used to provide access to entities that resell the service is outside the exemption.

My equipment runs Internet service 100% of the time -- isn't it fully exempt? No. If it is also used in a taxable activity, it is mixed-use, which cannot be 100% exempt. The tax is prorated, and you must document the allocation you want.

Did I have to submit vendor certification forms? Not for a 2014 refund request that predated the 2017 guidelines. But the Department still had to verify the tax and locality, and it denied what it could not verify.

Citations and references

• Va. Code Sec. 58.1-609.6 2 / 58.1-602 -- ISP equipment exemption limited to Internet service to end-user subscribers (retail); not wholesale (P.D. 00-18, 01-29, 13-179, 16-167).
• Mixed-use proration -- no predominant-use rule; prorate by time, or by revenue when time cannot be measured, with documentation (P.D. 13-136, 92-28, 93-229, 96-238).
• Item 3-5.05, 2014 Appropriation Act -- ISP exemption claimed as a refund; pre-2017 requests did not require vendor certification forms, but the Department must verify amount and locality.
• Commonwealth v. Community Motor Bus, 214 Va. 155 -- exemptions are strictly construed against the claimant.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 20-80

Original ruling text

May 12, 2020

Re: § 58.1-1821 Refund Application: Retail Sales and Use Tax

Dear *:

This is in response to your letter submitted on behalf of * (the “Taxpayer”), in which you seek a refund of the retail sales and use tax for the period September 2008 through June 2011. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer is engaged in the business of providing telecommunications services to its customers throughout Virginia. The Taxpayer filed a refund request with the Department for the sales tax paid on purchases of equipment used by the Taxpayer to provide Internet access to its customers. During the refund period, the Taxpayer was a subsidiary of a holding corporation (the “Parent”). The Taxpayer separated from the Parent in November 2011. A refund verification audit was conducted by the Department’s auditor. The verification audit was used to determine (1) whether the Taxpayer had properly paid the sales tax to its vendors on purchases of equipment, and (2) whether the Taxpayer properly accrued use tax in instances where the sales tax was not paid on purchases at the time the transactions took place.

In conducting the verification audit, the auditor reviewed vendor certification forms and the vendors’ sales and use tax filings with the Department. The refund was denied in instances where it could not be determined to which locality the local sales tax was due. The refund was also denied in instances where the gross sales filed by a vendor in its monthly sales and use tax returns were not large enough to have included the refund transaction, and in instances where a vendor did not file a sales and use tax return for the month the refund transaction took place. Further, a refund was denied on equipment purchases used by the Taxpayer to provide Internet services to wholesale customers.

The Taxpayer contends that the refunds were erroneously denied by the Department. The Taxpayer maintains that its equipment at issue was purchased to provide Internet services to its customers, and such purchases qualify for the ISP exemption. The Taxpayer further contends that it was not required to seek a refund from its vendors or to obtain vendor verification certificates in order to request a refund. The Taxpayer also asserts that its time allocation percentage should have been used to determine the sales tax on mixed use equipment rather than the revenue based allocation method used by the Department.

DETERMINATION

Internet Service Provider (ISP) Exemption

The Taxpayer maintains that the equipment at issue was used to provide Internet services and is exempt from the sales tax. The Taxpayer states that the Internet services were provided directly to end-users. Based on a review of the documentation provided in the refund verification audit, it was determined by the Department’s auditor that the equipment at issue was used to provide Internet access services to intercompany entities and that the sales were wholesale in nature.

Virginia Code § 58.1-609.6 2 provides that the retail sales and use tax does not apply to:

Broadcasting equipment and parts and accessories thereto and towers used or to be used by commercial radio and television companies, wired or land based wireless cable television systems, common carriers or video programmers using an open video system or other video platform provided by telephone common carriers, or concerns which are under the regulation and supervision of the Federal Communications Commission and amplification, transmission and distribution equipment used or to be used by wired or land based wireless cable television systems, or open video systems or other video systems provided by telephone common carriers.

This statute was last amended in 1999 by the General Assembly to add an exemption applicable to certain Internet service providers. The amendment became effective on July 1, 1999, and defined many of the words and phrases set out in the above statute with respect to the exemption. These definitions are set out in Virginia Code § 58.1-602 as follows:

"Amplification, transmission and distribution equipment" means, but is not limited to, production, distribution, and other equipment used to provide Internet-access services, such as computer and communications equipment and software used for storing, processing and retrieving end-user subscribers' requests.

"Internet" means collectively, the myriad of computer and telecommunications facilities, which comprise the interconnected world-wide network of computer networks.

"Internet service" means a service that enables users to access proprietary and other content, information electronic mail, and the Internet as part of a package of services sold to end-user subscribers.

"Open video system" means an open video system authorized pursuant to 47 U.S.C. § 573 and, for purposes of this chapter only, shall also include Internet service regardless of whether the provider of such service is also a telephone common carrier.

"Video programmer" means a person or entity that provides video programming to end-user subscribers.

"Video programming" means video and/or information programming provided by or generally considered comparable to programming provided by a cable operator including, but not limited to, Internet service.

The Taxpayer states that as a provider of Internet services, it qualifies for the ISP exemption. At issue in this instance is not whether the Taxpayer provides Internet services in general, and thus the equipment at issue qualifies for the ISP exemption. Rather, the issue is whether the Taxpayer’s use of the equipment in providing Internet services to its customers qualifies in accordance with the specific requirements of the ISP exemption.

Commonwealth v. Community Motor Bus , 214 Va. 155, 198 S.E.2d (1973) provides that “where there is any doubt as to the application of an exemption, the doubt is resolved against the one claiming the exemption.”

Under the doctrine of strict construction, it has been the Department’s longstanding interpretation that the ISP exemption is limited to certain tangible personal property used or to be used by eligible ISPs that provide Internet access, as well as certain other specific services to end-user subscribers. To be eligible for the ISP exemption, an ISP must provide Internet access, as well as access to proprietary content and other content, information electronic mail, and the Internet as part of a package of services sold to end-user subscribers. The inclusion of the statutory phrases “end-user subscribers,” “Internet service,” and “part of a package of services sold to end-user subscribers” in the aforementioned Internet service definition combine to restrict the exemption to retail ISPs. Wholesale ISPs sell or resell Internet services to other ISPs, and thus do not sell or resell services directly to end-user subscribers as defined with regard to the exemption.

The ISP exemption is applicable to purchases of equipment made by the Taxpayer only in instances where the equipment is being used to provide Internet services to end-user subscribers. The exemption does not apply to equipment used by the Taxpayer to provide Internet services to entities that sell or resell the Internet services purchased from the Taxpayer (i.e. , wholesale sales of Internet services). Based on the information provided with the Taxpayer’s appeal, the Taxpayer has not proven that the equipment at issue was used in an exempt manner, i.e., to provide Internet access services to end-user subscribers. Accordingly, these transactions were properly denied a refund.

Public Documents (P.D.) 00-18 (3/17/2000), 01-29 (3/29/2001), 13-179 (10/11/2013), and 16-167 (8/26/2016) support this determination. The application of the sales tax to tangible personal property sold to ISPs is addressed in these public documents. These determinations set out the Department’s longstanding policy that the ISP exemption is available only to those ISPs that provide Internet access, proprietary content and other specific services to end-user subscribers.

Vendor Certification Forms

The Taxpayer contends that the refund was erroneously denied because the Taxpayer did not request a refund from its vendors and instead requested a refund directly from the Department, as stated in the refund denial letter issued by the Department. The Taxpayer asserts that it was not required to comply with the refund guidelines published by the Department in June 2016. These guidelines require taxpayers to submit completed vendor certification forms to support the refund request. Rather, the Taxpayer maintains that it properly requested a refund from the Department pursuant to legislation issued by the 2014 Special Session 1 of the Virginia General Assembly (1).

During the refund verification process, the Department’s auditors requested that the Taxpayer have its vendors complete the vendor certification forms. In instances where the certification forms were not provided, the auditor reviewed the vendors’ sales and use tax filings with the Department to determine whether a refund was warranted. If the gross sales amount was insufficient to have included the value of the invoice, the refund was denied. The refund was also denied if the locality information could not be verified or if the vendor did not file a return for the month in which the transaction took place.

The Virginia General Assembly enacted legislation through the 2014 Budget Bill regarding the sales and use tax exemption for Internet service providers. Item 3-5.05 of the Budget Bill provides that “Notwithstanding any other provision of law, for purchases made on or after July 1, 2006, any exemption from the retail sales and use tax applicable to production, distribution, and other equipment used to provide Internet access services by providers of Internet service, as defined in § 58.1-602, Code of Virginia , shall occur as a refund request to the Tax Commissioner. The Tax Commissioner shall develop procedures for such refunds.”

On June 12, 2017, the Department issued Guidelines for Retail Sales and Use Tax Refund Claim Procedures (the “Guidelines”). The Guidelines provide that a taxpayer must complete a Refund Claimant Return in order to receive a refund of a tax remitted to the Department by the dealer through whom a purchase of tangible personal property was made. The refund request spreadsheet and the vendor certification form must also be included with the Claimant Return. This information is used by the Department to assist in verifying the refund claimed by the Taxpayer.

The Taxpayer filed its initial refund request with the Department on December 1, 2014. At that time, the Department had not established the Guidelines referenced above. Accordingly, the Taxpayer was not required to provide the vendor certification form as part of the review of its refund request by the Department. Further, the Budget Bill provided that the Taxpayer could make its refund request directly to the Department.

Notwithstanding the foregoing, the Department must be able to verify the refund amount requested by the Taxpayer. Further, the Department must insure that the local tax portion of the refund is allocated to the locality for which the tax was originally reported and paid. If the Department cannot verify the refund amount request or the locality, the refund cannot be granted. In this instance, transactions were excluded from the refund because it could not be verified if the sales tax was actually charged and remitted to the Department. Additionally, the Department could not verify the localities to which the sales tax was initially paid. On appeal, the Taxpayer has not proven its contention that the refund was erroneously denied. Accordingly, the transactions at issue were properly excluded from the refund.

Mixed Use Equipment

The Internet service equipment exemption does not require predominant use in an exempt manner in order for the exemption to apply. Lacking a predominant use requirement, the exemption is of limited application when the equipment is used for purposes beyond the scope of the exempting language. In other words, the tax must be prorated when the equipment is used in both exempt and taxable activities. The proration methodology is generally based on the percentage of time the property is used in a taxable activity and the percentage of time the property is used in an exempt activity. However, when it is not possible to prorate the tax in this manner, another approach may be considered. See, P.D. 13-136 (7/18/2013). The Tax Commissioner has previously determined that the percentage of time may be calculated by using revenue derived in exempt activities versus the revenue derived in taxable activities. See, P.D. 92-28 (4/20/1992), 93-229 (12/15/1993) and 96-238 (9/20/1996).

In this case, the Taxpayer maintains that its proposed time allocation percentage should be used to determine the sales tax on the mixed use equipment, rather than the Department’s revenue based allocation method. The Taxpayer contends that the equipment at issue is used to provide exempt activities 100% of the time. Specifically, the Taxpayer states that in order to provide uninterrupted Internet services, its mixed use equipment is dedicated 100% of the time to the provision of Internet services. The Taxpayer further contends that the fact that a piece of equipment is performing more than one function at a time does not take away from the fact that the equipment is performing exempt activities all of the time. As such, the Taxpayer contends that the equipment used to provide Internet services is exempt. As an alternative, the Taxpayer submits a spreadsheet for consideration to support an allocation based on the percentage of its revenue derived from providing Internet service.

With its original refund request, the Taxpayer provided a revenue based allocation method to be used during the verification audit. The Taxpayer provided financial data from the Parent’s 2013 SEC 10K filings to support the amount requested in the refund. However, the Taxpayer was instructed by the Department’s auditor that its specific financial data was required for review for the tax years included in the refund period. Once that information was provided, the Department’s auditor used a revenue based allocation to determine the sales tax on the mixed use equipment at issue, and the amount of the refund that was due to the Taxpayer with respect to the equipment.

Based on the information presented, the Taxpayer has not provided sufficient evidence to support its contention that a percentage of time allocation is proper in this instance. Mixed use equipment is equipment that is used in more than one activity. Therefore, equipment used in both exempt and taxable activities cannot be 100% exempt for sales and use tax purposes. As such, the Taxpayer’s contention that the mixed use equipment is exempt because it is used 100% of the time to provide exempt services is without merit. The sales tax must be prorated on mixed use equipment.

Further, the Taxpayer’s contention that the equipment at issue was used the most to provide Internet services does not support a 100% exemption for the equipment. I further find that the Taxpayer’s alternative method of calculating the allocation based on revenue attributed to its Internet services cannot be used in this instance because the Taxpayer has not provided documentation to support the information contained in the spreadsheet provided. Accordingly, the mixed used allocation method applied in the refund verification audit is deemed correct and use of another method is not justified.

The Taxpayer cites Public Documents 92-28, 93-229, 96-238, 13-136, and 17-163 (9/13/2017) in its appeal in support of using the percentage of time allocation method to determine the sales tax on the mixed use equipment. These public documents are instructive on how the allocation of tax can be computed for mixed use equipment. However, regardless of how the tax allocation is computed, all of these public documents require that taxpayers provide detailed documentation to support the chosen allocation method. The issue in this instance is that the Taxpayer contests the allocation method used in the verification audit, but does not provide sufficient documentation to support disallowing the method used in the verification audit or for using an alternative method.

CONCLUSION

Based on this determination, the refund is correct as issued. Accordingly, the Taxpayer’s request for an additional refund for the period at issue is not granted.

The Code of Virginia sections and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department’s web site. If you have any questions about this response, you may contact * in the Department’s Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

(1). See, Ch.1 (HB 5001), Special Session 1, Laws 2014, Sec. 3-5.05.

AR/1715P

Related Documents

00-18

01-29

13-179

16-167

13-136

92-28

93-229

96-238

17-163