United States

Pennsylvania: Services to Provide Internet Access not Subject to Sales and Use Tax

Oct 26, 2015
From KPMG TaxWatch

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Recently, the Commonwealth Court of Pennsylvania held that services sold to an Internet service provider (ISP) were not subject to Commonwealth sales and use tax. The taxpayer at issue, an international Internet service provider, sold various services to other, retail ISPs wishing to outsource the provision of remote access to their networks or to the Internet. Specifically, the taxpayer provided retail ISPs with the infrastructure and services necessary to allow the ISP’s dial-up users to access the Internet and direct users to the ISP’s homepage. The taxpayer did not collect sales tax on its sales of services to the retail ISPs. The Pennsylvania Department of Revenue audited the taxpayer and assessed tax on these transactions. The taxpayer appealed the assessment, first to the Board of Finance and Revenue, then to the Commonwealth Court. Although the parties reached an agreement as to part of the assessment, the portion of the assessment relating to the taxpayer’s sales to a particular ISP remained outstanding.

Before the court, the taxpayer argued that it was providing Internet access, which was exempt from sales tax under Pennsylvania law and the Internet Tax Freedom Act. The Department, relying heavily on a prior decision of the court, argued that the taxpayer was providing a basic telecommunications service that was subject to sales and use tax. The court held that although both the prior decision and the case currently before it involved services provided to a dial-up ISP, the services differed materially. In the court’s view, the key distinction between the two cases was that the taxpayer at issue was providing the  infrastructure and the “Point of Presence” (PoP) that constituted the point at which the end-users’ connection to the Internet begins. In the prior decision, the taxpayer provided infrastructure services to the retail ISP, but the connection to the Internet itself was provided by the retail ISP. The court concluded that because the taxpayer’s facility was a PoP, the taxpayer was providing Internet access, which is considered an “enhanced telecommunications service” under Pennsylvania law and excluded from the definition of taxable telecommunications services.  The court also addressed the Department’s argument that the taxpayer was not providing Internet access because it always delivered end-users to the retail ISP’s homepage. The court found this argument unpersuasive. In its view, it made no difference which website end-users were directed to, as long as they were connected to the Internet, and second, a skilled end-user could hack the ISP’s software and direct traffic to a different webpage. For more information on Level 3 Communications v. Pennsylvania, please contact Joseph Duch at 412-232-1578. 

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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.