United States: Tax Questions Confront VoIP Services

Like Tom Cruise in the movie Jerry Maguire, federal, state and municipal taxing authorities are asking IP enabled voice and video services to ‘show them the money.’

At the Federal level, the IRS recently sought comment on whether the Federal Excise Tax ("FET") should apply to the many forms of VoIP. The FET was originally imposed to pay for the 1898 Spanish American War. At the time the tax was first enacted – it applied to approximately 2,000 telephone lines. Over a hundred years later, millions of American continue to pay this 3% surcharge assessed on their local and long distance telephone bills.

In addition to the FET, of course, communications providers must also apply a 10.7 percent Universal Service Fund fee, subscriber line charges, relevant of state and municipal telecommunications taxes, surcharges and other fees that, all totaled, add upwards of 40 to 50 percent to the total cost to the consumer. It’s this combined tax burden that lead one telecommunications CEO and industry visionary to note during a recent industry conference keynote that bit for bit – the U.S. Postal service still remains the most cost efficient means of delivering information to much of the country.

While the FET and other state and municipal tax laws were imposed on fixed line telecommunications services, most of these laws were crafted well before the advent of the Internet and VoIP and, as a result, they were never intended to apply to these types of global data services. Although VoIP and other IP enabled services promise to improve productivity and reduce the cost of communications services to small business and residential consumers – an army of taxmen are launching blitzkrieg initiatives to expand the scope of their taxation authority to bits of packetized information that may traverse the Internet and arguably pass through a given state or locality. These ill considered initiatives not only fail to recognize the global nature of digital commerce – many proposals are so broad or poorly drafted that they could impose multiple or duplicative or otherwise unwieldy burdens on a wide variety of global e-commerce applications. Without careful thought, seemingly simple "local" laws could have far ranging consequences that will have a detrimental impact the development and deployment of Internet applications throughout the United States.

Perhaps more daunting than the imposition of these taxes themselves is the cost associated with trying to properly assess and collect them. Assuming that "local" tax could somehow be reasonably imposed on a voice "bit" – how should a service provider calculate, assess and remit such taxes. Consider a conversation initiated using a New York 212 area code, by a customer located in London, with a billing address in Miami to another VoIP caller physically being located in San Francisco but using a Miami telephone number? Does anyone question that the cities of Miami, New York, London and San Francisco will all concurrently claim that the provider is entitled to pay tax this communication? What now?

What is the chief executive officer of an innovative start-up to do? Hire the phalanx of lawyers and accountants or seriously consider the benefits of locating their enterprise offshore? The choice and the consequences are real.

Over the course of the next year, VoIP and other Internet content providers will face an increasing number of tax questions. Although the protections of the Internet Tax Freedom Act were extended – IP voice was excluded from the scope of the new legislation. Although Senator Sununu and Congressman Pickering introduced versions of the "VOIP Regulatory Freedom Act of 2004" the legislation has not yet been reintroduced. Under these reasonable proposals, VoIP would have been exempt from a patchwork of multiple and discriminatory state regulations; the bill would have also preempted the states from imposing upon VoIP applications various geographic tax burdens.

While it’s unclear what 2005 holds for VoIP, President Ronald Reagan’s thoughts on government generally can provide some foresight on the upcoming legislative and regulatory debate. When asked whether the government’s view of the economy could be summed up in a few short phrases, Regan responded: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it. Whatever direction telecommunications reform takes in 2005 – taxation, regulation and subsidies will clearly be at the top of the policy agenda for VoIP.