One of the biggest unknowns facing communications service providers (CSPs) today is the Internet of Things, or IoT. As more and more “dumb” objects—home appliances, medical devices, heavy equipment, wearables and the like—are becoming “smart” by way of WiFi, more and more companies are realizing the revenue that can be made by connecting products to the internet.

The question is: When does IoT become subject to communications taxes and regulatory oversight?

In many ways, the answer depends on the very definition of IoT.

What Is IoT, Really?
Webopedia defines the Internet of Things as “the ever-growing network of physical objects that feature an IP address for internet connectivity, and the communication that occurs between these objects and other internet-enabled devices and systems.”

If that sounds familiar, it’s because the concept of IoT has been a part of the communications industry for a while in the form of “machine-to-machine” communications. While there’s been some debate on the differences between M2M and IoT, the two models share many similarities, along with a key differentiator: Communications taxes.

When Is IoT Taxable?
The truth is, the “I” in IoT is often a bit of a misnomer. Many prominent IoT products rely on a bring-your-own-internet (BYOI) model where the customers’ existing connections are used to transmit data from one device to another. With the ISP Tax Moratorium, these types of devices are often a non-issue from a communications tax perspective.

Under the Internet Tax Freedom Act (ITFA) of 1998, a three-year moratorium prevented state and local governments from taxing monthly payments made to internet service providers, or ISPs. That moratorium was extended several times before being made permanent with the Trade Facilitation and Trade Enforcement Act of 2015. Since 1998, only a few states have been permitted to tax ISP services through a grandfather clause that’s now being phased out.

However, there are an increasing number of instances where BYOI is not being leveraged. In these instances, CSPs will need to determine when a connection qualifies for the legal definition of “internet access.” If the answer is “yes,” there’s most likely a component to the IoT device that enables a human to connect to the world wide web for activities such as browsing, streaming or launching apps. If the answer is “no,” and a machine is simply using the connection to transmit data, there’s a good chance the connection will not fit the definitions of ISP service.

So…how do you determine when an IoT service is taxable?

Let’s look at a few examples.

First, consider the smart thermostat. This device commonly uses home or business Wi-Fi to communicate with a smartphone, allowing users to adjust temperatures remotely. There’s no additional web functionality and no web browsing associated with the thermostat itself. You’re simply using a private internet connection to use a device, which makes communications taxes irrelevant for the IoT device on its own. Even if the user is in a grandfathered state taxing internet, that is between the consumer and their ISP.

Taxability Test:

  • Is it BYOI? Yes
  • Can internet access be used for surfing the web? Yes – just not on the thermostat
  • Is it taxable? Not likely

Now, let’s look at systems used to monitor oil rigs. These devices provide real-time data related to drilling and oil pumps. Because they’re out in the field, they often rely on air cards to transmit data wirelessly using connections of their own. Even though the data may be transmitted in IP, there is no access to the worldwide web; so one could make an argument that the ISP moratorium will not apply. Which means that the providers of these devices could be looking at some significant communications taxes and regulatory implications.

Taxability Test:

  • Is it BYOI? No
  • Is internet access solely machine-based? Yes
  • Is it taxable? Very likely

Maybe It’s Taxable… Maybe It’s Not
Now, compare the two relatively clear-cut examples above to the IoT products used in the over-the-road trucking industry. In our increasingly connected world, semi trucks are often equipped with connected devices that allow companies to keep tabs on matters such as fuel efficiency, location, and overall maintenance. Many of these devices are used solely to communicate data from the truck, which means communications taxes may enter the equation.

What happens when those same devices are used to power consoles in the cab and used to stream music or surf the web?

When the device was being used to transmit private data from one machine to another, it might be assumed that communications taxes and regulations will apply. But allow a driver to start using that same device to access the public internet, and an argument could be made that the connection now qualifies for an ISP moratorium exemption.

Taxability Test:

  • Is it BYOI? Maybe
  • Can internet access be used for other functions? Sometimes
  • Is it taxable? Possibly

Bottom line: It’s often easy to assume that a connected device won’t be subject to taxes or regulatory fees (and vice versa). But there are plenty of times when state communications taxes and federal regulations do come into play. Remaining compliant requires staying up-to-date on the latest tax law developments and definitions with each new offering and innovation.

In Conclusion
Yes, the possibilities with IoT are staggering. According to industry estimates, $6 trillion will be spent on IoT solutions between 2015 and 2020. But as CSPs race to invest in IoT-related offerings, failure to address potential impacts of communications tax compliance upfront can lead to misinterpretations—not to mention otherwise avoidable fees and penalties.

If you’d like to keep tabs on IoT connectivity and other high-stakes communications tax issues, sign up to receive future updates at communications.avalara.com.