Apr 30, 2018
From KPMG TaxWatch
Recently, the New York Division of Tax Appeals ruled that hardware and software purchased for managing customer accounts and performing billing functions did not qualify for New York’s telecommunications equipment sales and use tax exemption. The taxpayer, a nationwide provider of wireless cellular telecommunications services, operated a data center in New York State. The data center contained hardware that hosted software applications the taxpayer regarded as “mission critical” to its telecommunications business. The software at the data center was used to activate phones to run on the taxpayer’s network, to create and change a customer’s service plan, and in customer billing. For example, to activate a phone, the taxpayer’s employee entered customer data into the software, which communicated with other elements of the taxpayer’s network, which in turn responded back to the software to activate the device and add the customer to the network. A similar process occurred for creating or changing a customer’s service plan. Finally, the software captured a customer’s voice, data, and text usage and was used to create customer bills. Under New York law, a sales and use tax exemption applies to tangible personal property used in receiving, initiating, amplifying, processing, transmitting, retransmitting, switching or monitoring of switching of telecommunications services for sale or internet access services for sale. The state also exempts installation, maintenance, and other services performed on this exempt tangible personal property. The taxpayer filed a refund claim of approximately $20 million on the basis that the hardware and software at the data center was exempt under the state’s telecommunications equipment exemption.
In making this argument, the taxpayer relied on two prior decisions. The first decision concerned the application of the sales and use tax manufacturing exemption to items purchased for use at a coal power plant. The court in this case formulated a three part test: (i) whether the disputed item was necessary to production; (ii) how close, physically and causally, was the disputed item to the finished product; and (iii) whether the disputed item operated harmoniously with the admittedly exempt machinery to make an integrated and synchronized system. Using the test, the court determined that an ash and coal handling system was exempt because it was part of a system that supplied the power from which the electricity was produced. In contrast, transformers were not exempt because they were used in the distribution of electricity, not in the production of electricity. Applying the test to the case at hand (recognizing that the exemptions at issue were different), the Division determined that the data center software and hardware failed the first prong because the hardware and software were not necessary to receive, initiate, amplify, process, transmit, retransmit, switch or monitor switching of telecommunications services, which was analogized to “production” in the context of the manufacturing exemption. Rather, the hardware and software at issue were used to manage customer accounts and perform billing functions. The second decision relied on by the taxpayer concerned the predecessor to the current telecommunications equipment exemption, as applied to pay phone pedestals and enclosures. In that instance, the exemption applied because the pedestal and enclosure had an active causal relationship in the production of telephone communication, despite that they did not actually perform the initiating and receiving of telephone communication. However, the Division declined to extend the reasoning of this case to the facts before it, noting that statutes granting exemptions from taxation must be narrowly construed. The Division concluded that because cellular communications could occur without the software and hardware used at the data center, the taxpayer did not qualify for the exemption. Please contact Judy Cheng at 212-872-3530 with questions.
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