The proliferation of communications tax and what it means for your business

It can be easy to assume your business is liable only for sales and use tax, especially if that’s what you’ve always done. Plus, if you’re a traditional telecommunications company expanding your offerings, you need to be aware of the different ways communications services taxes and telecommunications tax apply.

Technology and communications change quickly, and tax legislation is constantly shifting to keep up, introducing new taxability rules and tax rates as fast as companies can introduce new offerings and features. Learn how you can stay compliant even in a dynamic industry.

Gone are the days when state and local governments could rely on traditional wireline, wireless, and even VoIP providers as reliable sources of revenue. Traditional voice services are being replaced with new technologies like streaming, videoconferencing, or being embedded into other cloud services and SaaS platforms, and more companies than ever are using these types of technologies to conduct business.

New rules and regulations have been introduced to keep up, and existing obligations like the Federal Universal Service Fund surcharge and the Florida Communications Services Tax are casting a wider net to new forms of communications. As such, a broad range of companies once liable for sales tax alone are suddenly subject to more complex communications taxes, often without even realizing it. The services and products impacted range from smart devices and fitness equipment to customer relationship management platforms and entertainment streaming services – and the list goes on.

Another factor to consider

Communications services are increasingly cloud-based, virtualized, and embeddable, making them more pervasive and found often in products, services, or apps that were typically never considered to be a telco or communications offering. The boom in the adoption of communications-platform-as-a-service (CPaaS) solutions, which deliver communications services like voice, videoconferencing, SMS, and wireless connectivity through simple APIs, has allowed communications services to become easily embedded in a wide range of product categories. And that can make them unexpectedly subject to communications tax. For example, many B2B SaaS providers have incorporated voice calling, video chat, or messaging services into their CRM and marketing automation platforms as either add-on modules or part of their base offering. That one change can make them subject to a wide array of communications taxes.

The term “communications tax” refers to a multitude of taxes, fees, and requirements levied at the federal, state, and local levels. These include taxes that were originally created for traditional voice and networking services but have continually been reinterpreted and adjusted over the years to account for emerging technologies.

For decades, communications tax applied to a very select set of industries. Telephone companies. Cable operators. Internet providers. But as communications technology advanced, the definition of telecommunications tax began to expand. Consumers abandoned traditional services for mobile and online options, and new tax laws followed.

However, with communications technologies evolving rapidly to include things like streaming, videoconferencing, collaboration tools, SD-WAN, and IoT, it’s become more difficult for tax authorities to keep up. When rates and rules change, it typically isn’t at a holistic, national level. As a result, communications tax today is a highly complex and varied web of local fees, state taxes, federal surcharges, and even special tax jurisdiction filing requirements, all of which can vary drastically from one location to another.

Unlike sales and use tax, which is often based on relatively straightforward calculations, communications tax can involve multiple calculations and considerations, each of which can be incredibly intricate. Compounding this, the jurisdictional boundaries for many communications differ from sales and use tax jurisdictional boundaries. With an industry in a state of constant transformation, simply monitoring changes and determining which rules and rates to apply is particularly daunting. And, these challenges continue across the compliance spectrum — there are unique returns for communications, with their own rules and filing schedules, and specific forms and rules for exemption management. Communications taxes often carry specific “truth-in-billing” requirements that govern how taxes must be presented and broken out on customer invoices.

Understanding your potential communications tax risk means first examining not only the technical nuances of your product or service but precisely how and where it’s being sold.

It’s increasingly typical for companies within the broad telecommunications, streaming, technology, and many other nontechnical industries to sell bundled services within the key market segments outlined earlier — and sometimes beyond. Companies may merge or partner, particularly to remain competitive, or they may develop and launch new products. This, often unknowingly, expands the potential communications tax risk. 

As more companies face the possibility of costly communications tax audits, it’s highly important to understand if, when, and how your business is responsible for communications tax. Often, all it takes is one new feature to quickly render a company subject to a highly complex web of rules, regulations, and fees. In general, if your product has any ability for voice, video, SMS, or data connectivity, you may have a communications tax responsibility. When your product or service is bundled with any one of these, you may immediately trigger this obligation, in different ways, across different jurisdictions.

Here are a few common scenarios: 

Just like your product or service mix, how you merchandise and price your products and services can greatly affect your tax scenario. Understanding the nuances of each of these, and how to track and manage the requirements in more than 60,000 jurisdictions in North America, can be overwhelming.

Bundling requires careful consideration

Bundling services has become common practice, for good reason: Bundled packages offer customers greater value and are often easy to sell. But as varying services are bundled together, the likelihood of communications tax complexity increases. Services like calling, SMS, videoconferencing, and click-to-call could each be subject to their own separate set of communications taxes, and how these are handled can vary greatly from jurisdiction to jurisdiction. In fact, in some states, including just one communications taxable item can make the entire bundle subject to communications tax.

Geographic expansions widen tax scope

Each time your business expands to a new market, the likelihood of communications tax complexity increases. At a time when cloud-based and virtualized, “over-the-top” environments make it possible to readily scale services for hundreds or thousands of different ZIP codes or even around the globe, this is an especially important consideration. Each new service area opens the door to new collection and filing requirements or e-invoicing requirements for global markets. That means virtually any fast-growing communications or technology business could soon find itself newly exposed to a wide range of state, county, and local communications taxes.

Mergers and acquisitions often create new obligations (and catch auditors’ attention)

Across the communications and technology industries, new offerings are being introduced at astonishing speed. Emerging trends are opening the door to new packages and portfolios, while mergers and acquisitions are broadening the volume of services companies are able to provide — all of which can trigger a new communications tax obligation. In a recent survey of executives, 92% of companies expect M&A deal volume to increase or stay the same over the next year. As relationships like these continue to grow, communications tax auditors are watching announcements closely.

Online selling increases complexity

For many companies, selling services on an ecommerce website is an essential part of the plan to remain competitive. Because online payments are instant, unlike traditional billing cycles, it’s imperative to quote and calculate communications tax in real time — and to ensure your tax platform is hardened to mitigate downtimes. That “always-on,” frictionless customer buying experience is critical not only to decrease shopping cart abandonment but also to help minimize communications tax risks.

Reselling creates additional demands

Whether it’s part of managed services or channel partnerships, reselling activity is highly likely to involve additional communications tax complexities. The communications tax treatment of any services you resell will need to align with the tax treatments of your partner, including mission-critical exemption certificates. As communications services become more intertwined, managed service providers find it necessary to expand their scope of offerings and, in doing so, dramatically increase their tax complexity.

Although the complexities of communications taxation aren’t likely to ease up any time soon, it is possible to be prepared. Several best practices can go a long way toward ensuring your business remains compliant.

Be ready for today, future-proof for tomorrow

Whether you participate directly in the communications space or plan to incorporate communications features or streaming into your existing product, staying ahead of communications taxes will remain important. The pace at which a growing array of businesses will face complicated communications taxes at the federal, state, county, and local levels will continue to increase. The sooner your organization can prepare for the complexities, the more likely you are to remain compliant and profitable.

The team at Avalara for Communications stays on top of the ever-changing communications tax ecosystem. Our SaaS-based solutions, industry knowledge, extensive tax experience, and exceptional service can help you successfully maximize tax efficiency and minimize tax risk, no matter how the industry changes.