Group Answers Questions On Communications Services.

Gary S. Kueltzo of American Information Technologies, Chicago, has submitted the comments of the U.S.T.A. Tax Group on the proposed regulations concerning the excise tax on communications services. In the comments, the group answers specific questions raised by the IRS regarding video and facsimile services and private communications service.

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December 17, 1993

Mr. Bernard H. Weberman

Dear Mr. Weberman:

The U.S.T.A. State and Local Tax Committee has completed it's [sic] response to the questions you presented to us earlier this year relating to taxation, for federal excise tax purposes, of video and fax service and private communications service.

Please review our attached response and if you need to discuss any elements of it either give me a call directly or write me at the address indicated.

We appreciate providing input to this important and much needed re-write of the federal excise tax regulations as they apply to our industry.

Sincerely,

Gary S. Kueltzo

cc: C. Shewbridge

USTA TELECOMMUNICATIONS STUDY GROUP RESPONSE

FEDERAL EXCISE TAX QUESTIONS:

The Internal Revenue Service has proposed revising the Treasury Regulations that apply to the Federal excise tax on communication services. The IRS representatives involved in the revision have asked a number of specific questions regarding how the private communication services exclusion operates. The questions suggest, that a distinction may be made in the law regarding whether a line or channel is a "voice" or "non-voice" grade channel in determining whether the private communications systems exclusion applies, and suggest, that the private communications exclusion applies with respect to local telephone service but may not apply to toll telephone service.

The following specific questions were asked of the USTA Tax Group by Bernie Weberman from the IRS' National Office Group.

1. Video and FAX service

a. Are the lines that carry these services special purpose

- Are there lines dedicated to these services that are

b. If not special purpose, can we tell if FAX is going

c. What are the fee structures for FAX service?

d. What are the fee structures for video services?

2. Private Communications

Needs help in understanding the following terms and the

- Software defined Network

- Virtual Private Line

- Private Network Service

Before attempting to answer the specific questions raised by Mr. Weberman, it is necessary to provide some background concerning the development and evolution of the statutory language defining taxable communications services. The existing statutory language defining taxable telephone service /1/ appears at 26 USCA section 4252, more commonly known as Internal Revenue Code section 4252. The federal excise tax on telephone service was first enacted in 1914, and significant changes to the statutory language were made in 1941, 1958 and finally in 1965 when the present language was adopted. What follows is a chronological analysis of the changes in the law from 1941 through 1965.

In the Revenue Act of 1941, Congress amended Code Section (1939 Code) 3465 (see Public Law 250, Seventy-Seventh Congress at 1941-2 C.B. at 399) relating to the imposition of the tax on telephone service to read as follows:

Section 3465(a) There shall be imposed:

(1)(A) In the case of each telephone or radio telephone message

(B) In the case of each telegraph, cable, or radio dispatch or

Only one payment of a tax imposed by subparagraph (A) or (B)

(2)(A) A tax equivalent to 10 per centum of the amount paid for

(B) A tax equivalent to 5 per centum of the amount paid for any

The tax shall apply under this paragraph whether or not the

(3) A tax equivalent to 6 per centum of the amount paid by

* * *

The House, Senate and Committee Reports discussing the amendments to section 3465 appear at 1941-2 C.B. pages 457, 483 & 504 and 515 respectively.

In 1958, Congress again amended the language relating to the imposition of the excise tax on communications. Section 133 of the Excise Tax Technical Changes Act of 1958 (P.L. 85-859, 1958-3 C.B. at 107) amended Section 4252 of the Internal Revenue Code of 1954 to read as follows:

(a) GENERAL TELEPHONE SERVICE. -- For purposes of this

(1) ANY PRIVATE BRANCH EXCHANGE (AND ANY FIXED OR MOBILE

(2) any tie line or extension line.

THE TERM 'GENERAL TELEPHONE SERVICE' DOES NOT INCLUDE ANY

(b) TOLL TELEPHONE SERVICE. -- For purposes of this subchapter,

* * *

(e) WIRE MILEAGE SERVICE. -- For purposes of this subchapter, the

(1) any telephone or radio telephone service, and

(2) any other wire or radio circuit,

not included in any other subsection of this section; except

(f) WIRE AND EQUIPMENT SERVICE. -- For purposes of this

In the 1958 Act, a tax of 10% was imposed on general telephone service, toll telephone service and wire mileage service. An 8% tax was imposed on wire and equipment service. General telephone service included what is commonly known as private line and PBX service if that service could be connected directly or indirectly to the local exchange system. A separate provision was included that provided that general telephone service did not include toll telephone service or wire and equipment service. No reason is provided in the House or Senate reports /2/ on this provision, and it seems to be unneeded with respect to toll telephone service, since the tax rate was the same on both services. For wire and equipment services, the rate was lower, so perhaps it made sense to make the distinction between general telephone service and wire and equipment service. We will see that in the 1965 Act, a similar provision was provided in the new definition of local telephone service that would exclude toll telephone service and private communications service.

In the Tax Rate Extension Act of 1962 (P.L. 87-508, 1962-3 C.B. at 58), Congress, in addition to extending the existing tax rates on general telephone service and modifying the language relating to wire mileage service, added a new exemption section to section 4253 concerning private communications services. The new law read as follows:

4253(j) Certain Private Communications Services. -- No tax shall

(1) such line or channel is furnished between specified

(2) such use is in the conduct of a trade or business.

This amendment was added to the Tax Rate Extension Act of 1962 by the Senate and was concurred in by the House once the effective date was changed from July 1, 1962 to January 1, 1963. The Senate Report accompanying this legislation appears at 1962-2 C.B. at 228 et seq. It provides in pertinent part, at page 233, as follows:

It [the Senate Committee] has also provided an exemption

This exemption from the general telephone tax removes from

Examples of the types of lines or channels and equipment

Private line telephone (if the conditions are met).

With the addition of this language, the law continued to impose the tax on local private line services following the definition in section 4252, to the extent that such services could be connected directly or indirectly to the local exchange, but exempted private line services used in a trade or business that connected preselected points in different political subdivisions of a state or between different states. The Senate committee made reference to services that were "used predominately for voice purposes" and "between specified and preselected points set aside for the exclusive use of customers, for whatever purpose he chooses." One could hardly have provided a better example for voice or data toll private lines between preselected points. In July 1963, the IRS issued Regulation section 49.4253-10 concerning code section 4252(j). Consistent with the law and the Senate Report, the Regulation provided in part that,

[a] line or channel is considered to be furnished between

The amendment, the Senate Committee Report and the Regulation are important, because they form the basis or starting point for the private communications service exclusion provided by Congress in the 1965 Act.

The Excise Tax Reduction Act of 1965 (P.L. 89-44, 1965-2 C.B. at 577) amended the 1954 Code to provide new definitions of taxable communications services. The law amended section 4252 to read as follows:

(a) LOCAL TELEPHONE SERVICE. -- For purposes of this subchapter,

(1) the access to a local telephone system, and the

(2) any facility or service provided in connection with a

THE TERM "LOCAL TELEPHONE SERVICE: [sic] DOES NOT INCLUDE ANY

(b) TOLL TELEPHONE SERVICE. -- For purposes of this subchapter,

(1) a TELEPHONIC QUALITY communication for which (A) there

(2) a service which entitles the subscriber, upon payment

* * *

(d) PRIVATE COMMUNICATION SERVICE. -- For purposes of this

(1) the communication service furnished to a subscriber

(A) to exclusive or priority use of any communication

(B) to the use of an intercommunications system for

regardless of whether such channel, groups of channels, or

(2) switching capacity, extension lines and stations, or

(3) THE CHANNEL MILEAGE WHICH CONNECTS A TELEPHONE STATION

except that such term does not include any communication service

The definitions provided in the 1965 Act are the same definitions that exist today. The IRS and the telephone industry have had nearly three decades to deal with and analyze the legislation. No rulings exist, either private or general, that hold that private communication services are excluded from tax ONLY as a subpart of local service. And while none have addressed directly the issue of whether there is a stand-alone private communications exemption, there have been statements by the IRS that clearly say that they have never decided the issue one way or another. For example in G.C.M. 37993, the IRS General Counsel was discussing the Services's "proposed" Revenue Ruling 79-405, concerning certain data communications services. One of the services, called "Service (2)" was a service between two cities whereby a customer could use non- dedicated microwave channels that were priced on a usage basis to connect preselected points in the two cities. The customer was provided service over the channels on a first-come first-served basis. The proposed ruling held that such a service was taxable toll telephone service under section 4251(b)(1) because the price of the service varied with time and distance. The IRS General Counsel disagreed with the Service's position saying that while the price varied with time, it did not vary with distance since the customer always was connecting two preselected points. Concerning the basis for it [sic] decision, Counsel went on to state as follows:

We emphasize that this conclusion is based upon our belief that

This statement had a footnote, footnote n2, which expanded on the

n2 G.C.M. 37140, *** I-84-77 (May 31, 1977), was not intended to

Revenue Ruling 79-405 was changed to comport with the General Counsel's position that Service (2) was not taxable toll service under section 4252(b)(1). Clearly, if the IRS General Counsel's Office had wanted to opine that the private communications exception was not a stand-alone exception or was not applicable to toll telephone service, it had ample opportunity to do so in G.C.M. 37140 and G.C.M.37993. It did not, and what it said clearly indicated just the opposite. It is our position that the IRS and the telephone industry have always operated under the presumption that the private communications exclusion is a stand-alone exception that is in no way dependent upon the definitions of local, toll or teletypewriter service. The industry's operating procedures and the IRS' rulings and memoranda support this position.

Notwithstanding this position, there were certainly some things said in the Senate Committee report accompanying the 1965 legislation and in the legislation itself that could lead one to believe that a private communication service that was also a toll telephone service would not be excluded. /3/ In order to understand how one could come to the conclusion that only local private line is excludable, we need to start with the statutory language and then move to the Senate Committee report (which effectively became the Conference Committee report) to the law.

Code Section 4251 imposes the tax on local telephone service, toll telephone service and teletypewriter exchange service. Code Section 4252, as set out above, provides definitions of four services: local telephone service; toll telephone service; teletypewriter exchange service (not shown above); and, private communication service. The definition for local telephone service includes a proviso stating that the term local telephone service does not include any service which is a toll telephone service or a private telecommunications service. /4/ The definition of toll telephone service and private communication service do not include such a proviso. The definition of teletypewriter service does, and it provides that teletypewriter exchange service does not include any service that is local telephone service. We should note that the definition of local telephone service does not say it excludes teletypewriter exchange service. The question is what do all these exclusionary provisions mean? Moreover, if a section does not have an exclusionary provision what does that mean?

It appears that the IRS representative is suggesting that because the definition of local telephone service specifically excludes private communication services and toll telephone service does not, that a private communication service that is also a toll telephone service is taxable. The reasoning appears to be that the law taxes only three services; local service, toll service and teletypewriter service. However, so the reasoning goes, section 4251 does not provide a specific exclusion for private communication service. The only exclusion for private communication services that exists is within the definition of local service in section 4252 (i.e., local service does not include private communication service). If the private communication service is a toll service or a teletypewriter service, the argument goes, it is taxable since neither of these definitions contain an exclusion for private communications services.

This argument seems, at first glance, to be buttressed by the Senate Report accompanying the legislation. The relevant part of the report provides as follows:

Under present law [the 1958 law], a private communications

This has presented problems under present law because of

For the reasons indicated above, both the House bill and your

The definition of a private communication service refers to a

This exemptions is to take effect as of January 1, 1966.

Questions have been raised as to the application of this

The Senate Report clearly states that the bill provides an exemption from the tax on local telephone service for private communications service if a separate charge is made for the service. It was understood that private lines and PBX's would immediately qualify for the exemption and that Centrex service would qualify once the charges were unbundled. The Report defined a private communications service as a "private line" which is a service where a subscriber is entitled to the exclusive or priority use of a communication channel or groups of channels. An example of this latter service would be the normal private line where a customer in the local exchange area has a hard-wired (non-switched) voice or non- voice line connecting two separate points, for example, a main bank with a branch office for the verification of checks. It could also be a switched line that is provided on a priority basis (so that if all normal circuits were busy, then the priority line would knock a non- priority line off).

The Report went on to discuss intercommunications systems and then concluded by stating that private communications system includes channel mileage for communication between a telephone station located outside a local exchange and a central office in the local telephone system (again if a separate charge is made for such service). There is no limitation in this definition about whether the line is a switched line or how the line (channel mileage) is priced. This definition would include, for example, the channel mileage related to a foreign exchange line, as was the case in Rev. Rul. 75-9, 1975-C.B. 348. We believe it would also include the channel mileage relating to what the operating companies consider a toll private line circuit connecting a station in, for example, Atlanta, with a central office in some other location such as Chicago, San Francisco, Denver or Macon. What seems apparent in this definition is that congress intended not only local private lines to be exempt, but all private lines connecting disparate points. This was clear in the context of section 4253(j) under prior law and it seems clear that a broader exclusion is provided under current section 4252(d)(3) relating to channel mileage.

Congress understood very clearly when enacting the 1965 law that local private lines were at that time taxable (if they could be connected to the local exchange), that local private lines that could not be connected to the local exchange were exempt and that toll private lines were exempt under section 4253(j) if they connected points in disparate states or political subdivisions. It would be curious indeed for Congress to basically reverse this situation and make toll private lines taxable and local private lines that could connect to the local exchange exempt. They did not do that. What we believe they did do is expand the private line exclusion/exemption to include private lines that could be connected to local service. The new 1965 law provided four definitions of private communications service, section 4252(d)(1)(A) & (B), (d)(2) and (d)(3). The definitions together cover the amount of possible private line services; private communications lines and channels and associated switching and equipment, intercom systems and associated switching and equipment and lines (channel mileage) connecting points outside the local area with a central office in the local area. Again, this latter item is the type of private line that would be required to connect two intercity private line stations in two different cities. Accordingly, we believe that the private communications service exception represents a stand-alone exception that is in no way dependent on the other definitions.

However, even if the private services exception were not a separate exception, the fact is that non-local private lines would not be taxable unless they met the specific definitions of toll telephone service contained in section 4252(b)(1) or (2). In the case of section 4252(b)(1), the price for the service would (except in exceptional circumstances) have to vary with both time and distance for each particular customer. Rev. Rul. 79-405. Thus, if a customer had a line between two preselected points in two different cities and paid on the basis of elapsed time, the service would not be a taxable (b)(1) toll service because it could never vary on the basis of distance, since the two points would always be fixed. This would be true even in the case of multiple point systems where each separate point was priced at a different level because of distance and time since each of the fixed points could not differ in distance from the other points. The above service would not be a section 4252(b)(2) service either, since it would not allow the privilege of an unlimited number of calls to the local system. If the service did allow such a privilege, either through a separate switchboard connection or directly, then the service would probably be considered local service and the private line link between the cities would be exempt under the local service exemption for private line services (it would be a section 4252(d)(3) service. Thus, under almost any conceivable scenario, "toll" type private communications services would be exempt, either because of the local service exemption or because they are not toll service.

There was a second issue raise by the IRS representative. He is suggesting that only non-voice communications are entitled to exclusion under the private communications service exclusion. This is apparently based on the use of the phrase "telephonic quality" in the definitions of local and toll service. However, one only has to look at the Senate Report to the 1965 Act to determine that voice services were cited as a specific example of the types of services that would be exempt. The Senate Report stated that answering service lines and boards that could be used only for answering the subscriber's telephone would be exempt as private communications service. Answering service lines are by their very nature voice-grade lines that are used to physically answer a customer's telephone line when the customer is otherwise unavailable. That is, a human being with a voice, picks up the line and answers verbally on behalf of the customer. It is clear that the lawmakers enacting this legislation saw no distinction between voice or non-voice lines or channels in determining whether a line qualified as a private communications service or not. What counted was whether the service met the tests set out in Sec. 4252(d). The service could be either voice or non- voice and still qualify for the exception.

Turning now to the specific questions raised by Mr. Weberman:

1. Video and FAX service

a. Are the lines that carry these services special purpose (or

- Are there lines dedicated to these service; that are not

Answer: Video and FAX service lines can be either special

b. If not special purpose, can we tell if FAX is going over, or

Answer: With respect to general purpose local, toll or

c. What are the fee structures for FAX service?

Answer: For normal local or toll FAX services that are sent

d. What are the fee structures for video services?

Answer: Again, if video is sent over a normal local or toll

2. Private Communications

Needs help in understanding the following terms and the relationship,

- Software defined Network

Answer: See the attached article on AT&T's virtual private

- Virtual Private Line

Answer: According to the article on AT&T's virtual private

- Private Network Service

Answer: Virtually all telephone companies have substantial

Attachments

[Copyrighted attachments omitted]

FOOTNOTES

/1/ For purposes of this discussion, I will generally leave out a discussion of teletypewriter exchange service.

/2/ The House Report appears in 1958-3 CB at 414, and the Senate Report appears in 1958-3 CB at 629.

/3/ There is nothing to indicate, however, that the private line exclusion was limited to non-voice private communications service. In fact, quite to the contrary, it is clear in the Senate Committee report that voice grade private communications services qualified for the exclusion.

/4/ Again note that this is similar to the language that was included in the 1958 law relating to general telephone service, which stated that general telephone service does not include any service which is toll telephone service or wire and equipment service. No reason was given in the 1958 law or conference reports for this provision. Moreover, the tax rates for general telephone service and toll telephone service were the same, 10%, while the rate for wire and equipment service was 8%.

/5/ Note that nothing is said here about private lines that cannot connect to the local exchange system as being nontaxable, which they were under the law, or about the toll type private line exemption contained in section 4253(j). The Senate Committee certainly understood that these items were already nontaxable.

END OF FOOTNOTES