Texas Ruling Addresses Sales Tax Sourcing for Services Provided Over the Internet

A Texas taxpayer’s use of registration IP addresses to source sales is just one example of how state sales tax rules are evolving in response to technological advances.

By Jess Johannesen, SALT manager

The evolution of business and technology typically outpaces the ability of states to enact legislation or to promulgate rules and guidance for the tax treatment of such new products and services. This dilemma creates scenarios in which taxpayers must apply antiquated state rules to scenarios that those rules could not have imagined. For example, over the last several years, many states have had to enact statutes or adopt regulations to address transactions involving remote access software and other cloud computing issues, as well as downloadable books, music and videos. Otherwise, states risked losing sales tax revenues due solely to technological advances that no longer required these products to be delivered in tangible form.

A similar aspect of this concept deals with sourcing of sales. As technology has evolved, products and services are consumed in ways that state rules could not have previously fathomed. Many state sales tax rules are written in terms of where a product is delivered, which historically was easily identified by the shipping address. However, what if the product or service is not delivered but instead remotely accessed? While taxpayers may take reasonable efforts to approximate where a product or service is used, collecting the data to approximate these locations has become increasingly more challenging as well. A recent Texas Private Letter Ruling, in which the taxpayer was able to use an unconventional piece of information to source the taxpayer’s sales for sales and use tax purposes, illustrates this issue. [1]

In the private letter ruling, the taxpayer was a Nevada corporation that provided voice over Internet protocol (VOIP) calling, Wi-Fi, text messaging, video messaging and instant messaging. These services were provided as either subscriptions or pay-as-you-go models, and users created an account with the taxpayer in order to access the services. While creating the account, users could supply address information (e.g., billing, residential, business, etc.), but were not required to, and the taxpayer did not check the accuracy of any user-supplied addresses. The terms and conditions, however, required that the users have a device that can access the Internet. Upon registration, the taxpayer retains each user’s Internet protocol identification (termed the “registration IP address”).

In the letter ruling, the taxpayer asked Texas whether such registration IP addresses could be used as the basis to source sales for sales and use tax purposes. In agreeing to allow the taxpayer to use the registration IP address, Texas first accepted the taxpayer’s characterization of its services as prepaid wireless telecommunications services. Under the regulations, those services are sourced to Texas if the services are purchased over the Internet and the primary business address or the residential address is in the state. [2] However, given that the taxpayer does not always have those addresses, the state concluded that the registration IP address was acceptable, and that the sale would be sourced to Texas if the registration IP address was associated with a physical address in Texas.

Sales tax sourcing rules vary by state and get particularly complex when multiple states are involved in the transaction. For example, as mobile phones became mainstream, the sourcing rules for mobile telecommunication services became very unclear. My account could be based in Georgia, but I could make a call while physically in California to a friend in New York. Which state had the right to tax that call? To prevent states from instituting a patchwork of various rules, the federal government enacted the Mobile Telecommunications Sourcing Act, effective Aug. 1, 2002. [3] Essentially, under the act, sales taxes on mobile telecommunications charges were sourced to the “place of primary use,” which is basically the residential address of the account holder. This greatly simplified a very complex issue and ensured that each state would follow the exact same rule.

If your business operates in multiple states with customers scattered across the United States, are you sure that your sales are being sourced correctly for sales and use tax purposes? Aprio has experience evaluating the sales and use tax sourcing rules in each state, and we can help your business determine the appropriate sales and use tax sourcing methodology. We constantly monitor these and other important state tax issues, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Jess Johannesen at jess.johannesen@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the January 2018 SALT Newsletter

[1] Texas Private Letter Ruling No. 201711002L, Nov. 9, 2017.

[2] Tex. Admin. Code § 3.344(b)(13).

[3] P.L. 106-252, 4 USC §§ 116-126.

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

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