Understand the complexity of communications tax to help minimize risk
The evolution of technology impacts every aspect of our world today - and communications tax is no exception. The pace of technological advances can further increase ambiguity in an already complex landscape. But, no matter where you are in your journey, Avalara is here to help you navigate communications tax compliance confidently to help minimize risk.
The communications industry continues to rapidly change as it adapts to increased competition, industry consolidation, product diversification, and technology innovation. Consumers and business users alike demand immediate gratification in today’s always-on society. We all expect access to the content we want, when and wherever we want it. As 5G expands, areas like the Internet of Things (IoT) will grow exponentially. As a result, new IoT applications are not only transforming our personal lives, but as they enter the commercial sector, they’re changing the way business is done.
All this is shifting how we think about the world around us, and leads to similar questions regarding communications tax. As more and more non-traditional telecom businesses become subject to communications tax, new entrants to the space must get up to speed quickly. Even for industry veterans, it’s challenging to stay on top of all the change.
This whitepaper provides a broad overview of the ins and outs of communications tax to help you better understand the basics of how it works and what you should focus on to prepare for these changes. Planning for the implications of communications tax can help businesses stay compliant, reduce errors, and minimize audit liabilities.
How is communications tax different from sales tax?
Most businesses are familiar with sales tax and how it works. While sales and use tax can be complicated, communications tax is vastly more so. For the most part, sales tax for a single transaction is based on one simple calculation. Communications tax, on the other hand, is based on complex rules and often numerous calculations. Communications tax must be managed across local, state, and federal regulatory authorities, as well as comply with rules imposed by special taxing jurisdictions. However, when communications tax should be applied and how it’s applied can vary greatly depending on particular circumstances and be subject to nuanced and specialized rules. It’s also worth noting that communications tax calculations typically include sales and use tax.
For businesses with a potential communications tax liability, it’s critical to understand how this tax works and the key features that make it different from sales tax. In addition to requiring an understanding of specialized rules, there are a number of general elements that add a layer of complexity to how communications tax applies.
Taxability depends on difficult-to-determine sourcing. Correctly determining customer locations is critical to avoiding audit risks and penalties, not to mention overpayments and lost revenue. However, particularly with VoIP and wireless services, many of the identifying elements associated with location — such as address, ZIP code, or phone number — can be unreliable or inaccurate.
Unique and complex calculations. Communications tax, especially with bundled services, provides a number of opportunities for complicated mathematical equations, which are highly error-prone if not automated. For example, some elements of tax must be broken out separately so sales tax can be levied on communications fees. Even more complex are calculations for tax on tax, self-taxing, tiered taxing, brackets, and prorated taxing.
Growth and complexity of product bundling. The moment non-taxable services are packaged with taxable ones, the entire bundle may become subject to communications taxes and regulatory fees. How these services are billed could change this in some states, so thoroughly understanding these nuances is key to lowering risk and liability. Similarly, taxing items in a bundle with different rates provides challenges not only for calculation, but also later with filing and reporting requirements.
Slowly changing tax laws combined with fast-moving product innovation. While jurisdictions are working to keep up with evolving communications business models and the technology that drives them, innovation is moving faster than government. Therefore, communications tax law has been known to change suddenly and drastically to try to catch up. Anticipating and preparing for changes on the horizon is critical to avoiding problems down the road.
What types of services are subject to communications tax?
While communications tax was once applied primarily to voice services provided through traditional telecom companies, those days are long past. Recognizing which industries may be subject to communications tax today is complicated. In the most basic terms, where communications tax applies can be categorized into three broad service types: voice, video, and tech. Within each of these, specific factors influence whether communications tax applies, so it’s important to stay on top of industry shifts, changing legislation, and internal product and service updates.
Voice includes what we traditionally think of as communications services and is typically delivered via wireless, wireline, or VoIP. Voice services can be found across the telecom, cable, unified communications (UC) provider, and SaaS solution industries. As preferred communication methods are shifting away from traditional phone communication, these core industries are racing to remain competitive with other unique service combinations that are more data, social, and video friendly.
All of this impacts the makeup of the service bundles that providers offer, which has communications tax implications. Additionally, the pervasiveness of UC in business and software with embedded voice, video, or text means more technology companies are entering the realm of communications tax, often without realizing it.
Video services cover the gamut of both traditional video and overall digital content. Traditional pay-TV offerings are found via cable or satellite providers, while over-the-top (OTT) solutions include streaming, live, and on-demand options. Cord-cutting will likely continue to increase as consumption of streaming and downloaded digital content rises.
As the boundaries between industry segments continue to blur, we find these services offered throughout telecom, cable, satellite, and media companies. It’s exactly this ambiguity that makes taxability so complicated. Services may be taxed differently depending on jurisdiction, definition of specific content type, and the way they’re bundled with other services.But knowing when (and which) communications taxes apply is far from easy.
Historically, many tech companies haven’t considered themselves subject to communications tax, but perhaps they should. Some businesses that often meet requirements for communications tax include SaaS solution providers; networking companies working with circuits, VPN, or the internet; tech services offering managed services or web hosting; and hardware companies that also offer services. Whether for a new product or for one they didn’t realize might have potential tax liability, these companies need to understand the risk.
Furthermore, the introduction of 5G networks is expected to have an enormous impact. With connectivity built into more devices and the exponentially growing volume of sensors in place to communicate data, the possibility for communications tax liability increases significantly. The breadth of 5G-enabled services is rapidly expanding to power incredible change in industries like vehicle telematics, autonomous vehicles, drones, healthcare, energy, industrial applications, logistics and transportation, agriculture, media, gaming and many more. Understanding whether communications tax applies or not adds complication and depends on the specific connectivity method as well as if it’s part of a product bundle.
Overall, service providers must be aware of key triggers for communications tax liability. It’s complex, so knowing when to find out more is critical to reducing risk. It’s worth asking more questions any time a product or service has anything to do with core telecom or cable, connects to the internet, has a sensor attached to it or includes digital content or voice, video or text functionality. Similarly, if an offering includes telecom or internet service bundled with a hardware solution, more investigation should be conducted since taxation of bundled services can be so variable.
What you need to focus on
Even if you’re a communications tax veteran, now is not the time to get comfortable. With decreasing tax revenues from traditional sources, authorities may soon search for replacement revenue. Landline usage continues to wane, with 43.8 percent of households using landlines in 2017, down from 90 percent in 2004. The use of cell phones for highly taxed call minutes is also on the decline, with increased usage of data and Wi-Fi, which aren’t subject to the same rate of communications tax. Given this shift, even industry experts need to watch out for potential tax and regulatory changes.
If you’re new to the industry, it’s vital to do your homework so you know what to be aware of given your specific circumstances. Your communications tax responsibility can change incredibly fast.
Watch out for key activities that should trigger you to evaluate your communications tax liability:
- New product development or feature add-on using any of these core technologies
- Cross-industry M&A activity or partnerships that might drive new and complex bundles
- Tax or regulatory changes that could sweep your business into the communications tax world
No matter your industry or level of expertise, there are several core issues everyone must stay on top of to navigate communications tax with confidence and minimize risk.
Determining communications tax applicability. Communications taxes now go far beyond wireline, wireless, cable, internet, even VoIP. Other companies are entering the realm of communications tax with integration of voice features, bundled digital content, and IoT applications. Knowing when and how taxes apply is more important than ever.
Understanding complex nexus. Unlike sales and use tax, where there are physical facilities, equipment, employees, and products to track, communications tax compliance is tied to invisible radio waves and digital signals. This makes determining sourcing and managing accurate compliance across multiple jurisdictions especially challenging.
Identifying the right tax jurisdiction. Pinpointing the location of customers to ensure compliance with the appropriate tax jurisdiction is essential but comes with its own complications. Many identification methods can be imprecise or unreliable. Using geocoding can help increase accuracy and reduce risk.
Managing bundling complexities. Even if you understand the options for unbundling services to lower tax liability, compliance requires constant research, validation, and updating of tax rates across states. Maintaining meticulous usage records is crucial to justify unbundling methods to an auditor.
Keeping up with rate changes. Technology changes raise new questions about communications taxes and regulations. There are thousands of tax jurisdictions across the country, each one working to keep regulations current with rapidly changing communications technology.
Ensuring billing requirements are met. Apart from accurately identifying customer locations, there are multiple billing requirements to address to ensure compliance. Some specific elements must be itemized on a customer bill while others can be summarized. These distinctions also can vary by jurisdiction and be applied differently depending on what kind of service is provided. A specialized billing platform can assist in automating this tedious work and help to improve accuracy.
Categorizing revenue for easy reporting. When it comes time to complete reporting, making sure revenue is categorized correctly upfront can ease the process later on. Instead of waiting until the end, be thoughtful while processing transactions about what information is collected, how it’s summarized, and where it’s stored in your financial and reporting systems. This level of detail can help ensure complete documentation and avoid expensive headaches down the road.
Checking all the boxes for accurate tax and regulatory compliance. Monitoring relevant statues, regulatory rules, and rate changes to ensure accurate compliance can feel overwhelming. But dotting every i and crossing every t is critical to make certain nothing is left out or incorrectly calculated so you can reduce your risk of audit liability or lost revenue.
How to ensure you’re prepared
If you think you might now, or in the near future, have a potential communications tax liability, there are three important questions to consider:
- Do you have technical systems in place to adequately calculate these taxes?
- Do you have a team in place to track changes throughout all jurisdictions?
- Do you have the expertise and the bandwidth to file and remit these taxes, as well as communicate with jurisdictions as needed?
You may have a sales and use tax engine, but a specialized communications tax engine used in conjunction with a communications billing platform is critical. These systems work together to ensure highly accurate calculations and invoice detail required for communications taxes.
With special taxing jurisdictions on top of each federal, state, and local jurisdiction, the volume of potential changes that need to be tracked and managed can be overwhelming. Identifying resources available to own these responsibilities provides the support needed to stay on top.
Not only are there a large number of forms to stay on top of, some forms are extremely long and complex, taking days to complete. Relying on someone with the capacity and knowledge to navigate this gives you confidence your bases are covered.
Implement a streamlined solution
Whether you’re a telecom industry veteran or new to the world of communications tax, keeping up with all the rapid changes and complex nuances of compliance can be overwhelming. Working with a trusted partner can help you streamline your processes to improve accuracy and help reduce risk.
Avalara AvaTax for Communications. Simplify the tax calculation process through automation that tracks complex and ever-changing rules and rates for thousands of jurisdictions.
Avalara Returns for Communications. Reduce time spent on tedious tasks associated with form preparation, filing, and remittance for ongoing compliance with extremely complicated tax regulations across jurisdictions.
Avalara for Communications is 100 percent focused on understanding the intricacies of the shifting industry and tax landscape. We have the knowledge, bandwidth, and tools to help you stay ahead.
Let us help you with the heavy lifting of communications tax compliance. You focus on expanding your business.
To learn more about Avalara’s products for the communications industry, visit avalara.com or call 844-722-5747.