September 13, 2017
Re: § 58.1-1821 Application: Retail Sales and Use Tax
This will reply to your letter in which you seek correction of the retail sales and use tax assessments issued to ***** (the “Taxpayer”) for the period of January 2005 through December 2010. I apologize for the delay in responding to your appeal.
The Taxpayer provides cable television, high-speed internet, and Voice over Internet Protocol (VolP) digital phone service to residential and commercial customers. The Taxpayer seeks correction of the tax assessed, either in whole or in part, for four categories of equipment held taxable in the audit. The equipment being contested includes equipment used in the Taxpayer's service offerings, i.e. cable television, internet, and telephone. The four areas of dispute include the following:
- Mixed-use equipment proration using the revenue method of allocation rather than a bandwidth allocation;
- Distribution signal testing equipment;
- Cable conduit; and
- Mixed-use cable equipment.
In addition to these issues, the Taxpayer requests waiver of the penalties applied in this case and requests waiver of one-half of the interest assessed.
Virginia Code § 58.1-609.6 2 provides a retail sales and use tax exemption for the following:
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 carrier 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 Communication 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 is addressed in Title 23 of the Virginia Administrative Code (VAC) 10-210-3030 which provides, in part, “the tax does not apply to broadcasting, amplification, transmission, and distribution equipment and parts and accessories thereto and towers purchased for use by cable television systems.” As provided in your letter, and agreed to by the Department, cable used in the Taxpayer's cable television and internet service is exempt from the tax, while cable used in the Taxpayer's telephone service is taxable. Therefore, when the same cable is used in both an exempt and taxable manner, proration must be used to determine what portion of the cable is taxable and what portion is exempt. Keeping all of the above in mind, I will address the Taxpayer's issues of contention separately below.
There are several ways to determine a taxable versus exempt usage of mixed-use equipment in the cable television/internet/telecommunication industry. The most common methods would be to use broadband width usage of the equipment, total revenue generated by each service, time used, a percentage of subscribers for each service provided, or any combination of these factors.
During the previous audit of the Taxpayer for the period of October 1999 through December 2004, the Taxpayer and the Department examined broadband width and revenue generated to determine what percentage of the Taxpayer's mixed-use equipment should be taxable. It was mutually agreed that the Taxpayer would be assessed tax based on the broadband width proration for mixed-use equipment.
While the broadband width method of proration was used in the previous audit of the Taxpayer to determine the sales tax liability on mixed-use equipment, the auditor in the current audit utilized a combination of factors focusing on a “revenue based” methodology to determine the proration factor. This methodology was selected based on Public Document (P.D.) 13-136 (7/18/13), in which the Tax Commissioner determined that a “percentage of time used” methodology was the fairest method to determine a taxable proration of mixed-use equipment within the telecommunication industry. While P.D. 13-136 establishes a proration methodology to be used for mixed-use equipment, the public document was issued subsequent to the conclusion of the Taxpayer's current audit period.
Based on the fact that the Taxpayer and the Department established an agreed proration method for mixed-use equipment based on the broadband width during the previous audit of the Taxpayer, I will allow this same proration method for mixed-use equipment for the current audit period, January 2005 through December 2010. This same methodology should also be applied for the January 2011 through December 2015 audit period. Effective January 2016 and forward, the Taxpayer is required to apply the “percentage of time used” methodology established in P.D. 13-136 for prorating all purchases of mixed-use equipment.
The Taxpayer was assessed tax on test equipment used by the Taxpayer's field personnel to detect leaks in the cable system between the outgoing head-end distribution of the cable signal and the customer residence or neighborhood. The equipment at issue consists of hand-held test equipment used by field repair technicians and cable installers. All the equipment is used to detect leaks, locate leaks, and transmit such information back to the Taxpayer's headquarters. The auditor maintains that this equipment constitutes repair tools and does not qualify as exempt distribution test equipment. The auditor also maintains that the exempt distribution function of cable television providers ends at the head-end.
The Taxpayer contends that this equipment is directly used in the distribution of the cable signal and is exempt in accordance with Va. Code § 58.1-609.6.2, and supported by P.D. 87-208 (9/15/87). P.D. 87-208 addresses distribution test equipment and provides, in part, “As § 58.1-608.12 [re-codified to § 58.1-609.6.2] contains a specific exemption for ‘distribution equipment used or to be used by cable television systems,’ I find basis for removal of this equipment [i.e., the distribution test equipment] from the audit.” [Inserts added.] The Taxpayer further believes that Federal Communication Commission (FCC) standards that require cable companies to test their distribution signals throughout the year to comply with FCC regulations further enhances the argument that the testing equipment in question should be exempt.
As provided above, Title 23 VAC 10-210-3030 provides that “the tax does not apply to broadcasting, amplification, transmission, and distribution equipment and parts and accessories thereto . . . purchased for use by cable service systems.” While the testing equipment at issue is not used directly in the broadcasting, amplification, or transmission functions of cable service systems, it can be argued that such equipment is used in the distribution function of a cable service provider. The question that needs to be answered is, where does the distribution function begin and, more importantly, where does it end?
According to the auditor, the distribution function for a cable television provider ends when the cable signal leaves the head-end, or main distribution center, and does not include cable and equipment from the head-end to the final customer. Based on P.D. 90-184 (10/12/90), power supply equipment and backup batteries placed at various points along a cable distribution system are used directly in the cable signal distribution process and are exempt from the sales tax. Because Title 23 VAC 10-210-3030 provides that the tax does not apply to “distribution equipment and parts and accessories thereto,” I find that the cable distribution system extends beyond the head-end to the point where the cable signal enters the customers’ residence. For this reason, I find that the test equipment at issue qualifies as exempt parts and accessories and will be removed from the audit.
The Taxpayer purchases and installs cable conduit in two different ways. First, the Taxpayer purchases and buries conduit that already contains the fiber/coax cable the Taxpayer uses to disseminate the cable signal, and secondly, the Taxpayer purchases and buries empty conduit in the event that the Taxpayer needs to run fiber/coax cable in the future. Cable and conduit containing cable was prorated in the audit as mixed-use equipment. The auditor held taxable the purchase of empty conduit, which may or may not be used in the future to run fiber/coax cable. The Taxpayer believes the empty conduit to be an accessory to their cable installation and is exempt.
P.D. 93-205 (9/30/93) addresses the application of the retail sales and use tax to parts and accessories attached to broadcasting equipment used by exempt cable television systems, and provides that the sales tax does not apply when such parts and accessories are used directly in broadcasting. This document goes on to provide that, “accessories, when attached to coaxial cable or exempt equipment, must act as integral components of the signal distribution and amplification functions in order to qualify for the exemption.” For this reason, I find that empty conduit purchased and installed underground by the Taxpayer for possible future use does not act as an integral component of the Taxpayer's distribution and amplification function and was properly held taxable in the audit.
This category includes purchases of equipment that the Taxpayer claims may be used for video, internet and telephone services provided by the Taxpayer. The Taxpayer believes the cable equipment in question should be prorated based on a mixed-use factor.
Based on the information provided, the auditor used the best information available to determine the use of the equipment. Such information included general ledger designations recorded by the accounts payable clerk at the time the equipment purchases were entered on the Taxpayer's books. The general ledger designation recorded on the Taxpayer's books included “Transport Telephony”, “Customer Premises Equipment”, “IT Equipment”, and “Electronic Business.” Due to the age of the equipment in question and the general classification of the equipment on the Taxpayer's books, a mixed-use proration calculation was not feasible. This being said, the auditor carefully examined the information made available and either held the equipment 100% taxable or, in some cases, prorated the equipment on a reasonable mixed-use percentage.
If the Taxpayer is able to provide additional documentation as to the actual usage of the equipment, an adjustment may be warranted.
Penalty, Amnesty Penalty and Interest
The Taxpayer requests waiver of the compliance penalty and amnesty penalty because its recalculation of the compliance ratio using the alternative method results in a use tax compliance ratio of 85%. In order to determine if the Taxpayer does qualify for waiver of the penalties based on the alternative method, Title 23 VAC 10-210-2032 B 2 requires the Taxpayer to provide the auditor with documentation supporting the Taxpayer's computation of the alternative method. If such documentation is furnished to the auditor within 60 days of the date of this letter, the auditor will review the computation and determine if the penalties should be waived and will notify the Taxpayer accordingly.
The auditor will also recompute the use tax compliance ratio after the tax adjustments noted in this determination are made. If the new compliance ratio meets or exceeds 85% for this fourth audit, penalty will be waived.
The Taxpayer also requests a 50% waiver of the interest because of the length of time, basically 4 years, to start and conclude the audit. The Taxpayer contends that the audit could have been completed much sooner. While it is regrettable that the audit took so long to complete, it is important to recognize that the magnitude and complexity of this audit required additional audit time and consideration. Furthermore, Va. Code § 58.1-1812 A requires the application of interest to all tax deficiencies for the period between the due date and the date of full payment. Title 23 VAC 10-210-2032 C also mandates the application of interest to all audit deficiencies. Interest is not assessed as a penalty for noncompliance with the tax laws. Rather, it represents a fee for the use of money over a period of time. Therefore, I find no basis to grant the Taxpayer's request for a waiver of 50% of the interest.
Refund Audit for Audit Period January 2005 through December 2010
By letter dated October 1, 2015, the Taxpayer filed an appeal of the denial of a portion of a sales and use tax refund following the refund audit of the Taxpayer for the period of January 2005 through December 2010. The appeal of the audit refund denial involves the same proration percentages used for mixed-use equipment, and the denial of mixed-use proration on purchases of cable equipment.
In the case of established mixed-use equipment, the auditor applied the revenue based method of allocation for determining the amount of refund to the Taxpayer (it should be noted that the Taxpayer paid tax in error on 100% of the purchase price of mixed-use equipment). As provided earlier in this letter, the Taxpayer and the Department agreed to use the broadband width methodology in the prior audit to determine the taxable allocation for mixed-use equipment. This being the case, I will allow the broadband width methodology of allocation for purposes of the refund audit. Also, it is my understanding that the Taxpayer has continued to pay the tax on 100% of the purchase price of mixed-use equipment. Therefore, I will also allow the broadband width methodology of allocation for any refund request for the period January 2011 through December 2015. Effective January 2016 and forward, all purchases of mixed-use equipment should be prorated using the “percentage of time used” methodology.
With regard to the cable equipment refund request, absent definitive documentation as to the use of the equipment in question, I am unable to authorize mixed-use status to this equipment. As provided above, if the Taxpayer can provide documentation substantiating the taxable and nontaxable use of the equipment in question, I will revisit this issue and make a mixed-use determination at that time.
Based on all of the above, both the assessed audit and refund audit will be returned to the auditor for revisions. For consideration of the alternative method for relief of the use tax penalty, the documentation must be furnished to the auditor within 60 days of the date of this determination. Once revisions have been made to both audits, the audits will be netted out and the appropriate refund will be issued to the Taxpayer.
The Code of Virginia, regulation, and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules, and Decisions section of the Department's website. If you should have any questions concerning this determination, please contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.
Craig M. Burns
 The “head-end” is the main distribution center where all incoming network signals are received, the broadcast equipment is located, and the final broadcast signals are sent out to the subscribers.